Thursday, May 08, 2008

The Baumol Effect and Rising College Costs

By Richard Vedder

The Greentree Gazette has reprinted an article by William Baumol and an associate from 1995 that points out that the service nature of higher education makes it difficult to replace humans with capital equipment unlike in many goods producing industries. In this respect, higher education is just like the performing arts and health care services. Hence productivity growth lags behind other sectors, meaning over time the costs of inputs rise more in higher education per unit of output than in the overall economy.

Will Baumol is a world-class economist who should someday receive the Nobel Prize. I admire his work immensely. And his theory has more than a grain of truth to it. There are limits to the use of computerized or interactive television instruction, for example. Efforts to substitute capital (e.g., computerized instruction) for labor run the risk of lowering quality, as students respond better to direct interpersonal contact with live professors in most situations.

But the argument has a huge limitation --instructional costs are typically a small proportion of the cost of going to college. The ratio of faculty salaries to tuition payments is typically well below one, and as a percent of total academic expenditures, it is typically less than 25 percent. And there is nothing in the Baumol thesis that would explain, for example, the doubling in the number of professional non-instructional personnel per student over the past three decades.

Moreover, a look at international data is instructive. The ratio of college to high school costs per students is about 1.6 for the entire OECD (about 30 top industrial nations), but it is about 50 percent higher, 2.4, for the U.S. Why does it cost more than 20 percent more to educate a college student in the U.S. than in Canada, or nearly twice as much in the U.S. relative to Britain, France, or Germany? Not all of that is explained simply in terms of the Baumol effect (these are all high wage countries and professorial wages are not that dramatically different between those nations and the U.S.) (I am indebted to Jonathan Robe for this insight).

Of course, much of the explanation for these differentials may reflect research spending, and part of it may reflect genuine qualitative superiority of American universities. Nonetheless, the evidence is clear that some other nations with high quality higher education, such as Britain, seem to operate at dramatically lower costs. A closer examination of these international differences seems warranted.

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