‘It’s the Economy, Stupid’

James Carville’s famous statement about what drives voting behavior also explains exceptionally well the major challenges facing higher education today. Not recognizing the role of the economy and just haranguing college and university presidents to reduce costs and better prepare students for the labor market largely misdiagnoses the causes of many of higher education’s challenges—and therefore the solutions. Only by understanding the impact of the economy on higher education can policymakers and college and university leaders find a realistic path forward to restore higher education’s contributions to our economy, society and the public good. 

The financial challenges currently facing colleges and universities are in large part the result of how the American economy has evolved over the last 40 years and how institutions have responded to the incentives created by that evolution. The state of the economy in both the short and long run impacts colleges and universities, and absent changes in the path of our economy in the coming years, it is going to be a challenging time for higher education.

Starting with the shorter run, after a challenging few years, the war in the Middle East is adding new financial challenges. The bottleneck at the Strait of Hormuz is creating a significant supply-side price shock that will now need to work its way through the macroeconomy, which will take time. This has several implications for colleges and universities, including direct increases in costs.

These increased costs are very hard to recoup through increased tuition, because families are also facing broad price increases, which are likely to reduce their real incomes and ability or willingness to pay. And if the price increases lead to recession, unemployment will aggravate this challenge. Sustaining tuition revenue in the face of inflation or stagflation is challenging.

Macroeconomists distinguish short-run and longer-run growth. Recessions are short-run reductions in growth, but the longer-run growth rate certainly matters, too. And, importantly, its distribution among workers also matters. 

While we have had good longer-run growth performance, it has not been shared equally, with rising income inequality over many decades. The labor market currently rewards skilled labor (though that may be soon to change). The implications of this for colleges and universities are that it has increased the cost of their inputs (faculty and administrators—even though faculty don’t like to think of themselves as inputs), while the incomes of many of their potential students and their families have not risen as quickly. These students and their families continue to value higher education but find it unaffordable.

Forty years of rising income inequality is not higher education’s fault. It has resulted from technological changes, globalization and macroeconomic policy decisions of the government. While increasing spending on need-based financial aid helps, improving the incomes of the bottom 60 to 80 percent of the income distribution would more directly address concerns about affordability. Only the government can do this. Exempting a large share of the bottom of the income distribution from taxes would be a place to start, as would changes in the minimum wage and cost of health insurance.

Expectations of what the economy will look like going forward also matter— particularly expectations around the labor market. If the job market (short run because of a recession, or longer run because of AI) looks bleak, families may decide not to invest in higher education. That would be unfortunate, because the best protection from a volatile labor market is a great education. No one is sure what the impact of AI will be on incomes across the income distribution, but it is certainly possible that it will worsen the already 40-year trend of rising inequality. The government should be ready to counter this potential outcome. Further increases in income inequality will make higher education even less affordable to large shares of the population.

In part in response to rising costs, policymakers have been questioning the value of the government’s involvement in higher education. If most of the benefits accrue to the individual through higher incomes, then maybe, the argument goes, government should play a lesser role. Such a role would be limited, perhaps, to supporting lower-income students who otherwise wouldn’t be able to invest in their educations. But there are lots of broader benefits to the economy and society from a highly educated workforce. Innovation, productivity advances and a strong economy, all supported by investments in higher education, go a long way in determining our place in the world.

College costs have gone up—even if the (inflation-adjusted) net price paid by most students has declined over the last six years—both because of the returns to skilled labor mentioned earlier, but also because we’ve positioned higher education institutions in the economy in a way that they compete with each other, particularly for students from those high-income families that are benefiting from rising income inequality. Colleges compete not only on price but also on quality, including the quality of amenities not directly related to the quality of education offered. The government actually encourages this competition, through antitrust enforcement.

The short-run and long-run states of our economy are creating significant financial challenges for higher education. Colleges need to do their part and control costs and get graduation rates up—even though the economy makes it harder for both these things to happen. But colleges cannot do everything. Addressing rising income inequality would directly help to address concerns about affordability. That is a responsibility of our government, as is avoiding recession/stagflation and supporting research that contributes to longer-run GDP growth. We would benefit from a new agreement between the government and higher ed, in service of the public good, one that recognizes what each brings to the table.