Brief Note On The Sources Of Cost Growth In Higher Education

As Anya Kamenetz recently observed, a recent article in the New York Times titled “Slowly, as Student Debt Rises, Colleges Confront Costs” should more appropriately be titled, “Colleges Refuse to Confront Costs.” Kamenetz’s excellent DIY U offers a far more sophisticated take on the underlying issues.

Andrew Gillen of the Center for College Affordability and Productivity recently released an extremely rich report, “Introducing Bennett Hypothesis 2.0,” in which he discusses a number of issues: how different kinds of financial aid interact with capacity constraints to impact cost growth (aid to low income students is more likely to improve accessibility and affordability than aid offered to all students irrespective of income, which is more likely to drive tuition increases); the role of selectivity, tuition caps, and price discrimination (schools face tradeoffs: revenue-maximizing tuition rates make it harder for schools to be as selective as they’d like to be, yet price discrimination allows them to target institutional aid at the most desirable students); and there are dynamic effects that compel competing colleges to converge around business models define by a high level of cost growth.

As an illustrative example, Gillen presents two colleges, D and E. College D is capacity-constrained and College E is not. Students all have a fixed amount of money (G) that they can spend on tuition. If G increases, College D can charge a higher tuition or become more selective or some combination of both. College E wouldn’t necessarily charge a higher tuition (it isn’t capacity-constrained, after all), and Gillen assumes that it does not.

But this is only the immediate (static) story. What happens the next year, and the year after that (the dynamic story) is also relevant and much less reassuring. To understand this dynamic story, we return to college D. It raised tuition, which gives it more revenue. But what does it do with that revenue? Because most colleges are public or non-profit, they cannot distribute the money to shareholders, which means that the extra revenue will be spent to improve the institution. It may hire more professors to conduct more research, to lower class sizes, or to allow teaching loads to be reduced. Or perhaps it builds new laboratories or classrooms, or expands student services to improve its graduation rate. Each of these may be an appropriate expenditure in some cases, but each will also raise the college’s costs in the future. Tenured faculty are difficult to get rid of, new labs and buildings must be maintained, and new bureaucracies become entrenched. What it spends the money on is irrelevant for our purposes; the important point is that the college spends it, and virtually regardless of what they spend it on, it will result in higher future costs. So at college D, costs in the next time period (t+1) are higher than starting costs (Ct+1 > Ct). This is not necessarily a problem for college D, since it is already charging students enough to cover its higher costs.

But what about college E? We know that initially, aid does not affect tuition at all at college E. But as college D spends more money, college E needs to spend more to avoid falling behind. If it wants to attract the best professors, it needs to increase pay, lower teaching loads, and build state of the art labs when college D does. And if it wants to recruit good students, it has to offer the same amenities that college D does. Thus, the same things that lead to higher future costs at college D lead to higher future costs at college E, so Ct+1 > Ct, which for college E means that Tt+1 > Tt. [Emphasis added]

I assume that some will push back against Gillen’s stylized model, and more empirical work needs to be done. But I greatly profited from reading his report, which raises a number of interesting conceptual issues. Frankly, Gillen’s work merits a far more detailed discussion. I intend to revisit it.
One obvious takeaway, however, is that capacity constraints are a huge part of the problem in higher education, an issue that Kamenetz takes great care to address in her work.


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