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Imposing Market Discipline on Public Colleges and Universities

Imposing Market Discipline on Public Colleges and Universities

October 1, 2001

By: Robert B. Archibald, Ph.D. and Michael J. BeVier, M.B.A., J.D.


Governor Gilmore has appointed a Blue Ribbon Commission to provide him with recommendations for reshaping Virginia’s 15 four-year public colleges and universities. This is the third such organization to be formed over the past decade, all with a similar charge of recommending improvements to the management of Virginia’s post-secondary institutions. In appointing this new body Governor Gilmore echoes the frustrations of previous governors of both parties, as well as legislators, administrators, and recent commentators.

     The premise of this proposal is that these frustrations reflect real shortcomings in the state’s method of subsidizing and overseeing these institutions. It argues that such failures cannot be corrected by attempts to further centralize managerial control, but only by exposing each school to greater market discipline.

     To accomplish this it proposes that the current system of operating subsidies and regulatory oversight be replaced with a long-term contract under which each school would receive a block grant equal to a fixed fee for each resident student it enrolls, which fee would increase each year only to the extent of an inflation index. In exchange, each school would agree: i) to enroll a specified number of Virginia resident students, ii) cap resident student tuition at an amount substantially below market levels, and iii) admit residents on a need-blind basis, while providing financial aid that varies by need in order to increase overall access to postsecondary education for Virginians. Within such constraints, each school would be responsible for managing its own resources over the contractual period.

     The current system of controlled tuition, operating subsidies provided at each biennium, and continuing regulatory oversight has several perverse effects:

  • Instead of holding the individual institutions to account, it acts to relieve their boards and their managers of full accountability for academic and financial performance.
  • This failure of accountability prevents an alignment of power and responsibility in the governing structure which would provide proper incentives to make efficient use of limited resources.
  • The current biennial budget cycle requires managers to spend too much time and staff resources developing and maintaining political influence. This interferes with the substantive management of the schools and leaves less time for cultivating private bases of support that are increasingly important to maintaining institutional quality without burdening Virginia taxpayers.
  • The limited time horizon of the budget cycle discourages long-range planning which is indispensable to the institutional restructuring and repositioning necessary to exploit strategic market and technological efficiencies.

     The proposed plan, by restructuring the subsidies as block grants, reducing bureaucratic oversight, and requiring financial assistance for all resident students based upon need, would provide a number of advantages.

  • It would impose strict accountability on the management of each school for fulfilling its educational contract within the agreed upon subsidy limits over the term of the contract.
  • It would limit the state’s subsidy obligation over the contract period by allowing the total amount of subsidy for each school to vary only with inflation.
  • It would eliminate the considerable costs incurred by the schools, the legislature, and the administration associated with the biennial budget process and subsequent regulatory oversight.
  • It would encourage long-range strategic planning, including restructuring decisions that permit schools to concentrate resources in their areas of market strength and take advantage of efficiencies that may be available from new technologies.
  • It would encourage schools to seek private sources of support and encourage donors by ensuring that their gifts will not simply replace state subsidies.
  • It would increase access to higher education by varying the amount of financial aid to Virginia residents based upon need.
  • It would provide greater flexibility of implementation, allowing the state’s strongest schools to contract first with additional schools being included only as they are willing and able to undertake the greater responsibilities imposed.

     This plan incorporates principles of decentralized, market-oriented decision-making which proceed from public choice theory, modern principles of decentralized management, and the experience with deregulation in various industries nationwide. By applying these powerful concepts of market choice and accountability to its system of higher education, Virginia can set a standard of intelligent innovation and creative deregulation for the entire nation.


The Problem

     In July 1998 Governor James S. Gilmore announced the appointment of the Blue Ribbon Commission on Higher Education for which he set three objectives: (1) to determine what can be done to raise the quality of instruction at all state-supported institutions, (2) to determine how higher quality and affordable costs can be compatible goals, and (3) to ensure that every educational expense is a wise one.1 In establishing the commission, the Governor made clear that he thought Virginia’s post-secondary schools should be providing higher quality educational services for less money.2

     These concerns are not new nor is the commission an original idea. In fact the Blue Ribbon Commission is the third such body in less than ten years. It follows the Commission on the University of the 21st Century formed in 1989,3 and the Commission on the Future of Higher Education in Virginia formed in 1994, which issued a report in 1996.4 The previous two Governors have also expressed dismay over the increasing cost of higher education and both acted summarily to stem it. Governor Wilder cut the state’s post-secondary subsidies and Governor Allen froze resident tuitions at their 1994 levels.5 These recent Virginia developments echo various other state and national initiatives, such as the National Commission on the Cost of Higher Education,6 the National Center for Public Policy and Higher Education,7 and the California Citizens Commission on Higher Education.8

     The origins of these concerns are not hard to find. As shown in Figure 1,9enrollments in post-secondary schools have increased substantially over the past 25 years, the increase in Virginia’s public post-secondary enrollments being particularly sharp ‘ almost 140% over the period.

     Along with large enrollment increases have come corresponding increases in costs. Figure 2,10 shows the inflation-adjusted increase in current fund expenditures per full-time equivalent student by public colleges nationwide from 1975 to 1995. The combined increases in enrollment and per student costs have placed pressure on state budgets at a time when other state outlays, such as medical care subsidies, have also been rising rapidly and taxpayers are resisting further hikes in tax rates.

