Why is College so Expensive?

44 million Americans collectively owe $1.5 trillion in student debt, a 457% increase since 2003. 

Since 1991, tuition has increased by more than 300%, according to the US Department of Labor’s “tuition and school fees” component of the Consumer Price Index. Tuition isn’t rising because professor pay has increased. Instruction costs accounted for only 28% of cost increases from 2000 to 2010. Faculty salaries have not risen proportionally to these tuition increases.

Why is the cost of college rising so fast?

Two theories named (1) Baumol’s Cost Disease and (2) the Bowen Effect account for the rising cost of a college education.

(Editor’s note: I want to remind you that college education is outside my circle of competence. Please take everything with a grain of salt. I am a curious outsider, perplexed by the rising costs of college. If you have a different perspective, I want to hear it).


Baumol’s Cost Disease

Baumol’s Cost Disease explains why some sectors of the economy become more productive while others stagnate. William Baumol’s original study, published in 1966, covered the performing arts sector. He found that, compared with the 19th century, orchestras require the same number of musicians to play a Beethoven string quartet. In the meantime, the real wages of musicians had skyrocketed.

Arts institutions had to increase their wages in order to attract the best musicians. Due to cost increases, the productivity, defined as the effectiveness of productive effort measured by the rate of output per unit of input, had fallen since the 19th century. In productive industries, firms increase their productivity each year. When they do, they get more bang for their buck. But in some industries, particularly labor-intensive ones such as the symphony, productivity doesn’t increase as fast.

In short, higher education has a volume problem. Each year, universities hire more and more administrative staff. As a result, overhead, administration, and tuition costs have exploded. The university system is a tangled, redundant, inefficient cobweb.

Figure 1: Expenditures for academic functions and faculty salaries have not increased as fast as tuition prices. Source:  Alex Danco.

Figure 1: Expenditures for academic functions and faculty salaries have not increased as fast as tuition prices. Source: Alex Danco.


The Bowen Rule

The Bowen Rule’s influence on rising education prices is twice as strong as Baumol’s Cost Disease. Writing in 1980, Howard Bowen, the president of Grinnell College argued that non-profit universities will spend everything they have. If you increase their revenue, their costs will go up too. This creates a revenue-to-cost spiral: higher revenues lead to higher costs, and higher costs lead to higher revenues.

Bowen wrote:

“Administrators have an incentive to spend every dollar that is available. They cannot spend more without appearing incompetent, but spending less would forgo the opportunity to make some members of their constituencies happier. Whatever is available is spent. … Revenues are the lid on expenditures during each period. Since existing resources are frozen in place, the resources required for the new initiatives that arise each year can only come from new revenues. Some of these new initiatives will be driven by competition; most will be the pet projects of faculty, administrators, or board members.

In business, new initiatives are chosen on the basis of their expected return. In higher education, priorities are determined by internal politics.

Because all the revenues are spent each year, costs typically increase as a result of these initiatives. If money is given to faculty to start a new program, for instance, that additional money will be expected in the next academic year as well.”

The Bowen Rule, also known as the “revenue theory of cost” is governed by five rules:

  1. The dominant goals of institutions are educational excellence, prestige, and influence.

  2. There is virtually no limit to the amount of money an institution could spend for seemingly fruitful educational ends.

  3. Each institution raises all the money it can.

  4. Each institution spends all it raises.

  5. The cumulative effect of the preceding four laws is toward ever increasing expenditure.

Even when universities raise money, they don’t have an incentive to save it. If they raise more than they need. It is hard for prospective students to judge the quality of an undergraduate degree. Students only purchase the degree once, so universities don’t worry much about satisfying repeat visitors. Many equate a university’s sticker price with the quality of an education, causing colleges to spend as much as possible per student, which drives prices up. When they’re applying for university, students can’t gauge the quality of an education. To be sure, actual tuition hasn’t increased as much as posted tuition fees. But the effects are still dire.


The Incentives

Limited by imperfect information, students favor the schools with the best reputations. To maximize prestige, colleges invest in peripheral, reputation-building assets such as rock climbing walls, movie theaters, and dorm rooms that are fancier than the local Hyatt hotel. As a university’s reputation increases, so does the inflow of grants, donations, and research contracts. As long as money is available, it will be spent. As long as it’s spent, total costs will increase, thereby causing costs to skyrocket.

That’s why tuition costs are rising so fast.


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Special thanks to Alex Danco, whose post on college education inspired me to investigate these ideas for myself.