The real cost of higher education per full-time equivalent student has grown substantially over the last 75 years, and the rapid rise since the early 1980s is a cause of considerable public concern. Opinion surveys consistently find that how much one has to pay for a college education is a serious national issue. (1) Policymakers have responded to this concern. In 1997 Public Law 105-18 (Title IV, Cost of Higher Education Review, 1997) created an 11-member National Commission on the Cost of Higher Education. (2) More recently, in June 2005, Secretary of Education Margaret Spellings created a National Commission on the Future of Higher Education with a broad mandate to look into costs and accountability in higher education. When public angst is high and commissions are being created, good policy outcomes require a clear understanding of the forces behind the phenomena of concern. Unfortunately, there is little consensus and considerable controversy about the causes of the rapid increase in higher education costs.
In his July 1996 congressional testimony, David Breneman laid out the difficulty very neatly. He said that there are two competing theories explaining the rise of costs in higher education. The first relies on the insights of William Baumol and William Bowen about the cost difficulties faced by personal services industries (Baumol, 1967; Baumol & Bowen, 1966). As we will explain below, the ideas behind the "cost disease" explanation in higher education have a distinguished heritage in economics. The competing explanation is Howard Bowen's "revenue theory of costs" (1980). In Howard Bowen's view, the source of cost increases in higher education is the rising revenue stream made available to colleges and universities. Higher education institutions spend everything they can raise, so revenue is the only constraint on cost.
We have a number of goals in this article. The first is to explain the two competing approaches in some detail. To summarize our view, cost disease rests on a firmer behavioral foundation than Bowen's revenue theory. Despite that advantage, the choice between them ultimately is empirical. This is our second task. As Breneman noted in his testimony, "it is hard to test these two theories because for most of the post WWII era, higher education has experienced remarkable revenue growth" (1996, p. 60). The time series evidence on college costs is indeed compatible with both the cost disease and revenue theory explanations. We propose instead a cross-section test using disaggregated price data from a broad set of industries.
One important difference between these two theories is that the cost disease theory is based on similarities between higher education and other industries, while the revenue theory of costs is based on peculiarities of higher education as an industry. Howard Bowen is by no means alone in proposing higher education-specific explanations for cost increases. Malcolm Getz and John Siegfried (1991) list six competing explanations, one of which is cost disease. The other five are higher education-specific explanations: cost increases arising from a change in the product mix toward more expensive disciplines; cost increases arising from shortages of higher education inputs; cost increases arising from faculty and administrators in charge having inflated desires for quality; cost increases arising from poor management in higher education; and cost increases arising from government regulations creating expanded duties for higher education. (3) We will focus on Bowen's revenue theory of cost because, unlike the other higher education-specific causes in this list, it is overarching. It is not tied to a specific time frame. Like cost disease, the revenue theory is meant to explain the entire evolution of cost in this industry.
Before proceeding, we need to bring in the substantial theoretical and empirical literature on cost functions and production surfaces in higher education. …