Sunday, September 24, 2006

Information Costs: Key Part of University Economics

By Richard Vedder

One of my academic friends, the distinguished economic historian Douglass North, won the Nobel Prize in Economic Science in 1993 in large part by showing over and over again how transactions costs played a major role in the evolution of our modern economy. Similarly, Friedrich Hayek and George Stigler earlier won Nobel prizes for showing how information and the cost of acquiring it were key to understanding markets and their operation.

Information and information costs play critical roles in explaining much of the peculiar economics of American universities. As I have argued earlier, there are high information costs for employers wanting to learn about the probable success of potential employees. A large part of those costs are the result of restrictions on employer testing resulting from the Griggs v. Duke Power Supreme Court decision and other laws and regulations. Universities exploit this information cost problem. A college diploma provides valuable information (namely that the individual is probably fairly literate, dependable, and intelligent) at low cost to the employer, but not to society. This increases the demand for college graduates, raises their salaries, and also increases the demand for college educational training, thereby increasing tuition charges.

While colleges exploit ignorance (lack of information) about job candidates in a way that raises tuition charges, they have unique legal rights allowing them to lower information costs in another critical area --learning about the financial condition of prospective students. Specifically, colleges can and do legally request information from applicants on all sorts of highly private financial data that usually suppliers of services do not and cannot request from their customers. Indeed, the federal government aids and abets this by providing the FAFSA form and in providing loans to students. Universities engage in price discrimination to a much greater degree than otherwise possible because they are able to obtain, at no cost to themselves, information on student ability to pay tuition. As indicated in an earlier epistle, this price discrimination serves to reduce what economists call consumer surplus, lowering the economic welfare associated with attending college.

Thus there is a great asymmetry at work -- on the one hand universities exploit a lack of information for their own advantage, while on the other hand they engage in practices that allow them to gather information for their advantage in a manner unavailable to other providers of goods and services.

In still another area, universities have consciously and deliberately worked to maintain high information costs. They have not provided clear information to consumers about the gains from attending college (the "value added"), not for example testing their students upon entrance and exit in order to see how much new knowledge was acquired during the college experience. Similarly, they have been less than transparent in providing information to potential customers as well as financial benefactors (including taxpayers) on their financial operations. They do not operate in a transparent manner -- customers and providers of funds for operations live largely in a veil of ignorance. The Spellings Commission's call to change this state of affairs is most welcome. We will learn tomorrow how Secretary Spellings and the administration views that commission's work (she is speaking at the National Press Club at 1:00 p.m. --I suspect CSPAN will cover it), and I will be there to here what she has to say.

The irony of all this, of course, is that universities are in the business of creating and disseminating information. Having a large portion of the citizenry with a college education is alleged to have positive spillover effects on society because some of the information and transactions costs associated with human economic interaction are overcome by having a population with common knowledge of key types of information important to efficient market transactions. The universities use this argument to justify the large third party subsidies that sustain them, and that have contributed to inefficiencies, high consumer costs, and a good deal of institutional elitism and arrogance.

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