Posted by: Discover Scholars | July 13, 2008

The Trouble(s) with Financial Aid

The Princeton Alumni Weekly recently published an interesting article by U.S. News & World Report writer Katherine Hobson entitled “Financial aid: Who wins?”  The article does a great job summarizing the problems with the current financial aid system, and is worth a read even if it falls short of offering concrete solutions.

In particular, Hobson discusses at length how financial aid policies of “elite” colleges are causing schools with smaller endowments to struggle to “stay in the game.”

Though some schools have followed Princeton’s lead in eliminating loans for all students, most colleges simply cannot afford it. Princeton’s endowment — $15.8 billion at the end of the last fiscal year — enables the University to pay out more in financial aid than it takes in through tuition, but few others have that flexibility.

A more typical college in this regard is Fairfield University, a Jesuit university in Fairfield, Conn, where the Rev. Jeffrey von Arx ’69 is president … “some students get a financial-aid package that does not meet their total need, and they have to take out loans,” he says. “That’s when it’s important for us to be as brutally honest as we can and tell them that, given the package, they should give careful consideration to coming here. That’s a hard thing to say. But it’s the reality of the financial-aid market at 90 percent of places.”

A similar situation exists at Wesleyan University in Middletown, Conn, as President Michael Roth explains:

“We want to make sure we are using resources in as strategic a way as possible to make it possible for those who want to come here to do so.” After all, a school that uses its limited financial-aid pool to offer grants instead of loans probably cannot help as many families as it could if loans were part of the package.

But the trade-off for most schools is even greater than Roth admits.  When colleges like Wesleyan are forced to give out larger financial aid packages than they can afford in order to compete with better-endowed competitors, they also are unable to invest in other important aspects of their schools:  better technology, upgraded laboratories, higher-profile professors, or a host of other possible expenditures.

While Hobson does not mention it specifically, it should be reasonably obvious why schools like Princeton are pursuing these financial aid policies, and it’s not because they care about promoting “greater access to higher education.”  Universities are businesses like any other, concerned about maximizing revenues, but unlike most other businesses, colleges’ financial success is largely dependent on a relatively intangible factor:  their reputations.  Of critical importance for top schools is keeping their reputations as well-regarded as possible.

A little game theory can shed some light.  Imagine a world in which there are two schools.  School A has a long history of being an elite college, and spends money on the best professors, laboratories, and neo-Gothic architecture.  As a result, the education it provides is of very high quality, but its tuition also is very high, on the order of $50,000 per year.  School B’s reputation, meanwhile, is good but not elite, and it does not have as top-of-the-line facilities as School A.  However, because its costs are much lower, School B’s tuition is only $20,000 per year.

In this example, higher education works like most businesses:  students decide where to go to school largely by weighing the factors of quality and price.  if price were not a factor, however, the choice between Schools A and B — like the choice between a Porsche and Pinto — would be easy.  Competing on price is important, because it allows for market segmentation: Individual consumers decide which goods they prefer, survey the marketplace for what is available, and then purchase those that most closely satisfy their preferences.

Unfortunately, this stylized example is not how higher education works today.  Why?  Because the current system ties the amount of accessible financial aid to the schools that students attend, giving schools with more resources a distinct advantage.  As mentioned earlier, historically elite learning institutions have much greater endowments and other financial resources at their fingertips.  These resources allow them to offer a better product and cheaper tuition to prospective students (which they will compensate for through interest on their endowments and subsequent alumni donations over coming years).  As a result, students accepted to a Princeton or Harvard face virtually no quality vs. price trade-off.

What this means for higher education as a whole is that the current financial aid system, whereby alumni and other prominent donors contribute to schools, rather than individuals, reinforces the perceived status of those schools that are considered “top-tier.”

While demand for high quality higher education continues to increase massively, the supply of top-tier higher education has not changed much at all (one need only look at the lack of variability in the U.S. News rankings for proof of this point).  And as any Econ 101 student can tell you, when demand far outstrips supply, costs are inevitably pushed upward.  In other words, while top-tier schools like Princeton continue to use their price-setting power to attract the highest-caliber students (thereby maximizing their expected future revenues), other schools (and their attendees) are left unable to compete in an environment where college costs are constantly pushed upward.

Or, to use the words of John Strassburger, president of Ursinus College in Collegeville, Pa:

People think, ‘Gee, if Harvard will only cost us $18,000, why should Ursinus cost us $30,000? I don’t get it.’

Later this week, we’ll discuss further how we believe these problems should be fixed, and how fits into the picture.



  1. See a more stern warning here: “Runaway Higher Education“.

  2. […] Trouble(s) with Financial Aid — continued On Monday, we discussed a recent article in the Princeton Alumni Weekly dealing with the problems that come with tying […]

  3. […] financial aid from the universities and colleges altogether.  As we attempted to lay out in our original post, we believe this sort of incentive is sorely lacking in higher education […]

  4. […] What is the real cost of college? In some of our recent posts, we’ve discussed the relative lack of price competition in the world of higher education.  That is to say, the cost of attending Harvard is largely the same as attending Ursinus — and may be even cheaper taking financial aid packages into consideration. […]

  5. […] that more tuition assistance can lead to higher education costs? The answer lies in a problem we’ve discussed multiple times — the tying of financial aid and other tuition assistance to the schools that students […]

  6. […] on their career choice.” But when high education costs are caused by preventable factors (the tying of financial aid to individual schools, artificially low interest rates, and crowding out effects from government grants) numbers like […]

  7. […] donations to schools with less funding are probably more productive than donations to rich schools, for reasons we’ve previously blogged about, donating to any school is still inefficient, and helps to push tuition costs higher. To maximize […]

  8. […] trends to think about We talk a lot on this blog about the changes we’d like to see in the world of higher education. In particular, we frequently discuss our view that spiraling […]

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