Market Discipline Is Absent

Richard Vedder, Distinguished Professor of Economics at Ohio University, is author of Going Broke By Degree: Why College Costs Too Much (AEI Press, 2004).

University presidents often blame rising tuition costs on stagnant state funding or lagging private support following the 2000-01 recession and stock market decline. But actually, tuition increases have exceeded inflation for at least four decades, including in periods when state funding and private support were rapidly growing.

The real reasons tuition has risen sharply are two-fold: a steady increase in demand for higher education and a lack of market discipline by colleges and universities, most of which are non-profits. Demand for higher education has grown because of rising incomes and population as well as the higher salaries college graduates earn.

Rising third-party payments — that is federal, state and private loans and grants — are largely to blame for the lack of market discipline. From 1998-99 to last year, student assistance (two-thirds federally provided) rose at an astonishing 11.67 percent annual rate. As a result, only a third of students today pay a full college bill and feel the full sting of a tuition hike. In any economy, when third parties pick up the tab, customers become far less sensitive to the price.

Additionally, when inflation-adjusted prices spike in the private sector, profits typically increase, and new suppliers step in to share the lucrative returns. In turn, prices are moderated and often reduced. This is not the case in most of higher education. There are no stockholders getting rich from rising tuition, nor are there many new low-cost colleges grabbing market share.

Indeed, unlike private businesses that have profits to measure success and induce firms to push cost savings and product improvements, there is no clearly defined bottom line in higher education. Did the University of Texas have a good year in 2004? Who knows? Even if we did know, are there powerful financial incentives to improve performance or adverse consequences for failure? The answer, of course, is no.

This gets us to actual university behavior in modern times. How have colleges used large increases in funds received over the past few decades? While the story varies some by institution, generally, American colleges have devoted only a small portion (I estimate less than one-fourth) of increased per student funds from tuition increases, state appropriations and other sources directly to instruction. The instructional proportion of university budgets has been declining for years. The share going for research, administration and, in some cases, student services has been rising.

In 1976, it took three non-instructional professional employees (administrators, diversity coordinators, public relations specialists, counselors, librarians, computer specialists, lab technicians, etc.) to service 100 students. Today, it takes six — twice as many. In most of America, rising productivity has meant a declining number of workers needed to produce any given quantity of goods. Given the rising staff-to-student ratio, it is unlikely productivity in American universities has risen in modern times, and it has certainly fallen relative to the rest of the economy.

The opening of fancy recreational and student centers is appreciated by students — but has added to rising fees and has almost nothing to do with the core academic mission. Sizable spending increases on intercollegiate athletics are an additional burden at some schools.

Costs have risen for other reasons as well. Tuition fees (the sticker price) are more discounted today than previously, as universities have learned from the airlines that it is possible to make greater revenue by raising fees enormously for some relative to others —what economists call price discrimination. One student pays $30,000 in tuition and fees because he is from an affluent family and has marginal test scores; another pays $10,000 (after $20,000 in grants and loans) because the family is less affluent and the student is highly sought after for her high test scores.

Also, being relatively unaccountable for their actions, universities have rewarded themselves rather well — the average total compensation in real terms for full professors now, for example, is about 50 percent higher than a couple of decades ago.

College costs cannot rise faster than incomes indefinitely. As costs rise, students are looking for substitutes — going to cheaper community colleges for two years before transferring to expensive universities; applying for admission overseas; taking courses on-line; going to the new rapidly expanding for-profit schools, like the University of Phoenix, that watch costs carefully; or even foregoing college for other forms of certification (e.g. becoming a Microsoft-certified computer technician).

Faced with growing budget pressures, some universities are cutting costs —eliminating costly, low-enrollment graduate programs; slashing administrative staff; increasing teaching loads; restricting tenure; using cost-saving technology (e.g., through more electronic teaching); and reducing spending on intercollegiate sports. By putting some brakes on student loan growth, the federal government can help dampen the growth in demand causing much of the problem. But until incentive systems promoting efficiency are instituted in mainline not-for-profit schools, the process of change is likely to be slow and painful.

Richard Vedder, Distinguished Professor of Economics at Ohio University, is author of Going Broke By Degree: Why College Costs Too Much (AEI Press, 2004).

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