Why Does College Cost So Much?

Here is an answer provided by two economists.    Consider two more factors.  First, colleges do charge different people different prices.   Here is some evidence from Yale.   Suburban parents are subsidizing other students.   Second, a fairly large share of university workers are unionized and are earning pretty good pay and benefits relative to market alternatives.   Both of these examples highlight that our universities engage in redistribution and this contributes to the price tag.   Are faculty and deans overpaid?  “Yes” and “No”.  There is a national competitive labor market here.  There are many ambitious universities and thousands of academics competing for these jobs.   And what about the tenured old guys?   I do support mandatory retirement at age 65.   I will retire from UCLA on February 16th 2031 (or earlier!).

Author: Matthew E. Kahn

Professor of Economics at UCLA.

15 thoughts on “Why Does College Cost So Much?”

  1. This is a really weird article. First, it ignores the rising health care costs that are costing universities big time. Money quote:

    “Health insurance premiums are a direct instigator to rising tuition at universities and colleges around the U.S. A report published in by The National Center for Public Policy and Higher Education expressed how healthcare is dramatically affecting tuition.

    According to the article, education budgets are very sensitive to professor and staff costs. These costs include benefits associated with healthcare. “As much as 85% of costs associated with education go towards compensation,” much greater than the “50-55% in most other industries.” With health insurance premiums increasing much faster than inflation, costs are passed onto students to maintain staff benefits.

    http://www.suite101.com/content/healthcare-increasing-higher-education-costs-a218779

    Second it lauds Georgia’ HOPE scholarships, a program that is on the verge of going belly up. Money quote from the NYTimes

    “But the program has become so popular it cannot sustain itself. Lottery sales, which by law can pay for only the Hope scholarship and a free prekindergarten program, will be short $243 million this fiscal year and as much as $317 million the next, according to state budget estimates.

    Last year, lawmakers had to pull millions of dollars from the state’s reserve fund just to cover the cost. But this year, there is nowhere to turn.”

    http://www.nytimes.com/2011/01/07/us/07hope.html

    Why do smart people say such dumb things?

  2. Smart people can become very good at building rationalizations, stories that they like very much, and smart people, particularly as they grow old and comfortable, can also become very bad at finding out stuff. Learning new things and testing hoary old convictions is hard, humiliating work, and can bring up uncomfortable emotions.

    These two gentleman have a very high, most probably wholly unjustified opinion about the quality of their understanding of the world and the economy. And, they are uncomfortable with passionate and contentitious political rhetoric. So, they set out to — using their words — “take an aerial view” of higher education and to avoid politicized issues, and they return with an opinion that they like very much. Lots of people very much like the opinions they have — that’s why they have those opinions. So, certainly nothing unusual, even if it doesn’t reflect much of a professional standard for inquiry.

    I was actually fairly shocked that they conclude that college, despite the price increases, remains affordable. The revolution in college financing, which has students borrowing stupendous sums, which cannot be excused in bankruptcy, has apparently completely escaped the good professors’ notice. Never mind, then.

    I don’t see any meanness in them. Their thinking is superficial and, even, in these short pieces, remarkably undisciplined. They cannot seem to make up their minds what they think about redistributive subsidization of education costs from one paragraph to the next; I get the feeling that it never really occurred to them, during their overflight, to think deeply about why society might want to subsidize college costs, and use that analysis to sort out and evaluate how American society handles that issue through various institutional channels (and how ways of handling that has changed).

    They appear to have aimed at a soothing rationalization and hit the target.

  3. I think you can mostly explain college pricing by noting that a college education is a positional good with virtually no credible quality measures and a lot of third-party payment. There are certainly cost pressures, but in general universities are under little pressure to reduce costs until they expand to use up all the available revenue.

