Why Does College Cost So Much?

First, for an overall review of the book I will refer you to the excellent review written in 2014, associated with a 3 star rating, by J.M. Alexander. The latter does an excellent job of covering every aspects of the authors’ analysis of the economic drivers of college costs and their recommendation on how to handle those through a more transparent and effective subsidy structure by shifting the Government funding away from the institutions and directly to the students and their families in the forms of yearly vouchers.I will not cover the same topics, as I would simply rehash what Alexander has already covered very well.However, I will drill down on a key issue of the authors’ analytical argument. They refer to Baumol’s cost disease theory to advance that college professors salaries have grown much faster than inflation. And, that they are one of the main drivers behind the overall staggering rise in college costs. By, data mining they uncover that a few other service professions such as lawyers and dentists have experienced nearly the same trends (way above inflation wage increases) as overall college costs. In the authors’ minds this confirms the validity of the Baumol’s cost disease as applied to college education.The authors further support their argument by indicating that splitting up college costs between administration, teaching, research, facilities, and other expenditures is either not feasible or arbitrary. Thus, given their framework college costs trends equal pretty much college professors cost trends. The authors make further assumptions that college costs trends equal college prices trends, but I won’t go into detail on this issue.However, while the authors were unable to isolate college professors wage trends, others have been able to do so. And, they have been able to compare those to college tuition trends that the authors identified is the component of college costs that has grown faster vs. room and board (see figure 7.3 on page 25). And, from 1978 to 2007 relying on data from the BLS and NCES these other social scientists uncovered that college tuition increased by a staggering annual compounded rate of 7.9%. Meanwhile, faculty salaries increased at barely above the overall inflation rate over that period at 4.5% per year vs. 4.1% for inflation. Others have extended this analysis through 2012 using similar data, and such trends pretty much continues.In other words, contrary to what the authors suggest college professors do not “benefit” from the Baumol cost disease. So, why have college professors not “benefitted” from the Baumol cost disease effect while other highly educated professionals like lawyers and dentists have (using the authors’ cherry-picked examples)? The answer is that there are far more PhDs in social sciences than there are available positions within universities. That is why much of these PhDs go begging and accept part-time jobs (because no full time jobs are available). Part-time faculty has risen from 30% of total faculty in 1975 to over 50% by 2011. And, many PhDs end up by default switching careers in often unrelated fields. In other words, the unfavorable supply-demand factors for college professors have entirely negated the Baumol’s cost disease effect experienced by other professionals in health care and legal services.The above facts are devastating to the authors’ arguments. It renders every single related graphs and tables (about cost and wage trends) within their book inaccurate and misleading.If you take out the flawed Baumol’s cost disease argument from this book, you are not left with much. Analysis of the funding sources of college costs, including declining public funding, and increased funding privatization to make up for the public funding is well known. Their proposal of shifting subsidies from universities to students would not resolve college costs. You are left with arguments that the authors thought they had rebutted, but given their inadequate analysis, they have not. In other words, universities are becoming increasingly expensive country clubs for pampered students that are overstaffed with expensive administrative staff benefitting from overly generous and unsustainable pension benefits. And, all of that has very little to do with pragmatic efficient education system.

