So Why Is College So Expensive?

This seems to be an appropriate time of the year to ask why it costs so much to go to college. A pair of articles has appeared trying to make sense of it. I don’t think either hit the mark. The first article appeared in Forbes magazine. It basically says college is expensive for fundamental reasons that can not be avoided. Education is a highly labor intensive proposition with no appropriate savings of scale. Productivity is relatively flat and advanced technologies only bring higher costs not higher productivity.
"Our technology story rests on three strong pillars. First, like many personal services, including much of health care, the law and banking, higher education remains essentially an artisanal industry. These are industries in which technological progress has not reduced the number of labor hours needed to "produce" the service. By contrast, labor productivity in basic manufacturing has soared, and this is why the cost of a year of college has gone up compared with the purchase price of a basic car or a basket of groceries."

"Students interacting directly with professors and other students in small groups remain a benchmark of quality in education. Ask any family if they want their son or daughter to learn in small group seminars taught by tenured professors, or if they prefer giant impersonal lectures or online chat rooms monitored by adjunct teachers who answer lots of e-mail questions."
"Secondly, higher education shares with many other personal services a reliance on an extremely highly educated labor force. Starting in the late 1970s, the cost of hiring highly educated people began a sustained rise. This has driven up costs in any industry that cannot easily shed expensive labor."


"Lastly, technological change affects higher education directly. But unlike steel or autos, where the primary impact of new techniques is to reduce the amount of labor or energy it takes to make the product, new technology in higher education tends to change what we do and how we do it. Colleges must offer an education that gives students the tools they need to succeed in the modern economy. The contemporary chemistry student, for instance, needs to be familiar with current laboratory tools, and they are more expensive than the chalk-and-test-tube world of the past. As in modern medicine, there is a standard of care that higher education must meet, and that standard is set in the labor market that hires our graduates."Surprisingly, for an article in a conservative magazine, there is no mention of market forces. That is probably because there are none.

The second article appeared in The Economist. The author was concerned not only with excessive costs, but also with a perceived decline in quality of the product. He might say that all the problems are mainly caused by a lack of market forces.
"As costs soar, diligence is tumbling. In 1961 full-time students in four-year colleges spent 24 hours a week studying; that has fallen to 14, estimates the AEI. Drop-out and deferment rates are also hair-curling: only 40% of students graduate in four years."


"The most plausible explanation is that professors are not particularly interested in students’ welfare. Promotion and tenure depend on published research, not good teaching. Professors strike an implicit bargain with their students: we will give you light workloads and inflated grades so long as you leave us alone to do our research. Mr Hacker and Ms Dreifus point out that senior professors in Ivy League universities now get sabbaticals every third year rather than every seventh. This year 20 of Harvard’s 48 history professors will be on leave."

"Given the size and competitiveness of America’s higher-education system, you might expect these problems to be self-correcting. Why don’t some universities compete by hiring teaching superstars? And why don’t others slash prices? The big problem is that high-status institutions such as universities tend to compete with each other on academic reputation (which is enhanced by star professors) and bling (luxurious dormitories and fancy sports stadiums) rather than value for money. This starts at the top: Yale would never dream of competing with Harvard on price. But it also extends to second-division universities: George Washington University has made itself fashionable by charging students more and spending lavishly on its facilities."These are more good and relevant points. However, both articles fail to discuss the economics of a modern university.

Let us consider Stanford and Harvard. They are of similar size and budget and they represent the class of universities that can charge whatever they want and get away with it. Other schools will see their costs not as something to beat, but as something to emulate in assuming a public perception that cost and value go together. Stanford’s finances are briefly but conveniently summarized here. The total budget for 2009-2010 was $3.7 billion. The sources of funds for that year were:

30% sponsored research

22% endowment income

 2% other investment income

17% student income

13% health care services income

  6% expendable gifts and net assets released

10% other income

Only 17% of its cash flow comes from students. One would think it could halve the student tuition and hardly notice the difference—but they won’t. The figure of 17% translates to $629 million. Here is another interesting figure: in 2008-2009 Stanford raised $640.1 million from donors. The school receives gifts in excess of what they take in from tuition. The data from Harvard are mirror images of these.

There is no market for a university education because income from students is not a driver in the operation of the institution. A cynic might say that the students, at least the undergraduates, are merely props to allow the school to pursue its money-making endeavors like sponsored research and investment income. What is the greatest contribution a student can make to his school? He can become a happy and nostalgic alumnus who will give and give for the rest of his life. How do you make happy and nostalgic alumni? You let them cross paths with famous people every once in a while. You provide them with spectacles in the form of sporting events. You give them the impression that they are going first class and they will leave proud of how much their education cost. None of this has anything to do with saving money.

The sad part is that other universities, including state-sponsored institutions, have to compete for these other sources of income, such as sponsored research. If Stanford pays top dollar to its professors, then there will be pressure on others to follow suit. If Harvard builds a new research facility, others will feel a need to try and match it. If the tuition is increased at these schools, others will wish to match the rise in order to be perceived as being "just as good."

It has a lot to do with economics, but it has little to do with a market place.