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The COVID-19 shock may fundamentally alter the economics of private colleges

The COVID-19 shock may fundamentally alter the economics of private colleges

How many private residential colleges will survive the COVID-19 shock? Certainly not all. Many U.S. higher educational institutions were already under financial duress, and the virus outbreak has created fresh hurdles for colleges and universities to surmount. The U.S. higher education sector, like the travel and leisure industry, is facing a rude awakening to a rapidly transforming reality in which traditional precepts are challenged, and institutions are forced to engage in radical changes to survive. 

Critics have long argued that the ever-increasing cost of a college degree is putting it beyond the reach of many. Sticker shock is a common response to published private college tuition and fees. Reality, however, is a bit more complicated. The College Board reports that the average published tuition and fees was $36,880 in 2019-20 at private non-profit four-year institutions. That figure is somewhat misleading as many students do not pay the full sticker price. Average net tuition and fees (taking into account various forms of aid offered to students) was a more reasonable $14,400 for full-time students. 

Complex tuition and fee structures are an interesting aspect of the economics of higher education. Top-tier private institutions are aware that many parents and students consciously or subconsciously view attending an expensive and highly regarded college in a similar vein to the purchase of a positional good — an elite degree is a valuable differentiator. Law school professor Paul Campos argues that sending a child to a prestigious and expensive college is a way to signal the parents' social status (similar to the purchase of a Louis Vuitton handbag). The more that elite colleges charge in tuition and fees, the more sought-after they become to status-conscious parents and students. 

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This phenomenon is characteristic of a so-called Veblen good. Unlike normal goods (whose demand fall when their prices rise), demand for a Veblen good will increase as it becomes more expensive. Status and pricing power (along with massive endowments) differentiate the economic reality faced by elite institutions from those encountered by second and third-tier private colleges.

Many lower-tier private institutions have embraced the tuition discounting model and practice price discrimination. Private colleges typically mark up their “sticker price,” which is then offset with sizable institutional aid and grants. Each private college has a few distinguishing characteristics that make it somewhat unique, thus allowing it to act like a price-discriminating monopolist. Colleges can capture a decent fraction of the consumer surplus by publishing a high sticker price and then utilizing institutional aid/grants/scholarships to target specific students. Many students and parents tend to view a high sticker price as a signal of quality. The pandemic threatens the viability of the discounting model, as some students become less willing to forego a true college experience and still pay full freight. 

On the operating expenses side, universities face a growing financial burden associated with maintaining ever more extravagant facilities and amenities in order to lure students amid a construction arms race. They also face growing costs related to the provision of expensive student services. Additionally, administrators and non-teaching staff account for a significant fraction of the payroll. According to data from the National Center for Education Statistics, in 2016-17, direct instructional expenses (which includes salaries and wages of faculties) accounted for 32 percent of total expenditure at four-year private institutions. Operating margins are quite thin at lower-tier colleges, and, given their puny endowments and high dependence on tuition and fees, they are just one major shock away from facing a debilitating financial crisis.

The COVID-19 coronavirus outbreak is already proving to be a once-in-a-lifetime shock to the U.S. higher education system. During spring 2020, campus shutdown and a rapid transition to the remote instructional delivery model created major revenue losses along with a spike in expenses. Sunk costs related to the maintenance of dorms and other campus facilities is proving to be a tremendous short-term burden. Growing backlash against China (more than 360,000 Chinese students were studying in the U.S. in 2019) and travel/visa restrictions are likely to lower international student enrollment. Health concerns, family obligations and financial constraints may limit domestic out-of-state enrollment as well. The pandemic has thus forced private colleges to reckon with a sizable negative demand shock.

Higher education institutions are caught in a bind. Charging the same tuition rates for remote delivery of lectures during the upcoming academic year is likely to provoke a backlash and may cause many students to take a gap year or to seek out cheaper alternatives (local public institutions or community colleges). Yet, the short-term cost structure is quite inflexible, and additional spending associated with implementing social distancing measures will add to the burden. Offering larger discounts is probably not economically feasible for lower-tier institutions. Many will therefore push for a return to campus activities in fall 2020 despite lingering health concerns.      

A perfect storm is thus brewing in the higher education sector, and college/university administrators have their work cut out for them. Unpopular cost reduction measures, including staff cuts, elimination of frivolous expenditures and reduction of administrative bloat appear inevitable. Furthermore, cost saving via a greater integration of technology into higher education appears necessary and may be a lasting legacy of the pandemic. Not all institutions will survive, but the crisis will leave behind a leaner and more efficient higher education system. 

Vivekanand Jayakumar is an associate professor of economics at the University of Tampa.