It is readily apparent that college costs have been rising rapidly in recent years. There is a conventional wisdom, or perhaps a political one, that places the blame on the colleges and universities themselves. It argues that, in a quest for better rankings and prestige, these schools have sought extravagantly gilded institutions. The argument goes on to criticize them as inefficiently run, and seeking ever more funds to create increasingly comfortable security for faculty and administrators. The authors, two professors of economics at William and Mary, a public university, have sought to dispel this perception. To do so, they take what they describe as an “aerial view” of colleges and universities, as opposed to the close up view taken by critics. I understand this to mean that others have closely examined the revenues and expenditures of individual universities, while these authors have sought to see how higher education fits into similar service industries in the overall economy. In making their analysis they speak of colleges “costs”- the amount needed by the institution for its operations; and “prices”- the “list price” for attendance. They do consider room and board in total costs, but really don’t feel that such increases have been too significant, and that tuition and fees are the drivers of higher costs, and also of higher prices. The authors argue that during the first 75 years of the 20th Century the educational system met demand for highly skilled workers. However, since that time rapid technological advances have created a demand for highly educated workers that has outstripped supply. When demand is not met, then the costs for such workers increase, both in manufacturing and service industries. These higher labor costs have not necessarily increased the price of manufactured goods because new technology has resulted in a corresponding increase in productivity. However, technological changes do not necessarily increase productivity in service industries, and may reduce it in certain instances. Thus, absent increased productivity, higher wages result in an increase in price. This is what the authors refer to as “cost disease”. Their conclusion is that rising higher education costs, and prices, are merely a reflection of changes in the economy at large and not a result of increased inefficiencies at institutions of higher learning. Historical statistical trends help in understanding the basic hypothesis. First, the authors note that over the period 1947-2006 the price of durable goods, such as autos, has decreased in inflation adjusted dollars by 67.3%. The price of non-durable goods, such as food and clothing, has decreased–again in inflation adjusted dollars- by 16% over the same period. But the cost of services has increased by 59.6%. The price of dental services which, like education, employs highly educated people, has seen price increases very similar to that at colleges and universities. Medicine and law show similar patterns. Technological advances have not had the salutary effect on services that they have on manufacturing. To appreciate the lack of productivity gains in service industries, one must recognize what increased productivity would mean. For medicine, the “output” is patients, so technological changes, to result in more productivity, would have to result in more patients treated per doctor, or more patients processed at a lower cost. Yet the amazing scientific advances that have driven down costs in manufacturing have in fact probably increased costs in medicine. Medical technology, in the form of new machines such as MRI’s, hopefully improve the quality of the service, but actually increase the cost. Likewise, schools of higher education must teach with and about the most cutting edge technology to keep up the quality of the education, but purchasing necessary new equipment does not lower cost, it raises them because the “output” of the university– students– is not increased. Indeed, an approach to make college more “productive” would be to increase class size so that each professor could process more “output”. But this is contrary to the customers’-students and their parents- expectation of quality. What parent or student chooses a school because it has the highest student teacher ratio? After taking their “aerial view” of broad economic trends, the authors take a more close up look at costs and pricing in higher education. In the normal world of buying products, prices are higher than costs of production, the difference being the seller’s profit. But, because education is a highly subsidized service, price is normally much less than cost. Public universities receive sums from State governments, as well as potential Federal grants, gifts, and revenue from endowments. Private colleges and universities draw from the same sources except the State. Thus, to reach the price for attendance, one must take the school’s projected cost of providing its educational services and subtract the total of all general subsidies. The result is the “list price tuition”. The university then has the option of providing selected students with “institutional grants”, or scholarships. These scholarships will affect the “list price tuition”, but not the average tuition. The authors use a simple example to illustrate such effect. Suppose a university estimates costs for 100 students at $2,000,000. The university receives $1,000,000 in general subsidies, leaving $1,000,000 to fund through tuition. Thus, before considering any institutional scholarships, list price tuition, and average tuition, would both be $10,000. If either costs rose, or general subsidies declined, tuition would rise in response. Perhaps less obvious is the fact that, if the university gave scholarships to students from its own funds, then list price tuition would rise, though average tuition would be unchanged. Using the same illustrative 100 student university, assume that the institution had $100,000 to apply to scholarships, and decided to selectively apply such funds to the 50 students most in need. Each would receive a scholarship of $2,000, reducing their tuition to $8,000. To make up for this, list price tuition would have to increase to $12,000. The university would then receive its needed $1,000,000 by the 50 scholarship students paying a total of $400,000 (50x $8,000), and the non-scholarship students paying the remaining $600,000 (50 x $12,000). The average tuition would remain $10,000. Thus, making college more affordable for those in need would result in a 20% increase in list price tuition. In 2007-2008 over half of all students at private universities, and 