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An excellent post to start off the new academic year!

The university where I work recently experienced the "oops too many students accepted" increase in enrollment. To cope with this, incoming students were offered a substantial discount to enroll at one of the branch campuses. Even so, there were a few introductory courses which could not accommodate all those who needed them. In one case it was because the available rooms were at times considered inconvenient by the department.

More recently, the issue of reducing the cost of senior faculty and staff has been addressed by offering "early" retirement incentive packages to people who had already met the age/time-in-service requirements for retirement.

Livio: thanks! (Yep, starting to get butterflies about teaching again starting Wednesday.)

Don: that sounds like a big overbooking problem.

"In one case it was because the available rooms were at times considered inconvenient by the department."

Oh Lord! About a dozen years ago, we had a similar problem, with some profs not wanting to teach at certain times. So we had empty classrooms at 8.30am, and a shortage at more "convenient" times. (Plus there is a non-trivial operations research problem in getting profs, students, courses, and classrooms, all to match up right.) We bought a new software program, and established rules so that you teach when and where the computer tells you, unless there are good documented reasons otherwise. (You can still put in your preferences, and the computer tries to satisfy them if it can. I like to teach at 8.30am, and the computer is always happy to oblige, because nobody else wants to.)

Suddenly, we went from a shortage of classrooms to having enough.

Duncan's problem is the same faced by almost every other modern business: airline can,t quickly adjust the numbers of planes or pilots. Costly and long to build-train. No one knows the number of passengers next month, let alone five years from now. As Bill Gates is supposed to have said that his balance sheet show the number of desk in Microdoft building but the reality is that 99% of my assets walk out each evening to go home for supper. (E si non e vero, e bene trovato).
When deans talk about running a university like a business, they are not that totally wrong. Or maybe, it is modern business who now are confronted with Duncan's problem:large specialized human capital, unconvertible buildings, unknowable future customers.
Just look at what happened when the Soviet Union collapsed.

You are missing deferred maintainence, which acts like a reverse mortgage, at least for a while. The MN secondary system has about $3B in deferred maintainence. New buildings get built with donations when there is no source of funds for their upkeep.

Nick,

This post seems to dance around the key problem: Post-secondary education is not a public good. The risks in the provision of post-secondary education fall on the taxpayer, resulting in all kinds of distorted decision making.

First, irreversibility occurs all over the place and it does not require special preferences to understand the decision making. Irreversibility creates an implied American style option and the value of that option tends to be quite valuable. Decision “inertia” with irreversibility results from the incredible value in the the information flow – you throw the ability to learn more when you make the decision. Note that an irreversible all-or-nothing investment is not like the CAPM or other usual micro pricing methods which get most of the attention in the undergrad econ curriculum. Those ideas assume the possibility of infinitesimal portfolio adjustments. In real option problems, I usually cannot adjust the investment by epsilon – hence the importance of understanding the value of the implied option.

Second, the university’s budget is a solution to a dynamic program. Given my possible actions and given the information I have about the current state of the world, how do I optimally make my spending allocation decisions? That dynamic program is solved by management. I submit to you that management at Carleton comes pretty close to solving that dynamic program to optimality. If you think they are doing the wrong thing or not paying enough attention to all the right information, it’s a question of incentives, which takes me to last point.

Third, who holds the risk if things don’t work out? Regardless of how well you plan (solve the dynamic program) there is always a chance that optimal decision making will still lead to failure. You can play pocket aces at the poker table perfectly and still lose. But in the post-secondary education case, it’s the taxpayer who holds the risk. Offering post-secondary education, like any business, is a risky endeavour. If we want the socially optimal outcome, then we need private investment (which will result in a lot less goofy degrees). If you want a government monopoly in its provision, don’t complain when decision making runs off the rails.

Fun things for profs to think about. We have the added complexity that males here spend about 2 years in the army and we accept them before they start. That means some foresite on numbers but also more uncertainty if they will actually show up (plus it doesn't apply to female students). So we now have a planned deficit two years out.

As a software prof I've always been amused by the use of software to solve human coordination problems. Your software is more or less doing the same allocation solutions as your admins did before, but now the school is more willing to say "8:30, tough luck". There are lots of such examples - XML is not a great technical advance, but it precipitated lots of inter-company data exchange agreements. Blockchain is doing it for finance now (stupid technical solution to a human coordination problem, but somehow it has cache, so the big wigs coalesce.).

