The Effect of Government Financing on the Behavior of Colleges and Universities

This paper examines the impact of external financial support on the behavior of colleges and universities. We present a simultaneous equations model in which changes over time in tuition and fee charges, institution-specific scholarship aid, and instructional expenditures are expressed as a function of changes over time in levels of federal student aid, federal grants and contracts, state support, and other variables. Variations in external funding are found to have significant effects on institutional behavior, which differ among private four-year, public fouryear and public two-year institutions. 1 The aim of this paper is to improve our understanding of the effects of external government financing on the behavior of colleges and universities, focusing on their tuition and fee charges, institution-specific scholarship aid, and instructional spending. The paper is organized as follows. After a brief discussion of some relevant literature in Section I, we turn in Section II to a description of our data set -a panel of individual college and university financial data for the period 1978-79 to 1985-86. Section III presents an econometric model of college and university finance and Section IV analyzes the empirical findings that result. Section V concludes. I. Relation to literature The research reported here fits into the growing but still quite limited empirical literature on the behavior of governmental and not-for-profit institutions. This important subject has recently started receiving considerable systematic attention from economists, legal theorists and other social scientists.2 2 Within higher education, empirical work on institutional behavior has been surprisingly rare. Papers by James (1978) and by Hoenack and Pierro (1986) develop models of the behavioral response of institutional resource allocation to changes in external constraints. The piece by Hoenack and Pierro includes some empirical estimation of the influence of state legislative appropriations on the behavior of a public institution. To our knowledge, no systematic empirical work has been done on the implications of other forms of government spending on institutional behavior. Several studies of student aid do, however, note the potential importance of these issues (Hearn and Wilford (1985) and Finn (1978)). Empirical studies parallel to this study have been performed for policy areas other than higher education, and they have instructive findings. An interesting example is the work on measuring the effect of state and federal grants on the spending patterns of local school districts. 1 The academic year 1985-86 is the latest for which national data are available. 2 See the useful collection of articles assembled in Rose-Ackerman (1986). 2 Not surprisingly, the results indicate that responses depend on the type of subsidy and the manner in which it is distributed (examples include Tsang and Levin (1983) and Craig and Inman (1982)). Feidstein (1978) examined the effects of federal Title 1 aid on local district spending. The major question was whether local governments spent all of their Title 1 grants on additional educational expenditures (as required under the terms of the program) or whether, instead, some of the federal money was used to replace state and local money or even to provide tax relief. While this question relates to elementary and secondary schooling rather than post-secondary education, the analogous issue in higher education is whether federal funds targeted at lowincome groups replace institutional support. Feldstein’s regression results indicated that an extra dollar of Title 1 funding augmented total educational spending by 72 cents.3 Craig and Inman (1982) examine the effects of different types of federal aid on the educational spending of state and local governments. Their results indicate that different types of aid are in fact allocated differently. A dollar of federal aid that is given to local governments but administered through the state ultimately increases local spending by 87 cents. On the other hand, a dollar of federal aid that goes directly to the local government appears to have a zero or even negative impact on total spending on education, indicating substantial substitutability between federal and local educational expenditures. The relevant literature is not limited to studies of education. Some of the work on the effects of government subsidies on demand and supply in housing (for example, Barnett and Lowry (1979) and health markets (for example, Sloan, Cromwell, and Mitchell (1978)) is germane. In each case, response functions are estimated which seek to ascertain the effects of different forms of government expenditures. In sum, while relatively little work has sought to address the response of higher education institutions to changes in external funding, there are a variety of studies that provide a 3See Craig and Inman (1982), Tsang and Levin (1983) and Gurwitz (1980) for discussion of this work. methodological basis for our work, and which lead us to believe meaningful empirical estimates