Tuesday, March 25, 2008

Higher Education trends

Harvard University has finally taken the plunge, and it was only to be expected. In an industry/activity, where the quality of students is the primary determinant of success, it was not surprising that the University announced significant expansion of its aid coverage for undergraduate students. It is a belated acknowledgement of the fact that any University, even Harvard, is only as good as its students. And fortunately, economic background do not determine the quality of students! But the consequences of this shift are likely to be more profound.

Harvard's decision has led to a number of other richer Universities following suit in increasing aid and substituting grant for loans. The Universities claim that these efforts are aimed at making higher education more affordable and also clear the damaging perception that the elite Universities are going out of reach for all but the richest. But the real motivation may be the growing realization that high tution fees and other college costs are driving away many middle and even upper-middle class students from the elite Universities, in turn depleting the quality of these schools.

Harvard currently provides a free undergraduate education to students from families earning up to $60,000 a year. Under its new plan, families earning between $120,000 and $180,000 a year would pay only 10 percent of their incomes for tuition and fees on an education that is currently priced at more than $45,000 a year. More than 90 percent of American families would be eligible for this aid. More than half of all Harvard undergraduates will now have some form of scholarship. It would cut costs by a third to 50 percent for many students and make the real costs of attending Harvard comparable to those at major state universities. In fact, a Harvard degree will now be cheaper than degrees from many leading public universities.

The cost for the University with a $35 bn and rapidly growing endowment, thanks to the generous tax exemptions on their investments, is a miniscule $120 million, up from $ 98 million earlier. The Harvard management Company (HMC), which manages the University's endowment, made nearly $ 7 billion from its investment income in 2006-07, a 23% rate of return. (Former PIMCO ED, Mohamed A. El-Erian, heads the AMC)

In this context, it is important to highlight the most important development in US higher education since the early 1990s - spectacularly growing university endowments. Since then, universities have hired sophisticated money managers and moved their portfolios into hedge funds, private equities and other high-performing investments, resulting in skyrocketing endowments. This development has coincided with the decline in subsidies to public universities. The result has been the emergence of a sharp division among university endowments - fewer than 400 of the roughly 4,500 colleges and universities in the United States had even $100 million in endowments in 2007.

The market for higher education has certain unique characteristics, which set it apart from the regular forces of supply and demand. The quality of a school is dependent on the quality of its students and to a lesser extent on its instructors. It is therefore important for any University to widen its recruitment base, so as to be able to reach out to all the best and the brightest students. This in turn demands that entry barriers for such students are eliminated or atleast lowered. One of the more commonest ways of doing this is to incentivize them by offering fantastic aid packages, which competitors cannot match. Only Universities with deep pockets can play this game and succeed.

What are the likely consequences? In the short run, it is likely to make it more affordable for even the middle class students to access the elite Universities. But the more long run distortions possible are
1. Those high achieving students from less well-off backgrounds and therefore unable to afford the expensive elite universities, would have gone to the other colleges. But the generous aid packages attract them to the elite schools, thereby depleting the quality pool for the not so rich colleges. The already wide gap between the elite and the rest widens.

2. The tuition discounting to the middle and upper middle class in smaller universities could end up shifting financial aid from low-income students to wealthier, thereby making pricing seem even more arbitrary and creating pressures to raise full tuition to pay for all the assistance.

3. This will open up pressures on the universities to expand aid coverage to include even the wealthy high achieving students, thereby reducing the amount of aid available for the poorer. Aid will become an instrument for buying off the merit students, a practice openly flaunted by the numerous IIT and other professional courses training institutes in India.

4. Reduce the economic diversity of the student intake, thereby reducing the quality of the school. Donald E. Heller, director of the Center for the Study of Higher Education at Pennsylvania State University, says that "if Harvard’s new aid program encouraged more middle- and upper-middle-income students to apply, then the number of slots for low-income applicants in an entering class will probably decline."

5. In all likelihood, this trend will hasten the process of attracting the superstar instructors. Do not be surprised if the remuneration for the other critical determinant - superstar professors - too rockets up at a much larger rate in the coming years. Superstar professors are being courted by Universities by offering better pay and benefits and tenurial positions.

6. A distribution similar to private and public schools is likely to emerge in college education, with the best schools attracting the best students and the others left with the remaining. A self-reinforcing spiral of widening quality gap between the elites and the rest is set in motion. The increasing quality of students improves the quality of the elite universities, while the depleting quality of students lowers the quality of the rest.

7. A distinctly two-tier higher education system will emerge, with a set of elite universities having massive endowments, thriving and attracting the best, leaving but the crumbs for the rest.

The same trend is observed in India among training institutes for entrance examinations to the various professional courses like Engineering, IIT, Medicine, IAS, MBA etc. This trend can be gauged by the same names dominating the field every year. The well established reputation and the deep pockets of the major training institutes ensures that most of the good students join them, thereby imposing forbiddingly high entry barriers on new entrants. These institutions compete to woo the best students, even offering them financial incentives over and beyond full fee expemptions, thereby effectively buying them over. Simulataneously, they raise the fees on the remaining students, and rake in more profits.

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