Why every college is struggling financially

A friend who works primarily in health care recently asked me why so many colleges and universities are having financial troubles, cutting programs and freezing salaries even while they are raising tuition. To my friend, it just didn’t make sense. Here’s an edited version of what I wrote in response.

Colleges all have different reasons for having budget problems, depending on their different missions. But some of the problems, on both the revenue side and the cost side, are shared across institution types. Colleges face some of the same problems health-care providers face, with some crucial differences that make colleges’ situation more precarious.

First: revenue. Colleges get revenue from government appropriations, tuition, investment income (endowment), and a few other sources like grants. Public universities have been getting less and less from state governments over several decades. U.Va., for example, gets something like 6% of its budget from the state; this is down from something like 40% 20 or 30 years ago. (Big caveat: U.Va. gets half of its revenue from the hospital, which has grown exponentially in recent years, so the diminishing state funding is driven at least partly by a growing budgetary pie as U.Va. transforms into a giant health system that also grants a few bachelor’s degrees.) Even private universities depend on state appropriations, as they do work that the state wants done, for example by serving students who have special learning needs. Private colleges in Pennsylvania also lost revenue when the state put a moratorium on paying for public school teachers’ continuing professional education.

It’s true that tuition prices have increased dramatically. Part of that is to offset the decline in public funding–money has to come from somewhere. Part is because of increasing costs (about which, more later). Part is also something of an illusion. Yes, the sticker price has gone up a lot, but the actual average amount people pay has not increased by quite as much. The reason is that that the “discount rate” (the average amount colleges discount tuition by giving merit or need-based aid) has also been increasing. Here are two reports (from 2011 and 2012) on discount rates. Discount rates represent colleges’ efforts in price discrimination. “Need-based financial aid” is really about the college charging a price it thinks it can get you to pay.

Discount rates have gone up recently for a few reasons: one is increased competition for students in some regions (like the Northeast, where there are a lot of colleges but fewer and fewer college-aged residents), but a bigger one is the recession. If a family doesn’t have as much money to spend on tuition, then the college can’t charge them as much as it would like. It then has to offer more “grants” and “scholarships,” which are just phantom money.

Most small and medium-sized colleges are “tuition-driven,” meaning they don’t get a lot of revenue from sources other than tuition. So their budgets are very sensitive to how much money families have. And the revenue problem colleges run into is having to discount tuition more and more in order to fill all the spots in the freshman class. Due to tuition discounting, it is actually possible for a college to bring in less revenue with a higher tuition sticker price and a constant number of students.

Many of the most prestigious colleges and universities are endowment-driven. A few have more than $1m in endowment per student. While these colleges are “rich” in many senses, they are highly sensitive to fluctuations in the stock market. When the market crashed in 2008, Harvard’s endowment lost eleven billion dollars in one year. Since colleges usually take 4% – 5% of their endowment fund as revenue each year, Harvard lost half a billion dollars in annual revenue due to the crash (though in fact, Harvard probably takes 4% – 5% of a three-year average of the endowment, smoothing out the revenue hit over time). So every college has had some form of revenue problems lately, with the public universities facing the worst situation.

The cost problem is, to me at least, more mysterious. Whereas improved technology lowers costs in most industries, it doesn’t do that for education. The magic whiteboard in my classroom is fun to use, and it might actually improve student learning on some level, but it doesn’t help me to teach more students without diminishing educational quality. So college, like health care, is subject to Baumol’s cost disease (explained clearly here; also here). Costs keep going up not just because of technology but also because of increased staffing needs. Part of this is the bureaucracy expanding to meet the needs of the expanding bureaucracy, part of it is universities’ ever-expanding missions (e.g., as business incubators or real estate holding companies), and part of it is to meet the needs of the increasing proportion of students who need extra services: mental health, learning disabilities, etc. Spending on faculty has generally not increased; spending on professional staff has.

These are the latest numbers on faculty salaries. We faculty seem to be doing well. But the survey only covers the small minority (30% or so) of faculty who are full-time. The other 70% are part-timers, adjuncts, or graduate students, and they get paid an average of less than $3,000 per class. And they don’t get benefits. Since colleges’ reliance on part-time faculty has increased lately, there has been no real increase in the amount colleges are spending on faculty pay. No college would consider hiring someone in the admissions office to work part-time at a third of the normal hourly wage, but they do it all the time on the faculty.

Many colleges also have big expenses due to servicing debt on the orgy of building they are constantly engaged in. Drexel has half a billion dollars in debt. Every college president wants to build things. It’s great for their reputations. It looks like the university is thriving. And supposedly it will attract more students if your college has the most impressive buildings–especially student centers, dorms, and athletic facilities. But of course, the bills have to be paid eventually.

So, I’d say that higher ed faces the same problems that just about every industry has faced on account of the financial crash and the recession, plus it faces the same cost disease problem as health care, but it also has a few problems that health care doesn’t have.

There is no federally-funded education program comparable to Medicare. There is no incredibly powerful lobby threatening to mobilize college-student voters against Congressmen who attempt to reduce higher-education funding. There is no political movement that takes pleasure in mocking the supposedly short workweeks and exorbitant pay of physicians who are just trying to push their liberal views on their patients anyway. There are no highly-publicized medical startups claiming that medical costs can be cut dramatically by having a handful of the world’s greatest doctors treat tens of thousands of patients simultaneously through the Internet. No one sees health as basically just a credential, and doctors’ recommendations as impediments to patients going out into the world and enjoying the healthy future they are rightfully owed.

I think that colleges are harmed by seeing other colleges as competitors, rather than as collaborators in a larger effort. College A needs more students, so it builds a gym to lure students from College B, which then builds a bigger gym, and so on. It’s stupid. I’ll bet hospitals do the same thing, but then, there are fewer hospital options out there. It’s hard to shop around. Colleges use the language of the market to describe how they operate (especially when talking about attracting students), but the situation in higher ed strikes me as a classic case of market failure. And it isn’t just the colleges themselves that suffer as a result.

Update: I posted this about ten seconds before I became aware of Jeffrey Selingo’s piece in today’s Times, which covers some of the same ground.