The Challenging Economics of Higher Education

q1361This is the time of year in which college presidents get to have one of their most difficult communications with parents: the tuition letter.  After budgets are constructed on campus and then passed by boards, presidents send a letter to parents of continuing students informing them of the tuition (and typically room and board too) increase for the next academic year.  As has been true for several decades tuition increases are rising faster than inflation.  While there are understandable reasons that tuition outpaces inflation, students and families must find the additional money to pay these higher costs, which can be especially challenging in times of slow income growth.

There was a recent story that passed with too little notice that offers some insight into the economics of higher education.  Five years ago, Middlebury College, one of the nation’s best small liberal arts colleges, announced that it was committing to limiting its comprehensive fee (tuition + room and board + fees) increases to the consumer price index (CPI) plus 1%.  While this is still above the rate of inflation, “in the 18 years before it announced the CPI+1 plan, Middlebury’s price rose an average of 2.36 percentage points above inflation per year.”  So the expectation was that this plan would moderate comprehensive fee growth—and it did.

But in February of this year, Middlebury announced that it would be abandoning CPI + 1%.  “President Ronald D. Liebowitz, who was there when the arrangement was announced five years ago and plans to step down this year, said the college simply had to move away from its plan….A college spokesman said Middlebury remains committed to meeting the financial needs of students who are admitted but suggested the college’s expenses were rising faster than the basket of consumer goods that dictate the Consumer Price Index.”  The comprehensive fee at Middlebury for the 2015-16 academic year will be $61,456, an increase of 3.83% from the current academic year.

Why is it that a school with an endowment of more than $1.0 billion and a student body that is among the most selective in the nation believes it must continue to increase its tuition at even more than 1 percentage point above inflation?  The answer has to do with the economics behind the “production” of education, and has nothing to do with Middlebury in particular.

Take a simple hypothetical example.  Assume there is a school of 1500 students and a faculty of 100.  Further assume, for simplicity, that the only source of revenue is tuition (more true at tuition driven institutions like Saint John’s University and the College of Saint Benedict—but still a plausible assumption for well-endowed places like Middlebury), and that the only costs are financial aid (which discounts the comprehensive fee for some students) and faculty compensation.  Finally assume that the faculty, like most employees, expects to see a small increase in their real compensation each year—meaning an increase above the rate of inflation.

Assume the comprehensive fee (CF) increases by CPI + 1, that is approximately 3% in the low inflation environment of recent years.  Consider three cases:

  1.  All students are full pay, meaning there is no financial aid given to anyone.  A 3% CF increase equates to a 3% increase in revenue, which can be used to increase faculty compensation by 3% and still balance the budget.  So the faculty receive a real increase of 1 percentage point above inflation.
  2. All students get some financial aid that is means tested and, for simplicity, students’ families see no increase in their incomes from one year to the next, so their ability to pay does not change.  A 3% increase in the CF leads to a 3% increase in revenue, but all students’ financial aid packages go up by 3% to cover the 3% CF increase.  There is no revenue left over to increase faculty compensation in this case and the faculty see a drop in their real compensation of 2%, equal to the rise in the CPI.
  3. Or consider the case in which 50% of the students are full pay and 50% receive means tested financial aid.  Assume, as in #2, that the students receiving financial aid see no increase in their families’ incomes.  The 3% increase in the CF leads to a 3% increase in revenue.  Half of that revenue is used to cover the increase in financial aid for the 50% of students receiving aid.  The other half of the revenue increase is used to increase faculty compensation by 1.5%.  The faculty see compensation rise but by less than the CPI and, therefore, their real compensation drops by .5% (2%-1.5%).

Reality for colleges and universities is much more like case #3.  An increase in the comprehensive fee of X% nets the institution less than an X% increase in revenue because some of that increase must immediately be put back into the financial aid pool (and this example does not consider the complexities of merit based aid that is often increasing because of competition for students between institutions).  The revenue increase left over to cover compensation, by far the largest part of educational costs, is often not sufficient to provide real increases in compensation.
The options available to institutions all have drawbacks:

  1.  Modest tuition increases, modest to low compensation increases.  This is case #3 where new revenues are small (or non-existent) and costs, particularly compensation, need to be kept in line with those revenues.
  2. Higher tuition increases, more revenue for costs.  In this case, which Middlebury is opting for, tuition increases are greater than CPI + 1% and there is enough new revenue to cover cost increases, including real compensation increases for faculty and staff.
  3. Modest tuition increases, change the educational model.  In this case, new revenues are small but to increase real compensation for faculty and staff, their numbers are cut.  In the example above, faculty size goes from 100 to, say 80.  The savings on faculty (and staff) costs can be passed on to those who remain, but the experience of students is different as classes get bigger and there are fewer staff to assist with student needs.  The Middlebury experience goes from being a small, liberal arts college to an experience more like a Research I (RI) university with larger classes or even a lecture hall-based education.

