Public and Nonprofit Higher Education as the Optimal Second‐Best

• Author: Robert Shireman
• DOI: http://doi.org/10.1111/puar.12577
• Published date: 01 September 2016
• Date: 01 September 2016

758 Public Administration Review • September | October 2016

Public Administration Review,

Vol. 76, Iss. 5, pp. 758–759. © 2016 by

The American Society for Public Administration.

DOI: 10.1111/puar.12577.

Robert Shireman is a senior fellow at

The Century Foundation, working on issues

related to education policy. He served in

the Clinton White House as senior policy

adviser to the National Economic Council

and later for the Obama Administration as

deputy undersecretary in the Department of

Education. He holds a bachelor ’ s degree in

economics from the University of California

at Berkeley, a master’s degree in education

from Harvard, and a master’s degree in

public administration from the University of

San Francisco.

E-mail: shireman@tcf.org

Perspective

A

reporter who covers Wall Street recently asked

me whether the for-profit college industry

has hit bottom yet. She meant the stock price,

but my mind went immediately to the predatory

behavior—aggressive and misleading marketing and

low-quality programs leading hundreds of thousands

of students into crippling debt—that has plagued the

industry. Those egregious practices were at their worst

precisely when the stock prices of for-profit colleges

were at their highest. And therein lies the market

failure that burdens for-profit higher education: While

in other industries consumer value and shareholder

value can move in tandem, with products and services

like education, the guiding light of the enterprise—

the stock price—can lead to the worst outcomes for

students.

Education exhibits a problem known as contract

failure, in which the buyer cannot reliably evaluate

the quality of the promised or provided product or

service. As a consequence, profit maximization fails to

produce optimal outcomes because the profit-seekers’

drive to overpromise and underdeliver is rewarded

rather than punished by the market, causing other

firms to emulate the bad behavior. The problem

becomes particularly severe if the firms target the least

sophisticated or most desperate customers, those who

are least able to evaluate the quality of the service

provided. Contract failure is common in enterprises

with ambiguous goals like building character,

developing critical thinking skills, or spiritual

fulfillment, or in industries involving vulnerable

populations like children (schools) and the elderly

(nursing homes).

Note that the school owners’ problematic behavior

is not necessarily illegal, such as outright deception.

More commonly, the strategies involve legal but sleazy

strategies that shortchange consumers in ways that

are difficult to detect or interpret (such as employing

a less-qualified instructor), or can be blamed on the

customers themselves (they didn ’ t come to class).

Sleaziness is a judgment call, not an easily enforceable

boundary like a speed limit. Law enforcement and

monitoring strategies, therefore, are inadequate for

steering the market toward optimal outcomes for

consumers. Rather than rewarding the best providers,

law enforcement alone rewards the firms that hew

closest to the illegal line, which means consumers and

taxpayers are not getting the value they deserve for the

money. Having colleges that are not outright corrupt is

a step in the right direction, but it is far from optimal.

There is one restriction, however, that actually does

a demonstrably effective job of preventing both

the illegal and sleazy behavior in contract-failure

situations. That restriction is what economists call

a nondistribution constraint . The nondistribution

constraint is a requirement that the revenue of a firm

always be used for the enterprise itself, rather than

being distributed to any owners or shareholders. Most

people do not recognize the nondistribution constraint

as a “regulation” because it is hidden as part of the core

definition of public and other nonprofit enterprises.

Predatory behavior is more common and more severe

at for-profit colleges than at nonprofits for one simple

reason: the lack of the nondistribution constraint.

We can think of education as exhibiting what the

economists Richard Lipsey and Kelvin Lancaster in

1956 described as the theory of second best: When

one condition of the optimal economic model cannot

be satisfied, adding a second distortion—in this case

the nondistribution constraint—can lead to the more

efficient outcome, even though it is the second-best

approach. The “best”—the market in which the profit

motive and consumers’ perfect knowledge leads to the

best value for the price—is not achievable. But the

“second-best,” the optimal condition, is one that can

exhibit many characteristics that appear (but may or

may not be) inefficient from an optimality standpoint.

In higher education the arguably inefficient choices

include esoteric courses, sprawling campuses, small

classes, limited and selective enrollments, constrained

schedules, professors who spend time on research

Robert Shireman

The Century Foundation

Public and Nonprofit Higher Education

as the Optimal Second-Best