What should university presidents and provosts know about economics that they don’t?

I'm giving a talk to such a group tomorrow and I am curious to hear what you think I should be telling them.  This isn't a talk about public policy per se, it's a talk about the economics of universities.

In addition to what I say, I will refer them to the answers you all give. 


At our university we have a program that evaluates whether international students are sufficiently proficient in the English language to be given teaching duties. The person who heads this program, and also serves as one of the panel judges during evaluations, also provides for-profit classes on the side that teach international students how to pass these exams. These classes are neither provided nor monitored by the university; the students must pay for them out of their own pockets. Amazingly enough, very few students pass the exams on the first try, and not that many even on the second... except for students who take the class.

When this system has been brought up to the provost as a conflict of interest or perverse incentive structure, the professor (not me) who mentioned it was derided for being so cynical. All of which is to say that it is entirely possible university officials don't think incentives matter, or at least that pecuniary incentives are secondary among academics. Please reassure them this is not the case.

I think it would be interesting to wonder what a bubble in the price of university education would look like (is it here?), how we would recognize, and what we would do about it.

I believe the endowment number that is published by a university only includes the assets of the university. The health of a university is best measured by assets minus liabilities. Presidents and provosts should be reminded that equity equals assets minus liabilities and, in the interest of transparency, publish a balance sheet for their institution rather than using "endowment" to signal financial strength.

When this system has been brought up to the provost as a conflict of interest or perverse incentive structure, the professor (not me) who mentioned it was derided for being so cynical.

But, of course the university cannot think anything is wrong with such an incentive structure. Think about it. If the university were to recognize an inherent conflict of interest between providing instruction for a fee and in evaluating results of that instruction, then it's only a short hop to recognize that the university model itself is built on exactly that same conflict of interest writ large. Actually, it's somewhat worse -- with the English proficiency exams, students who don't pay for the classes are permitted to take the exams and have at least some chance of passing. This is a model of openness and fair-dealing in comparison to university courses; in that case, students who haven't paid thousands in tuition can't even sit for the exams at all let alone pass them and gain credits or degrees.

Which suggests to me that university presidents who truly understood Public Choice theory and the concepts of rent-seeking and conflict of interest would be worse at their job (understanding the job to be to promote the interests of the university as the highest priority). It's easier to do this if you believe that you are serving the general good while also serving your own interests. Too much of a grasp of these issues would only interfere.

Are university professsors free agents once they fulfill their teaching and committee work? If so, then I'd expect athlete/actor like labor pricing where the best teachers can leverage their brand widely and get absurdly rich doing it, while most will labor along at lower wages and less benefits (or more likely as the proctors and recitation masters at the classrooms all over the world that take the feed from the best professors.

As technology enables this, I would like to see this union busted, in the name of economic liberty.

I'm confident that the classroom experience is oversold. There are some GREAT ones, but the vast majority of classroom experiences are easily outdone with a nice web based instruction tool.

Information technology will disrupt the business models of the university-industrial complex, just like it has others. And at the same time, learning in general is being transformed. It will take courageous leadership to survive.

The way to remain relevant is to provide the best possible learning experience. Pay attention to how MIT is adding value by improving the their teaching methods: http://www.nytimes.com/2009/01/13/us/13physics.html?partner=permalink&exprod=permalink and consider the importance of collaboration and the new workflows it enables.

That economists still do not have a good theory of exactly how innovations in university laboratories eventually result in economic growth. That the comparative static equilibrium approach used in most innovation policy analysis cannot explain how innovation are made and hence what policies are most effective in promoting innovation. That compared to private benchmarks, roughly three to four times as many tech transfer agreements (in dollars) between universities and industry could be made every year than are being made right now. That many of the best ideas of pure theory emerged organically from feedback loops of communication among mathematicians or physicists and engineers or other applied scientists facing technical challenges in product or service innovation.

That's all I've got.

Tell them about the Dissolution of the Monasteries.