     One way that states have reacted to these pressures is to substantially reduce their relative contribution to the total costs of higher education. Figure 3,11 shows that since 1980 the percentage that states contribute to the total revenues of postsecondary institutions has dropped from 46% to 36%, a decrease in relative support of more than 25%. To compensate for this, public schools substantially increased tuition, as shown in Figure 4.12

     Over the 20-year period, 1976 to 1996, average in-state tuition rose from $617 to $2,986 (484%), while out-of-state tuition rose from $1,935 to $7,331 (379%). These figures are in actual dollars, but still far in excess of inflation, which was 271% over the period.13 Such rapid cost increases for a widely sought service that receives large government subsidies has occasioned considerable public debate.14 Though similar reaction has occurred in healthcare, there may be evidence that rising medical costs support technology that improves quality, where no consensus exists that quality has improved in higher education.15

     We are unaware of any hard evidence that the quality of education at Virginia’s public colleges and universities is in decline, and comparing Virginia’s tuition increases over the past 20 years, shown in Figure 5,16, we find them comparable to what has occurred nationally (Figure 4). At the same time, these increases have been substantial, and, along with the Governor’s obvious concerns, we believe this justifies a review of the current system of subsidy and control.


Bureaucratic Control vs. Market Discipline

     There are two recent commentaries on Virginia postsecondary institutions. One is the report of the Commission on the Future of Higher Education in Virginia, entitled Making Connections: Matching Virginia Higher Education’s Strengths with the Commonwealth’s Needs, published in 1996 and often referred to eponymously, as the ‘Chichester Report’ after the Commission’s chairman, John Chichester.17The second is a report by Gordon Davies on the occasion of his retirement after 20 years as Director of the State Council of Higher Education for Virginia (SCHEV), Twenty Years of Higher Education in Virginia, which he wrote in 1997.18 The similarities of the documents are revealing. Both were written in a similar context in which Virginia’s public universities and colleges are seen to be in a state of change and beset by wide criticism and political and financial insecurity. The Chichester Report speaks of ‘an unprecedented period of upheaval and financial insecurity’19while Gordon Davies saw these institutions as ‘struggling to regain a place of grace’ and decried ‘the intensified politicization of education that has infected our nation in this decade and now threatens Virginia higher education.’20 Both articulate problems and suggest solutions in quite general terms, and both urge higher subsidies, recommending that the level of relative support be increased to that enjoyed by these institutions in the late 1980s.21 But neither comes to grips with the key issue of accountability; i.e., how to ensure that these subsidies are properly spent. And we believe that to be the most critical, albeit the most difficult, issue: the efficiency and effectiveness with which the state’s colleges and universities spend whatever amount of public monies they do receive. Both papers convey earnest and acute concern over the variety of problems faced by the schools, but with this comes an impression of inadequacy, even of awe, in the face of what they see as the immense complexity of addressing them. This is hardly surprising given the sheer number, geographic dispersion, and the organizational and academic diversity of the institutions involved. The University of Virginia alone, with more than 18,000 students, 2,000 faculty, and more than 7,400 support staff, is itself a formidable undertaking for any professional manager, however experienced in education, administration, or strategic thinking.22 As shown in Table 1,23, however, there are 15 widely separated four-year institutions, while the community college system comprises another 24 schools, also widely dispersed.

     The obvious difficulties of attempting to prescribe strategic, structural, and managerial solutions for these disparate institutions creates in both reports an odd tension. On the one hand, both seem fastened to the traditional concept of regulatory control which is based on the unstated assumption that a centralized bureaucracy in Richmond is somehow able to understand, better than the individual institutions, what the individual mission of each is and in quite precise terms how to achieve it. The Chichester Report places great emphasis throughout upon a mandated ‘restructuring’ of the schools, speaks of the schools being ‘directed’ or ‘encouraged’ to take specific actions, and calls for increased funding for SCHEV to ‘coordinate more activities and develop more programs.’24 The Davies Report approves of the state’s role in ‘discrete planning activities such as enrollment projections, capital outlay recommendations, faculty salary increase plans, and equipment inventory replacement schedules,’ and sets forth a list of planning objectives which Davies believes Virginia higher education should follow over the next several years.25

     At the same time, both reports continually recognize, in ways explicit and implicit, that there are substantial limits on the extent to which this system can be competently managed by any centralized bureaucracy. The Chichester Report, for example, in most of its recommendations, is alarmingly vague about who has the responsibility for carrying them out. Many of its recommendations are either in the passive voice (‘The commission recommends that each state-supported college and university be directed to adopt and include in its restructuring plan…’26) or have as the actor an indefinite pronoun (‘We should encourage…true integration of technology into the curriculum.’27). Who precisely has the quite particular knowledge to give such explicit directions to each of the 15 schools: the commission itself, or SCHEV, or the legislature? And how are those directions reconciled with the statement that the commission ’emphatically do[es] not want the Council of Higher Education to do the kind of rigid, top-down planning that would put each Virginia college and university into a strait-jacket’?28 The commission recognizes that centralized management can have perverse effects on the very individuals it is trying to regulate:

We believe that the faculty, administrators, and staff of the institutions will assume greater responsibility for the results they produce when they are given greater responsibility for their operations. This is true not only of institutions of higher education, but of any organization. If the state intrudes, oversees, or over-rules, college and university employees will regard their obligations to the public as diminished because they are not in control.29

     If anything, the Davies Report is even more aware of the weakness of attempts at centralized management of diverse institutions, particularly in a time of rapid change:

I do not think any central administration will be able to develop strategies that are responsive to the changes that occur in the complex environments that now exists. We have to learn management techniques that do not attempt to force-feed all information through a central mechanism, because such mechanisms can’t react quickly or creatively. Authority and responsibility need to be dispersed throughout the system.30

     In addition, both reports are acutely aware that centralized control is further complicated and degraded within a political environment. For example, the Chichester Report suggests the difficulty in eliminating academic programs in some schools that wastefully duplicate those in others, admitting that ‘legislative or gubernatorial interest lies behind the development of some academic offerings,’31 and again: ‘[c]losing the more costly or specialized programs means real savings. But each has political support that probably is stronger than the impulse to efficiency and cost reduction.’32 The Davies Report is even more emphatic. In the chapter entitled ‘Leave Politics at the Door’ it states:

