Subsidies, hierarchy and peers: the awkward economics of higher education

H igher education is a business: it produces and sells educational services to customers for a price and it buys inputs with which to make that product. Production is subject to technological constraints. Costs and revenues discipline decisions and determine the long-run viability of a college or university. ‘‘But higher education is not just a business.’’ While that statement is often meant to imply that higher education is nobler than business—more decent and humane in the purposes it serves—it can also mean that even in economic terms higher education is, in important ways, simply different from a business. This paper asks how well our extensive experience with commercial businesses—and the microeconomic theory of firms and markets that has evolved to describe them—helps in understanding the economics of higher education. That experience and those insights will be used by trustees, politicians, administrators, lawyers, reporters and the public, as well as by economists, to understand and evaluate the behavior of colleges and universities. So it is useful to ask how safe it is to use ‘‘the economic analogy’’ in the context of higher education, drawing parallels between universities and firms, students and customers, faculty and labor markets, and so on. The discussion here seeks to identify the key economic features of higher education that make it different from familiar for-profit industries and to ask what difference those differences make. This is a stick that can be picked up from either end. One approach is to start with meticulous economic theory and see how far it can be made to encompass the economic realities of higher education. An excellent recent paper by Rothschild and White (1995) does that. In their matching model, students and colleges meet