Alternative Theories for Rising College Tuition: Baumol’s Cost Disease and Bowen’s Rule

In the first post in this series (about rising college tuition) we talked about the Bennett Hypothesis – the possibility that federally subsidized loans increase tuition prices. Next, we talked about two alternative theories explaining the persistent increase in college tuition: namely, decreased state funding, and increased competition among schools.

In this post, we discuss Baumol’s cost disease and Bowen’s rule.  These aren’t quite “alternatives” to the other theories, but rather complements, as they help us better understand the effects of decreased funding and increased competition.

Baumol’s Cost Disease

Baumol’s cost disease has to do with the lack of productivity growth in service industries.  These industries have had difficulty replacing human labor with capital labor.  For example, a teacher can only teach a handful of students, and that has not changed much in the past hundred years (MOOCs aside).

Baumol provides two reasons why productivity growth is not rapidly rising in these industries. First, these jobs cannot be standardized. While we have standards for what teachers must learn and what licensing they must receive, there is no such thing as a standard student. Teachers must adapt to their student’s way of learning; one student may excel with little help while another needs tutoring. Even a standardized curriculum like the Common Core will not standardize the teaching profession. Second, quality is, or is believed to be, correlated with human involvement. This is very apparent in education. A teacher who turns on a PowerPoint and leaves the room won’t win any teaching awards, but a teacher who personalizes their teaching and makes it directly applicable to their students’ lives will be highly regarded.

Baumol’s reasoning is not exclusive to teaching. This cost disease can be found in all areas where humans provide the crucial components needed to produce the good or service: health care, performing arts, automotive repair, and others like these.

Bowen’s Rule

Bowen’s rule, alternatively known as the “revenue theory of cost,” applies four rules to higher education (and non-profits in general), that explain increasing costs. These four rules are:

The main goal of higher education instructions is excellence, prestige, and influence.
There is virtually no limit to the amount of money that can be spent to increase these.
Each institution raises as much money as it can.
The institution spends all the money it raises.

The cumulative effect of these four rules is increasing expenditure. Bowen’s rule fits perfectly with the alternative theories of decreased state funding and increased competition. As states decrease their funding, schools strive to continue raising money to support their goals, thereby increasing tuition to make up for (or surpass) the difference. As more schools enter the education landscape, each institution must strive even harder to obtain prestige and influence. To do so, they must raise money, and one of the simplest ways to do this is increase tuition – which, in turn, raises perceived prestige

Evidence for Baumol and Bowen

The Washington Post’s Dylan Matthews has great articles about both Baumol’s cost disease and Bowen’s rule, and their effect on higher education costs. In one article, Matthews quotes Robert Archibald, an economist at the College of William & Mary, explaining that since colleges must compete for professors – not only from other colleges, but also industries where they could be highly paid – the wages for professors must increase. This holds true even while productivity is relatively stagnant. Matthews, on the other hand, explain how this expanded wages hasn’t happened in the recent decades so it cannot explain tuition increases.

However, the author does argue for Bowen’s rule. He states, similar to the theory of increasing competition, given the fact that school quality is often hard to determine, schools often signal quality with a high sticker price and large expenditures. This means schools can increase their prestige by raising tuition and increasing expenditures – exactly what Bowen’s rule implies.

Do we see these results empirically? In recent research, Martin and Hill (2014) show that both Baumol’s cost disease and Bowen’s rule are in effect, though they do note some limitation of measurement. The effect from Baumol’s cost disease caused a 23 to 32 percent change in total cost, while the effect from Bowen’s rule caused a 29 to 64 percent change in total cost (depending on school type and monetary constraints).  Overall, they estimate that the combined effects account for 74 percent of public university change in total cost and 63 percent of private university change in total cost from 1987 to 2011.