It is unfortunate that we seem to have entered into another phase of overt political interference with higher education because it distracts colleges and universities from important changes they need to make. …

     Systems boards probably are most vulnerable to political interference because they have no alumni, no prominent financial backers, and no football teams. Taking them over can help to advance some agendas or to resist change. Playing on historic American distrust of the professional and managerial classes, board members at both the system and institutional levels may attempt to micromanage, producing a huge amount of friction that inhibits administrators who actually run things from getting their work done. Complex organizations that thrive on ideas can be reduced to shuffling bureaucracies by board micromanagment.33

     Aside from their conviction that subsidies should be increased, these commentaries leave three dominant impressions. First is the sharp, if implicit, conflict between their authors’ instinct toward centralized prescription and the simultaneous recognition of the danger and futility of trying to micromanage the state’s colleges and universities from Richmond. Second is the concern that centralized control will increase the extent of political manipulation for ends unrelated to the legitimate purposes of these institutions. Third is the failure to address the issue of accountability. Thus, neither alone, nor together, do they seem to get to the root of the problem. They do not offer a consistent and coherent method for managing such a large and complicated public program with which both taxpayers and their elected representatives are increasingly dissatisfied. Is it possible for the Blue Ribbon Commission to succeed now where these others have failed?

     In attempting to answer that question, let us, for now, accept Mr. Davies premise that education is a ‘public good.’ That is, its benefits extend beyond the individual who is paying for it to the society as a whole, which is enhanced if constituted of individuals who have more, rather than less, education. Mr. Davies uses this assumption in deploring the recent rise in tuition at Virginia’s public colleges and universities:

From a financial perspective, we probably saved the colleges and universities from disaster by moving quickly to replace the lost state support [by raising tuitions]. It may have been the right decision in a bad situation. But it was not good public policy, and we shall live with its consequences for some time to come. The high tuitions have fueled a widely held perception that higher education is a private rather than a public good. From a consumer standpoint, it is viewed as a service purchased at a high price, with no resulting social or ethical obligation to the recipient. No matter that half the costs of college education still are subsidized by the taxes of citizens, many of whom will never participate in higher education themselves. The notion of higher education as a public good, as one of the cohesive elements that holds society together, is largely discounted today.34

     To complain that education as a public good is now ‘largely discounted’ overstates the case: Virginia continues to spend large amounts on higher education. But the basic premise of his argument ‘ that subsidizing education is justified because it is a public good ‘ proceeds from the widely considered set of theories that make up welfare economics. This branch of economics does not deal with welfare programs but seeks to describe the limitations of private markets: ‘why and where they work efficiently [and] why and where they do not.’35 In the case of most goods and services we rely upon competitive market forces both to set prices and to discipline providers into offering the highest quality for the lowest price. We do not require a state commission to force shoe manufacturers to stop wasting leather or hotel managers to make the beds. Departure from pricing mechanisms can be justified only in those cases, and only to such extent, that market systems are clearly inadequate. These inadequacies exist in cases where the activity involved either creates or is subject to some type of externality ‘ a situation in which private markets fail because individual choice does not reflect the full costs or benefits involved in producing or consuming a specific product; i.e., some of the costs or benefits of the product or activity are external to the private decision-maker. A classic case is air pollution. Manufacturers pollute the air because it is difficult to assign property rights to clean air that would force manufacturers to pay for it. The result is inefficiency, for even when a polluter can substantially reduce emissions at little expense to himself, he has no incentive to do so because the air is free. Higher education, it can be argued, presents the reverse situation. Where as manufacturing imposes external costs, or negative externalities on society that are not captured by market forces, education may confer external benefits that are not included in market decisions. And just as market imperfections result in too much air pollution, on one hand, they may result in too little higher education on the other.

     A common reaction to negative externalities is to pass laws that, in our case of air pollution, attempt to get rid of them by command and control regulations: the government directly prohibits smokestack discharge, or more realistically, creates a bureaucracy that is charged with setting specific limits on various types of pollutants and is given authority to police those limits and impose fines (or worse) for non-compliance. In their attempt to generate the external benefits of education, states have been similarly direct. They built public colleges and universities, appropriated direct operating subsidies, and created bureaucracies to monitor how the monies were being spent. This may work reasonably well with a few small institutions operating in a stable economic and social environment. But over the past 30 years, the rapid growth in enrollments and the need to educate an increasingly diverse student population over a broader range of subjects has led to growing dissatisfaction with the results of direct subsidies and regulatory control.

     As bureaucracies get larger and administrative costs rise, control decreases and political conflicts cloud or compromise the objectives that these expensive mechanisms were created to accomplish. In order to explain such problems, economists have developed alongside welfare economics, a branch of study called public choice theory.36 Public choice theory accepts that private markets do not always work perfectly ‘ that externalities may theoretically justify government intervention. But it argues that while private markets may be imperfect, the government action taken to correct them may well be even worse. Such perversity may result from programs that are poorly designed due to ignorance or stupidity, but public choice theory emphasizes the extent to which government subsidies and regulatory ‘assistance’ are subject to manipulation by public officials for purely private ends. For example, none of us would be surprised to find that state legislators resist decisions that reduce the relative subsidies to colleges or universities within their particular districts, irrespective of whether or how such reallocation may be justified by reference to the good of the entire state. Less obvious, but just as disturbing, public choice economists would argue, is the calculus of supposedly impartial bureaucrats in making regulatory and administrative decisions. There is a considerable and growing amount of both theoretical literature and empirical research showing that bureaucrats are not necessarily seekers after the public good. Instead they act according to highly localized incentives such as the growth or prestige of their particular agency or their own status within that agency.37 The result is not a beneficent government wisely and impartially administering public funds for the public good, but an extremely messy, highly partisan, and continuous struggle, both political and bureaucratic, over who gets how much.38