@Avon - a simple solution to goofy degrees is for the government to allocate seats in different departments. Every department here has a cap on the number of students who get gov (tax-funded) payments. The tradeoff is that we get students who would rather be doing something else.

Nick - one thing that someone once said to me is that it's in some ways harder to deal with a budget cut of 1% than a budget cut of 20%. When the budget is cut by 20% it is possible to start closing departments and programs and laying off profs - taking actions that decisively cut costs. A cut of 1% isn't enough to lay people off - but when 90% of your costs are salaries, non-salary costs have to be cut 10% to make up a 1% shortfall overall - and that really hurts.

This is why I hoard paperclips.

Nice post b.t.w. - better than the one I'm about to post!

...a simple solution to goofy degrees is for the government to allocate seats in different departments...

Why does everyone seem to think that government is good at making these kinds of decisions? What does anyone even think it's appropriate?

@Avon: "Why does everyone seem to think that government is good at making these kinds of decisions? What does anyone even think it's appropriate?"

Especially when it is the government that is a main *promoter* of the "goofy degrees"?

Nick -question for a back of the envelope calculation: how much worse is the problem of irreversible investment made by the fact that there's no longer a standard retirement age. If, say, the average prof's career rises in length from 30 years to 35 years (say)?

Jacques Rene: Hmm. You may be right. The problem I have sketched here does sound similar to most/many businesses that face an uncertain demand curve.

Tom: the deferred maintenance is indeed a biggy. It's one way to get some flexibility in the expenses side of the budget. If you are unexpectedly flush with cash, you do more deferred maintenance; if not you deferr it a bit more.

Avon: I know it's not a "public good" (in the economic sense). But do the risks fall on the taxpayer? Would the government bail out a university that went bust?

" I submit to you that management at Carleton comes pretty close to solving that dynamic program to optimality."
That is my hunch too (given constraints on information etc., of course).

Squeeky: "As a software prof I've always been amused by the use of software to solve human coordination problems. Your software is more or less doing the same allocation solutions as your admins did before, but now the school is more willing to say "8:30, tough luck"."

Great insight. Looks right from my experience. Partly it's simply because you have to formalise a problem (establish rules) before you can ask a computer to solve it.

Frances: thanks! I think you have a point about the paperclips. LS used to complain about the shortage of admin assistants, so very expensive people were wasting time doing routine stuff.

The key parameter is the "depreciation rate" (or quit rate) of profs. Assuming a steady state, with even demographic profile, everyone identical, if tenure increases from 33.3 to 40 years, the depreciation rate falls from 3% to 2.5%. Not that big a difference.

You live in an interesting world.

It's curious that universities haven't created more flexible structures to deal with the uncertainty. For example, why wouldn't more more schools lease buildings to deal with the ebbs and flows of student numbers? With every second tier city around convinced that luring a post secondary institution into the urban core is the secret to downtown renewal, I imagine there are some great deals to be had.

Or perhaps tenured faculty should be treated like sports stars, traded off to another school when their appeal fades, performance drops or they become just too tiresome to deal with. Wouldn't that get interesting.

"Would the government bail out a university that went bust?"

Abstact things like universities can't get bailed out, only people can be made whole. When banks gets bailed out its really the creditors. Who are the creditors and owners of Carleton? Hmmm... Even if the government shuts a university like Carleton down due to financial mismanagement, who paid to operate at a loss? Who's responsible for the pension liability? Yes, the taxpayers are fronting ALL the risk.

This is the problem we run into when we use government inappropriately. The risks and costs involved in providing middle class kids with lifetime private gains gets shifted on to lower middle class people and the politically weak. And we wonder the source of modern inequality!

KD,

"It's curious that universities haven't created more flexible structures to deal with the uncertainty."

That's Yogi Berra: "You better cut the pizza in four pieces because I'm not hungry enough to eat six."

To a first approximation, how the university finances itself won't matter - someone has to hold the risk. It's only the risk and real opportunities that matter. The disconnect happens when the "owners" are forced to invest even when they don't think it's a good idea (using taxes to pay for non-public goods).