Why not talk about the lack of productivity in education at all levels.

It is not just public education that has no productivity growth, private schools have exactly the same problem.

Despite numerous attempts to use modern technology the best education methods are still the teacher on one end of a log and the pupil on the other. The teacher/student ratio remains a major measure of education quality.

The difference between education and health care in this regard is only one of degree -- health care is obviously becoming more expensive then business and/or private individuals are willing to continue supporting. But education is not that far behind.

Your public policy and sociology professors have a lot to say about economics, but know nothing about it.

Not a fact so much as a thought. The nature of these academic institutions seem to be perpetually expansive in nature. Why? If schools are made up by the people in the room, then why constantly find money to spend? I recognize that there are some expensive research cost, but is the constant expansion necessary to a university's success as a place of higher learning

How about the economic properties of knowledge? Specifically, that "knowledge" (whether it be scientific/technical knowledge) is not merely a form of information: although it is a public good, it is usually costly to transmit and acquire, which creates important economic issues for universities and firms.

Although knowledge is a quasi-public good (it is non-rivalrous but is only partially excludable), and can generate increasing returns to scale, it can be very costly to transmit. Costless transmission, which is needed for long-term economic growth, depends on whether knowledge is codified, but codification itself is a costly process that only occurs when the right incentives are in place. Especially nascent forms of knowledge, like that being developed in university laboratories, take the form of tacit "know-how" that is very costly to transmit, and can usually only be transmitted on a person-to-person basis. Cowan, David & Foray (2000) wrote a great paper discussing the economics of knowledge and the incentives driving its codification.

Another important economic consequence of knowledge's unique properties is that it requires a certain level of "absorptive capacity" to acquire new knowledge. As Cohen & Levinthal (1989) observed, this is a big part of the reason firms do fundamental research -- to have the intellectual capital needed to spot and acquire extra-firm knowledge that can be useful for product development.

For universities the economic properties of knowledge have important consequences for university strategy. To be economically useful to firms, new forms of knowledge usually must be transmitted through a person -- usually a professor or freshly minted PhD student working in industry -- and so universities should encourage useful collaboration between students and industry. In addition, one justification for the US Bayh-Dole Act (which granted universities the right to patent and license the outputs of federally funded research) is that without IP protection, firms won't use the outputs of university research because there will be too much uncertainty about whether they can appropriate the benefits of their product development efforts if their competitors have access to the same knowledge. However, if one of the primary economic benefits of university research is to get firms to do their own research, IP restrictions can be welfare decreasing.

Cowan, R., P. A. David, and D. Foray (2000, Oct). The explicit economics of knowledge codification and tacitness. Industrial and Corporate Change 9 (2), 211-253.

Cohen, W. M. and D. A. Levinthal (1989, Jul). Innovation and learning - the two faces of
r&d. The Economic Journal 99 (397), 569{596.

Maybe you could comment on how little many of even the most knowledgeable posters on your economics blog understand about the actual role of education and the economics of universities in competition to fulfill that role specifically.

They deserve some sympathy regarding the accreditation groups. The parents and students and grant-givers and trustees have their say but the people who can truly put a university out of business are the accreditation groups. A lot of resources are wasted at strong schools jumping through hoops for those folks.

I agree with others above that education is a bubble that eventually will burst. Costs can't continue to go up faster than the economic value of an education. Like auto companies going from 3 year to 5 year loans (and houses from 20 yr out to 30 yr mortgages), student loans stretch out longer, but this can't continue indefinitely.

What then?

If you want to understand why costs are going up, you should contact Clark Gilbert at BYU-Idaho. It is one of the only schools in the nation where costs are going down every year. He has numerous insights as to why, and what universities can do about it.

One insight, not too different than what has already been said - Research is one of the most expensive possible ways of increasing the prestige and value of an academic institution.

The reason that research at a university makes sense is they can harness VERY cheap labor. A science or engineering graduate student would be earning 2-4 times what they earn at a university if they were working in the private sector and a post-doc 2-3 times.