     All of which suggests that the postsecondary educational system is unlikely to be forced or managed toward greater efficiency by increasing regulatory control from Richmond. Establishing and enforcing rules for efficiency in higher education are not easy tasks. Each institution of higher education has individual characteristics that make it difficult to write one-size-fits-all rules. This means that either general rules have to be selectively enforced, or rules have to be customized for each institution.39It is a common finding in the study of regulation that the regulated have such a large informational advantage over the regulators that they can customize the regulations to their own advantage or block effective enforcement.40 Both types of failure are likely in the case of bureaucratic control of higher education, and attempts to increase efficiency in this way may have exactly the opposite effect ‘ the increased administrative costs will outweigh what little programmatic savings they impose.

     If direct imposition of political and bureaucratic control is unlikely to provide a solution, is there an alternative? We would argue that a better way of attempting to correct for market imperfections is one that minimizes direct control in favor of retaining as much of the market’s highly effective disciplining power as possible. In the case of air pollution, for example, instead of passing laws that lock every manufacturer into a set limit for pollutants, some modern regulations provide each manufacturer with tradeable pollutant rights.41 This harnesses market forces to achieve the most efficient distribution of pollution control efforts among all manufacturers by allowing those manufacturers whose location or specific processes allow them to reduce pollution at less cost than others to sell their pollution rights to those for whom pollution control would cost far more. The result is an equal reduction in the amount of pollution overall, but at less cost. Similarly, large efficiencies have been gained over the past 20 years by lifting government controls on industries as diverse as long distance telephone service, natural gas, interstate trucking, and air travel.

     Experience and theory both argue that market discipline is far more effective than bureaucratic regulation, and there is nothing inherent in higher education that prevents it from being disciplined in the same way. The market for higher education is quite robust. Many institutions actively compete for students. Parents of prospective college students can attest to the amount of direct advertising they receive. A call to any particular college will result not only in marketing and curricular information, but an invitation to visit the campus and offers to interview current students or nearby alumni. There are also multiple sources of independent information, from high school guidance counselors and a plethora of published college guides, to the widely read annual ratings of colleges and universities in U.S. News and World Report, Newsweek, Money Magazine, Kiplinger’s Personal Finance Magazine, and Barrons. The information these contain is extensive.

     The rankings in U.S. News and World Report are probably the most widely read. U.S. News collects data on 17 different factors to create its rankings. These data include measures of student selectivity (acceptance rate, percentage of admission offers accepted, percentage in the top 10 percent of high school class, and SAT/ACT scores); faculty resources (faculty compensation, percentage of faculty with Ph.D., percentage of faculty that is full-time, student/faculty ratio, percentage of classes with fewer than 20 students, and percentage of classes with more than 50 students); retention rate (graduation rate, freshman retention rate); financial resources(educational expenditures per student); alumni giving rate; graduation rate performance (actual graduation rate minus predicted graduation rate); and academic reputation. Many of these factors are just the kind of information required to know how well an institution is using its resources. A hallmark of competitive markets is that consumers vote with their feet. They leave firms not offering value for the dollar and go to firms that do. Such behavior strongly affects the US News rankings. A school not offering value for the dollar will have few applicants (yielding a high acceptance rate) and many students who transfer (yielding a low freshman retention rate and a low graduation rate), and it will have a low ranking by US News. Some of the measures are more directly measures of resource use such as educational expenditures per student, the percentage of classes with under 20 students, and percentage of classes over 50. Other measures such as the alumni-giving rate are more measures of consumer satisfaction.

     It is important to recognize that, while newspaper reports focus on the top of the rankings, e.g., ‘Princeton, Harvard, and Yale tied for first in the 1998 rankings,’ all of the data are printed for every school. Furthermore, they recognize that the market for higher education, like many other markets, is segmented. There are markets for liberal arts colleges, for business schools, for engineering schools, for graduate education, for part-time education, among others. Rankings are provided for these sub-markets, encouraging colleges and universities to find a market niche in which they can excel. These rankings are very important to college and university personnel who are strongly affected by prestige. They provide a formula for increasing their prestige, and schools where tuitions are high relative to the quality of education they provide will fail.

     There are then four tenets that should guide any undertaking to reform Virginia’s system of public higher education:

  • Market discipline is a more exacting method of eliciting operational efficiencies than attempts to force change through bureaucratic control.
  • Postsecondary education is a service for which market choice and competitive forces can be largely effective.
  • The efficiencies of market discipline can be captured if postsecondary schools are subsidized in a manner that imposes maximum responsibility for performance upon the management of each of the individual institutions and allows them maximum flexibility to compete with one another.
  • The objective of postsecondary education subsidies is to increase the accessibility of colleges and universities to able and deserving students.


A Plan To Introduce Market Discipline To State-Supported Colleges And Universities

     We believe that the frustrations with Virginia’s system of postsecondary education expressed not only by this administration but several prior administrations, as well as by other experienced and thoughtful commentators, proceed directly from the current subsidy and regulatory mechanism governing that system. It has proven inadequate to the financial pressures of the 1990s and will be found increasingly ill equipped to grapple with the additional challenges presented by technological innovation and private educational entrepreneurs over the next 10 to 20 years. We advocate a bold departure from the traditional regulatory apparatus, one that harnesses the flexibility and dynamism of competitive markets to provide a more efficient and responsive postsecondary education for Virginia. This plan is based upon six structural elements:

  1. Replace biennial operating subsidies with long-term contracts that

include long-term block grants.

