For-Profit Colleges and Universities--Posner's Comment

I agree with what Becker has written on this important subject. I want to approach the subject from a slightly different angle, however, which is to consider why higher education in the United States is dominated by public and nonprofit-private institutions (abroad, almost all education is government-operated) and what this implies about the reasons for the growth of the profit-making institutions. A nonprofit enterprise is one that (1) enjoys an exemption from taxation and (2) operates under a nondistribution constraint--that is, any surplus of revenues over expenses cannot be distributed as profits to the firm’s "owners." The points are related. To enjoy a charitable exemption from taxes, an institution must not only have a purpose deemed worthy (such as promoting education, health, religion, the arts, and so forth), but must also devote all its resources, including income on endowment, to its charitable purpose. The nondistribution constraint is indeed constraining, because it means that the institution cannot raise money in the equity markets. It can compete with profit-making competitors only if it can attract investment from donors. Generally, this requires that it have many affluent alumni, as they are the principal donors to colleges and universities (partly out of gratitude, partly for the less altruistic reason that they derive prestige from having attended a distinguished institution and they want to help it maintain its distinction). There is a chicken and egg problem. To attract children of well-to-do families, and other children who have good earning prospects, the school has to offer an attractive program, good living and athletic facilities, and a distinguished faculty, but all those things cost money, which is hard for a nonprofit institution to raise unless it already has wealthy alumni. This may be why the very successful nonprofit colleges and universities tend to be quite old. They have had a long time to "grow" alumni who make generous contributions. Brandeis University, founded in the 1940s, is one of the few prominent private universities that is not very old--and it has had great trouble building up an endowment (though in part this is because of the elimination of Jewish quotas at other prominent universities--those quotas were one of the major factors in the decision to create Brandeis). The result is a tendency for nonprofit colleges and universities to be quite expensive. Access to them by kids who are not well off and do not have good earnings prospect is further restricted by the practice of "legacy admissions," an important part of the fund-raising strategy of the classy nonprofit institutions. Public colleges and universities take up much of the slack by subsidizing tuition; there are also federal and state loan programs for college tuition. But tuition expense at public institutions has been rising, at the same time that these institutions have begun angling for more affluent students by becoming semi-private--sometimes more than semi: for example, the University of Michigan, though state-owned, now derives only about 10 percent of its revenue from the state. The rise of the profit-making college and university, described in Becker's post, can therefore be interpreted as a response to the increasing scarcity of places in nonprofit and public colleges and universities for students who for whatever reason do not have good prospects as high earners, which would make them attractive to and able to afford the tuition charged by the nonprofit and public institutions. Not being able to rely on future alumni donations from such students, the capital required for their education must be raised from nonaltruists, i.e., profit-making investors; hence the increasing adoption of the for-profit form. Nonprofit institutions catering to the low end of the market have also emerged in recent years, but they may be at a competitive disadvantage vis-à-vis profit-making firms, as they may find it difficult to raise capital without an alumni base. Is fraud and other malfeasance more likely in the new profit-making institutions? I think so, for two reasons. First, the consumers served by these institutions are less sophisticated than the consumers (the students and their families) of the educational services provided by the established institutions. Second, established institutions have more “reputation capital” at stake than a new enterprise; hence fraud or other misconduct is more costly to them and so they make greater efforts to prevent it. This has nothing to do with any differences in "greed" across different organizational forms, but merely with differences in the cost of engaging in misconduct, which is greater for the nonprofit and public institutions because of their clientele and reputation. But reputation capital is as important to established profit-making institutions, such as the University of Phoenix, as to nonprofit ones. However, the the rapid growth in the number of profit-making colleges and universities means that a disproportionate number of these institutions are new and therefore not yet established, and that would suggest that fraud may indeed be on the increase, as the New York authorities believe. Even so, that is no reason to shut down the profit-making educational sector, which may have discovered a demand for college education that the nonprofits had overlooked. Given the private as well as social return to higher education, the contribution of for-profit colleges and universities should not be disparaged.

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