Do Business Cycles Affect State Appropriations to Higher Education

1. Introduction and Motivation Business cycles affect higher education in a number of important ways. Anecdotal evidence from college admissions officers and administrators, as well as empirical evidence on the behavior of students and institutions of higher education, suggest that enrollment in higher education is countercyclical. For example, Betts and McFarland (1995) recently showed that enrollments in community colleges are highly responsive to changes in local labor market conditions. These authors found a 1% increase in the unemployment rate among all adults associated with a 4% increase in enrollment at community colleges in a large panel of community colleges across the United States. Leslie and Ramey (1986) found a similar relationship between economic conditions and enrollment using data aggregated to the regional level. This paper examines the relationship between state appropriations to higher education and state-specific measures of business cycle conditions in order to better understand the effects of the business cycle on government funding of higher education.1 I further investigate the relationship between the business cycle and state government appropriations to higher education reported by Betts and McFarland (1995) and Leslie and Ramey (1986). Both of these studies aggregated state and local government appropriations to higher education to the regional and national level. While data aggregated to the regional and national levels are readily available, decisions about government funding to higher education are made at the state and local levels, and these decisions may be affected more by local economic conditions than by aggregate economic conditions. If the timing of turning points in the business cycle varies across states, then aggregating government appropriations data across states may obscure important statespecific phenomena. Most research has focused on the effects of economic conditions on demand for higher education. One notable exception is Leslie and Ramey (1986), who examined the relationship between enrollment, business cycles, and state appropriations to higher education using regional appropriations and enrollment data and a national measure of business cycle conditions. That study found a procyclical relationship between the NBER coincident index and regional-level government appropriations to higher education. For one region, the estimated elasticity of appropriations with respect to changes in the coincident index was three, suggesting that a 1% change in the NBER coincident index was associated with a 3% change in appropriations to higher education in that region. This study also highlighted the complex relationship between state funding for higher education, enrollment, and business cycle conditions by documenting a statistically significant relationship between enrollment and state appropriations at the regional level, although they found that the appropriations-enrollment relationship weakened after 1977. Betts and McFarland (1995) also describe, in an informal way using aggregate data, a procyclical relationship between the business cycle and funding for higher education. These authors report that aggregate state and local government appropriations to higher education fell in the years 1971, 1975, 1980-1982 as well as in several years in the early 1990s; all of these years are either coincident with, or immediately following, years when the NBER Dating Committee has identified a cyclical downturn in the economy. The transmission mechanism linking business cycles and government appropriations to higher education during recessionary periods seems clear: recessions reduce tax revenues; state and local governments, most of which operate under legally required balanced budget restrictions, reduce appropriations to institutions of higher education, as well as other types of expenditures, in order to balance their budgets. Betts and McFarland point out that these cyclical patterns of government support for higher education may place tremendous financial pressure on institutions of higher education during economic downturns, because the cuts in government funding happen at the same time enrollments are increasing. …