Legal Commentary

College Tuition and Endowments-Becker

By becker

The agitation about the fraction of endowment that colleges spend is driven in large measure by the rapid rise in tuition since the late 1970's. The increase in tuition has been much faster than the rise in consumer prices over the same time period. However, the benefits from a college education in the form of higher earnings, better health, better educated children, and many other aspects of life have grown much faster than tuition has. The result is that benefits net of all college costs have increased at an unprecedented fast rate during the past 30 years. College-educated persons increasingly have achieved elite status not only in the United States, but in other countries as well, including developing countries like China, India, and Mexico.

So it is hard to feel sorry for college students despite the rise in college tuition.
To be sure, high tuition makes it more difficult for students and their parents to finance a college education. To make that easier, especially for students with few financial resources, colleges have been engaging in greater price discrimination by increasing financial aid to students with limited resources while they are sharply raising tuition to students from more well to do families. This price discrimination policy has enabled many more students from poorer families with good high school records to go to colleges where they pay little tuition. Students also can help finance their college costs with student loans when they do not receive sufficiently large support from their colleges. The debts of students who borrow a lot by the standards of what the average student borrows is still usually not large relative to the earnings most students receive after working for several years. I believe students in need of financial support often do not borrow enough. By borrowing more, they would be able to work less, and thereby concentrate on their studies and finish school more rapidly.

I do not deny that colleges invite criticism when they increase tuition while their endowments are increasing by a lot. Although it seems much more natural and appropriate for colleges to lower tuition when their endowments grow, there is a powerful reason why endowment growth is often accompanied by a growth in tuition. A rapid increase in endowments, even by schools that spend a small fraction of their endowments, enable schools to spend more resources on increasing the quality of the college education they offer. They would tend to attract better teachers and researchers, provide smaller classes, enlarge their libraries and other information storage and dissemination facilities, and provide better athletic facilities and other amenities. These improvements in what a college offers in turn helps attract students who are willing to pay higher tuitions. Since American colleges are in a highly competitive environment, they tend to raise tuition when they can attract good students who are willing to pay more.

Although I disagree with Senator Grassley and other Congressmen about whether we should be concerned by the sharp increases in tuition, I do agree with him and other critics that colleges should spend a larger fraction of their endowments. However, my reasons are very different from theirs, and I certainly do not believe that schools should be required by law to spend a larger fraction of endowments. The problem I believe with the governance of many schools is that their boards of directors believe they are managing financial assets that should be maintained, and preferably increased, in perpetuity. In my judgment the major goal of presidents and boards should be to improve teaching and research, and that may well mean spending much more than the income from endowments.

Of course, the persons in charge of a college's governance should be concerned about the effects of spending down endowment on the college's future financial strength. However, colleges that compete well against their peer schools generally attract more generous private and public contributions. As a result, schools that spend wisely higher percentages of their endowments may well increase, not decrease, future endowments. Likewise, schools that refuse to spend more than a rigidly fixed percent of their endowments may experience a decline in their competitive position that will tend to reduce their ability to attract contributions in the future. Therefore, boards of directors that do not allow greater spending because they want to maintain, or increase, their schools' endowments could be responsible for reductions in future endowments.

In arguing this I am partly influenced by the experience of the Olin Foundation. This was a large foundation that explicitly decided to spend down its endowment in order to better accomplish its goals. The Olin Foundation did spend all its endowment on law and economics and other programs, and has essentially now closed its doors. During the relatively short time of its existence the Olin Foundation accomplished far more than most other large foundations do over many more years. I am not suggesting that all colleges follow Olin's example and plan to go out of business- some of them should, however. Rather, I suggest that they should copy Olin's example of trying to be successful now, even if that means spending more than their incomes on attracting and teaching good students, and in producing path-breaking research.

Full post as published by Becker-Posner Blog on February 24, 2008 (boomark / email).