The Irascible Professor^SM

Hanlon's Razor: "Never attribute to malice that which can be adequately explained by stupidity."... ...Anonymous

Commentary of the Day - November 28, 2001:  Perverse Incentives and Corporate Delusions in the Administration of the California State University System - Guest commentary by Robert H. Daniels.

You can try to teach a dog how to be a cat.  Reward him when he says "meow", and yank on the choke chain when he barks.  But at the end of the training you will not have a cat, but an unhappy and neurotic dog.  Similarly, powerful people who really should know better are trying to teach the California State University campuses how to be business corporations.  Education and scholarship, however, are fundamentally different from the pursuit of profit, so applying a corporate model will predictably result in policy failure.  Let's see why:

The business corporations that sell us our daily bread and produce our circuses can only survive and prosper by selling those goods and services for more than the cost of production.  An enterprise competes for customers by cutting costs, improving service, or winning the advertising battle for the consumer imagination.  The success of a business is measured by its profits over time – the losses of today's "dot.coms" are not ends in themselves, but are endured as necessary investments to produce eventual greater returns (ed. note: It appears that many "dot.com" managers overlooked this!)

When we consider California's 23 state universities (collectively the "CSU"), two differences are starkly obvious.  First, CSU sells education for one-fifth of the cost of production.  The average cost of educating a student for one year is about $10,000, yet each California student pays about only $2,000 in "fees" (a political superstition prevents use of the correct word, "tuition".)  Second, the fee CSU collects is only a small fraction of the economic price a student has to pay to obtain an education.  The biggest cost to a student is not the money paid in registration fees (which are further subsidized through various loans and grants), but the loss of present earnings from work.  It takes a good deal of faith in the long-term value of higher education to take time away from earning wages, and instead spend unpaid time sitting in a classroom, in the library, or in front of a terminal.

These differences in the basic economics of the enterprise mean that university policy decisions based on a corporate model will almost certainly be wrong.  Supply and demand do not work the same way in CSU's ivory tower as they do in the corporate world.  It is as though your favorite supermarket bought milk for $10 per gallon and sold it to you, the customer, for $2 per gallon.  Often, someone else pays the $2 for you: your real cost is the need to drive 50 miles each way to get to the store.  If such a store rewarded the Dairy Product managers based on sales volume, it would be motivating them to maximize losses – a formula for bankruptcy.  If such a store decided to promote sales by cutting the price to $1.90 per gallon, customers wouldn't gain much, because they still have to drive 50 miles to save the dime.  Worse, the loans and subsidies might be cut by ten cents, so the customers would be no better off, yet that price cut could wipe out the small fraction of revenue that pays for repairing the shopping carts and modernizing the store.  Anyone familiar with academic administration in the CSU will recognize the goofy and perverse results when education bureaucrats apply misplaced corporate analogies.

1. Follow the money, follow the FTE's

 "Follow the money", said Deep Throat, so let's do exactly that.  The  sprawling bureaucracy of the CSU, operating from the modern equivalent of the Forbidden Palace in Long Beach, supervises 23 campuses where roughly 20,000 professors teach 350,000 students.  The State Legislature currently appropriates about $2.4 billion per year from tax dollars to run the system, student fees chip in another $600 million, while various research grants and (God bless them!) donations add another $200 million or so.

The annual appropriation is the result of political negotiations (prison guards and medicaid doctors need to be fed, too), centering on incremental funding for year to year changes in "full time equivalent students" and the estimates of the marginal cost of filling one more seat with one more warm body.  The total is then divided among the campuses through an opaque budget process, largely based on prior year amounts, as adjusted for change in "full time equivalent enrollment".

Each university's allocations, after being charged with the burden of a swarm of deputy deans and mid-level administrators, are sub-allocated to schools, and then parceled out to the academic departments according to various traditional or arcane calculations.  No level of the bureaucracy involved in this process trusts the competence of any other level, perhaps because academic administration traditionally was practiced by amateurs drawn from the ranks of redundant professors.  As a result, each level tries to build in a healthy cushion against the perceived incompetence of the other participants, leading to the inevitable "use it or lose it" spending frenzy as each fiscal year draws to a close.

Throughout the process the two biggest factors are tradition (last year's budget) and enrollment (FTE).  In the competition for money at each level, the winners are those with the largest, growing, student enrollments.  It's those campuses, schools or colleges and academic departments that get the supplemental appropriations.  Want a bigger office, more clerical assistants, or new jobs to hand out?  Get more FTE!  The way an administrator builds an academic fiefdom in the CSU is by cultivating and harvesting FTE's.

