News & Events

Response to Moody’s Outlook on Higher Education

Accepted for publication in abbreviated form by The Financial Times

Catharine Bond Hill

President, Vassar College

February 15, 2013

It is no surprise to any institution of American higher education, or any other sector of the economy, that the recession continues to create challenges. The appropriate response, however, depends very much on one’s expectations for the performance of the economy in the future, and whether some of the shocks we’ve experienced are short-run, cyclical shocks or longer-term trends. The recent Moody’s report, “US Higher Education Outlook Negative in 2013” does little to address these issues, which are critical to appropriate policy responses.

As an economist and college president, I find Moody’s negative outlook on (all of) US higher education puzzling on a variety of fronts. Their analysis is in fact more a statement about the recent, current and expected state of the US economy than an evaluation of how higher education has or should adapt in the next year or so.

I am very much reminded of my prior work as a development economist. This involved thinking about the appropriate response to changes in commodity prices for developing countries that earned significant foreign exchange through exporting such goods as diamonds, copper and coffee. The appropriate response to changes in commodity prices and the value of these exports depends on the extent to which the price change is considered to be temporary (and therefore cyclical) or permanent (and therefore a change in longer-term trend.)

The appropriate response to a cyclical change is to recognize its temporary nature, and not allow significant changes to the structure of the economy as a result of these price movements. If permanent, adjustments are warranted that would not be, were the drop in prices only cyclical. Of course, it is often difficult to know exactly which shocks are permanent and which are temporary, but making some judgment about this is important to good policy responses. There is a tendency to assume that positive shocks are permanent and negative ones only temporary. Yet when wrong, this assumption leads to inappropriate policy responses. This is as true for institutions of higher education as it is for commodity exporting countries, and is part of the explanation for the problems currently facing many colleges and universities.

The appropriate response of the higher education sector to these problems -- developments such as falling family incomes, reduced support from state governments, and poor returns on endowments -- depends on whether they are temporary or permanent, but the Moody’s 2013 report does not really help elucidate this difficult question.

Consider the following challenges:

Income Growth

One of the most important developments in the US economy going forward that will affect higher education is the growth of real incomes. During the last decade, the real incomes of families across the income distribution suffered. This has been a major cause of the downward pressure on tuition increases at many institutions of higher education. A major source of uncertainty is what is going to happen to real incomes going forward. If real income growth picks up, so will the ability of some institutions to increase tuition.

The distribution of income across families also matters. One of the challenges of the last few decades has been that real income growth has been very skewed toward higher income families. This has created significant challenges for higher education. The highest income families are willing and able to pay the full sticker price. And schools compete for these students, supplying the services that they desire, pushing up costs. At the same time, schools have been committed to increased socioeconomic diversity. With lower income families’ incomes lagging behind the top groups, greater need for financial aid results. If the income distribution were less skewed, the demand for services at one end on the part of higher income families and the need for financial aid at the other on the part of lower income families would moderate. Therefore, growth going forward in family incomes and its distribution are important to the pressures that institutions of higher education will be facing over the coming years.

During a recession, schools should expect to face pressures on tuition increases and financial aid, as unemployment and slower wage growth affect family incomes. But, schools should attempt to smooth expenditure responses over time, since those students who happen to be in college during recessionary years shouldn’t bear the cost of the recession in terms of the quality of their education. For many institutions, expense control during recessions, through one-time savings or reductions, make sense.

Funding Public Higher Education

Many challenges are cyclical, and can be expected to improve with improvement of the economy. On the other hand, an expectation that the public sector of higher education faces longer-term muted revenue growth is realistic, given demands on state budgets. This has pushed up tuition by significant amounts, much more rapidly than in the private, non-profit sector. This is in fact much of the source of the public outcry against the cost of higher education. But, this is the result of decisions on the part of state governments and the electorate to allocate resources to other areas, including medical expenditures and prisons, and is not the result primarily of increasing costs (as opposed to tuition) at the public institutions. In the absence of a change in priorities, public higher education will need to adjust to reduced support from state governments. And, families will have to pay more of the cost than in the past, through tuition increases.

Moody’s also cites decreasing the fiscal deficit as a negative factor for higher education. If the deficit is cut too quickly, and pushes the economy back into recession, this would be the case. But, the reason for worrying about a long-term deficit is its effects on long-term growth of the economy. The real worry about long- term deficits is that they crowd out more productive private sector investment, reducing long-run growth. So, if we successfully reduce the long-term deficit, it should improve growth in the U.S., which is the whole point. This would be a positive for higher education. It is of course possible that the policies adopted to reduce the deficit will be ones that harm higher education, but hopefully these can be avoided. It is understood that investment in education and skills is also needed to support the growth of the economy. So, the same justification for worrying about long-term deficits should encourage policy makers to protect education as they reduce the deficit.

Market Returns

Moody’s negative outlook for higher education also was based on financial market returns in 2012, since part of the sector relies on endowment earnings and because low returns can affect giving. Again, what really matters for higher education is the long-term return expected in the coming years. Financial markets are volatile, and institutions should plan based on longer-run average expected returns. Of course, there is uncertainty around this, but the one-year number gives us very little information about the future. It may be prudent to not be too optimistic about this number, but it is also possible to be overly pessimistic and disadvantage current students at a time when the return to higher education suggests that we are investing too little, not too much.

