For-profit higher education

For-profit higher education has been growing recently, now enrolling about 2 million students or 10% of the student population. Given that these institutions tend to be of lower quality and much more expensive than traditional institutions, several questions arise.

First of all, what explains the rise of for-profit schools? Is attending them even worth it? And if not, then why do students go anyways? Secondly, how does the emergence of these institutions affect traditional schools? What role do subsidies play? And finally, what should policymakers do? Should the entry of for-profit institutions be encouraged or not?

These are the questions addressed in a new working paper by Jacqmin (2014). Let us set the scene by looking at how recent the rise of for-profit attendance is (vertical axis is the number of full-time equivalent students in millions).

Enrollment by public, private, for-profit school

We can see that in the early 2000s the growth accelerated, and that in around 2007, for-profit growth shifted to yet another gear. As mentioned above, now these schools enroll about 2 million students. Their qualities are generally considered worse than (or at best on par with) traditional institutions’. They are, on the other hand, 6-13 times more expensive.

10% of the student population attends for-profit schools, but this 10% represents 26% of those who have some student loans, and 43% of those who default on said loans. Other studies generally concluded that the returns to for-profit education (after taking student outcomes and costs into account) are generally not high enough to make attending one of these institutions worth it.

Why do students still go then? One explanation (that plays a crucial role in the paper of Jacqmin) is advertising. For-profit schools spend enormous amounts on advertising as illustrated below (figure based on Table 1 in the paper; dark columns represent institutions/companies that are not for-profit schools, for comparison).

Advertising expenditure of for-profit schools

Not only do we have absurdly large ad expenses at these schools, the ads are also often of questionable quality. I.e. they misrepresent the benefits of attending a for-profit school. There are several lawsuits pending regarding this according to the paper.

Besides advertising, it’s hard to find other reasons why students would attend these colleges. While they may be more cost effective (given their for-profit nature), and the public/private for-profit price gap has declined (thanks to a rise in tuition at public institutions driven by federal grants), attending for-profits is still not worth it. So it’s not possible to explain students’ choices assuming that they make a rational cost-benefit analysis.

Consider the following model to further study for-profit institutions. Students decide whether to attend a school (and if yes what kind of school) by performing a cost-benefit analysis. Benefits are increasing in an institution’s quality and the student’s ability, costs are increasing in tuition and the fraction of the tuition the student has to pay (the rest being financed by governmental subsidies/grants).

Traditional institutions aim to have high-quality education and research, while also obeying a budget constraint (i.e. they can’t spend more money than what’s covered by tuition and governmental subsidies). They can choose the quality of their education.

In this simple setup, Jacqmin (2014) shows that the quality traditional institutions choose is increasing in the subsidies/grants that students receive, tuition and also the fraction of the tuition that is actually paid by the student. Increasing quality, however, diverts resources from research and increases enrollment. More students have both costs and benefits for the institution, which could on net be either positive or negative.

Now, let us add a for-profit institution into this setup. Consider a for-profit school that uses advertising to distort the benefits of attendance upwards. The advertising is (as consistent with evidence) more effective on low ability students. A for-profit does not receive direct subsidies from the government, but students attending a for-profit do receive subsidies.

A for-profit institution maximizes its revenues from tuition minus its costs (which include ad expenses, operating costs, and a fixed cost of entry into the higher education market). It can choose its level of advertising and tuition to maximize its profits. Its quality is assumed to be exogenous (i.e. fixed), and lower than the quality of traditional institutions. This fixed quality can be thought of as the minimum quality for which the institution can get accredited (or make sure that its students are eligible for receiving federal subsidies/grants/loans, etc.).

Then we proceed in four steps.

  1. The traditional institution chooses its level of quality taking into account that this level may influence whether the for-profit school will enter the market.
  2. The for-profit school makes its entry decision. The likelihood of entry is decreasing in the quality of the traditional institution. I.e. the traditional school can prevent entry but it is costly do so (and hence is not always in the best interest of institutions to do so).
  3. The for-profit school decides on its advertising intensity and tuition. The tuition it charges is increasing in federal loans/grants. So higher federal grants can drive an inflation in (for-profit) tuition. It is also increasing in the non-profit schools’ tuition.
    The amount of advertising is increasing in federal subsidies and traditional school tuition as well. It is also increasing in the quality of traditional schools (i.e. must use more ads to compete against better schools). Also, the more misleading ads can be (the more they can distort benefits of attendance upwards), the more for-profits will spend on ads.
  4. Finally, students decide on whether to study and if yes which school to attend.

The author analyzes this 4-stage model using numerical simulations. First, let us look at some comparative statics, then some welfare analysis.

If the traditional institution places more weight on education (as opposed to research), then for-profit entry will be less likely (due to the higher quality of education at the traditional school). What if the traditional school increases its tuition? This will have two effects: the potential tuition (and hence profits) of for-profit institutions will be higher, but since higher traditional tuition increases traditional quality, it will be harder for for-profits to compete. In the simulations, the former effect outweighs the latter. This means that higher tuition at non-profit schools will facilitate the entry of for-profit schools. (And hence federal policies that inflate tuition (at traditional schools) can indirectly increase the prevalence of for-profit schools.)

What if the ads for-profit schools use can be more misleading (i.e. if ad opacity increases)? This will have some interesting effects. First and quite obviously, the entry of for-profit schools will be more likely. Second, the quality at traditional institutions will be higher. This is due to the “disciplining” effect of competition: more competition means that traditional schools need to pay more attention to their quality.

A similar effect can be found for student subsidies. If students receive lower subsidies, i.e. if they have to pay a larger fraction of their tuition out-of-pocket, then for-profit profits (and hence probability of entry) will increase, but so will the quality at traditional schools.

If, however, the subsidies that (traditional) schools receive increase, entry will be less likely and quality (at traditionals) will increase.

Let us finish off with some interesting welfare analysis. The author introduces two measures of welfare: democratization of education, and the social welfare benefits of education. The former refers to how many (or what fraction of) students can attend college. The latter is a more intricate measure of social welfare, which can be summarized as

Students’ net benefits from education + Traditional school’s utility + Profit of for-profit school – All subsidies.

In other words, the first welfare measure rewards high college attendance, while the second doesn’t care about college attendance for its own sake, it cares instead about the total benefits it brings to society as a whole.

The distinction between the two is crucial. Depending on which welfare measure you prefer, you could reach quite different conclusions about the effect of for-profit schools. Namely, the first (democratization) measure prefers the entry of for-profit schools because it increases college attendance. The second measure doesn’t like entry, because on net its costs outweigh its benefits. For instance, in some cases the entry of a for-profit can increase the overall quality of education, but the costs (i.e. increased public spending in the form of subsidies for instance) are too high to justify the entry.

We can conclude with the following facts. This paper shows that

  • improving the availability of information on for-profit school student outcomes (i.e. decreasing or combating ad opacity) can make the entry of for-profits less likely;
  • demand-side education subsidies (i.e. those given to students) can facilitate, whereas supply-side subsidies (i.e. those given to (traditional) schools) can help prevent the entry of for-profit schools;
  • students attend for-profit schools even though it’s not worth it for them, and the social welfare costs of for-profit schools in general outweigh the benefits;
  • on the other hand, for-profit schools increase access to higher education, and in many cases force traditional schools to improve their quality.
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