By Jonathan Fu
The United States is often praised for hosting many of the world’s top colleges and universities despite their rapidly growing costs. With institutions like Harvard, the Massachusetts Institute of Technology (MIT), and Stanford often topping global rankings while tens of thousands of students compete for a meager number of spots, the American college system may seem at first glance to be the clear-cut global leader. Despite the average tuition rising roughly 3% more than the Consumer Price Index (CPI) in recent years, many students and parents feel these high costs—some of the highest in the world—may be justified.
And yet, upon further inspection, these sentiments may be misguided. America’s “elite” private institutions represent only a tiny fraction of American universities and enroll fewer than one percent of American students. Indeed, there are three primary types of colleges and universities in the U.S.: private, public, and for-profit. This article considers only private and public institutions since for-profit colleges and universities are controversial and only make up a small portion of overall enrollment. More than three-quarters of students attend colleges that accept more than half of their applicants). Furthermore, a recent study on adult skills found that American adults with post-secondary education performed worse than their peers in Finland and Japan on literacy and numeracy tests. Thus, the question arises: if American colleges are not truly the best in the world, why are students paying some of the highest costs for the privilege of attending them? The answer lies in the fact that colleges differ tremendously from other consumer goods.
College is fundamentally different from other goods: as a service, not a product, it cannot as readily reap the production benefits of technological advances. Typically, when a new technological advancement helps increase production efficiency and quantity, the supply curve on a supply-demand graph shifts right since producers are now willing to sell more goods at the same price. This results in the equilibrium price decreasing. However, this shift does not happen for colleges since colleges have limited resources and so cannot substantially increase the student population without infrastructural changes. Furthermore, while workers in other fields can increase their wages by increasing their productivity, faculty members cannot take advantage of similar productivity increases due to the nature of their work. Barring radical changes, it would be extremely difficult for faculty members to improve upon their current teaching and research standards. Thus, to keep salaries competitive with those in business and industry, colleges are forced to increase tuition, a phenomenon named “Baumol’s cost disease” after its proponent, economist William Baumol.
Tuition increases at private institutions are associated with increasing expenditures while tuition increases at public institutions are associated with stagnant state funding. At private institutions, particularly selective ones, tuition increases are merely a side-effect of growing ambitions. To grow their reputation and attract more students, these schools will constantly build new facilities, generate new programs and fellowships, and recruit accomplished faculty, just to name a few activities. Doing these requires additional income, so private institutions impart some of that cost onto the students via tuition. Private institutions do not rely primarily on income from the state government, and so they are much more in control of changing their income streams as they see fit. In contrast, public institutions rely heavily on state funding, so their income streams are vulnerable to changes in state legislature and budgets. A combination of recessions, public reluctance for state tax increases, and competition have caused the share of state funding to decrease in the budgets of public institutions. As a result, public institutions have had to increase their tuition to compensate for this decrease in state funding.
Ultimately, the cost of American college seems destined to continue increasing. Even as undergraduate college enrollment has declined after the Covid-19 pandemic, tuition has continued to rise. And yet, in an era where equality dominates political discussion, colleges have cleverly utilized tuition increases to demonstrate their commitment to equality. To do so, colleges price discriminate by increasing tuition costs and then reimburse certain students through grants and financial aid (funded partially by some of the increased tuition revenue). In this way, colleges charge each student and their families closer to the maximum price that many are willing or able to pay (whichever is lower) based on their income and background, imposing third-degree price discrimination. As a result, they are able to maintain their commitment to equality while increasing their tuition revenue. The “generosity” of this aid significantly decreases the net cost for as much as 70% of all students and families. And thus, even if tuition increases continue to surpass CPI growth, colleges have a blueprint for maintaining equality. The biggest challenge ahead will be to standardize this practice across all colleges despite the heterogeneity in the U.S. college system.