Though the choices are difficult and the economics almost impossible to get around (save manna from heaven or generous alums who help grow the endowment), none of this is new or surprising for economists.  This problem was identified by William Baumol and William Bowen in the 1960s and even has a name:

Baumol’s Cost Disease: The original study was conducted for the performing arts sector. William Baumol and William Bowen pointed out that the same number of musicians is needed to play a Beethoven string quartet today as was needed in the 19th century; that is, the productivity of classical music performance has not increased. On the other hand, real wages of musicians (as well as in all other professions) have increased greatly since the 19th century.

The problem applies to a variety of industries, including education, health care and the performing arts, which are labor intensive and where productivity increases are small over time.  Baumol and Bowen’s string quartet example offers clear intuition into the problem, but a Shakespeare lecture or a hernia repair (though here technology has changed some) also still take the same labor inputs now that they did years ago.

The reality is that as a society we are likely to see a growing share of GDP devoted to sectors affected by the cost disease, as has been true in recent decades.  In a review of a recent book, The Cost Disease: Why Computers Get Cheaper and Health Care Doesn’t, by Baumol,  The Economist writes:

[Baumol’s] theory is that a “cost disease” caused by low productivity growth in health care means that costs will continue to rise in real terms. The same applies to education and the performing arts.  The theory means that higher costs are not down to distortions, inefficiencies or market failures, but something fundamental and unavoidable. It also means that cutting costs without reductions in quality may not be possible.

But the review ends with an optimistic note on the overall affordability of sectors affected by the Cost Disease:

But most striking is his conclusion that even as health care costs go up and up, they will always remain affordable because progress in other sectors offsets the slow crawl in those hit by the cost disease….The addition of this conclusion to his longstanding work on the cost disease makes it even more important.

A reminder of the importance of overall economic growth and in particular, the importance of increases in productivity in those sectors that see these changes: technology, agriculture, manufacturing, etc.  And where do those productivity increases come from? Human capital that comes from investments in education.

By |April 27th, 2015|Categories: Economics, Higher Education||0 Comments

Monks in the World

Photo: © L'OSSERVATORE ROMANO

Photo: © L’OSSERVATORE ROMANO

Last week was a big week for Saint John’s on the world stage.  On Friday a small group from Saint John’s had the pleasure of delivering the last volume of The Saint John’s Bible to Pope Francis in Rome.

On Thursday the Hill Museum & Manuscript Library (HMML) marked the 50th Anniversary of its founding.  Both were important reminders of the exceptional community the men of Saint John’s Abbey have formed.

The Saint John’s Bible project, which reached the end of a particular chapter in its history with the delivery of the last of seven volumes to the Pope, was an ambitious undertaking that began in the late 1990s.  Artist and calligrapher Donald Jackson had long dreamed of a hand-written Bible, which had not been done in 500 years, but it took the vision of Fr. Eric Hollas and Br. Dietrich Reinhart, and the support of the Saint John’s community, to bring the dream to reality.  The project was not without its bumps: the financial breakeven point, while in sight, has not been reached yet and there remain more than a few skeptics.  But I think it is safe to say that the final work and its impact in the world have exceeded the initial hopes of the cultural entrepreneurs who undertook it.

Father Oliver Kapsner, OSB, and his microfilming team at the Kodak offices in Vienna, Austria (September 1971) via Books from the HMML Basement

Both the audacity and generosity of the vision are striking.  The creation of the The Saint John’s Bible was not for Collegeville, or even just for Catholics.  It was an ecumenical act for the world, “to fire the spiritual imagination” of those who experienced the art and theology of the illuminated text.  It was financially risky and certainly beyond the previous conception of Saint John’s mission.  Yet the monks felt it was important to give this gift to the world.

In many ways HMML was an even more generous decision.  Monks had long played a role in preserving culture and, in 1965, the Saint John’s community decided to use technology to continue this longstanding Benedictine charism.  Fr. Oliver Kapsner was the visionary in this case, but the Abbey made a commitment of time, treasure and labor to build a microfilm library of ancient manuscripts, both to preserve them and to make them available to scholars.  This was a pure gift to the academic world.  Unlike The Saint John’s Bible, there would be no commercial opportunities to repay the financial investment in HMML.

Monks traveled the world, negotiating with various communities and governments for the privilege of microfilming ancient documents.  The microfilm was brought back to Collegeville where HMML has cataloged the materials and hosted scholars from around the world.  This project has made the University well-known among historians, even as the rest of the world sometimes can’t quite place Saint John’s.  Modern digital technology has made capturing the images easier and the internet has made dissemination potentially world-wide.  At the same time, the need to preserve cultural artifacts appears to be just as great, if not greater, than it was in 1965.  Terrorism and war in Africa and the middle east in particular threaten ancient cultural artifacts and the prescience of monks in 1965 has been rewarded with an even more pressing mandate with each new conflict.

abbey

Saint John’s Abbey Church

The presence of Saint John’s in the news this past week is a powerful reminder of the spirit of the monastic community.  Monks might quite understandably choose a quiet life of study, prayer and contemplation.  The community could live apart from the world: ora et labora.  But from the beginning, when they came west to serve the German Catholics of Minnesota, the community has been outward looking, fully living in the world and serving those both near and far.

