An Institutional Economic Analysis of the "Consumer Model" of Higher Ed

Neoclassical economics teaches us that markets are efficient when they are competitive (with an arbitrarily large number of buyers and sellers); when buyers and sellers are "rational" by some technical definition; when the good or service they are allocating is private; when there are no externalities; and when transactions costs (including the cost of obtaining information) are low. When these conditions are met, the market will automatically create contracts (usually a simple posted price) that captures the marginal benefits an the marginal opportunity costs to the buyer and seller. However, the over-application of this model to any situation can be problematic and harmful. 

Specifically, applying this model to higher education is fraught with failures with respect to these assumptions. Knowledge is non-rival (but can be excludable in the short run); educating individual students may have spillover benefits (by making others more productive as well); and transactions costs are considerable (the costs and benefits of various types of education are uncertain, and often unverifiable by future employers). Despite these limitations, many presidents and provosts at a large number of colleges and universities (and in particular deans of business colleges) have taken up the view that students are the "customers" to the university's "firm." Other outlets have made compelling arguments against this model. I intend to express the economic case for why this view might lead to a general deterioration in the quality of education. 

Who is the customer of a university providing the service of higher education? Surely part of the answer is that the student is, but in what regard? The student attends the classes, does the coursework (usually), and learns the material. As I emphasize to my own students, "no one can learn the material for you." So, surely it is the student who receives the education who solely benefits from it!

Not really. First of all, students presumably attend college to become more productive. Attending my microeconomics class is different from buying a ticket to see Jurassic World. It is not entertainment or pleasure to be consumed and completed; rather, it is an investment to be accumulated and maintained through no small amount of blood, sweat, and tears. The beneficiaries of this effort are both the future self of the student, and also the firms that eventually employ those students. So our stakeholders in the student's education are now three: current student, future student, and future employer.
At this point we have a contracting problem: information. Students are uncertain as to how beneficial their investments will be, and may not know which investments will be most beneficial after they have graduated. Moreover, the skills that will have a value in the future (math, science, economics) may not be the same as those subjects that the current student finds most interesting, entertaining, or even "easy" (art, history, management). Then, when the student has graduated (and is seeking a job), employers are poorly informed about the true abilities of the graduates applying for positions. A college transcript may tell firms something about what and how much you learned, but not everything. Lazy graduates, or graduates who got good grades by "gaming the system" have an incentive to disguise themselves to be hard-working and thus manipulate the information (and therefore the contract) to their strategic advantage. 

On top of that, how well you are able to learn a rigorous topic (like economics) depends somewhat on "peer effects." Zimmerman (1998) shows that average students with below-average roommates fared worse in their academic standing than similarly-capable students with above-average roommates. In other words, associating with smarter people makes you more productive! So, it turns out that my little motivational quip is not entirely true: Being in the company of other good students does in fact help average students learn! Once you have graduated and found work, these peer effects continue. Glaeser (1994) suggests that workers in cities are about 33% more productive than similarly-educated workers in more rural settings. Moretti (2004) shows that workers in firms with higher percentages of college graduates are also more productive. At this point the contracting problems are really piling up because now we are having trouble isolating the private beneficiaries, and, therefore, excluding "free-riders". 

Hence, the stakeholders in any student's - even if we focus solely on the economic benefits - could be said to include: (1) the current individual student; (2) the current student's classmates; (3) the individual student's future self; (4) the student's future employer(s); (5) the student's future co-workers. I could also probably include (5) the student's alumni (who benefit from the continued value to their degree); and (6) society at large (to the extent that well-educated students today will be better-informed voters for their lifetimes). Contracting among these various stakeholders involves very high - likely prohibitive - transactions costs. 

But there is one key way in which students are, and have increasingly become, the sole consumer: paying the bills. The increasing burden of cost on the individual student gives the student much more leverage over colleges and universities. Thus, it is a group of 18-22 year old current students' preferences for increasingly high grades for increasingly little work (along with fitness centers, fancy dorm rooms, gourmet cafeteria food, and successfull athletic programs) that dictate the revenue streams (recruitment and retention) for colleges and universities. Direct public funding of colleges and universities is down substantially, and the extent to which this has been offset by redistributing those monies directly to students in the form of grants may not help. So, the likely result is that problems in higher ed will get much worse before they get better. And it is hard to blame administrators for treating students as "the consumer" because they're just following the money.