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Taxpayers Lose When Colleges Are Too Big to Fail

Illustration by Adrian Forrow Close

Illustration by Adrian Forrow

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Illustration by Adrian Forrow

Many Americans opposed federal bailouts of financial institutions and large corporations. By promoting a “too big to fail” policy, favored businesses can engage in risky, undesirable behavior, while deriving unfair advantages over competitors, all financed by the taxpayer.

Too-big-to-fail thinking saved huge financial institutions such as Citigroup Inc. (C), American International Group Inc. and Fannie Mae, not to mention an industrial giant, General Motors Co. (GM) Critics argue that market conditions should have led these businesses to fail, sending a powerful lesson to others to act more prudently.

Although those criticisms are at least somewhat valid, it is surprising that no one has recognized that governments (state as well as federal) have been following a too-big-to-fail policy in higher education for decades. While I can name several large businesses (Enron Corp., Bethlehem Steel Corp., Arthur Andersen LLP, Lehman Brothers Holdings Inc., TWA Corp., Montgomery Ward, Borders Group Inc., WorldCom Inc.) that have failed over the last decade or so, I cannot think of a single example of a large American university that has failed or closed its doors.

Market forces that frequently topple private-sector companies in acts of what economist Joseph Schumpeter called “creative destruction” are suppressed in higher education by huge government subsidies.

Government Subsidies

There are two reasons why universities never “fail” in the sense that they cease to operate. First, of course, with governments paying part of the bill, the probability that revenue won’t cover expenses, leading to bankruptcy, is remote. If a school can manage to cover even only, say, 75 percent of its costs through tuition fees and other sources of revenue, it is likely that government will cover the rest -- through operating and federal research grants; indirectly through federal student financial aid, which allows higher tuition fees; or through private donations and investment income enhanced by favorable tax status.

Universities don’t fail for another reason, as well: We don’t meaningfully define “success” or “failure” in higher education. Did Wesleyan University or Trinity College in Connecticut have a good year in 2011? Who knows? Did their students learn more than they did the year before, or develop better critical-thinking skills? Does the “value added” from an expensive education at those private schools exceed that at, say, the state-supported University of Connecticut, which is far less pricey?

It may well be that some schools are “failures” in a meaningful sense -- their seniors know no more than their freshmen; their graduates are underemployed or have low-paying jobs; and they provide less student satisfaction per dollar spent than at comparable institutions -- but we really don’t know that.

Yes, there are some decent performance metrics, and what they show is disconcerting. At schools such as Idaho State University, Chicago State University or the University of Texas at San Antonio, fewer than 10 percent of full-time students graduate in the customary four years. Isn’t that “failure,” even though the schools continue to exist because of government subsidies? At Chicago State, where several newspaper accounts described dubious management practices in recent years, almost half of entering full-time freshmen don’t even make it to their sophomore year.

At the same time, many schools have four-year graduation rates of 80 percent or higher -- iconic names such as Harvard and Stanford, as well as lesser-known colleges such as Centre, Colorado, Kenyon and Whitman.

Measuring Success

Yet these two classes of schools are treated exactly the same by the government with respect to federal student financial assistance. Some educators will point out that the institutions with low four-year graduation rates have a lot of students who are poor and have to work while going to school. But doesn’t this governmental disregard of academic performance in the awarding of financial aid contribute to subpar performance and only widen the inequality gap by increasing the number of college dropouts with low-paying jobs and big college debts.

The accompanying graph shows, at least by the graduation rate metric, the huge variation in success or failure rates across American higher education. Success and failure are relative concepts. Most schools are neither elite, where hardly any students drop out, nor institutions where graduation in a timely manner is a rarity. Yet the overall reality -- only 38 percent of American college students at four-year schools graduate within four years -- is a disappointing statistic, suggesting that many of them spend vast amounts for schooling without achieving the expected result.

Probably the most important bottom line to those who do graduate from colleges is success in obtaining employment. Although actual unemployment is relatively low among college graduates, they are increasingly underemployed, mostly in relatively low-paid jobs requiring little skill, as a survey released in April by the Associated Press found. In its latest issue, Bloomberg Businessweek cites research showing that the portion of college-educated 25- to 29-year-olds with jobs outside the so-called college labor market rose to 31.5 percent in January through May this year, compared with 26.1 percent in 2007.

Is that not failure?

Although the price of college rises rapidly, the gains from this schooling may be falling, meaning the payoff on one’s college “investment” is less than expected. What if kids start saying no to college? Will this ultimately lead to an enrollment decline? Will the too-big-to-fail subsidies of colleges lead to a new phenomenon: too failed to be big?

(Richard Vedder is director of the Center for College Affordability and Productivity and teaches economics at Ohio University. The opinions expressed are his own. Read his article on federal college loans here.)

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Today’s highlights: the editors on the Obama administration’s transparency shortcomings and on the resurgent European debt crisis; William D. Cohan on the SEC’s persecution of an honest ratings firm; Noah Feldman on the Supreme Court’s torture case; Albert R. Hunt on Obama’s biggest liability in debating Romney; Simon Johnson on how to assess the soundness of banks.

To contact the writer of this article: Richard Vedder at vedder@ohio.edu.

To contact the editor responsible for this article: Katy Roberts at kroberts29@bloomberg.net.

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