From the issue dated April 20, 2001
POINT OF VIEW
Preparing for Hard Times Shows Wisdom, Not Pessimism
By MICHAEL S. McPHERSON and MORTON OWEN SCHAPIRO
We don't know a single economist, including Alan Greenspan, who has declared the business cycle obsolete.
After the longest economic expansion in our history,
we should expect more-difficult times ahead. Inevitably, what goes up must come down.
If recent downturns in employment and the stock market presage a full-fledged recession, how will that affect colleges? And what can they do about it?
Already, governors in many states, anticipating budget shortfalls, have proposed substantial cuts in allocations for higher education. Meanwhile, corrections in the stock market and write-downs in private equity valuations have resulted in dismal returns on college endowments.
Not all is doom and gloom -- especially for those observers who see the glass half full. For individuals, the economic returns on a college degree are as high as ever. In addition, demographics are working in favor of higher-education institutions; the size of the college-age population, after decades of contraction, should continue to swell through 2010. And despite the latest stock-market plunge, the previous unprecedented growth in endowments has created nest eggs far larger than anyone conceived even a few years ago.
On the other hand, a pessimist could point out that a college degree doesn't create high standards of living for graduates so much as it helps them avoid the economic disadvantages of those without postsecondary training. Moreover, while enrollment in higher education may continue to hit record levels in the coming years, the majority of new students won't be able to afford high-priced colleges unless they receive substantial discounts off the sticker prices. Finally, only about a dozen institutions have amassed breathtaking wealth in their endowments; most colleges would be imprudent to dig deeper into their endowments to make up for losses of other forms of revenue.
Which colleges have the most to lose in an economic slowdown? The sad fact is this: Although their revenue sources differ, all sectors in higher education will probably take a significant hit in a prolonged recession.
A review of revenue sources, based on the detailed breakdown reported in our most recent book, The Student Aid Game (Princeton University Press, 1998), makes the point. Many private institutions, for example, will inevitably be affected if an economic slowdown reduces the number of full-pay students, whether by leading them to move to less-expensive institutions, bypass higher education altogether, or be eligible for more institutional financial aid as a result of their lower incomes. Our research shows that, out of every revenue dollar, after accounting for institutional aid, tuition supplies 55 cents at private research universities, 76 cents at liberal-arts colleges, and 85 cents at private universities that are less research-intensive. Public institutions, despite claims about their "privatization," would be much less vulnerable on the tuition front. Even though their dependency on tuition grew significantly between the late 1980's and the mid-1990's, less-research-intensive public institutions get only about a third of their revenues from tuition. Public institutions with substantial graduate programs and federal research dollars depend on tuition for just a quarter of their revenues. Community colleges rely even less on tuition.
Public institutions, however, are also much more dependent on government support; state and local appropriations supply, on average, half of the revenues at public research universities and more than half at other public institutions -- topped by two-thirds of the revenues at community colleges. Even in good times, colleges have been getting a shrinking share of the budget in many states, because spending on higher education is often viewed as more "discretionary" than commitments to prisons, health care, elementary and secondary education, and social welfare. A recession would exacerbate that trend -- the costs of government support for public assistance, health care, and other social-welfare programs would shoot up at the same time that tax revenues dwindled. Although public institutions may be less vulnerable to state and local budget shortfalls than they were in the late 1980's -- when appropriations for those budgets accounted for 59 percent of revenues at public research universities and 74 percent at community colleges -- the risks are still significant. Many leaders of public institutions still have fresh memories of the tough budget battles occasioned by the relatively mild recession of the early 1990's.
The federal budget is of prominent importance to the nearly 150 universities with substantial federal research grants and contracts. Federal spending accounts for an average of 19 percent of the revenues at public universities and 27 percent at private universities. Although the federal budget now has an ample surplus, the Bush administration's plans for large and sustained tax cuts, if enacted, would consume much of it. A sustained recession could then bring red ink to the federal ledger, which would probably spill over to government support for university research. A federal budget squeeze might also threaten the size of federal financial-aid programs, which are especially important to institutions that serve many low-income families. States that support large student-aid programs might also face pressures to cut back.
To round out the picture, both alumni giving and investment returns on endowments are sensitive to the business cycle. Certainly, the handful of colleges with major endowment resources are in the best position to ride out a season of bad economic weather -- provided that their boards of trustees and investment committees recognize that endowments should operate like balance wheels. That requires the foresight to accumulate wealth in good times and to spend when times are tough -- not always the easiest concept for boards or presidents to grasp. Moreover, at most colleges, investment returns and gifts rarely have more than a marginal financial impact.
While colleges can't do much to influence the economy in the short run, they should at least prepare contingency plans. We have analyzed federally reported budget
data that indicate how expenditure patterns at colleges changed during the economic difficulties of the early 1990's. A striking finding was that the sharpest cuts focused on a few budget areas: libraries, operations and maintenance, and capital projects. That might not be surprising; cutbacks in such areas help colleges to appear to be protecting the current generation of faculty members, students, and staff members, even at the expense of future generations. It would be much more reassuring, however, if colleges reached those decisions after carefully weighing relative costs and benefits, rather than in response to the popular outcry that often accompanies cuts with immediate impact on current programs.
As a first step, either a standing budget committee or an ad hoc planning group that includes faculty members, staff members, and students should identify what might constitute a plausible economic downturn -- for example, a two-year decline in national income that produces a sustained unemployment rate of a modest 6 to 8 percent. The planners should then develop estimates of how that scenario might affect the college's revenues and expenditures, and should outline various options to deal with it.
In most circumstances, the planners should present several alternatives instead of proposing only one specific program of budget cuts. Depending on the institution, they might suggest different combinations of salary freezes or cuts, program and personnel adjustments, and revised financial-aid policies. Such an analysis shouldn't dictate decisions if hard times indeed arrive, but should serve to encourage and structure further discussions.
Of course, it's never easy to project ways to respond to an economic downturn, and public institutions can face an additional difficulty: Any effort to declare some activities as having a higher priority than others, even hypothetically, may invite legislators to go ahead and cut the less-favored programs. In many states, the rules of the budget game strongly encourage an irrational "use it or lose it" outlook. Administrators at public institutions might be tempted by the "Washington Monument Syndrome": When they must identify places to cut, they will choose what will be most painful to important constituents, just as in the perhaps apocryphal story of the bureaucrats who threaten to shut down the Washington Monument at the first hint of a federal-budget shortfall. In California in the early 1990's, that instinct helped produce headlines about crucial classes being canceled and students being unable to graduate.
Successful contingency planning in state systems requires partnerships between public institutions and their legislatures. Colleges need to be confident that rational planning for potential budget cuts will not immediately bring out legislative knives. Legislators need assurance that when a need for reductions does arise, it won't be met with proposals that do more to embarrass them than to deal with real problems.
An effective study of the potential impact of a downturn can have an important educational function. Few people on a campus are eager to consider even hypothetical budget cuts. Giving advance thought to economic difficulties may seem unduly pessimistic, but it requires people to think through hard, often politically unpalatable, choices -- such as whether to reduce salaries or cut positions.
It is sometimes said that college presidents are paid optimists. But, while we hope for a continued boom in higher education, we should force ourselves to prepare for the worst. In adverse situations, denial is often the first reaction. Having a realistic plan in place can help everyone move more quickly past that denial and focus attention on dealing with -- and resolving -- the difficult dilemmas they may face.
Michael S. McPherson and Morton Owen Schapiro are economists and the presidents of, respectively, Macalester College and Williams College.
Section: The Chronicle Review
Copyright © 2001 by The Chronicle of Higher Education