Labor Costs and Tenure

Among the recommendations of the Moody’s report is that tenure needs to be modified. After a period of high unemployment and job insecurity for many, the antagonism to the institution of tenure from the non-academic world seems to intensify. But, there is little evidence that tenure has been responsible for the challenges facing American higher education in the last few years. Tenured faculty account for a shrinking share of the academic labor force, so if anything, things are moving in the direction recommended by Moody’s. And, it isn’t clear how reducing it further would address the challenges the sector is facing. It is suggested that changes would allow higher education to reduce costs by hiring less expensive adjuncts. This seems to get very close to recommending age discrimination as a solution to the cost of education challenges. If it isn’t this, then it is a suggestion to replace full-time, tenure track faculty with less expensive adjuncts, assuming that they are very close if not perfect substitutes for each other. It is not clear that this can be done without reducing the quality of the faculty employed, as is the case in almost all labor markets. Tenure does reduce the flexibility of the institution to respond to some changes, but not significantly. If total compensation needs to be cut, there is usually some ability to change headcount, and there is always the ability to change salary and benefits, regardless of the institution of tenure.

Moody’s suggests that the high costs of labor result from the guaranteed employment through tenure. In fact, the high costs result because higher education is one of the most skill-intensive sectors in the economy, and part of the reason for the increasing income inequality in the US is the returns to skilled labor across the economy. Were tenure eliminated, but the quality of the labor force maintained, it is conceivable that the costs would actually increase. With less job security, attracting equally skilled people into the profession could command a premium. Suggesting that costs could be reduced by cutting back on tenure assumes that there is an excess supply of talented people willing to take these jobs. While this might be the case in the short run, in the longer run, fewer skilled people would be attracted to academia. To think that this wouldn’t affect the quality of the education offered suggests a lack of understanding of the sector, and that somehow market principles that apply in other sectors somehow don’t in higher education.

Cost of Student Services

Moody’s also suggests that higher education needs to figure out how to control costs by containing student services. This is partly a similar phenomenon to that discussed above, regarding the pressures put on schools as a result of increasing income inequality and higher income families demanding more services and being willing to pay for them. But, another view on this is greater success in recognizing the needs of students, whose needs previously just would not have been met. For example, campuses are significantly more ADA accessible, offer assistance to students with learning differences, and also address a variety of mental health issues. We could cut costs if we didn’t do any of these things, but this would exclude a group of students from higher education. It is better for them and for society if they can achieve a higher education.

Online Education Models

What about MOOCs? Challenge or opportunity? Higher education, like dentistry and the legal profession, has experienced increasing costs because of the increased returns to skilled labor in the economy in the absence of the productivity increases that other sectors of the economy have experienced. Perhaps MOOCs or some other closely related innovation will allow for some productivity increases in higher education. To date, we have not figured out how to teach more students with a given size faculty, without reducing quality. Reducing costs, while maintaining quality, is the challenge. The new technologies are promising, and work is underway to determine their potential impact on both cost and quality. Our society would benefit tremendously from productivity increases in the higher education sector. If we can educate more people or lower costs, while maintaining quality, we can contribute to increasing growth and incomes.

Will this be disruptive to higher education? Possibly. Technology will potentially replace some things that faculty currently do, for example lecturing. But, faculty will then be able to specialize in teaching where they are most valued, interacting with students in the learning process. If we increase the number of students we educate, which is one of the ways we’ll benefit from productivity advances in this sector given the returns to higher education, there could be increased demand for the services of faculty, improving job prospects in higher education.

The Boom Years

Some of the challenges facing higher education after the 2008-09 recession have resulted from our being overly optimistic earlier in the decade, and to some extent making the mistake that the boom years were going to continue indefinitely. This is the same mistake frequently made by commodity exporters, assuming price booms are permanent, rather than temporary.

It would have made sense to recognize that the boom was temporary and not let it fundamentally change our cost structures. Instead, many institutions increased spending, rather than saving for the inevitable leaner years. Some of the spending took the form of capital projects, and this to some extent is less of a problem. This is a form of investment and savings, and will yield a stream of services to the institution over many years to come. Investing in needed capital projects during boom periods is not a bad strategy, as long as there is not overbuilding that cannot be supported during down years. (An example might be dorms that cannot be filled.) But, tuition increased at rapid rates given increases in real incomes and wealth of the top end of the income distribution and operating expenditures increased as well. In retrospect, it would have been better to moderate spending and tuition increases, recognizing that the boom would not continue indefinitely. Of course, given that the 2008-09 recession was the largest since the Great Depression, no one could have reasonably been expected to predict its severity. And, during the boom years, the wealthier schools were actually being criticized by policy makers, including Senator Grassley, for saving too much. There were concerns that higher education was receiving a public subsidy, which was not intended to contribute to accumulating additional wealth.

Given the response to the boom of the last decade and given the severity of the 2008-09 recession, colleges and universities have needed to adjust and many have and continue to do so. But future challenges depend on longer-term trends in the US economy. Longer-run real income growth and real returns in financial markets are key, and the Moody’s report sheds little light on these. Given the importance of investment in education (human capital to economists) to both long-run growth and its distribution, it would be ironic if we cut education worrying about future growth and real returns.

The Future

There are many reasons to be optimistic about American higher education:

• The economy is coming out of recession, one of the worst experienced by the US in the last century.

• Pessimism about our long-term growth prospects seems more a reaction to the difficult recession than anything else, and policy makers are taking actions to encourage long-term growth, recognizing its importance.

• If the government addresses its deficit issue over the longer term, for example, without jeopardizing the shorter-term economic recovery, this will contribute to our long-term growth prospects.

• Technological advances are creating opportunities in higher education for long elusive productivity advances. Although potentially disruptive for some, they could also contribute significantly to our long-term growth prospects.

While the recession and its aftermath have been painful, and we continue to face a variety of challenges, higher education is incredibly important to the future prosperity of the United States. We should be careful to distinguish the short-run from the long-run challenges, and respond with the long run in mind. 

Posted Friday, March 15, 2013