Of course, in the corporate world the enterprise insists on measuring and quantifying the performance of the managers.  Just so it is in the CSU.  "FTE's" are determined by the enrollment in each section, class and department during the "census period", typically the fourth week of instruction.  Observe what perverse incentives this creates for the faculty, and what misery for students (who are either the customers or the product – it's not clear which – in the corporate model of the university.)  At meetings which open each semester, faculty are routinely told not to discourage or scare away any students before the fourth week, for fear of hurting FTE.  Any weeding out, any quality control will have to wait for later in the term.  However, to discourage unqualified students from signing up for understaffed classes (blocking other students and delaying their graduation), there is a policy making withdrawals after the fourth week much more difficult.  Indeed, the fourth week was originally chosen as the census date on the expectation that enrollments would have stabilized at that point.

The result is predictable: a mob of students who

Note 1

underestimate the time requirements of university study, sign up for too much, try to balance job and school, and then find when the semester is 1/3rd over that they are in too deep but are stuck in their classes.  Bad grades, disappearing students, hard feelings, mountains of academic probation paperwork, repeat enrollments – and more FTE points for the academic administrators.  The process of measurement skews incentives and distorts the thing being measured, because any department that screened student qualifications too heavily in the first four weeks would cut its own throat in the zero sum competition for resources.  Safeway was never like this.

A similar dynamic drives the proliferation of courses and the elaboration of program requirements.  A rational business organization recognizes that it's costly to roll out new product models, and that customers will resist complexity that brings no benefit.  In the CSU world, however, each program and department has an interest in requiring students to take more courses with its professors – more FTE.  "Mission creep" raises requirements to where it takes about 4 ½ years to finish a four-year degree.  (San Francisco State, for example, has three levels of General Education requirements, with "segment" or "cluster" regulations at each level.  The description in the University Catalog resembles the Internal Revenue Code.)  "Hidden" requirements are invented for major fields of study – courses that are technically not required parts of the program, but are prerequisites for enrollment in the required courses.  "Not invented here" rules are enacted, requiring transfer students to undergo protracted rounds of meetings with faculty advisors to determine if classes taken elsewhere are acceptable substitutes for each University's required list.

What makes these requirements proliferate so?  There's no countervailing consideration of the cost they impose.  These rules provide work for – they justify the existence of -- the administrative bureaucracy of counselors and deputy deans.  The longer the paths to graduation, the bigger the departmental

Note 2

budget, as long as the students do not drop out in despair.  And why do the students put up with it?  They are paying only 1/5th  the cost, and a tedious bargain is still a bargain.

The CSU administration, in the one sensible part of the "Cornerstones" initiative, called for a rationalization of these requirements.  "Let's remove all these obstacles to timely graduation", say the education bureaucrats in Long Beach.  "Fine", say the Department Chairs, Program Directors and Academic Senators, up and down the State.  "Great idea – as long as it doesn't decrease my enrollments."

2) True/ False: When Demand Rises, Prices Fall?

It seems the legislature is now worried that "Tidal Wave II" (the increase in births in the 1980's as the baby boomers started families) will swamp higher education in California.  The CSU central office is toying with solutions like year-round, evening and weekend classes, to squeeze more use out of the existing classroom space (and squeeze more work out of the faculty.)  A rational business organization, when swamped by demand, would raise prices – for  prices are the primary way the market allocates resources.  Those who value the items the most bid the most, while the higher price beckons additional supply into the market.

Here, educational politics departs from business economics.  Higher prices are

Note 3

anathema to politicians and CSU bureaucrats, who respond with platitudes about "access" and "diversity".  However, there is also a reasoned economic case that supports the many subsidies governments give to college education.  Individuals tend to under invest in education for at least two reasons: short term thinking underestimates/can't afford long term benefits, and much of the benefit from schooling is diffused throughout society, so a student may not want to pay in order to benefit others.  Responding to these considerations,  California pays (by annual legislative appropriation) about 80% of the CSU's actual cost of instruction, and in addition, students may benefit from Federal Pell Grants, Cal Grants, government-backed subsidized or guaranteed loans, and two new tax credits called "Hope" and "Lifelong Learning" which took effect in 1998.  Over half -- 55% -- of all CSU students received financial aid, in the form of grants, scholarships, student loans etc. in a recent year (1996-97), for a total of nearly $840 million.