  4. It can at this point be interesting to contrast the average American college with ETH Zürich (http://www.ethz.ch/).

    To study at the ETH, you’re paying CHF 644 per semester (about $680), both as a Swiss citizen and as a foreigner. If you are a professor, you can expect to have a fairly generous staff and budget allotment, reducing your need to hunt for third-party grants. We are, to be clear, talking about a university that is probably in the same class as MIT or UMich.

    How does this work? Basically, around 80% of the university’s expenses are paid through public sources (http://www.fc.ethz.ch/facts/jahresberichte/ar_ethz_09_at_a_glance_en.pdf, pp. 10-11). Or, in short, Switzerland and Europe view higher education and research as such an important public good that they heavily subsidize those activities.

    Another thing to consider: Here in the UK, some top-ranked universities are actively and successfully recruiting US students, even though their fees for foreigners are exorbitant by European standards (http://www.washingtonpost.com/wp-dyn/content/article/2010/12/19/AR2010121903165.html).

    I have dual US/German citzenship, my husband is British. With most of Europe’s quality universities to pick from, I doubt that either of my daughters will want or need to spend money on a (comparatively) overpriced US education, regardless of where we will live at that time.

  5. Katja, your example illustrates a critical misunderstanding of Matt’s question. He’s asking why college costs so much, and you tell us about a place where its price is low. Subsidizing something may or may not be a good idea, but it doesn’t make it any cheaper. To learn anything from ETH, we would need to look at its budget. After all, national defense is completely free for citizens of every country, but that doesn’t mean its costless.

  6. Colleges charge what they charge because they can. And why can they? Because the student loan system allows colleges to force students to mortgage their future income stream to pay tuition bills, while placing the risk of default on the federal government. Colleges take no risk for turning out students who cannot earn enough to repay their loans. This means that they can increase tuitions without fear of shrinkage of the pool of qualified buyers. The buyers, meanwhile, are in no position to evaluate the risks of the loans they are burdening themselves with.

    And because colleges can collude on pricing, there is little competitive pressure to lower tuition. Add this to the fact that the value of a college education is a much in the degree as in the education, and the value of the degree comes from the reputation of the institution, which relates primarily to selectivity, and you can see that there is little or no competitive pressure to lower tuition.

    And college costs have nothing to do with what colleges pay the faculty. Colleges pay faculty members as little as they can. They charge students as much as they can.

    Most of the difference goes to fund the ever-increasing administrative bureaucracies and ever-more-highly paid top administrators. Some of it goes to football teams, which are a very expensive form of advertising. And some of it goes to fancy new gyms and dorms and cafeterias and other stuff that will attract buyers and their parents when they’re taking the college tour.

  7. “After all, national defense is completely free for citizens of every country . . .”

    Some citizens pay a very high price.

    “. . . a critical misunderstanding of Matt’s question. He’s asking why college costs so much, and you tell us about a place where its price is low. Subsidizing something may or may not be a good idea, but it doesn’t make it any cheaper.”

    I could distinguish between the cost of an iPhone and the price of an iPhone, and explain the subsidy provided by service providers as a means of financing the use of the capital by consumers, and it would probably all make a certain amount of sense, and be informative. But, people would still go to the Verizon counter or the AT&T counter and ask, “how much does it cost?” And, I don’t think that that is just a vernacular imprecision. The financial structure that determines the opportunity cost for the consumer in terms of the consumer’s current consumption is part of the deal, and not just part of the deal — it is driving the organization of design and production, marketing and distribution, as well. The “cost” of the iPhone is a property of that organizational structure, and not an independent, technological ‘given’.

    College education is organized around a cross-generational subsidy. That subsidy is not incidental to the project; it is inherent in the nature of the project. It’s why parents educate their young; its why Cardinal Wolsey and Henry VIII channeled funds from the Dissolution of the Monasteries into the endowments of Oxbridge. One of the largest costs of college education is the sacrifice of youth, and what it costs the young could well be the most, critical framework in which to answer the question.