     The current system, under which the subsidies for each institution are granted in conjunction with approval by Richmond of their operating budgets, contains perverse incentives. First, instead of focusing the management of each institution on how to utilize limited resources for best effect, it encourages them to structure their proposed budgets in that manner which they believe will maximize their subsidy allocation. Second, the biennial review process is extremely expensive in terms of the time and personnel required, both from the schools and from Richmond. Third, it encourages the schools to spend additional time and effort developing and maintaining permanent political allies who can assist them during each budget session. Fourth, it favors short-term expediency over long-term strategic financial planning, which is critical over time to properly align the resources of any institution with its specific mission.

     We propose replacing the operating subsidy for each school with a block grant equal to the school’s 1998 general fund appropriation. The block grant would be fixed under the terms of a contract between each school and the state for a period of not less than five, and preferably 10, years, with annual adjustments to reflect only inflation and enrollment changes. The block grant would cover operating expenses, including routine building maintenance,42 but would not affect the current system for capital improvements, nor would it change the employment status of any college or university employee. In exchange for the block grant, each school would agree to educate a specified number of Virginia students each year over the term of the contract. The block grants would not automatically reward enrollment growth, but be structured to encourage the development and realization of enrollment targets as part of each school’s strategic planning.

     A system of block grants would go far to remove the political and administrative gamesmanship inherent in the current process. The contract would prohibit the college or university from appealing to the legislature for additional operating funds during the term of the block grant. This would discipline each institution’s management team to allocate efficiently its limited resources to maximize measurable results, and by fixing the amount of resources to be provided over an extended period, encourage the kind of strategic planning that is vital to long-term success.

  1. Require, by contract, a flexible pricing policy under which each institution must: (i) set tuition for out-of-state students at full cost, (ii) provide a tuition discount to all residents, regardless of need, (iii) admit all Virginia students on a need-blind basis, (iv) ensure that Virginia residents who qualify for financial aid do not pay tuition greater than Virginia resident 1998 tuition (adjusted for inflation), and (v) agree to make significant progress toward the goal of meeting all the demonstrated financial need of Virginia students.

     The ultimate futility of governmental price controls is well documented, whether the product is rental housing, gasoline, interest rates, or as in this case, education. Such controls may initially have political appeal because they are highly visible and unequivocal. But there are no free lunches. Though their pernicious effects may not be immediately apparent, such policies will eventually be found counterproductive. If you force prices of anything lower you will get less of it ‘ less quality or less quantity. The current price controls on tuition should be dropped.

     While eliminating the tuition freeze, though, the state subsidies require that each school have some limits placed on its discretion in setting tuition and fees. In discussing such limits, we adopt the following definitions used by the National Commission on the Cost of Higher Education: (i) production cost is the cost of delivering education to a single student; (ii) the nominal price is the posted ‘sticker’ price, or amount students are asked to pay in tuition and fees without consideration of financial aid; (iii) the net price is the amount of tuition and fees paid by the student net of financial aid; (iv) the cost to the student to attend college is the total student outlay including the net price plus room, board, books, supplies and transportation.43

     We propose that no change be made to existing state policy requiring the nominal price for out-of-state students to be the full production cost, including some allocation for use of capital facilities. The block grant contract would then require that each school provide its Virginia students with a nominal price which is significantly below such production cost and that it explicitly commit itself to eventually eliminating monetary barriers to college attendance for all qualified in-state applicants. As a first step toward this latter goal, the contract would require that the net price to Virginia students with demonstrated financial need will not be raised above 1998 levels, and that the school submit a plan specifying how it intends to expand its financial aid to achieve this target over a specified period of time.

     These provisions respond directly to Governor Gilmore’s desire to keep college education affordable for Virginians. One of the great weaknesses of the current operating subsidies is that they are poorly directed. The subsidy provided by low tuition at state-supported schools goes to every student no matter how affluent. The result is that some capable students from lower-income families are unable to attend or left with excessive debt burdens after graduation while many students who do attend are able, and would be willing, to pay more than they currently do. As long ago as 1968 Nobel prize winning economist Milton Friedman wondered, ‘Why should families in Watts pay taxes to subsidize families in Beverly Hills who send their children to UCLA?’44 In 1994, Sandra Baum, an economist at Skidmore College and a consultant to the College Board stated, ‘Even now, the main problem in this area is the distribution of public subsidies, rather than the level of public subsidies. Too many of the dollars subsidize relatively affluent people, who should be taking more private responsibility for funding their own educations.’45 This proposal responds directly to this criticism by redirecting the state’s subsidies toward those who need them most, thereby increasing access to postsecondary education for all Virginians.

  1. Emphasize the attainment of quality and cost targets while minimizing

regulatory micromanagement from Richmond.

     The recommendation common to both the Chichester and Davies reports is that the management of the colleges and universities devolve from Richmond to the individual institutions. The Chichester report proposes that the state consider ‘a plan whereby Virginia might assign selected colleges and universities greater responsibility for their daily operations and for their long-term development’ and goes so far as to suggest that it ‘consider the possibility that certain schools or colleges within a university might be recommended for independent status, as well.’46 The report saw four advantages of greater decentralization:

First, accountability would be increased because the people working in the institutions would know that they are fully responsible for how the institutions operate and how well they serve their clients….

     Second, the institutions would have added flexibility to adapt to changes in our economy and the society and could move more quickly and efficiently to do what has to be done….

     Third, the increased autonomy would result in a greater sense of ownership by those who work in the institutions. This, in turn, would yield more imaginative, cost-conscious decision-making….

