On Public Funding of Colleges and Towards a General Theory of Public Options.

Via Aaron Bady, here is Colleen Lye and Chris Newfield, from “The Struggle for Public Education in California” (in the South Atlantic Quarterly, Spring 2011).  If we want to wonder why public education is becoming expensive it is in part because we aren’t supporting it as much as we were in the past. I need to file the second paragraph below as a great observation on some of the consequences of “pity-charity liberalism.”  Quote (my bold):

California, one of the world’s wealthiest places, has seen one of the world’s most astonishing declines in college achievement. The state’s continuation rate, the proportion of students starting college who complete it, fell from 66 percentto 44 percent in just eight years (1996–2004). California’s rank among states in investment in higher education declined during the same period,from fifth to forty-seventh,according to Tom Mortenson, a higher education policy analyst.The state has cut its investment in higher education by close to 50 percent since 1980, forcing tuition increases like the 60 percent rise at the University of California from 2004 to 2008, which was followed by a 32 percent rise between 2009 and 2011. Meanwhile, half of California’s students (kindergarten through grade twelve) are now eligible for thefederal school lunch program, up from one-third in 1989. As Mortenson notes, these students will have no personal resources to cover the costs ofattending college, which at UC is nearly $30,000 per year.

Throughout this period, the Democratic opposition came to accept the description of the public infrastructure as a “safety net”—something remedial, for society’s alleged losers. Higher education by its very nature falsified this idea, since it was a public investment that created and constructed new technology and new ideas, new craft knowledge, new andmore effective economic and sociocultural systems. Specialists were well aware that public funding was the only source of support for the early development of scientific and cultural knowledge, for fundamental experimentation, for breakthrough creativity. And yet even progressive politicians seemed unable to learn a basic concept like “market failure” that had been part of economics since the 1950s. They accepted the premise that public outlays could and should be replaced by private funding wherever a higher education manager expressed an eagerness to try.

Lots of people are talking about the financing of public universities and the current student debt crisis. Yglesias notes “The current incentive structure points toward always reinvesting excess money into moving up the prestige hierarchy rather than toward lowering prices to broaden the customer base” while responding to Freddie DeBoer. But how can Yglesias’ description happen in a competitive market? We have to look at a situation where a producer of a good has some monopoly pricing power combined with a strong inelasticity of demand on the part of consumers.

One of the general principles of a neoliberal approach to providing goods is that it is better to give people cash to spend among private providers of a good rather than the government provide these goods themselves at a discount. Giving people cash fosters competition, innovation and choice, while the government providing goods directly at a discount will likely lead to stagnation, dependency and wasted resources.

But that’s in a perfectly competitive market. What happens when we have producers with pricing power and where demand for a good – say because education is the main source of socio-economic mobility in this country – is inelastic? What if we decide to give people cash instead of directly providing a good at a discount? We can expect incumbent institutions to simply capture that money as a rent.  Is replacing public provisioning of colleges with pell grants and student loans actually helping students with college costs or is it simply increasing tuitions?

I encourage you to read JW Mason’s post Public Options: The General Case, which fleshes this case out.  It’s one of my favorite posts on the internet. Mason (my bold):

Under what conditions does public spending on higher ed increase the number of people in college, and under what conditions does it just enrich Kaplan and the Harvard endowment? More broadly, it seems to me that the price effect of subsidies is a neglected argument for direct provision of public goods.

Formally, a subsidy is just a negative tax, and like a tax, its incidence depends on the relative elasticities of supply and demand. If supply is less elastic than demand, most of the cost (of a tax) or benefit (of a subsidy) will fall on the producer; if demand is more elastic, most will fall on the consumer….