This allows universities to have huge bureaucratic and administrative structures while still being competitive in the research market with private institutions.

If you want your students to get better jobs, then do everything in your power to manipulate the US News and World Report rankings in your favor, even if this manipulation is artificial.

Unlike most of the commenters, I am assuming that your talk is about a description of the economics of universities, not a call for what universities should do in the future in response to likely economic trends in the rest of the world, such as those that some respondents think will burst a current bubble.

I wish I could hear the talk, and hope you'll blog it and/or otherwise make your presentation available. The prof's version of the dream of having to take an exam in a class you didn't know you were in is to have to give a talk on a subject you haven't prepped for. Imagining the nightmare scenario where I (a non-economist) would have to step in for you and give your talk, I'd try to discuss:
- the merits of the common statement that a university should be run like a business. Is this valid? Do academics dismiss it to easily? If a business, what kind, what are the products, who are the consumers, and how do we measure productivity?
- what are the currencies in the intra-university economy? What are the modes of trade/barter within the campus? I'm wondering about how universities fit with some of what I've read from Yochai Benkler on "social production", i.e. I may serve on a committee or cover a class with an expectation of reciprocation, and I'm happy if you bring coffee and cookies, but I'd be insulted if you offered to pay me in cash to do those things. But I expect an honorarium if I speak at a different university. Why?
- public choice theory in the context of the intra-university economy. Has any administrative function, from a deans office to a faculty committee, ever voluntarily reduced its size?
- whether university prestige is correlated with the accessibility to either a) good coffee or b) good local ethnic restaurants.

You can't talk about the economics of universities without touching on the practical issue of the present-day endowment crisis. Ie, the disastrous investment returns recently at Harvard and probably other universities, which have slashed the value of their endowments.

It has been conventional wisdom that university endowments were a category apart: they could invest in highly illiquid assets with correspondingly very high investment returns, because their time horizon for investment spanned multiple human lifespans. The recent debacle seems to contradict that. For all its massive losses, Harvard's endowment has merely fallen to its level of 2005 (compared to, say, the S&P 500, which lost more than a decade), but in the meantime the university allowed its expenses to rise by more than 50%, and is facing a severe liquidity crunch as a result.

As a practical matter, money managers for universities will probably face the same constraints going forward as other investment funds. They can't build up a cushion to get through lean times because the political reality is, that cushion will get spent during fat times. So endowments will need to refocus on more liquid investments, and as a result, Harvard and Yale and their would-be emulators can't expect to see the legendary endowment growth of recent decades ever repeated. Any projections made on that basis will have to be revised.

Tell them to look up the work of Terence Kealey, Vice Chancellor of the University of Buckingham in the UK, on the case against government funding of science. Or just watch this video of him speaking on the topic a few weeks ago.

It's mostly bunk.

Too often (for my tastes), university presidents try to justify parts of the operation by pointing to the "economic impact" university budget expenditures have on local economies. While this "job creation" argument can be effective politics, presidents should keep in mind what the central mission of a university is: instruction, research, and service. The role as a redistributor of taxpayer wealth or other funding, while good politics, should be left to the chamber of commerce.

I would just say...
"I understand that you don't have the proper incentives to run your organizations effectively or efficiently, so I'm not bothered by the fact that they are run so poorly."

Pick the low-hanging fruit first. Universities are often small cities, and like all cities they are distorted price systems. The best example is the provision of university parking, which is usually priced in a way that heavily subsidizes solo-driving to campus, and consumes valuable land (if it is above ground) or valuable capital (if it is below-ground). So tell the presidents and provosts that they can make an immediate change for the better by charging a market price for parking.
see http://repositories.cdlib.org/uclaspa/cpo/906/

Why is the state of higher education in the U.S. considered to be so much better than that of K-12? Are feedback/incentive forces pushing higher education toward or away from the state of K-12?

Comments for this post are closed