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Why Does College Cost So Much?

Two economists try to explain rising college costs, but miss the mark.

By Robert E. Martin

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November 10, 2010

The biggest story about higher education over the last 30 years has been its chronic cost increases--increases exceeding the general rate of inflation, the rate of inflation in the service industries, and the rate of inflation in health care costs. Inflation in higher education costs is exceptional with respect to other sectors in the US economy.

Many people have tried to explain why that is so. In their new book Why Does College Cost So Much? economics professors Robert Archibald and David Feldman (both of William and Mary) offer their analysis. In a nutshell, they maintain that higher ed’s rising costs are mainly due to outside influences beyond its control.

In my view, they are mistaken and I will try to explain why. First, however, I’ll present Archibald’s and Feldman’s position as fairly as I can.

They identify two approaches to higher education cost analysis, the “aerial view” and the “microscopic view.”  The aerial view considers the cost question from outside of higher education per se: the question is, what external factors from the general economy drive up costs?  In contrast, the “microscopic view” looks for cost drivers inside higher education. 

Archibald and Feldman restrict their analysis to the aerial view and, not surprisingly, they conclude that higher education’s dismal cost record can be explained by outside influences.    

William Baumol and William Bowen’s theory of “service industry cost disease” is at the heart of Archibald and Feldman’s analysis.  In 1966 Baumol and Bowen recognized an anomaly in the service industries; real wages rise even though productivity does not improve.  In the general economy, real wages rise only as productivity improves.

According to the cost disease hypothesis, rising productivity in the general economy raises the opportunity cost of working in the service industries, including education. That is because service firms have to pay higher real wages in order to attract skilled workers from sectors of the economy where productivity and wages are rising.  But the productivity of service firms (like colleges and universities) doesn’t improve because they can’t substitute capital for increasingly expensive labor inputs. 

Therefore, Archibald and Feldman conclude, the true villain in the higher education cost story is productivity growth in the rest of the economy.  Faculty wages have to go up to keep professors from looking for better-paying jobs in other fields, but since productivity in higher education is stable, that means its costs must rise.

There are, however, some factual problems with that argument. 

If this “disease” is responsible for the rapid increase in college costs, it must work through real faculty wages.  Faculty members are the only inputs unique to higher education.  All of the other inputs purchased by higher education come from resource markets common to the rest of the economy. 

The fact is that average real faculty wages hardly increased at all from 1970 to 2008.  Real wages declined during the 1970s and then began to slowly rise after 1980.  From 1970 to 2008, the average annual increase in the full time faculty real wage rates at 4-year public and private institutions were only 0.2 percent and 0.6 percent respectively. It just won’t do to blame rising college costs on the supposed need to pay faculty more. 

Real faculty wages did not rise for several reasons.  First, a chronic excess supply of humanities and social science PhDs has existed for the past four decades.  This excess supply is an industry disgrace, since higher education produces the surplus itself and the surplus leads to chronically underemployed people who act like Marx’s “reserve army of the unemployed” and keep wages low in those fields. 

Second, administrators substituted less expensive adjunct and non-tenure track instructors for tenure track faculty throughout the period from 1970 to 2008.  Finally, a large inflow of foreign graduate students stayed to teach in the US.  The external cost disease, working through real faculty wages, can't responsible for the rapid climb in college costs after 1980.

Faculty wage costs per student did increase significantly after 1980, but the reason the wage component went up is because faculty productivity went down. The student/faculty ratio in both public and private institutions declined by about 25 percent. It is notable that the ratio of students to nonteaching administrative staff fell by even larger percentages during this same period, by approximately 50 percent for both public and private institutions. 

As the recent Goldwater Institute report confirms, most of the cost increases since 1970 come from “administrative bloat.”  Administrators and governing boards set the terms of employment; so, the decisions to reduce teaching loads, make classes smaller, and reduce administrative productivity were internal decisions, not decisions imposed from the outside. Archibald and Feldman completely miss this enormous source of rising costs.

The authors conclude: “The critical factors are that higher education is a personal service, that it has not experienced much labor-saving productivity growth, and that the wages of the highly educated workers so important at colleges and universities have soared. These are economy-wide factors.  They have little to do with any pathology in higher education.”  I think that is mistaken because real faculty wages have barely increased at all and colleges have actually reduced faculty productivity.  Blaming external factors simply isn’t convincing.

Archibald and Feldman might respond that colleges and universities reduced teaching loads and class sizes in order to improve quality. That’s a fair response, but if that were the case, then we should find at least a 25 percent improvement in teaching quality and at least a 50 percent improvement in administrative quality since 1970.  I know of no evidence showing that teaching and administrative quality have improved. 

Unfortunately, the authors devote just one page to H. R. Bowen’s “revenue theory of cost,” which argues that costs are driven by the incentive structure inside higher education. Their failure to engage with this line of analysis is the fatal flaw in their book.

At the core of the revenue theory is the insight that expenditures will rise to meet revenues. Since higher education institutions are nonprofits, they can be counted on to spend every dollar they can get. Unlike businesses, where there is a strong incentive to minimize costs, college leaders don’t gain from lowering their costs. In fact, doing so can be harmful to the school’s reputation.

My Pope Center paper “The Revenue to Cost Spiral”  and my forthcoming book The College Cost Disease explain in detail why the great upsurge in college costs is an internal problem based on the incentives faced by college leaders. Faculty members, administrators, and board members respond to the incentives they face, and those incentives are the problem because they are not aligned with the public interest in efficiency and quality.

Higher education in America does suffer from escalating costs, but unless we properly understand the reason why, we are apt to come up with false solutions, such as increasing government financial aid for students. It’s too bad that Why Does College Cost So Much? gives us a mistaken diagnosis of the problem.

 


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