Why Colleges Act as They Do

Researchers' framework for analyzing public and private colleges' pricing and enrollment strategies suggests that federal aid drives up private college tuition.

August 13, 2013

Do increases in federal spending on student financial aid drive up college tuitions? Do cuts in state budgets for public colleges impede college-going? Do public and private colleges admit and award financial aid in similar or different ways?

Research on higher education tends to have difficulty answering such broad questions because there is so much variation among states and such great diversity in the types of postsecondary institutions.

But several economists believe they have developed at least the beginnings of a theoretical framework to examine how state and federal funding affect the American higher education system, writ large. In a paper released by the National Bureau of Economic Research (abstract available here, though the study itself is behind a paywall), the researchers assert that the model they've created -- accounting for institutions' differing missions and students' differing economic and academic backgrounds -- can begin to answer some of the questions that divide researchers.

They answer yes both to federal spending driving up tuitions, at least at private colleges, and to cuts in state financial support resulting in lost enrollments at public four-year colleges.

And private institutions are likely to bristle at the researchers' assumption that public and private colleges have differing objectives -- with public universities (prodded by state officials) focused mainly on providing affordable education to in-state students, and private colleges driven mainly by trying to maximize their quality and reputations -- that influence how they enroll students. (Independent college officials also won't like the researchers' statement that they "game" the federal financial aid process.)

The researchers concede several limitations to the framework so far, notably that it ignores two-year institutions and does not differentiate among strata of public colleges. Those concessions to simplicity undercut some of the study's conclusions, since some elite public universities behave a lot more like well-endowed private universities in terms of pursuing wealthier students and rankings glory.

Building the Framework

The economists -- from Carnegie Mellon University, the University of Florida, and the University of Pennsylvania -- have sought to create a model for analyzing how postsecondary institutions, driven by federal, state and other sources of funding, compete for students. "We want to understand the dynamics that are leading to the differences in costs to students that you see at different institutions," said Dennis Epple, a co-author and Thomas Lord University Professor of Economics at Carnegie Mellon's Tepper School of Business.

Given this reporter's lack of an economics Ph.D. (and a C+ in Econ 101 in college), this article doesn't venture to try to explain how the model works. Suffice it to say that the authors believe they have created a model that accounts for students' choice preferences and academic and socioeconomic backgrounds, as well as colleges' characteristics (endowment size, percentage of in-state vs. out-of-state students, etc.) and missions.

The latter is among their more controversial assumptions. They start with the view that "neither public nor private [colleges] are likely to maximize profit," but go from there to say that private institutions are motivated "primarily" by a desire to maximize quality (in terms of which students they admit and how much they spend to educate them) in pursuit of "legacy or reputation."

Public colleges, by contrast, are compelled to "provide affordable education to in-state students" by state policy makers, who also impose price caps and largely control financial aid policies, the researchers argue. (Skeptical policy analysts are likely to point out that many public flagship universities have significant control over their tuition-setting policies and use their own institutional funds to chase high-quality students just as some private institutions do.)

It's not that public colleges do not pursue high-achieving students, said Richard Romano, Gerald L. Gunter Memorial Professor at Florida's Warrington College of Business Administration, but that they want top in-state students to fulfill their state mission, and high-achieving out-of-state students "because they can be good students and good peers" to the in-state students -- "and they are able to get more tuition from them."

Aren't some of those institutions also interested in rankings "legacy and reputation" in the form of rankings success? "Some of the public institutions probably act more like privates," Romano conceded. (The opposite may also be true in some cases, with some private colleges -- by choice or not -- focusing not on high-achieving students but on academically and socioeconomically disadvantaged students.)

The assumptions the researchers have built into their framework, when populated with data and computed, largely matched the aggregate distribution of students and the amounts of need- and merit-based aid awarded by four-year public and private colleges in 2007-8, though they acknowledged that they have much more work to do to validate the model. The early analysis, they said, gave them confidence that it "can be used to evaluated recent policy changes that have been enacted in the U.S.

The Policy Experiments

Using their framework, the researchers play out two major shifts: the roughly $2,000 increase (from $6,000 to $8,000) in maximum federal aid per student under the Obama administration, and the shift of roughly $2,000 per student that has occurred as states have cut their operating support for public colleges and increased student tuitions.

In terms of the major investment the Obama administration has made in student financial aid, the researchers find that it has had relatively little positive effect. "The increase in federal aid results in only about a 1 percent increase in college attendance of the potential student population," virtually all at state colleges and most of it among "low-ability students" and "middle-income students of very high ability." (For-profit colleges -- which received a sizable amount of the additional federal aid -- were like community colleges not examined in the study.)

The average federal aid to students at private colleges raises by $1,100 in this analysis, with tuition rising by $440 and the average award of institutional aid falling by the same amount. The average change in student cost at private colleges drops by $630.

"Hence, roughly 40 percent of the increased federal aid is offset by a reduction in institutional aid, with private colleges using those funds instead to increase expenditure on educational inputs," the authors write. "The private colleges also become a bit more selective, this entailing some substitution of high-ability middle-income students for lower-ability rich students. Hence, average income of students at private colleges declines somewhat."

At public colleges, the average federal aid rises by about $240, they find, and the average student cost drops by roughly $50.

"If the policy change is intended to increase attendance by the poorest students, it does so, but the effects are very small," the researchers write. "Cost saving to state college students is small and only moderate at private colleges."

Assessing the changes in state funding policies also produces disappointing results.

"Over all, enrollment in all colleges drops substantially by 3.2 percent of the potential student population, or 8 percent of the pre-change college student population," the authors find. The reduction is entirely at state colleges (private colleges actually see enrollments rise slightly), and low-income students are disproportionately affected. (Whether they end up at two-year colleges or out of higher education entirely isn't clear in this analysis, since the model focuses only on four-year colleges.) The average student cost at public colleges rises by $1,768, with the full impact of the state cost shift moderated only slightly by the increase in federal aid.

The "attendance and cost effects, especially for the poor, of these state policy changes are dire," they conclude.

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