  8. Michael, my understanding of Matt’s question was that it referred to tuition costs, because that’s what the referenced article (“Why does college cost so much?”) was talking about. When you say that “[s]ubsidizing something may or may not be a good idea, but it doesn’t make it any cheaper”, that is true, but it still does drive down tuition costs. Which, incidentally, is explicitly referenced in the article: “The way we subsidize higher education can have a big impact on who gets to go to college.” So I’m not sure who of us is misunderstanding Matt’s question. So, is it about tuition fees or the complete socialized cost of higher education (which the New York Times article doesn’t seem to talk about at all)?

    As to the bigger picture, I suspect that a major factor is that the United States face very little international competition due to their geographical location. If tuition in Switzerland became too expensive, Munich or Grenoble are just across the border. Of course, going to college in your home country does have significant advantages, so students will tolerate quite a bit of difference in tuition for the convenience; but if you’re talking about a $10k-$30k/year higher price tag associated with the privilege of attending a local college, then that would have to be a really fancy place, especially when combined with the ease of moving between countries in Europe allowed by current EU/EEA regulations.

  9. I would just note that in Katja’s example, the operating cost of a good university is apparently around $6800/year. That’s 1/2 of the University of California system’s instate tuition, which I don’t believe is enough to cover its costs.

  10. Sam, the poop sheet Katja links to says tuition pays 4% of the 20% of costs not covered by government direct appropriation, or 0.8% of total costs, 1/120. So the total operating cost per student year is 120 x $1360 = $163,200. As this cost covers lots of research, including (at ETH) the expensive kind with labs and atom-smashers and stuff, and other non-teaching activities, it’s not absurdly far from UC or US university actual costs. No, UC tuition doesn’t nearly cover the budget of UC divided by the number of students.

  11. Let’s do a little back-of-the-envelope:
    $7,000/ 15 week semester; 15 credit hours per student representing, roughly 15 classroom hours per week. Rounding to $30 per classroom hour. A lecture course with 200 students rakes in $6000/hr; even a teaching fellow with 20 students is generating gross revenue of $600/hr, and the teaching fellow is a serf (oh, I’m sorry, a professional employee or a scholarship student, exempt from the rights of collective bargaining).

    Assuming State appropriations and endowment offset some costs somewhere in the system, it still seems like the educational component is somewhat less than a model of lean and mean efficiency, where cutting the pay of kitchen and janitorial staff is going to make all the difference, per Professor Kahn’s suggestion; substituting an ice floe for a professorial pension might conserve a tidy bundle of cash, too — just a wild thought!

    In my higher education career, I always attended ruling-class schools, where things were fairly posh, and I appreciated the amenities and care, where it was taken (which it wasn’t always — Professors have tougher unions than the longshoremen and can be jealous of their privileges and immunities). But, I’ve heard tell that “higher education” encompasses a diversity of institutions in these United States, including a for-profit sector that scams students for access to Federal student aid, and a community college sector, where the teachers may work more than a fifty hour week for less than a good waitress at a moderately expensive restaurant-bar.

  12. the poop sheet Katja links to says tuition pays 4% of the 20% of costs not covered by government direct appropriation

    I missed that; thanks for the correction. I was assuming that tuition covered the whole 20% that direct appropriations didn’t.

  13. College costs a lot because a significant portion of the population thinks that non-attendance ruins your chances of gaining entrance to, or staying in, the upper middle class. Or even the middle class. That this is true mostly because of the credentialing effecti of college doesn’t chane that dynamic. If the credentialing effect ever weakens (there are various scenarios where it might), the demand and therefore the cost will drop.

  14. I’m surprised that, being economists, they didn’t at least mention that some colleges appear to be facing a backward sloping demand curve. In other words, if a college wants to get more (or better) applicants, one of the things it can do is to raise its tuition. Potential applicants presumably believe that good schools have high tuitions, so that raising the tuition increases the perceived value.

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