Clearly, our education bureaucrats are not using -- for good reasons -- the profit maximizing pricing strategies of the corporate world to which they pretend to belong.  But things don't stop there.  It can be good politics to support ideas that are bad economics, so -- despite an impending enrollment surge, dramatically called "Tidal Wave II" -- last year's State budget called for a $10 million decrease in student fees.  The Legislature promised money to offset this reduction, but presumably it could have voted the additional money, left fees alone, and actually funded some

Note 4

improvements.  Divided among 18,000 faculty, the money would have raised pay by $500 each, or covered travel to one academic conference, or been used for 5,000+ new computers in student computer labs system wide.

The real irony is that many students won't benefit from the cut in fees.  If fees are lower, "need" is less, so some part of the Legislature's gift just causes a reduction in Federal grants.  How nice of our Legislature to frees up some California money, which will now go to students in other states.  In addition, because the Legislature ignored the way the new Federal tax credits work, the fee cut may just mean smaller tax refunds.  The "Hope" credit for eligible families with students in the Freshman and Sophomore years equals -- fully reimburses -- the first $1,000 per year of a student's college fees, plus half of the next $1,000.  Result?  The $50 fee cut that an Assembly candidate points to with pride might just mean $50 less of income tax credits for middle income families with children in the CSU.  Our Legislature gives, the IRS takes – and not a cent remains to hire student assistants or fix the creaky elevators.   (For technical tax reasons, the credit is not much use below about $25,000 in income, and it is phased out when families have income over $80,000.  Yet CSU's studies show the "average" student comes from a family with income between $40,000 and $50,000 -- tax credit territory.  Indeed, a State Senate Education Committee staff report on an alternative fee reduction plan concluded that it would mean a $10 million to $20 million reduction in the income tax relief Californians get from Washington DC.

The Moral

There we have it.  California colleges don't and can't operate as clones of business enterprises, and strategies that make sense in the business world (incentives to increase sales, pricing adjusted to demand) either make things worse for a University or are politically out of bounds.  Considering the many, many other differences between universities and corporations – it's impossible to quantify scholarship, it's ludicrous to translate educated citizenship into dollars, it's not possible for the spirit of free inquiry to flourish in an organization based on hierarchy and command – one can only be amazed at the power of self-delusion, and how strong a hold it has on the advocates of the corporate university.

It shouldn't happen to a dog.
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Note 1:  The effect of the FTE budget link is to drive up peak enrollment -- just at the time CSU managers claim that an enrollment crunch is forcing year round operation. (The real reason: the managers envy faculty summer vacations.)  The CSU does not systematically collect or give out statistics on enrollment falloff after the fourth week, so it's hard to know precisely how inefficient the practice is.  Year on year, the "retention rate" tends to be around 80% (it varies, because the system is huge and what happens in San Diego might not affect Chico.)  A rational business corporation in CSU's position might try to  screen out students who are over committed and probably won't finish a class they start -- but at the CSU, that would mean a loss of FTE's and a budget cut.

Note 2:  The CSU's budget system reminds me of the grocery store up in the little hill town of Hardwick, Vermont that had a rodent problem.  The store owner offered a bounty of 50 cents for every mouse the employees caught.  The second week the employees started bringing mice into the store and releasing them, so they could catch them there and pocket the bounty.  Be careful what you decide to count…

Note 3:  They seem to be suggesting that CSU should restructure in a way that decreases quality for everyone, in order to enroll more students than it can handle, additional students who generally wouldn't be willing to pay the full cost of the education they receive.  Would a rational store manager decide to sell a promotional item at a loss -- way below cost -- so some customers who didn't want it very much would buy it anyway – and wait in long lines to do so?

Note 4:  The Chancellor's office might also have used the money in its continuing futile effort to justify its existence by hiring more bureaucrats and consultants, rather than spending it on teaching.  For example of such a power grab by Headquarters, check out the expensive new "Common Management System", a/k/a/ "The Software that Ate California".

As of Fall, 1999 the CSU had 1,407 administrators, 6,269 full time professors, 3,667 full time faculty with rank below professor, and 9,665 part timers.  If current trends continue, in 2021 there will be more managers than teachers, and by 2047 there will be just one professor left in the entire CSU system, supervised by 20,512 Vice Presidents, Assistant Vice Presidents, Directors, Deans and their deputies.

©2000 Robert H. Daniels
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Robert H. Daniels is a Professor of Accounting at San Francisco State University.  He holds an L.L.M. degree.
 

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