The interesting question is what happens when we generalize this logic to other areas, like higher education. Imagine a state that’s considering a choice between spending, let’s say, $1 million either subsidizing its public university system, enabling it to keep tuition down, or as grants to college students to help them pay tuition. On the face of it, you might think there’s no first-order difference in the effect on access to higher ed — students will spend $1 million less on tuition either way. The choice then comes down to the grants giving students more choice, fostering competition among schools, and being more easily targeted to lower-income households; versus whatever nebulous value one places on the idea of public institutions as such. Not surprisingly, the grant approach tends to win out, with an increasing share of public support for higher education going to students rather than institutions.

But what happens when you bring price effects in? Suppose that higher education is supplied inelastically, or in other words that there are rents that go to incumbent institutions. Then some fraction of the grant goes to raise tuition for existing college spots, rather than to increase the total number of spots. (Note that this must be true to at least some extent, since it’s precisely the increased tuition that induces colleges to increase capacity.) In the extreme case — which may be nearly reached at the elite end — where enrollment is fixed, the entire net subsidy ends up as increased tuition; whatever benefit those getting the grants get, is at the expense of other students who didn’t get them.

Conversely, when public funds are used to reduce tuition at a public university, they don’t just lower costs for students at that particular university. They also lower costs at unsubsidized universities by forcing them to hold down tuition to compete. So while each dollar spent on grants to students reduces final tuition costs less than one for one, each dollar spent on subsidies to public institutions reduces tuition costs by more.

The same logic applies to public subsidies for any good or service where producers enjoy significant monopoly power: Direct provision of public goods has market forces on its side, while subsidies for private purchases work against the market. Call it progressive supply-side policy. Call it the general case for public options. The fundamental point is that, in the presence of inelastic supply curves, demand-side subsidies face a headwind of adverse price effects, while direct public provision gets a tail wind of favorable price effects. And these effects can be quite large.

This argument seems straightforward and logical, and has some empirical backing. But it’s only very rarely made in support of direct provision of public goods. One can speculate why that might be. But the important thing is those of us seeking an incremental de-marketization of society, should recognize that the logic of the market is often on our side.

There’s more at the post, including a critique of the EITC using the same model. I like the idea of a progressive supply-side along these terms, where the government is in the business of fostering opportunities for its citizens rather than bribing incumbent institutions while further extending and entrenching their monopoly powers.

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20 Responses to On Public Funding of Colleges and Towards a General Theory of Public Options.

  1. Tim says:

    That’s a new way to look at the problems of higher ed. I’ll have to give this one more thought, thanks for the post & referral.

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  3. First of all, is California the best example? Their budget is such a mess all around, so perhaps there are other states to look at that would be more aligned with national trends.

    Second of all – and more importantly – pricing of anything needs to reflect costs of doing business. Public institutions of all kinds, not just higher education, need to attract an excellent talent pool to remain competitive and offer a great service to their customers. Recently, we’ve seen in many states – Wisconsin is an example – that public spending on the salaries and benefits of public employees has become an explosive topic.

    In private companies, top tier leaders command an increasingly large compensation package, compared to their employees. The rising inequity we’re seeing in private sector salaries is having an impact on the costs of talent acquisition in the public sector.

    We see this in academia. Presidents of private colleges are now much more frequently getting million dollar salaries. Professors, too, get more money at a private institution. How will you get great talent in the public university if salaries are significantly lower than in the private sector?

    Public hospitals have to attract great doctors and administrators – but are paid by tax dollars. Yglesias recently had a blog post about the uproar over the salary of the head of a public hospital in NY. Attracting the talent you need if you can’t pay them a competitive wage is an impossible job. Isn’t that supposedly why our financial regulatory arm is so weak? Those with all the brains would never settle for a piddly federal salary when there’s so much money to be made on Wall Street? [And what universities are most represented on Wall Street? State universities? Or the Ivies?]

    After decades of stagnant wages for most Americans, there is a massive need for affordable higher education. If “the logic of the market is on our side,” we need to recognize that compensation in America has become lopsided in ways that impact the cost of doing business as a public institution AND the ability of our citizens to pay for college. I’m not sure the supply side model accurately reflects that issue.

