January 22, 2006 to January 29, 2006
For-Profit Colleges
For-Profit Colleges-BECKER
An article in the New York Times yesterday discussed the moratorium imposed last week by the New York State of Regents on new for–profit or commercial colleges in that state. Commercial colleges have been growing rapidly nationally, and the Times' article discusses problems that have been found with some of them in New York and elsewhere. Despite various abuses, I believe that for-profit colleges and universities fill an important need, and the moratorium imposed by New York is unwise and should be lifted.
Government-run schools dominate higher education in most countries, including the U.S. where some 70-75 per cent of undergraduates attend public colleges and universities. To be sure, private non-profit colleges and universities make important contributions in some countries, such as the University of Chicago, Stanford University, and Swarthmore College among many others in the United States, Keio University and numerous little known other schools in Japan, and Insead in France. During the past thirty years, the number of for-profit colleges and universities has grown rapidly from negligible numbers, especially in the United States but also in China and elsewhere in Asia. The Career College Association, an association of for-profit postsecondary institutions, lists over 2000 members, and that association does not even include the best-known for-profit colleges, The University of Phoenix and DeVry University. Phoenix is the largest accredited private university, and among the oldest of the for-profit universities. It was founded in 1976, enrolls 100,000 online student, even more students at 170 campuses in over 30 states, and it is publicly listed with a market capitalization of several billion dollars.
According to the Times' article, commercial colleges enroll about 7 per cent of students in higher education in NY State. This is even without the University of Phoenix, which has not yet been allowed to enroll students in that state. Other states also have rapidly growing enrollments in for-profit colleges, although I do not have figures on their enrollment shares.
What explains the boom in commercial colleges, given the difficulties in competing against highly subsidized taxpayer-financed institutions, and private non-profit institutions with considerable endowments, and exemption from property and income taxes? To me, the obvious answer is that commercial colleges are meeting a need not met by these other institutions. For-profits generally enroll lower income and older students who are disproportionately African–American and from other minority backgrounds. They offer specialized programs with classes that often meet in the evening and at other convenient times. Such opportunities are usually less available at cheaper government-run colleges and non-profit institutions.
In addition, for-profit institutions have taken the lead in providing online education that offers the greatest flexibility for working students. Students can take online courses in the evening, weekends, before they start working, or at other times that are convenient for them. Online courses do not allow direct interaction among students and faculty available in classrooms, but virtual classrooms provide opportunities to chat with other students no matter where they are located. In addition, they often provide direct and immediate access to faculty who answer questions and provide other information. No wonder that hundreds of online for-profit institutions continue to operate even after the crash several years ago of internet-based companies. Some of these online institutions offer degrees, including advanced degrees, while most offer specialized training in particular areas, or refresher courses for out-of-date professionals.
Students at certified for-profit colleges have long been eligible for federal-backed loan programs, and are also eligible for most state programs that provide financial assistance, such as New York State's extensive tuition-assistance program. Since for-profits enroll relatively many students from poor backgrounds with modest earnings, it is no surprise that their students take a disproportionate share of federal-backed loans and state grants. For example, according to the Times' article, they get 17 percent of the tuition assistance provided by New York while enrolling only 7 per cent of the students.
The Times concentrates on a few examples of corrupt practices uncovered in New York State and elsewhere. In addition, it is well known that students who went to proprietary colleges have higher rates of default on federal-backed loans than students who went to state or non-profit institutions. For-profit institutions have been accused of false advertising about their programs, very low standards for admission, and even changing student answers to make them eligible for state aid.
However, no one to my knowledge has conducted a good study that analyzes the frequency of misleading advertising, or deceptive and dishonest practices, at commercial institutions of higher education compared with state and private non-profit institutions. Many of the private and public non-profit colleges and universities are guilty of shoddy teaching, misleading claims in their handbooks and advertising about what students would learn at their institutions, taking students in PhD programs where jobs are almost impossible to find upon graduation, and other false, misleading, or immoral practices. The late George Stigler, a Nobel Prize winning economist, wrote a humorous essay entitled "A Sketch of the History of Truth in Teaching" (reprinted in his collected essays The Intellectual and the Marketplace) where he basically argues that if traditional universities were held to the same standard of truth as private companies, they would be subject to large and numerous lawsuits.
Some economists have argued that non-profit organizations perform better from a social perspective than for-profit firms when customers have difficulty assessing various hidden qualities of the services provided. But that argument does not seem important in comparing performances of non-profit and for-profit institutions of higher education. Students can usually quickly evaluate the type of teaching they receive, and they can also learn whether graduates of their institution get good jobs. Many students at commercial institutions may overestimate their abilities and the job market they would have upon graduation or finishing a program, but that is also likely with students who major at the most prestigious universities in subjects where few jobs are available, such as Icelandic Literature or Medieval European History.
Commercial colleges have grown rapidly in a highly competitive industry where other colleges are greatly subsidized. This suggests that they generally are filling a useful niche inadequately covered by traditional colleges and universities. Sure, lying and cheating by these institutions should be attacked by private and public lawsuits, but government moratoriums and other orchestrated attacks should not be the way non-profits are allowed to fight off new and tough competitors.
On For-Profit Colleges Again-BECKER
A set of varied comments, with some interesting and insightful. I have a few reactions.
Some of you questioned whether for-profit colleges provide a useful education. The only decisive way to get at this is to calculate how much earnings increased as a result of attending for-profit colleges, and then compare that to the cost of attending them in order to estimate rates of return on this investment. Rates of return estimates can also take into account that relatively many individuals who attended commercial colleges default on government-backed loans. Thousands of rate of return calculations have been made for traditional public and private non-profit colleges and universities, but I am not familiar with any for commercial colleges (that does not mean there are no such estimates; only that there are not many).
