Sunday, January 20, 2008

Harvard's and Yale’s Endowments: A Bias to Quality vs. Quantity in Higher Education?

Some of our leading universities have been criticized lately for hoarding their endowments – accumulating huge warchests and then not spending on appropriate socially valuable causes. Given that the general public supports higher education financially through a variety of mechanisms, the criticism does sting. Yale has the second-largest endowment of all US universities, at $22.5 billion, and Yale just announced that it will increase its yearly take from a little under 4% to at least 4.5%. Bear in mind that a half percentage point means an additional $113 million per year and that Yale’s endowment enjoyed a return last year of 28%! Harvard has the largest endowment -- $34.9 billion. It recently announced a new financial aid policy that will limit how much families pay for tuition: up to $180,000, a family will pay at most 10% in tuition. Yale is considering a similarly generous tuition reduction policy.

What is of interest to me is how little the top universities have grown, especially the private Ivy League colleges (I am going to focus on undergraduates in this, for reasons that will be apparent later). Data on incoming class sizes historically has been hard to find, but for Harvard at least, I know that in 2000, the incoming class size was 1637 and in a faculty report that I located, there was a statement that enrollment had been steady at that level for some time. In fall of 2006, Harvard matriculated 1640 students, basically the same number. Let’s take it for now as a stylized fact that there has been very little expansion.

(Yale’s President Richard Levin has just announced that Yale is considering an increase in its undergraduate student body to 6000, from 5300. This is interesting. Note these are total student body numbers, not incoming freshman only.)

It is somewhat curious to me as an economist that we have an industry with tremendous growth in demand and where the leading firms do not grow. Do we have an increase in demand? Clearly yes: US population has increased, from about 250 million in 1990 to 300 million today, plus we have an increasing number of foreign students applying to US universities. Acceptance rates at the top schools are extremely low – Yale last year took only 9.6 % of its 19,323 total applications for the class of 2011. Plus we observe tuition rising at above the rate of inflation for many years now. That is a strong indicator of increased demand.

Sure, the stylized model of an industry just has more firms enter the industry in response to a demand increase. This is because the existing firms are at optimal scale, so if they grew they would be at a disadvantage relative to others. I think there is some of this story going on in academia, but I don’t think it can completely explain the lack of expansion of existing schools. Among other things, there is already tremendous variation in size of universities, even within the Ivy League, so it is not clear at all what the optimal scale is. I think there is something else going on.

So why don’t schools like Harvard, Yale, Dartmouth and Princeton expand? It is easy for me to make a social case that they should. These schools serve as tremendous gatekeepers for the next step in someone’s career progression. It is not a slam dunk to get into a top law school or business school, or consulting firm or investment bank from HYPS (Harvard, Yale Princeton Stanford) but the probability is certainly higher than if you graduate from….well, let’s say Northern Michigan University. The pyramid with top universities at the top and the world’s undergraduate population at the bottom has gotten much broader at the bottom but it has not expanded at the top. As a result, it is even harder for someone out of the usual social and economic classes to break into the most valuable circles of society. Yes, the top schools do promote diversity, but the focus tends to be racial and ethnic, not economic, and there are just not enough slots available. The top schools do not have to take virtually any risk at all with their incoming class; they routinely turn away students with perfect SAT scores.

I am working towards a theory of bias towards quality in higher education. Perhaps this has already been done, so don’t be shy in letting me know of prior work.

Any decision to expand a school will be made by the faculty, so we need to think of their incentives. Since a university is not owned by anyone, the incentives are more similar to those of partners in a partnership than shareholders in a for-profit firm. Specifically, the existing professors are going to disapprove of any expansion that worsens their own situation. This can play out in a variety of ways in a university setting. The main mechanism, I think, is as follows. Suppose that tuition covers 50% of the total current cost of the university, with the rest being covered by endowment spending (these are not far from truth). Then the “profitability” of additional students depends upon how the endowment will change with an additional student versus the incremental cost of additional students. If we are dealing with a significant increase in students, the incremental cost will be closer to the current average costs, for the university will have to increase all the fixed assets to serve additional students (dorms, classrooms, professors, labs, etc.) However, it is doubtful that the increase in future endowments (through anticipated gifts by the new students) will equal the average endowment per student currently enjoyed (I could expand on this assumption, and it is important). Therefore, increasing students will reduce the “surplus” of the university, and the existing professors could rightly infer that an expansion will make them worse off. It will also make the existing students worse off, so they are likely to oppose it as well. Even alumni might infer that their degrees will be worth less, if the average student in the future will have fewer resources and therefore receive a lower quality education.

So we will get opposition to expansions that in some sense reduce the “average” quality of the institution. But nothing in the above story implies that the addition of the new students is not worthwhile from a pure cost-benefit calculus. The current situation could be one where the “surplus” from the existing endowment is being spent to make the lives of the current students and faculty of higher quality – but that quality is more than is necessary, in some sense. This is the bias towards quality: the existing beneficiaries of the top schools’ wealth are unwilling to lower the average quality. And indeed, this sounds very respectable: who can stand up and say that we should expand and accept lower quality in any sense?

I think this theory could be built up formally, and it is potentially testable. Schools that cover a lower percentage of their costs from tuition, and a higher percentage from an endowment, ceteris paribus should be less likely to expand. I think this prediction might help explain why business schools have generally been more responsive to demand and increased their class sizes – generally they fund more of their operations from tuition.


Sam Jackson said...

Your argument needs a little more research in the case of HYP. First, all of them are trying to expand, let's put that forward... it's a top institutional priority in many ways for all three. Princeton just built a huge new residential college at great expense, to increase enrollment; Yale is currently ignoring all student opinion to the contrary and its Trustees (NOT faculty, trustees are the final word on things) are generally supportive of the President, who has had college expansion on the agenda for years and years. Adding 2 new residential colleges to Yale would not be completed for many years to come and is budgeted at having a direct cost of 600 million dollars. That is an ENORMOUS sum. The reason why it has not been done sooner is because there is literally NO LAND in new haven on which to site the colleges until relatively recently / the funds have not been available / other priorities have been pursued first. But that's 600 million UP FRONT, when factoring in the necessary expansions in cost for the student body increases, additional faculty and facility expansions, etc etc etc... you easily see how it is such a tremendously expensive proposition. It isn't a possibility to just throw up some high rise apartment buildings without tragically undermining the same education which they wish to expand. And Harvard, well--their plans are in many ways the most sweeping of all, having outlined basically a 50 year expansion plan to take over half of Allston and chunks of Boston with a mega-expansion.

So... that's just to start. The issues you talk about ARE at work but they are significantly more complicated!

Nicholas L. said...

Well, what I don't understand is why there is such a great necessity to expand among the top schools. HYP pride themselves in a tight-knitted community, do they really need to expand to a student body like the University of Florida or Berkeley? What's more, the overall quality of universities have significantly increased in the past several decades, so it is not necessary to attend HYP to have a successful career either. Schools such as HYPSMC are known to be extremely selective, that is known and accepted by everyone. Is it so necessary to change that?

Anonymous said...

We are not talking about making HPY into "University of Florida or Berkeley." We are talking about relatively minor expansions (25%+/). When I applied to college, a 4.0, together with a great SAT, was virtually a guaranteed admit to HPY, but as the author points out, these same students are routinely rejected by all ivies today. The capacity to educate should expand commensurately with the capacity of the potential student population to meet the rigorous standards of HPY.

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Harvard is still the best university in America, but it lacks of spirit.