A fortune in tuition: why does college cost so darn much?

TUITION fees at the typical American state university rose "only" 9 percent this year, USA Today tells us, down from 14 percent last year. For every single year for over 20 years, average tuition hikes have exceeded the inflation rate. When I entered Northwestern University in the late 1950s, it took a median-income family less than two months' income to pay the annual tuition; today it takes over six months' income to pay it, at a typical selective private school.

Why is tuition soaring? According to conventional campus wisdom, it's because of declining external funding: lagging state subsidies to public universities, inadequate contributions and investment income at private ones. Schools also sometimes argue that higher tuition is funding qualitative improvements.

My own research--published in a new book, Going Broke by Degree: Why College Costs Too Much (AEI Press, 2004)--suggests that the conventional wisdom is wrong. Tuition has been growing for decades--during periods of rapidly rising as well as falling state and private funding. As to qualitative improvements, it is true facilities are nicer these days and some new academic offerings have been introduced, but at the same time the average score on the Graduate Record Exam is lower today than in 1965; it is highly questionable whether college kids are learning any more than they were decades ago.

The real reason for soaring college costs is higher demand for colleges, largely resulting from well-intended but dubious governmental policies. When demand rises relative to supply, prices (in this case, tuition fees) go up. Demand is rising partly for non-governmental reasons, such as higher incomes and a growing earnings differential between high-school and college graduates. But it is also rising rapidly because of the huge growth in government loan and grant programs as well as tuition tax credits. Pell grants, Stafford and Perkins loans, tax-sheltered college-saving schemes ("529 plans"), work-study programs, etc.: All serve to increase the number of students wanting a college education at any given price. Kids without money for college simply borrow it.

Rising tuition and enrollments have meant surging college revenues. Real per-student spending rose about 70 percent over the past 20 years. How have the universities used this extra money? Financial data provided to the federal government suggest that remarkably little of the higher spending has gone toward instruction: perhaps 21 cents for each new dollar per student since 1976. Teaching and learning are becoming almost secondary activities at some universities. Research has grown, but so has spending on myriad other things. Administrative staffs, for example, have soared. In 1976, it took the typical university about three "non-faculty professionals" to service each 100 students; today, it takes nearly six. My fairly typical university spends over $10 million a year subsidizing intercollegiate athletics.

Awash with funds, university personnel have taken good care of themselves too. Over the 1980s and 1990s, real average faculty compensation (including fringe benefits) probably rose about 45 percent, and near-mid-six-digit salaries are commonplace for top administrators and superstar faculty. A large proportion of tuition increases has gone not for qualitative learning improvements, but to making life better for the permanent paid members of the academy--lower teaching loads, more travel, higher salaries, etc. University presidents beg legislatures and big donors for more funds "to improve student access and academic quality," but use most of the money for fancy facilities, athletics subsidies, administrative-staff increases, and other things peripheral to the main mission of the institutions.

How can universities get away with it? Unlike the private for-profit sector, which faces strict financial discipline imposed by competition and markets, the not-for-profit modern American university is largely (although not completely) shielded from these forces. How is IBM doing? You can get real-time changing assessments of its fortunes by following its stock price, and at least quarterly estimates of its profits in press releases and stockholder reports. But how did Stanford do last year? Who knows? There is no bottom line in higher education. The closest thing to a bottom line for most high-quality schools is privately issued rankings of universities. The most influential, that of U.S. News & World Report, evaluates partly on the basis of the amount spent on inputs (e.g., faculty resources): The more the school spends, the higher the ranking.

Not only is there little financial discipline, but political or institutional accountability is lacking as well. Unlike most governmental agencies, state universities typically are largely operationally independent of their funding source, with relatively little legislative or executive oversight to ensure accountability. Boards of trustees nominally run most not-for-profit institutions of higher education (both public and private), but they are usually dominated by part-time volunteers with little time for independent exploration of campus issues, and are usually co-opted by the administration they supposedly oversee.

The sharp rise in the cost of student education suggests that productivity in American higher education is falling, certainly relative to the private sector, but probably in an absolute sense as well. While productivity is hard to measure (how do you evaluate research?), under any reasonable assumption universities are becoming relatively more costly and inefficient.

As the cost of conventional higher education rises, people seek out other options. For-profit institutions such as the Apollo Group's University of Phoenix use about one-third the resources of the typical not-for-profit to educate a student, and are both rapidly growing and extremely profitable (with pretax profit margins approaching 30 percent in some cases). Owing to their relative efficiency, their tuition costs are not much greater than those of some highly governmentally subsidized state universities.

There are other options. Computer whizzes are sometimes foregoing degrees in computer science to become certified in major computer tasks by Oracle, Microsoft, or Novell. Some kids are heading overseas for college, or to the relatively lower-cost community colleges instead of the more expensive state universities. In time, universities may grudgingly get serious about cost-cutting, raising teaching loads, ending tenure, slashing administrative bureaucracies, and leaving peripheral businesses (such as food and lodging operations or sports teams). But it has not happened yet--because the incentives to do so are still largely missing.

A compelling case can be made that government should get out of the higher-education business. Two arguments are used to defend public subsidies: Universities have positive externalities (spillover effects that benefit non-attendees as well as those getting degrees), and public funding expands access for lower-income students. As to the positive-externality argument, I have actually observed a negative correlation between state-government spending on universities and economic growth, controlling for other factors. Universities literally lower the incomes of non-participating citizens. And in the case of the second argument, there is only the very weakest of positive correlations between government spending on universities and the proportion of students either attending or graduating from college. (Another scandal: Over 30 percent of entering four-year-university students do not graduate within six years.) The recent reduction, in some states, in government support for universities is thus sensible public policy.

One worthwhile approach is Colorado's: Allocate more money directly to students, rather than to institutions. Give scholarships (vouchers) to students who are poor, to increase their access to education--but limit the funding to those with decent academic performance (in other words, stop subsidizing party-loving mediocre students). As for the rest, let them pay their own way: They are the ones who benefit, so they should pay the bill.

Mr. Vedder teaches economics at Ohio University and is an adjunct scholar at the American Enterprise Institute.