I do not believe signaling is an important factor in explaining returns to higher education in general, or to commercial colleges in particular. The signaling interpretation of the benefits of going to college originated in the 1970's and had a run of a couple of decades, but is seldom mentioned any longer. I believe it declined because economists began to realize that companies rather quickly discover the productivity of employees who went to college, whether a Harvard or a University of Phoenix. Before long, their pay adjusts to their productivity rather than to their education credentials. I agree with one of the comments that such credentialism is more likely to survive among public sector employees.
The federal government already punishes proprietary colleges and others whose graduates have high default rates on their loans. As I understand the procedure, if default rates get above a certain level, students at these schools have trouble getting loans. Of course, that makes it much more difficult to attract students.
Studies do show that retraining of adults over age 40 generally produce very little in the way of higher earnings. But for-profit colleges mainly enroll students in the twenties and thirties, not much older than that.
Someone asked why States like New York oppose for-profit colleges? As someone pointed out, the University of Phoenix had to fight hard to get accredited in many states, and is still denied the opportunity to enroll student In New York and about fifteen other states. I suggested in my post that the answer is opposition from public and private non-profit colleges that do not want the competition. It is common for companies in many industries to restrict the entry of competitors if they can. Why should traditional colleges be any different? They only express their opposition in more high-falutin and self-righteous language.
For-Profit Colleges and Universities--Posner's Comment
I agree with what Becker has written on this important subject. I want to approach the subject from a slightly different angle, however, which is to consider why higher education in the United States is dominated by public and nonprofit-private institutions (abroad, almost all education is government-operated) and what this implies about the reasons for the growth of the profit-making institutions.
A nonprofit enterprise is one that (1) enjoys an exemption from taxation and (2) operates under a nondistribution constraint--that is, any surplus of revenues over expenses cannot be distributed as profits to the firm's "owners." The points are related. To enjoy a charitable exemption from taxes, an institution must not only have a purpose deemed worthy (such as promoting education, health, religion, the arts, and so forth), but must also devote all its resources, including income on endowment, to its charitable purpose.
The nondistribution constraint is indeed constraining, because it means that the institution cannot raise money in the equity markets. It can compete with profit-making competitors only if it can attract investment from donors. Generally, this requires that it have many affluent alumni, as they are the principal donors to colleges and universities (partly out of gratitude, partly for the less altruistic reason that they derive prestige from having attended a distinguished institution and they want to help it maintain its distinction). There is a chicken and egg problem. To attract children of well-to-do families, and other children who have good earning prospects, the school has to offer an attractive program, good living and athletic facilities, and a distinguished faculty, but all those things cost money, which is hard for a nonprofit institution to raise unless it already has wealthy alumni. This may be why the very successful nonprofit colleges and universities tend to be quite old. They have had a long time to "grow" alumni who make generous contributions. Brandeis University, founded in the 1940s, is one of the few prominent private universities that is not very old--and it has had great trouble building up an endowment (though in part this is because of the elimination of Jewish quotas at other prominent universities--those quotas were one of the major factors in the decision to create Brandeis).
The result is a tendency for nonprofit colleges and universities to be quite expensive. Access to them by kids who are not well off and do not have good earnings prospect is further restricted by the practice of "legacy admissions," an important part of the fund-raising strategy of the classy nonprofit institutions.
Public colleges and universities take up much of the slack by subsidizing tuition; there are also federal and state loan programs for college tuition. But tuition expense at public institutions has been rising, at the same time that these institutions have begun angling for more affluent students by becoming semi-private--sometimes more than semi: for example, the University of Michigan, though state-owned, now derives only about 10 percent of its revenue from the state.
The rise of the profit-making college and university, described in Becker's post, can therefore be interpreted as a response to the increasing scarcity of places in nonprofit and public colleges and universities for students who for whatever reason do not have good prospects as high earners, which would make them attractive to and able to afford the tuition charged by the nonprofit and public institutions. Not being able to rely on future alumni donations from such students, the capital required for their education must be raised from nonaltruists, i.e., profit-making investors; hence the increasing adoption of the for-profit form. Nonprofit institutions catering to the low end of the market have also emerged in recent years, but they may be at a competitive disadvantage vis-à-vis profit-making firms, as they may find it difficult to raise capital without an alumni base.
Is fraud and other malfeasance more likely in the new profit-making institutions? I think so, for two reasons. First, the consumers served by these institutions are less sophisticated than the consumers (the students and their families) of the educational services provided by the established institutions. Second, established institutions have more "reputation capital" at stake than a new enterprise; hence fraud or other misconduct is more costly to them and so they make greater efforts to prevent it. This has nothing to do with any differences in "greed" across different organizational forms, but merely with differences in the cost of engaging in misconduct, which is greater for the nonprofit and public institutions because of their clientele and reputation. But reputation capital is as important to established profit-making institutions, such as the University of Phoenix, as to nonprofit ones. However, the the rapid growth in the number of profit-making colleges and universities means that a disproportionate number of these institutions are new and therefore not yet established, and that would suggest that fraud may indeed be on the increase, as the New York authorities believe.
Even so, that is no reason to shut down the profit-making educational sector, which may have discovered a demand for college education that the nonprofits had overlooked. Given the private as well as social return to higher education, the contribution of for-profit colleges and universities should not be disparaged.