26% at public universities, received some form of institutional grant. The authors do propose some solutions. They first look at possible ways to decrease costs, and then to restructure aid. Both of these subjects involve considerations of the broader purposes of both universities and higher education itself. The authors have few suggestions to control costs, not inconsistent with their basic hypothesis that recent increases are caused by systemic economic influences. However, they do acknowledge the potential cost saving from on line courses- what they refer to as “distance education”. Obviously, widespread use of on line courses greatly reduces the costs associated with a university’s physical plant if most students were not only non-residents, but also did not attend a physical classroom. The authors think there is an opportunity to increase on line classes, but see them as limited to more basic courses that neither entail nor require face-to-face contact with faculty, joint work, laboratories, and other similar considerations. Such classes may be best suited for older students who can’t afford the time to attend university full time. But what would a large scale switch to on line classes portend for the educational system as a whole? How would the more sophisticated classes be taught? How would the system replace the non-teaching duties of professors such as research, counseling of students, and other similar functions? Who would write the textbooks and train the future scholars? How would our educational institutions continue to be centers of learning as opposed to “manufacturers” of graduates? And, without resident universities, how would we replace the value of the transitional experience of a large group of 18-22 year olds, many away from home for the first time, who can begin to “grow up” among a diverse student body and amidst an intellectually expansive environment? The authors then address the issue of aid. Looking at aid in general, it is either need based or merit based. As the terms imply, one looks to assist qualified students in need of funds to attend college, and the other looks to reward a student who has exceptional talents, or entice him or her to attend a school, or both. All Federal aid (Pell Grants, Loan guarantees, etc) is need based, and thus requires families to fill out detailed paperwork to determine a student’s eligibility, and the amount of aid that will be available. This process, leading to a finding known as the “Expected Family Contribution (EFC)”, can be complicated and confusing. In addition, since much of the data gathered is dependent on a family’s prior year’s tax return (2014 for a student entering in Fall 2015), the student does not know the amount of aid until after he or she will generally have made the decision on which college to attend. The authors feel that this process may discourage at need students from attending school, and also narrow their choices. Other aid is both need based and merit based. A significant exception is the “universal aid” provided all resident students by their State’s general grants to its colleges and universities. A type of State merit aid that is almost universal is Georgia’s HOPE (Helping Outstanding Pupils Educationally) program. HOPE essentially provides grants covering tuition, fees, and a book allowance to all Georgia high school graduates who earn a B average and attend a state college or university. Those going to private schools receive a grant of $3500/yr. The grant goes for four years as long as the student maintains a B average in college. There is no financial threshold–even the most wealthy student maintaining a B receives the grant. HOPE has been quite successful and other states have instituted or are considering similar approaches. HOPE has the advantage of being simple to administer and gives each student a reasonable expectation of the aid he or she will receive. The authors have an affinity for the equity present in properly targeted need based aid, but feel that the complicated nature of such programs, particularly at the Federal level, outweighs its benefits. If the country’s goal is to encourage more students to attend and stay in college, they feel that broad based aid would work best. They envision a new Federal system that does away with all the existing programs and replaces them with an “education savings account” for every potential college student. Such fund would accumulate an amount equal to the Pell Grant four year maximum by the time a child reaches age 18. This, at least initially, would be a more expensive aid structure, but there would be great administrative savings by eliminating the costs of multiple agencies. Also, as with the State model, the authors suggest that the certainty and simplicity of the program would encourage more students to take advantage of college. The political viability of such a plan seem much more problematical. Finally, the authors advocate universal aid at the State level, essentially a HOPE type model, but implemented by direct grants to the students, not through the universities. Much like the proposed Federal model, each student would have an account that he or she could draw on for a four year education. In addition, the authors seek much greater independence for the universities, allowing them to set tuition and also “own” their tuition revenue instead of sending it to the State. The State would still maintain some control over its colleges and universities, but more in the form of a public/private partnership than the current model. The authors see a great need for change in our public institutions of higher learning. Subsidies from the States have fallen from a combination of decreased revenues as a result of the various “Tax Revolts”; other State spending priorities for programs such as K-12 education and prisons; and greatly increased unfunded Federal mandates, especially in the Medicaid systems. The result has been a widening gap between public and private universities. In 1980 public universities spent about 70 cents per dollar spent by private schools. By the mid ‘90's that had decreased to 53 cents. The number of public universities ranked highly in the US News & World Report survey has decreased substantially, and the most talented students appear more clustered in private schools. The authors fear that the value of degrees from our public schools will decline over time if needed changes are not made. Our public universities have been, and remain some of our greatest sources of intellectual and economic energy, as well as upward mobility. To see them diminished would be most unfortunate.