     Fourth, the domain of state government becomes smaller as the institutions are assigned this quasi-public status. They are serving their clients rather than responding to central state agencies. This is an excellent example of how operational responsibility should be given to those closest to the points of service; government can be downsized to realize the efficiencies inherent in flexible organizational units responsible for the results they produce.47

Similarly, from the Davies Report:

We need to decentralize the greatest possible operational responsibility to the colleges and universities themselves. They have to be lean and efficient, and able to move quickly. Following the example of the autonomy given to the teaching hospitals of Virginia Commonwealth University and the University of Virginia during the 1996 Session of the General Assembly, we should give colleges and universities complete responsibility for their personnel and their operating and capital expenditures. Those that are too small to assume all of these responsibilities themselves either should form cooperatives or purchase the administrative services from larger universities.48

     Such are the most insightful and powerful recommendations made by each of these commentators. They are the product of long experience and considerable research and confirm both the insights of public choice theory and the broader national experience with deregulation.

  1. Expand SCHEV’s role in assessing the quality of each institution and provide for the wide publication of such assessments among potential students and their families.

     As valuable as are the numerous publications that evaluate colleges and universities, SCHEV’s role in assessing the quality of education in Virginia’s postsecondary schools should be extended. Competitive markets work best when information is easy for consumers to access and the market accountability so vital to institutional discipline will be enhanced if SCHEV makes detailed comparative information on Virginia schools widely available to prospective students.49

  1. Encourage individual institutions to engage in private fundraising under principles that ensure support of appropriate educational goals.

     The expansion of charitable giving to Virginia’s public colleges and universities should be a cornerstone of state policy for two reasons. One, it is a means of garnering substantial resources that principally benefit Virginians without burdening taxpayers. Two, it is another means of forcing accountability on individual institutions. The foundation of all development efforts is the educational quality of the institution as perceived by alumni, business, and foundations. To the extent that private contributions are critical to their mission, if not survival, schools will be under great pressure to provide a level of quality that can gain broad acceptance.

     That successful fundraising is possible for public institutions is demonstrated by the five Virginia schools listed below in Table 2, which are among the 50 most highly endowed public institutions in the nation.50

     The final column to the right suggests the importance of these funds to the state in terms of annual support. Assuming that 5% of the corpus is available annually as income to support current operations, there is over $100 million from these five schools alone. We believe that the block grant system may significantly increase the pace of giving. For one thing, the time college presidents and their staff spend lobbying the legislature and encouraging others to lobby the legislature can be redirected to private fundraising. In addition, although current state law prohibits decisions on state funding to take into consideration the availability of endowment funds,51 it is impossible to separate these completely. Long-term block grants ensure that contributions will not merely replace appropriations, but will allow the school to make improvements not otherwise possible without the donor’s generosity.

     A policy of encouraging contributions meshes well with the policy of minimizing bureaucratic control. Donors wish to benefit their alma mater, not contribute money to the state. Increased state control reinforces the latter perception and is likely to lead to considerably diminished private assistance.

  1. Implement the plan gradually, beginning with the stronger schools and use the contract as a flexible tool to provide incentives to achieve particular goals.

     Virginia’s public colleges and universities vary considerably in size, mission, as well as financial and administrative strength. Because this proposal represents such a sharp departure ture from past practices, it may be prudent to begin with, say, four to six of the strongest schools. Virginia is fortunate to have a particularly strong group of schools. In the 1995 Barron’s Profiles of American Colleges (20th Edition), 19 state-supported colleges or universities are among the 134 institutions rated in the top two categories ‘ either ‘Most Competitive’ or ‘Highly Competitive.’ Four of these schools ‘ the University of Virginia and the College of William and Mary, rated Most Competitive, and James Madison University and Mary Washington College, rated Highly Competitive ‘ were from Virginia. New York had three schools included and no other state had more than two. These same four schools, along with Virginia Tech, also rated among the top 25 state-supported schools for value in a recent rating by Kiplingers Personal Finance Magazine. The University of Virginia, William and Mary, James Madison, and Mary Washington all receive two or more applicants for every student they admit. They are good candidates to experiment with a block grant system.

     Various uncertainties will attend implementation of block grants. For example, the expense of meeting a higher proportion of financial need is unknown because the availability of additional aid may change the overall needs profile of those applying for or accepting admission. Also, while we expect block grants to increase private contributions we do not know the magnitude or timing of this effect. As we gain experience with a few schools, additional schools can be moved into the program with less uncertainty. Even those schools that do not participate initially, though, may see immediate benefits because the traditional legislative and regulatory process should be less congested.



     The key elements of a successful Virginia postsecondary system is that it be: 1) efficiently managed, 2) accountable for the quality of the education it provides, and 3) accessible to all capable and deserving Virginians. This proposal is founded upon the premise that competitive markets are far better at ensuring efficiency and quality than government regulators. To harness such benefits, Virginia must redesign the way it subsidizes and oversees its colleges and universities in such manner that market forces can work. We propose that it replace the present combination of price controls, operating subsidies, and close regulatory supervision with block grants and a flexible tuition policy.

     The block grant system will align managerial power and responsibility at the institutional level, replacing bureaucratic oversight by the state with market discipline to force efficient use of resources. Educational quality will increase because each school will have the incentives, as well as the managerial flexibility to plan for, and respond to, the rapidly changing social and technical environment we may expect to encounter over the next 10 to 20 years. The governing boards and management of state schools now spend much of their time either positioning themselves politically to protect short-term interests in the legislature or responding to state regulators. Governor Gilmore has urged that boards be more active, more involved, more vigilant, but this will not happen so long as they are second-guessed constantly by a centralized locus of control. Only by returning real responsibility to these boards, can the state generate the kind of active and intense involvement the Governor seeks, including the development of private sources of support that can contribute to the improvement of academic facilities without burdening Virginia taxpayers.

