Why Does College Cost So Much? (in the Motley Fool)

Why Does College Cost So Much?
By Rich Smith
October 29, 2009 | Comments (55)



Two William & Mary professors tackle the "hot-button issue" of the skyrocketing cost of higher education in a new book to be published by Oxford University Press next year. Here, Fool contributor Rich Smith shares the answers he got from his former economics professor David Feldman, co-author of the book with colleague Robert Archibald.

Why does college cost so much? If you have kids in college -- or kids, period -- in America today, the question's more than academic. It can mean having to make a choice between getting your child a college degree or planning a comfortable retirement for yourself.

As college tuition costs soar, a lot of us wonder why. What's wrong with these people that they keep raising prices that are already unaffordable? And what can we do about it? I sat down with Professor Feldman to talk over these issues, and more.

Rich Smith: So, Professor, let's tackle the question head-on -- does college cost too much?

David Feldman: Not "too" much. "So" much. What we've tried to do in this book is go back over the history of the last 60 years and examine college from an aerial view that is rooted in broader U.S. economic history, comparing cost trends in the higher education "industry" to those of other similar industries. We take each of the common arguments against college costs -- that colleges are dysfunctional, that they engage in arms races with their peers, and that give "Country Club U." amenities to their students -- and examine whether they hold water, whether college costs really are rising faster than they should, and if so, why?

Smith: And ...?

Feldman: And what we've found may surprise you: College costs are rising faster than the inflation rate. But that isn't because they're "country clubs" -- it's more because they're "prep schools."

To prepare an undergraduate these days requires a lot more expensive stuff, like high-intensity lasers and big computing resources, than it did in the past. It costs money, sure, but our students demand it because their potential future employers demand it.

Nor is higher education alone in seeing higher costs. Lots of other industries show trends in cost appreciation that mirror those found in higher education, and there are two key reasons for this -- neither of which supports the "country club" critics. If you look at the trends in education costs at not-for-profit four-year colleges, at two-year community colleges, and at for-profit educational institutions like Apollo Group (Nasdaq: APOL), they're virtually identical, up across the board. Yet you don't have the same "gold-plating" at a two-year community college or for-profit institution as critics suggest afflicts four-year, on-campus universities. So clearly, there's something else driving costs upwards.

To understand what's happening, you need to understand that college is a service. As opposed to manufacturing, where labor is just one input in pricing and improvements in productivity generally lead to lower costs, labor is the primary input in service industries like higher education. This makes college especially vulnerable to cost disease ...

Smith: Hold up a sec. "Cost disease?"

Feldman: Right. That's the real culprit behind the rising cost of college. You see, in a labor market, when one worker's wages rise, so do wages for other workers -- because employers compete to attract them. How does this work in higher education? Improvements in productivity can lead to higher wages at firms like Hewlett-Packard (NYSE: HPQ). But they also raise wages at colleges that must compete for a limited supply of labor.

The problem lies in the fact that when HP raises wages, it can offset higher labor cost with improvements on its other input costs -- more energy-efficient machinery, better manufacturing processes. As a result, PC prices actually get cheaper every year. Colleges are different because their primary input cost -- labor -- is terribly resistant to productivity improvements.

Example: In 1960, students paid roughly the same for tuition and fees as they did for room and board. Today, you see tuition and fees together exceeding room and board by perhaps two to four times. So tuition has been growing much faster.

Why is this? You can make the teaching process more "efficient" by using Blackboard (Nasdaq: BBBB) software and the like. But generally speaking, every move you make to decrease the amount of time a professor spends with students is viewed not as "improved productivity" but as less personal service.

And so costs rise faster than inflation in any service-intensive industry -- higher education, law, or medicine. This is exacerbated by the fact that ever since the 1980s, workers with college degrees and even higher levels of education have become much more expensive than workers without such degrees. This accelerates the rise in the cost of any industry that uses a lot of this well-educated labor, and directly leads to increased costs for service-oriented industries like higher education.

Smith: So what's your take on last week's news that the government is slashing compensation for executives at AIG (NYSE: AIG), Citigroup (NYSE: C), and the other bailout recipients? Would you expect this to depress wages for university professors, for example, and lower college costs?

Feldman: Actually, no. Remember our aerial view! Compensation in finance has soared relative to compensation in many other industries that use similarly educated people. Ask engineering grads. They'll tell you. What happens in one industry, like finance, is not likely to have a big impact on higher-education wages unless it is part of a much larger market movement toward lower compensation for highly educated workers. I don't see that at present.

Smith: So what is the solution?

Feldman: There really isn't any -- this is a solution in search of a problem. You see, the fact is that the same productivity growth that's pushing education costs up by driving wages higher ... drives wages higher. This provides the income needed to pay the higher costs of higher education.

Our research shows that despite the rapid increase in education's cost, over the long haul, higher wages mean families wind up with more money in real dollar terms after paying the tuition bills.

Smith: Good to know. But let's see if we can help our readers keep even more money. From your vantage point at the college, can you see any "bargains" in higher education? How can parents of soon-to-be-college students best spend their dollars wisely?

Feldman: You can get a fine education at many of the nation's flagship public universities, where tuition remains quite low compared to elite private universities. But remember, list price tuition is paid by a small fraction of students at private universities. Between federal financial aid and discounted tuition that most universities offer on a "need" or "merit" basis, very few students pay the list price.

Smith: Professor, before we close, I'd like to ask if you see the high price of higher education shutting out qualified students. Will the 21st century see U.S.-based companies like Intel (Nasdaq: INTC) and Microsoft (Nasdaq: MSFT) starved of talent?

Feldman: It could happen. While our research shows that a rise in the cost of higher education is not a problem on the whole, it is a problem in certain instances -- namely in how it discourages poorer students from seeking a higher education.

Over the past 30 years, income in the U.S. has become increasingly polarized. More people are becoming very rich -- and more very poor. The hollowing of the middle class is an even bigger affordability issue than cost disease. But we believe that a few common-sense changes to how we distribute financial aid could make real progress towards making college more accessible to those who need it most.

Start with the FAFSA application for federal student aid, which all students seeking Pell Grants much fill out. Currently, students must fill out and submit a FAFSA indicating their income and assets, then apply to colleges, and then find out how much financial aid they qualify for. It's absurd to require students to apply to colleges before they know which colleges they can afford.

Second, the government can improve access to higher education and reduce the price of it (not the cost, mind you, but the price students pay directly) by increasing financial aid. We realize that increased government spending is not a popular subject these days, but if legislators were to offer a universal, standard stipend -- and make this the standard student financial aid package -- this could gain broad support and improve access to higher education across society.

Such financial aid, by the way, would be only an incremental increase over the substantial, but extremely disorganized, system of federal programs that currently exists. As such, it would not cost much more than we are already spending on financial aid. In fact, Prof. Archibald and I have developed new evidence suggesting that increases in federal financial aid lower the list price tuition. It could be that extra federal aid reduces each school's need to discount tuition for its own needy students, and this allows the school to cut the list price tuition faced by everyone else.

The changes we suggest in the federal financial aid system would not cost much more than the current system -- really, they would just make it more straightforward, easier to understand, and more reliable for the students.

What do you think about the cost of college, and how are you handling it?