    [Can you please explain how the Harvard endowment is enriched by federal investment in public colleges?]

    • Tim says:

      From personal experience, I can tell you that it’s a fundamental misunderstanding to try to understand why faculty (not necessarily the administration, unless it’s drawn from the faculty) works at any specific university purely through the lens of salary. Often the major determinant is non-monetary, such as who they can work with on research, what kind of research the institution specializes in, personal ties to either the area or the university itself, etc.

      The key is to pay them respective to the amount of work and cost it takes them to receive their positions. So as the cost for attending university explodes, of course you would have to pay them more since no one enjoys a mountain of debt for 15 years. However, if education is much more affordable then you don’t need these rock star wages.

      • Tim – I agree that many who work at public institutions are oddly motivated by elements other than money. But if you are looking to “the logic of the market” to help determine the costs of providing public higher education, the cost of competing with the private sector for talent needs to be considered. To ignore that reality flies in the face of market pressures.

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  5. Ripley says:

    Main street muse, the logic of market must take into account people’s actual preference, whatever they may be. It is odd to say that because we are considering a market solution, we should ignore people’s preferences that are not defined narrowly in terms of salary. (Sounds like “looking where the light is” instead of where the wallet was lost, to rehash the old joke about the economist who lost his wallet in a dark alley but spent all his time searching under the streetlamp at the corner)

    People considering jobs in education are not odd to consider reputation of department faculty, collegiality of work atmosphere, ability to find work for a spouse or partner, availability of childcare, location, sabbaticals, travel, etc in their choice of work – especially because universities historically explicitly compete on many of these grounds, they know they cannot always offer salaries but they CAN offer advantages that many people would spend their salaries on (were they even able to).

    • Ripley – you are right, “odd” was an inappropriate choice of word for the issue of salary. I am one of those who judge compensation by more than the dollar amount, but since the collapse of the financial sector, I’ve been shocked and awed by the salary demands of people in finance, many of whom seem to be rather bad at their job.

      As you note, there are many factors to consider that draw people into the university sector. However, salary is a big factor in compensation and the astronomical rise of executive salaries in recent years creates a challenge for public institutions interested in acquiring top talent. They cannot afford to let the salary gap grow too large.

  6. Mark T says:

    Interesting, thanks. I take it the author is opposed to Pell grants. It would be interesting to experiment by diverting all Pell grant money along the lines he suggests.
    However, while I agree with the negative part of his piece (that handing out tuition subsidies to consumers drive up cost), I think the positive case is much weaker than he acknowledges because it depends on a terribly naive world view. Handing the same amount of money to the institution rather than the consumer is unlikely to reduce prices dollar for dollar, rather, the money will simply be redirected toward other things that the people running the university value – nicer offices, more faculty, more fringe benefits for staff, more esoteric departments and courses, etc.

    I also suggest the remorseless rise in higher ed cost plays a role in income inequality. Not in respect of the top 0.1 %. obviously but in the neighboring percentiles.

    • JW Mason says:

      Mark-

      I’m not necessarily against Pell grants or other targeted forms of education aid. I just think we need to recognize that its function is mainly to redistribute the existing spots in higher education, rather than to increase access overall. In the same way, I support rent control because it contributes to stable, economically-diverse neighborhoods (and recognizes the quasi-property rights of tenants), but I recognize that it may not do much to increase the supply of affordable housing.

      On the other side, obviously it’s an empirical question how much of an incremental dollar in subsidy to a public institution goes to increase capacity, and a practical policy question how easy it would be to raise that proportion, if it’s low. Hopefully I’ll be able to return to those questions at some point. But historically, you have to admit, there was a long period in which public support for higher education mainly took the form of subsidies to institutions, during which capacity rose a lot and prices rose relatively little; and there has been a subsequent period in which support for higher education has increasingly taken the form of aid to individuals, during which prices have risen a lot and capacity relatively little. Which is at least consistent with the argument of the post.

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