     A flexible tuition policy will provide every Virginia student with adequate financial means to attend college. The current system, under which every Virginian is charged a low nominal price tuition and those with financial need have only a portion of this need met, subsidizes many students who have no need for government assistance at the expense of burdening students with less means. By requiring need-blind admissions and clear progress toward meeting financial need, our proposal will expand access to education in the Commonwealth.

     Virginia is not alone in seeking answers for the problems facing colleges and universities. The issue is of nationwide concern. This proposal, to replace the conventional system of operating subsidies and regulatory oversight with block grants and market discipline, can do more than improve Virginia’s colleges and universities. It will be seen as vigorous and innovative leadership that sets an example for the rest of the nation. Let Virginia demonstrate again that Mr. Jefferson was right: government governs best that governs least.



  1. See Jim Gilmore, A Plan to Put Universities on Course, Daily Press, July 26, 1998, pages H1 & H4.
  2. See R. H. Melton, Gilmore Takes Colleges to Task on Spending, Wash. Post, Aug. 22, 1998, at D1.
  3. Comm’n on the University of the 21st Century, The Case for Change, S. 990-18 (Va. 1990).
  4. Comm’n on the Future of Higher Education in Virginia, Making Connections: Matching Virginia Higher Education’s Strengths with the Commonwealth’s Needs(1996) [hereinafter Chichester Report].
  5. See State Council of Higher Education for Virginia, 1996 Council Notes, (Feb. 12, 1996), (visited Sept. 22, 1998) [hereinafter 1996 Council Notes]; Virginia 1995 Executive Budget, 1995 Amendments to the 1994-96 Appropriation Act, (Dec. 1994); State Council of Higher Education for Virginia, The 1994 General Assembly: A Summary of Higher Education-Related Legislation and Appropriations, (Apr. 1994); State Council of Higher Education for Virginia, The 1992 General Assembly: A Summary of Higher Education-Related Legislation and Appropriations, (June 1992); Virginia 1991 Executive Budget, Amendments to the 1990-92 Appropriation Act, (Jan. 1991).
  6. In May 1997, Congress created the National Commission on the Cost of Higher Education and funded it with $650,000 to investigate the cost of higher education and to suggest remedies. See William H. Honan, The Ivory Tower Under Siege, N. Y. Times, Jan. 4, 1998, at 4A, 33. The commission issued a report in January 1998. National Commission on the Cost of Higher Education, Straight Talk About College Costs and Prices (Oryx 1998).
  7. The National Center for Public Policy and Higher Education, (visited Oct. 4, 1998) .
  8. California Citizens Comm’n on Higher Education, (visited Oct. 4, 1998) . See alsoThe Education Comm’n of the States, (visited Oct. 4, 1998) ; The Midwestern Higher Education Comm’n, (visited Oct. 4, 1998) . For other information on postsecondary initiatives, see the Nat’l Postsecondary Education Cooperative, (visited Oct. 4, 1998) , and The Am. Council on Education, (visited Oct. 4, 1998) .
  9. Office of Educational Research & Improvement, U.S. Dept. of Education, National Center for Education Statistics, Digest of Education Statistics 1997, at 199 tbl. 191, 200 tbl. 192 (1997) [Hereinafter NCES Digest 1997]. Several hundred tables of education statistics, including those cited, may be downloaded in spreadsheet format from the NCES Web page. See Nat’l Center for Education Statistics, (visited Oct. 5, 1998) . These data are extracted from the NCES’s Integrated Postsecondary Education Data System, a system of surveys which collects annual data from the individual institutions. The original survey data are available from NCES on CD-ROM.
  10. NCES Digest 1997, supra note 9, at 359 tbl. 342, 362 tbl. 345.
  11. Id. at 341 tbl. 325.
  12. Id. at 326 tbl. 312.
  13. This figure results from dividing the average Consumer Price Index during 1996 by the comparable figure for 1976, as reported in the applicable Federal Reserve Bulletins.
  14. See, e.g., Anderson, Imposters in the Temple: A Blueprint for Improving Higher Education (Simon & Schuster 1996); William C. Barba (ed.), Higher Education in Crisis: New York in National Perspective (Garland Pub., Inc. 1995); David W. Breneman, Liberal Arts Colleges: Thriving, Surviving, or Endangered? (Brookings Inst. 1994); James M. Buchanan & Nicos E. Devletoglou, Academia in Anarchy: An Economic Diagnosis (Basic Books, Inc. Publishers 1970); Education Comm’n of the States, The Preservation of Excellence in American Higher Education: Report of the ECS Task Force on State Policy and Independent Higher Education (1990); Christopher J. Lucas, Crisis in the Academy: Rethinking Higher Education in America(St. Martin’s Press 1996); Michael M. McPherson & Norton Owen Shapiro, Keeping College Affordable: Government and Educational Opportunity (Brookings Inst. 1991); John W. Sommer (ed.), The Academy in Crisis: The Political Economy of Higher Education (Transaction Publishers 1995); Charles J. Sykes, The Hollow Men: Politics and Corruption in Higher Education (Regnery Gateway 1990); Charles J. Sykes, ProfScam: Professors and the Demise of Higher Education (Regnery Gateway 1988). The American Council on Education has suggested that at least some of the public concern with rising college costs results from the widespread overestimation of college costs. See American Council on Education Office of Government Relations, Public Perceptions of College Prices, (visited Oct. 4, 1998) .
  15. For example, Governor Gilmore, in swearing in ceremonies for new university trustees suggested that students in some cases are being shortchanged and asked rhetorically: ‘Do the degrees they receive confirm that they are proficient writers, critical thinkers and ethical citizens?’ R. H. Melton, supra note 2; see also T. Bertonneau, Declining Standards at Michigan Public Universities (Mackinac Center for Public Policy 1996).
  16. Computed from data supplied by SCHEV.
  17. Chichester Report, supra note 4.
  18. Gordon K. Davies, Twenty Years of Higher Education In Virginia, (1997) (visited Sept. 1, 1998) [hereinafter Davies Report].
