Should Harvard pay out less?

Larry Summers says it is worth a rethink:

Former Harvard University President Lawrence Summers suggested that the school consider curbing annual payouts from its world-record $37.6 billion endowment to reflect the likelihood of lower investment returns.

Real, or inflation-adjusted, short-term interest rates have been falling steadily since 1999 and are effectively projected by financial markets to be around zero percent in the long-run, Summers said in a presentation Friday to a National Bureau of Economic Research meeting in Cambridge, Massachusetts, where Harvard is based.

“If it makes sense for Harvard University to pay out 5 percent of its endowment in 1999 when the real interest rate was 4 percent, it’s really quite unlikely that it makes sense to pay out 5 percent of its endowment in 2016 when the real interest rate is zero,” said Summers, a former U.S. Treasury secretary who is now a professor at Harvard.

I’ve never had a good handle on what you might call “the welfare economics of endowments,” in part because I don’t think economists have a good theory of endowments period.

One normative view is that if g > r, funds should simply accumulate in the endowment, more or less indefinitely, to further maximize societal wealth.  The g > r condition might hold for Harvard, though it is hard to measure what the school’s borrowing rate consists of.  Arguably new money at the margin comes from donations rather than from loans or bond issues.

A second view is that inequality is bad, and institutions tend to become sluggish and excessively bureaucratic in the longer run.  Perhaps every now and then they should be required to “start afresh”; a’ la Jefferson: “every now and then higher education must be refreshed…” etc.  That would suggest a higher payout rate.  You will note that the law mandates a payout rate of five to six percent for charitable foundations; Harvard isn’t a foundation, but analogous factors might apply.

A third view is to note that income inequality has gone up, and that means higher returns from investing in Harvard students, even if overall rates of return in the economy are low.  We know that the variance of corporate returns is much higher than it used to be, and many of those successful corporations stem from Harvard, MIT, and Stanford, among other top schools.  That would suggest spending more money today, because the Harvard endowment may not always be so valuable in terms of the uses to which it can be put.  Low rates of return on (most) investments are more reason to follow this advice and keep on spending, not less reason.  Can you imagine a better investment these days than Harvard human capital?  You will note that in this view “keeping Harvard at the top,” while a goal, is not the number one consideration.

There is something to be said for all of these perspectives, but mine is closest to number three.  In any case the question deserves closer consideration than I see it receiving.


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