Sunday, October 19, 2008

Necessity Is the Mother of Invention

By Richard Vedder

I just learned from an insider that one of the nation's largest teacher retirement funds, the State Teachers Retirement System of Ohio, has suffered over a 30 percent ($25 billion) loss on its common stock portfolio over the past year, including big losses in Fannie Mae and AIG. I am seeing the probability of more and more universities having to reduce, in absolute terms, their spending for next year, in a few cases by 10 percent or more. In real terms, huge restraints on spending will be necessary in many cases. Even the Harvards of the world, heavily dependent on endowment income, should be forced to reduce outlays funded from endowment, even using a three year moving average rule to smooth out fluctuations. It is hard to believe that these funds will not have some erosion of endowment values, unless we see a moderately impressive improvement in equity values in the next 9-10 months, which is certainly a real possibility, but not a certainty. The two year schools and non-research oriented four year state schools are certainly going to face at least a freeze on state subsidies, and often a noticeable reduction. The non-elite private schools, which are heavily dependent on tuition income, face the biggest problem, as I can see the possibility of enrollment drops reducing total tuition income at many institutions. Tuition increases will be sharply constrained, I think, by demand and supply considerations at many schools, although not at the most elite institutions.

What to do? Simple. Cut spending, and cut it decisively. It is a rare school that could not reduce administrative staff by at least 10 percent without facing meaningful quality reductions. It is a rare school that could not save money by contracting out some institutionally provided services, or by even selling assets (e.g., housing facilities) to private investors as a way of rebuilding battered endowments. Schools do not need a myriad of diversity coordinators, public relations specialists, or high-priced athletic programs (only 19 of the top schools are in the black according to NCAA accounting methods). Most large universities have at least a few Ph.D. programs that are mediocre, with low enrollment and a high cost of operation. Do we really need to store millions of library books that get very infrequent use and that are increasingly available in digitized form?

And, horrors of horrors, cannot we cut labor costs by not replacing some retiring faculty and asking the remainder of faculty to shoulder a higher teaching load? Why should persons without major scientific research grants teach less than, say, six courses a year, or certainly five? They used to teach that many. What if some obscure academic journals bite the dust for lack of good papers? The marginal return on most research investment outside the hard sciences and engineering has to be very low, and that may also apply for some scientific research as well.

As Plato said, necessity is the mother of invention. Perhaps financial pressures will lead to some economies of scale and efficiencies. As long as incentive systems to cut costs and improve efficiency are weak, however, do not expect too much. The universities expect to muddle through this, and perhaps they will, but public sympathy for their plight has sharply declined in the era of million dollar university presidents, ultra-swanky recreational facilities, and other examples of ostentatious university consumption. And even universities have to pay their bills.