A January 10th Wall Street Journal article pointed out how financial aid results in some students subsidizing other students' education:
Well-off students at private schools have long subsidized poorer classmates. But as states grapple with the rising cost of higher education, middle-income students at public colleges in a dozen states now pay a growing share of their tuition to aid those lower on the economic ladder.
The student subsidies, which are distributed based on need, don't show up on most tuition bills. But in eight years they have climbed 174% in real dollars at a dozen flagship state universities surveyed by The Wall Street Journal.
During the 2012-13 academic year, students at these schools transferred $512,401,435 to less well-off classmates, up from $186,960,962, in inflation-adjusted figures, in the 2005-06 school year.
At private schools without large endowments, more than half of the tuition may be set aside for financial-aid scholarships. At public schools, set-asides range between 5% and 40% according to the Journal's survey.
I've frequently witnessed this phenomenon. Every time a school I attended or taught at raised tuition, we were told that financial aid would be going up too. But is it fair or efficient that some students subsidize others? In today's WSJ letters column, a professor at the University of Tampa argues that financial aid is just a perfectly acceptable form of price discrimination:
Colleges are following a pricing strategy employed by airlines, car dealerships and other businesses. Customers who are able and willing to pay more are charged more. Anyone who has studied microeconomics principles knows both revenue and profitability increase as do the total number of customers served.
Colleges engage in scholarship programs (price-discrimination strategies). Eliminating or reducing these programs would result in some private colleges closing, enrollment overall would decrease and the percentage of the population receiving college degrees would decrease.
I think that he's basically right that financial aid is a form of price discrimination. Indeed, colleges and universities are uniquely positioned engage in price discrimination, as Richard Morrison observes (57 U Chi L Rev 801):
Colleges and universities are uniquely positioned to price discriminate among students because the barriers that may prevent businesses from practicing perfect price discrimination do not restrict them. First, ordinary firms are usually unable to ascertain the maximum amount each consumer is willing to pay for a product. However, the information schools obtain from financial aid forms, especially students' income and assets, greatly aid them in determining each student's reservation price. Students who misrepresent their income on financial aid forms face severe penalties, thus insuring that the schools have reliable information on which to base their estimates of reservation prices.
Second, schools do not face the problem of arbitrage. Businesses that price discriminate often find that low-paying customers will sell their purchases to high-paying consumers, luring the high-paying customers away from the original supplier. Financial aid recipients, on the other hand, cannot sell their university places to those students who do not receive financial aid.
I'm also prepared to accept that price discrimination is not the unmitigated evil that politicians and lawyers believe it to be.
Yet, I think it's worth noting that price discrimination in the form of financial aid has been a major driver in the higher than ordinary inflation rate of increase in higher education costs:
Gordon Winston in Hierarchy and Peers: The Awkward Economics of Higher Education, 13 Journal of Economic Perspectives 3 (1999), argues that tuition keeps rising because “sticker prices have risen to allow more price discrimination in the form of financial aid among potential buyers.” As Joseph B. Keillor likewise observes (87 Wash. U. L. Rev. 175):
One prominent economist [Thomas Sowell] has explained that the federal funding of higher education in general enables universities to price discriminate like monopolies, and skews market factors so that universities have “no incentive to keep tuition affordable and every incentive to make it unaffordable.” Financial aid forms provide colleges with detailed financial information about applicants and their families, thereby facilitating price discrimination as colleges “set an unrealistically high list price and then offer varying discounts. In academia, this list price is called tuition and the discount is called ‘financial aid’ . . . . [T]he net price actually charged is adjusted to the most that can be extracted from each applicant's family” and the government. Indeed, tuition has skyrocketed since the federal government initiated substantial funding of higher education through the Higher Education Act of 1965.
Worse yet, the ability to price discriminate via financial aid has led to collusion, as illustrated by the infamous case of the “Ivy Overlap Group,” which further jacked up prices at a rate well in excess of inflation. As Morrison explains:
… elite private colleges probably have more market power when they operate as a cartel, and thus are able to charge some consumers higher prices without driving them away. The more market power a firm or cartel has, the greater its ability to charge differential prices. A price discriminating cartel makes more profit than either an individual price discriminator or a cartel that is unable to price discriminate. Thus an individual school, lacking the cartel's combined market power, would not be able to price discriminate as effectively. Even though individual schools may legally engage in price discrimination, the added power of the cartel may increase the wealth transfer away from students and to the participating colleges and universities.
And that's the point. The ability to engage in rampant price discrimination results in a wealth transfer from the middle class and the taxpayer not to poor families but to bloated university administrations and all the other well-documented abuses that raging tuition inflation has occasioned.