The Saint John’s Bible and the Hill Museum & Manuscript Library are but two of the innovative things that can be credited, at least in part, to the monastic community.  The list is long and varied: the ecumenical movement that spawned the Collegeville Institute, the liturgical reforms that were part of Vatican II, the founding of Minnesota Public Radio, the decision to invite Marcel Breuer to design and build some of the most striking modern architecture in the world,  the creation of the Abbey Arboretum and Outdoor University, bringing one of the first mainframe computers to a Minnesota college, the establishment of the Saint John’s Pottery and surely others of which I know too little.

Those of us who have studied at the University, as well as the faculty and staff, have benefited from the ferment, energy and entrepreneurial spirit that the monks bring to all they do.  It is one of the things that makes our educational experience unique and truly differentiates Saint John’s University from the many other fine residential, liberal arts colleges in the United States.

By |April 21st, 2015|Categories: Alumni, History||0 Comments

Demography is Destiny…or Is It?

Photo: kenfagerdotcom via Flickr

Photo: kenfagerdotcom via Flickr

Census data reveals the changing demography of the United States.  In 2011 the majority of babies born were non-Caucasian. This, naturally, allows us to predict that 18 years hence, the majority of the  potentially college bound students will be “minority.”

Economists and demographers often say that, “Demography is destiny.”  Once a cohort of babies is born, we will not be “making” any more of them.  We know how many kindergartners there will be in five or six years;  we know how many new voters in 18 years and how many Medicare recipients in 65 years.  So, in this sense, a country’s demography is destiny (this, of course, ignores immigration).  But some recent commentators have taken this aphorism a bit too far.

National Journal Ron Brownstein argues that recent demographic changes will ensure changes in the education of our workforce. Citing the work of the Brookings Institute demographer William Frey, Brownstein writes:

Frey has calculated that if the U.S. does not improve its college completion rates for young people, the share of Americans holding at least a four-year degree will start to decline as soon as 2020. After that, his model forecasts that the share of college-educated Americans will not climb back to its level in 2015 (just under one-third) at least through 2050. That’s an almost unprecedented prospect for the American economy: The percentage of Americans holding at least a four-year degree has increased steadily since at least 1940, according to the Census Bureau. It’s also an ominous prospect in an international economic competition increasingly centered on knowledge and innovation.

These observations are made by simply taking past trends for education among different demographic groups and extrapolating them into the future.  But unlike attending mandatory kindergarten, a college education is a choice.  Four factors can change these choices by changing incentives.

    1.  Economic conditions and the job market—as the financial premium for a college degree stays high and potentially increases, the economic incentives for pursuing a college degree get stronger.
    2.  Parents and students themselves –as parents and their children come to understand how important a college degree will be for a middle class lifestyle in the future, their commitment to education may well change.  In particular, parental engagement and the preparation of students in the K-12 years could be affected, leading to better prepared high school graduates.
    3.  Colleges and universities—as institutions see the demographic changes, they will have incentives to change their recruiting practices and to strengthen their policies to increase retention among students of color once they are on campus.  At the College of Saint Benedict and Saint John’s University we have already seen increased diversity on our campuses, at a faster rate than we predicted, and our strategic planning process is explicitly considering how we can make our good retention among our new student populations even better.
    4.  Government policies—even at private schools, policies like the Pell grant program, guaranteed student loans and the GI Bill have all had an impact on college enrollment over time.  Though budgets are obviously tight at both the federal and state level, the choices we make through our legislators can have a significant impact on college enrollment and completion.

We have been down this road before in some ways.  Prior to WWII, college graduates were less than 10% of the population, which was majority white.  Economic incentives changed in the post-war boom, and government policy in the form of the GI bill brought many more men into colleges.  Later, social changes did the same for young women.  Colleges and universities responded to these changes in demand by making more places available for new students and accommodating them with programs designed to meet their needs and backgrounds.  The result was that college graduates now make up about 30% of the adult population, and college enrollment of students just out of high school is now at 70%.  Demography was not destiny during the post-war boom.  A few tables show the extent of the changes:

Overall enrollment has risen steadily:


enrollment chart

Post WWII completion rates have risen for all groups, though non-Asian minorities lag the Caucasian majority:
demographic-chart

Women have responded strongly to new opportunities, which is, in part, why nearly 60% of undergraduates are women these days:

gender-chart

There is no reason to think that exactly the same kind of forces might not combine to respond to the growing number of students of color and eventually bring their college enrollment and completion rates to the same levels, or even beyond, those we currently see among traditional majority students.  It will not be simple as the minority population does not have the same preparation or economic resources their Caucasian counterparts did when they moved in large numbers into colleges, but it is certainly not impossible.

This is one place where our economic destiny will be determined by the conscious choices of parents and students rather than mere demography, and the actions of colleges and governments will be an important determinant in that future.