  19. Chichester Report, supra note 4, at ii.
  20. Davies Report, supra note 18, Introduction at 1, 2.
  21. See Chichester Report, supra note 4, at 20; Davies Report, supra note 18, Fund Higher Education Adequately at 2-3. There is no indication that this level of funding is other than arbitrary as neither report provides any factual or theoretical support for this specific funding level.
  22. University of Virginia, Data Digest, (visited Oct. 4, 1998) .
  23. See State Council of Higher Education for Virginia, Virginia Colleges and Universities, (visited Oct. 7, 1998) .
  24. See, e.g., Chichester Report, supra note 4, at 7, 14, 16, 30.
  25. Davies Report, supra note 18, The Practical Limits of Planning at 1-2.
  26. Chichester Report, supra note 4, at 7.
  27. Id. at 14; See also id. at 16.
  28. Id. at 30.
  29. Id. at 25.
  30. Davies Report, supra note 18, The End of Cartels at 2.
  31. Chichester Report, supra note 4, at 8.
  32. Id. at 11.
  33. Davies Report, supra note 18, Leave Politics at the Door at 1, 2. The extent of involvement by the legislature is suggested by the fact that over 100 bills and resolutions pertaining to higher education were enacted in the 1996 session alone of the General Assembly. See 1996 Council Notes, supra note 5.
  34. Davies Report, supra note 18, Fund Higher Education Adequately at 2.
  35. Glen O. Robinson, American Bureaucracy: Public Choice & Public Law 28 (U. of Michigan 1991). See the accompanying note for sources providing useful overviews of welfare theory.
  36. The roots of public choice theory go back as far as Joseph Schumpeter’s Capitalism, Socialism, and Democracy (Harper & Brothers Publishers, 1st ed., 1942), and Kenneth Arrow’s Social Choice and Individual Values (Yale U. Press, 2d ed., 1963) (1951). Its current inspiration and insights, though, were formulated by Nobel Laureate James M. Buchanan and Gordon Tullock in their classic work, The Calculus of Consent (U. of Mich. Press, 1st ed., 1962), which they published while in the Department of Economics at Virginia Tech.
  37. For example, the following is a partial list of the working hypotheses used by Anthony Downs in his study, Inside Bureaucracy: every official is significantly motivated by his own self-interest even when acting in a purely official capacity; each official is biased in favor of those policies or actions that advance his own interests or the programs he advocates, and against those that injure or simply fail to advance those interests or programs; each official tends to distort the information he passes upward in the hierarchy, exaggerating those data favorable to himself and minimizing those unfavorable to himself; each official will vary the degree to which he complies with directives from his superiors, depending upon whether those directives favor or oppose his own interests; no one can fully control the behavior of a large organization; any attempt to control one large organization tends to generate another; the greater the effort made by a sovereign or top-level official to control the behavior of subordinate officials, the greater the efforts made by those subordinates to evade or counteract such control; the expansion of any organization normally provides its leaders with increased power, income, and prestige; hence they encourage its growth. See Anthony Downs, Inside Bureaucracy (Little, Brown and Co. 1966).37
  38. Not everyone accepts the inevitability of this conclusion. For an argument that bureaucracies can be structured to avoid such perverse results, see Jerry L. Mashaw, Greed, Chaos, and Governance: Using Public Choice to Improve Public Law (Yale U. Press 1997); and Abner J. Mikva, Foreword to Symposium on The Theory of Public Choice 74 Va. L. Rev. 167 (1988).
  39. A simple example illustrates this point. Suppose a state mandate forced the elimination of departments granting fewer than an average of five degrees a year. The Italian Department at one institution might be cut, while at another institution the Modern Languages Department (that offered, among others, exactly the same Italian major with exactly as many students) would not be in jeopardy at all. It would be difficult to convince the first institution of the justice of the situation, and it would lobby hard to gain an exception for its Italian Department.
  40. This is a classic case of what economists call ‘asymmetric information.’ It is well known that it is difficult to control behavior in the presence of asymmetric information (see, e.g., Varian, Intermediate Microeconomics: A Modern Approach, Chapter 35 (4th ed., Norton 1996).
  41. For a description of the Clean Air Market at the Chicago Board of Trade, including SO2 emissions auctions and trading, see (visited Oct. 4, 1998) . The program appears to be successful, judging by the increasing volume of trading. See Clean Air Market at the Chicago Board of Trade, (visited Oct. 5, 1998) .
  42. The building maintenance to be included is that now covered under operating budgets.
  43. Nat’l Comm’n on the Cost of Higher Education, Straight Talk About College Costs and Prices 6-8 tbl. 1(Oryx Press 1998).
  44. See Milton Friedman, The Higher Schooling in America, 11 The Public Interest 108 (Spring 1968).
  45. See Sandra R. Baum, Financing Liberal Education in America: Public and Private Responsibilities, in America’s Investment in Higher Education, David H. Finifter & Arthur M. Hauptman (eds.), 85 New Directions for Higher Education 101 (Spring 1994).
  46. Chichester Report, supra note 4, at 25.
  47. Id. at 26-27.
  48. Davies Report, supra note 18, The End of the Cartels at 2.
  49. SCHEV should be encouraged to be inventive in developing measures of college or university performance. The nation’s better law schools and graduate business schools regularly publish information on employment rates and starting salaries. Similar data for all state colleges and universities would be useful to prospective students.
  50. See 45 The Chronicle of Higher Education – Almanac Issue No. 1, at 36 (1998).
  51. See Va. Code Ann. ‘ 23-9.2(2) (1950).





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