Monday, September 30, 2013

How Tenure Reduces Tuition

A recent article in CNNFortune repeats claims that eliminating tenure for law school faculty (and presumably university faculty generally) will reduce schools' costs, thereby allowing schools to reduce or stabilize tuition.  In particular, the article states as follows: 

"But with signs mounting that the law school predicament is not a blip, administrators are looking to address their biggest fixed cost -- the full-time faculty. . . .  While salaries and secure employment are not inextricably linked, they are related. With tenure comes the security of consistent paychecks, regular raises, and no abrupt layoffs -- and most universities bestow tenure, or near-guaranteed employment, to guard against firing teachers for expressing controversial or unpopular views. But decades ago, the American Bar Association, which accredits law schools, took it a step further by tying accreditation with tenure protection for most full-time professors. But last month, amid complaints from graduates who cannot find sufficient work, the professional body decided to float two proposals that would sever this link. . . . [C]hanges to faculty tenure -- and compensation -- are inevitable as law school tuition costs barrel ahead."
This assertion echoes similar claims that eliminating tenure would reduce the cost of higher education in general and at law schools in particular.  (See here and here.)

However, and as previously explained on this blog, those who claim that the institution of tenure increases labor costs and thus tuition seem to have things backwards. Both common sense and basic economic theory predict that, other things being equal, eliminating tenure will actually increase costs, as schools increase faculty salaries to retain high quality faculty and thus maintain the quality of the education they provide.  Moreover, schools that failed to increase salaries after eliminating tenure would see faculty quality suffer and thus reduce the quality of the education they provide, without an correlative reduction in tuition. 
Presumably universities pay whatever total compensation they deem necessary to attract and retain desireable faculty.  Such compensation generally includes a mix of salary and non-salary compensation, the latter of which can include such benefits as health insurance, paid vacation, free parking, or free day care, to name just a few.  Tenure, of course, is a form of non-salary compensation, economically indistinguishable from the benefits just described.    Actual or prospective employees will interpret the elimination of tenure in the same way they would interpret the elimination of health insurance or free parking, that is, as a reduction in compensation.  As a result, schools that eliminated tenure would thus effectively cut faculty compensation and thus attract and retain less qualified faculty, thereby reducing the quality of the education provided.  Students at such schools would thus pay the same tuition for a lower quality product, the economic equivalent of higher tuition for the same product.
Of course, schools that eliminated tenure could maintain faculty quality by increasing salaries, thereby offsetting the elimination of a non-salary benefit.  Such salary increases, however, would increase schools' overall costs, and schools would presumably pass such costs on to students.  In these circumstances, then, eliminating tenure would increase and not decrease tuition. 
Some may still contend that the elimination of tenure will empower schools to fire incumbent faculty, hired long ago, thereby reducing labor costs. (Though of course universities would have to hire new faculty to perform the varies duties once performed by fired faculty.)    However, this contention does not withstand close scrutiny.  To be sure, like any other firm, a university can reduce its nominal costs by breaching its long term contracts.   For instance, a university that has borrowed $100 million to construct a new building could reduce its costs by repudiating that debt and thus attempting to avoid its obligation to pay annual debt service.  While such a tactic might reduce costs in the short run, it will have the opposite effect in the medium and long run, as firms pay damages for breach of contract to disappointed creditors and find it more expensive to borrow in the future, as future creditors demand an interest premium as compensation for the risk that the firm will default again.  In the same way, a school that breaches its contracts by firing tenured faculty will find itself liable for contract damages.  Such a school will also tarnish its reputation for trustworthiness, thereby making it far more difficult for the school to make credible promises to prospective faculty, staff and administrators, who will demand higher salaries to offset the risk that the university will breach such promises.

No doubt pundits will continue to debate what accounts for the cost of higher education.  (See here for one important contribution.)  It should be clear, however, that tenure reduces that cost.