The dramatic economics of the U.S. market for higher education.

• Author: Hoxby, Caroline M.
• Position: The 2016 Martin Feldstein Lecture

We have in the United States what is arguably the world's only true market for higher education, as opposed to systems that are largely centrally controlled or financed. This market exhibits a strong positive correlation between students' college readiness (hereafter "CR") and the educational resources of the institution they attend. Moreover, my research shows, the more powerful the market forces, the stronger the correlation.

From my latest research, which breaks new ground with both data and methods, I show the productivity of institutions across this market. Strikingly, among institutions that experience strong market forces, the productivity of a dollar of educational resources is fairly similar, even if the schools serve students with substantially different CR. On the other hand, among institutions that experience weak market forces, productivity is lower and more dispersed. These facts suggest that market forces are needed to keep schools productive and to allocate resources across schools in a way that assures that the marginal return to additional resources at different institutions is roughly comparable.

If we take the productivity results and the resources-CR correlation as manifestations of market forces, then it follows that a student with higher CR must make more productive use of any marginal dollar of educational resources than a student who is less prepared for college. This property, which economists call "single-crossing" has long been hypothesized to be a law of nature, at least in tertiary education. This is the first compelling evidence. Single-crossing has profound consequences for the role of higher education in income growth, a point I clarify when concluding.

The U.S. market for higher education includes about 7,500 institutions. Some are publicly controlled; others are private non-profits or for-profits. Institutions are largely free to decide on pricing (tuition, fees, grants), CR requirements, students, faculty, curriculum, salaries, financial aid, and how to raise money from donors if non-profit or investors if for-profit. Although public schools have less discretion, they still have enormous autonomy by world standards, partly because they are controlled by local and state governments, not a national one, and partly because those governments recognize that public schools must be given latitude if they are to compete with local private schools. Federal intervention is mainly in forms that students can receive regardless of the school they attend: means-tested grants, tax credits and deductions, subsidized loans. On the whole, it is best to think of the U.S. tertiary sector as a market with numerous price distortions relative to laissez-faire, but without central control. (1)

U.S. institutions vary enormously in selectivity --that is, in the CR of their students. Selectivity is holistic but, roughly speaking, the "most" selective institutions' average student has a combined (math plus verbal) SAT (or translated ACT) score above 1300, the 90th percentile among test-takers. (Since some students do not take the tests, this corresponds to the 96th percentile among all students.) "Highly" or "very" selective institutions have an average student with combined scores above the 75th percentile (about 1170). "Selective" (without a modifier) institutions ask students to submit scores, grades, and other materials and turn down those judged to be inadequately prepared. Schools with combined scores above 1000 (the 47th percentile) are at least modestly selective. Non-selective schools usually only require that a student have a high school diploma or the equivalent and often have average combined scores of 800 (the 15th percentile) or below. The divide between non-selective and modestly selective schools is rough but somewhere between 800 and 1000.

At its highly selective end, the market is well integrated across geography. Schools compete for students and faculty. Schools are highly informed about their applicants, and students are fairly well informed about schools. High CR students are so valued that they are admitted without regard to their ability to pay, and alumni-donated funds fill the gap between what a student...