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The Tuition is Too Damn High, Part VI — Why there’s no reason for big universities to rein in spending

A pool at the University of Northern Iowa, put in a <a href="">presentation by Purdue</a> as evidence that the school needed the Córdova center to keep up. (Purdue)
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Freddie de Boer is a grad student at Purdue University, one of Indiana’s flagship public research institutions. Purdue has a new gym - excuse me, a new “sports center,” the France A. Córdova Recreational Sports Center, to be exact. When de Boer went to check it out, he found treadmills that each featured a TV and an iPod dock, a bouldering wall and a 55-foot climbing wall, a spa with Jacuzzi function that can fit 26 people, six racquetball courts, and a “demonstration kitchen” for cooking lessons.

“It really is lovely to look at,” he concluded. “It looks”

The Córdova Center wasn’t an expense that needed to be paid for. It was an expense made because it could be made, because the nonprofit university rewards those who spend money, not those who save it. This basic principle has come to be known as the “Bowen effect.”

First elaborated by the late Howard Bowen, an economist and president of Grinnell College, in his book "Costs of Higher Education," the theory, in its most basic form, is that universities will spend all the money they can possibly raise. If they raise more than they need for educational objectives, they will spend it on non-educational uses like climbing walls and nicer buildings.

But it doesn’t go the other way.Under financial strain, universities will seek to increase revenue and avoid cuts at all costs. Bowen summarized the theory, also known as the "revenue theory of cost," in five rules:

1. "The dominant goals of institutions are educational excellence, prestige, and influence."

2. "There is virtually no limit to the amount of money an institution could spend for seemingly fruitful educational ends."

3. "Each institution raises all the money it can."

4. "Each institution spends all it raises."

5. "The cumulative effect of the preceding four laws is toward ever increasing expenditure."

Here’s the good news: that implies that universities could be spending far, far less than they are now without any corresponding decline in educational quality. Hooray! On the other hand, it implies the moral character of college and university administrators may be somewhat lacking, to put it politely. They’re not raising tuition because they’re forced to do so. They’re raising tuition because they want the money.

As Centre College's Robert Martin, the leading exponent of the Bowen explanation, explains, there are a number of features of the higher education marketplace that make the effect possible. One is that higher ed is dominated by nonprofits. If revenue increases, it must be spent, or else refunded. It cannot simply be pocketed by the college or university (update: obviously it can be saved, as emailers have noted, but the key is that there aren't shareholders who get dividends if there's more coming in than going out, and thus have an incentive to control costs). That means that it's likelier for increases in revenue to lead to increases in spending than it is for normal companies.

Another, and perhaps the most important, feature of the market is that higher education is an experience good - that is, a good whose quality is unknown to the consumer before purchase. Given that ideal markets feature consumers with full information about the products they're choosing between, experience goods, where full information is literally impossible, pose an interesting challenge for the market system.

Economists, Martin explains, generally think that experience goods markets can be efficient if the product in question is bought frequently, the quality becomes known as soon as the product is consumed, there are only two parties to the transaction, and they abandon bad quality products immediately.

The market around soda is a good example of an experience good market that works well. I don't know what Sunkist tastes like the second before I taste it for the first time, but I do know the second after; its quality is unknown before purchase, but evident immediately thereafter. Many consumers buy soda a lot, and are not going to buy a brand if it's low quality, so producers have a strong incentive to produce quality products.

None of that’s true about higher ed. The quality of college isn't completely evident during freshman orientation. People overwhelmingly only get one undergraduate degree, so colleges and universities don't have to worry as much about satisfying repeat customers. And there are more than two parties to the transaction. There's a student and a college, sure, but there is also the student's parents, and the government, and even the student's future employers. Those all end up mattering for the financing of the product in question. It's a really, really messed up market.

And colleges and universities can exploit that. In the absence of first-hand knowledge of colleges' quality, students are forced to glean that information from various signals. For a handful of students, things like US News rankings are important. But because the overwhelming majority of students go to nonselective schools that aren't mentioned in such publications, that's really a trivial part of it.

The main signal that you can use is price, and in particular sticker price. The theory is schools that cost more will deliver a better education. That means schools have a real incentive to push up tuition for its own sake. And if the Bowen theorem is right, once tuition goes up, so too does spending, making it harder for the effect to be undone.

"It sets in motion some really bad incentives," Martin says. "The first is that consumers tend to take their cue on quality from how much each institution spends. Even more damaging is that any institution that tries to compete on the basis of cost, consumers are going to construe that to mean they’re cutting quality. So you don’t have cost competition, and you thus don't have a competitive pressure to reduce cost."

Sure enough, that's exactly what Martin and R. Carter Hill find in their empirical work on the Bowen and Baumol effects. They use a comprehensive dataset (courtesy of IPEDS, the same source Delta uses) spanning the period of 1987 to 2010 and see what factors correlate with increased spending. If the amount of money spent on faculty salaries, say, has a strong association with overall spending, that's at least suggestive evidence that the Baumol effect of needing to pay more and more to faculty is at work. If, however, the previous year's revenue level has a strong association with a given year's spending, that suggests that universities respond to getting more money by rapidly spending it, just as Bowen suggested.

Their conclusion is that while both effects are at work, Bowen effects dominate in public research universities, with $2 in increases due to administrators seizing on increased revenue for every $1 in increases due to upward pressures on faculty and staff salaries from other industries. Same for private research institutions. What's more, they find a plausible culprit within universities. They notice that cost increases are likelier when the ratio of staff to faculty is higher. That suggests that when administrators within the university accumulate bargaining power, they're better able to force increases in costs. The administrative staff, they suggest, is what's really driving this.

It's a common theory. Benjamin Ginsberg, in his book "The Fall of the Faculty: The Rise of the All-Administrative University and Why It Matters," advanced a version of it. So did Douglas Belkin and Scott Thurm at the Wall Street Journal, who note that, between 2001 and 2011, the number of college and university administrators grew 50 percent faster than the number of instructors.

And there’s other data to back it up. At public and private research universities, "institutional support" costs grew more than instruction costs from 2000 to 2010. Indeed, instruction costs accounted for only about 28 percent of cost increases (in those areas where they occurred) for public research universities from 2000 to 2010. It sure looks like administration, rather than instruction, is what's driving this.

But Martin and Hill are the first researchers I've seen to provide really good quantitative evidence for the theory. They're the first to tell you their research is young, and more expansive investigations must follow before drawing too many hard conclusions. But their evidence is a pretty powerful indication that resource hoarding, rather than inevitable economic pressures, are what's driving costs up.