A New Study Investigates Why College Tuition Is So Expensive

Over the past two decades, published college tuition has increased in price more than any other good or service besides hospital care. Tuition inflation has risen at a faster rate than the cost of medical services, child care, and housing. While generous financial aid means that students usually pay far less than the “sticker price” of tuition, the net price of public four-year colleges has still more than doubled since the turn of the century. Moreover, underlying costs at American colleges are the highest of any large country in the developed world.

A new paper by economist Beth Akers of the Manhattan Institute (my former employer) asks why college tuition is so high and still rising. The proximate causes of tuition inflation are familiar: administrative bloat, overbuilding of campus amenities, a model dependent on high-wage labor, and the easy availability of subsidized student loans.

However, the deeper question is why the market has allowed these cost inefficiencies to persist. In most industries, competition brings down the cost of products over time. The first laptop computer cost over $5,000 in today’s dollars, but now laptops with far more computing power can be bought for $200. Why hasn’t the same phenomenon occurred in higher education?

Akers explores four potential explanations: students overestimate the return to a degree; colleges are not transparent about their true prices; too few institutions operate in each regional market; and there are significant barriers to entry for new educational providers.

Many students treat a college degree as a “golden ticket” to the middle class, Akers argues. The decision to go to college is fundamentally a cost-benefit calculation. If the financial return to college is high enough, then students should theoretically be willing to pay high amounts for tuition, because they still come out ahead in the long run.

But few students are sitting down with Excel spreadsheets to calculate the return to college; instead, they rely on impressions of how much a college degree will earn them in the long run. Yet only some degrees are worth paying top dollar. The general impression that every degree is valuable—a “golden ticket” or so to speak—pushes up students’ willingness to pay for college, and consequently inflates college tuition.

Even if that is the case, a sufficiently competitive market for higher education should still bring down the price of college. Akers therefore identifies another problem: the true price of a college education is usually hidden. While most students get at least some financial aid, prospective students usually don’t know how much aid they will get until after they are accepted to college.

This makes comparison-shopping across a wide swath of institutions impossible. Application fees and time constrain the number of colleges each student can apply to, so the number of colleges among which a student can compare prices may be as little as one. Knowing that students will have few alternatives by the time they actually see what they will pay, colleges have every incentive to be stingy with financial aid.

Another factor constraining choice is that most students have limited options for higher education. While there are thousands of accredited colleges nationwide, the typical student has far fewer options. Most students attend a college in their home state, thanks to a combination of steep discounts for state residents, familiarity with local schools, and a desire to save money by living at home. With few competitors, colleges face less competitive pressure to provide price discounts or improve the quality of education.

High prices and few institutions should provide ample opportunity for alternative providers of education to enter the market and lower prices through competition. However, most of these alternative providers will find it difficult to access federal financial aid, which means that the playing field is not level between traditional schools and new ones.

All colleges must be accredited to access federal aid, but the accreditation system is typically hostile to new players. Accreditors often judge schools based on factors such as curriculum and faculty rather than whether they achieve better student outcomes for a lower price. This system disadvantages schools with newer and cheaper but potentially more effective educational models.

These problems are deeply ingrained in America’s higher education system, and reversing them will take work. Akers has several proposals to address them, which fall into two main groups. The first prong of her strategy is transparency. Better data on financial aid and net prices should be made available and accessible, along with data on typical earnings after graduation. This will help inform students whether a particular college degree is worth the cost.

The second prong involves opening the higher-education marketplace to competition by removing accreditors from their role as gatekeepers of federal financial aid, and instead allocating funds based on student outcomes. Not only will this encourage new entrants, but it will force existing universities to search for cost efficiencies and lower their prices to compete.

Industries like higher education have seen enormous cost growth over the past decades, even as the cost of other goods and services has fallen. Price transparency and robust competition have gone a long way towards reducing prices in other industries. The higher education system should follow their lead.