KD:leasing building? Classes are not offices or stores. The guy building them want a long-term contract. It would work if there is a finite knowable quantity of students who shit between schools and a different one lease the building each year. Airlines face the same problem: they either buy (and resell , there is a brisk market, sometimes in used planes), they dry lease (plane only for various periods of times) or they wet lease (crew and fuel and maintenance included, a favorite of serious 3rd world airlines. In the end, someone holds the bag and want to be compensated.In the end, it is an accounting or regulatory problem, not an economic one.
Industrial organisation (I/O) deal with that.
So sorry, no can do.

Erratum: "students who shift between schools...)

U's did goof when the mandatory retirement age was abolished and they did not put a limit on tenure.

@Avon Barksdale:

> Who are the creditors and owners of Carleton?

You missed the bit in the original post about professors being long-term liabilities, didn't you? They -- the staff -- are the largest implicit creditors. Second to that are the current students, who have a claim on future education that will expire worthless if the university closes shop.

There's nothing magic about the university being public or private. An insolvent university breaks implicit medium-term contracts with its students and long-term contracts with its tenured staff. Any residual loss to the government is a rounding error compared to those figures.

Majromax

Uh, no. Professors are employees and students are customers. Creditors lend to the institution. There is a big difference between public and private ownership. One has to convince investors the other uses force. The demand for goofy degrees would dry up without government subsidies.

"say, the average prof's career rises in length from 30 years to 35 years"

I don't think it's quite that severe. We dropped mandatory retirement at BC universities in 2007, and even out of those who stayed past age 65 I think the average retirement age is now only 67 or 68.

The more interesting question to me relates to using retirement as a vehicle for reducing faculty numbers: I've heard several anecdotal reports of faculty using their continuing positions as bargaining chips to ensure that the VPA and Dean approves hiring someone to replace them. Ironically, this may mean that anticipation of a need to reduce faculty numbers would make it harder for the university to reduce faculty numbers.

Colin: "I don't think it's quite that severe. We dropped mandatory retirement at BC universities in 2007, and even out of those who stayed past age 65 I think the average retirement age is now only 67 or 68."

The average retirement age is pulled up substantially by what happens in the tails of the distribution. Take, for example, this McGill professor, who is still on faculty at the age of 91: https://www.mcgill.ca/politicalscience/faculty/brecher. And we don't yet know what the tail will look like - a good chunk of those who stayed past 65 are still collecting a regular faculty salary.

On offer: accounting lessons to economist.

It's all about providing useful statements for the board to make decisions on. For example, valuing the land at what was paid for it in 1947 is a choice. GAAP allows a historic cost option, or a revaluation option, when fair value is assessed periodically, and the gains increase income statement profits (or occasionally decrease them). What's helpful for decision making for a board concerned about financial sustainability, which is unlikely to sell the land unless the university is failing? An organisation that may sell and move to the suburbs if it makes good business sense, would prefer to know the fair value of their land holdings.

The professors come from the matching principle: the costs associated with them can be expected to occur in the same period and the benefits received from employing them. You'll note that any underfunding of the pension fund does show up as a liability, and those retirement costs increase the cost of employing someone every year. The cost of the building is front-loaded...you pay a lot in years you derive no benefit, so they are expensed later over the years when the benefit is received. In between, they show up as an asset.

By your logic, the present value of future maintenance should show up as a liability on the balance sheet, but to an accountant, since the benefit of operating the building occurs in the same year operating costs are paid, there shouldn't be any balance sheet impact.

On a different note, the uncertainty is probably far less than you think. University enrolment is pretty predictable, and at a large university I'd be very surprised if there's much variation from year to year in the proportion of acceptance letters that turn into actual students, or the proportion of students that continue into higher years. I'd be willing to place a bet (say $100, even money), that given access to your historic data, and knowing how many offer letters have already been sent, I could predict enrolment to within 2%. Smaller schools, individual departments, etc, are going to have more variance.

Private business has similar challenges, but many sectors have far less capacity to predict their revenues. At my day job, hitting a 2-month forecast to within 5% is considered a success. After three months the numbers are meaningless. And while layoffs might be easier than tenured professors (who make up only one portion of a university's payroll), they're still costly, and whether it's a contract with a client that was mispriced and therefore losing money for years on end, or a decades-long lease, where you'll forfeit millions in leasehold improvements to break, there's plenty of long-term commitments that can't be easily terminated.

Thanks Neil. Good comment.

I won't take your bet. Because a 2% margin of error (for total enrolment) is in the right ballpark (usually). But that would be enough to create a roughly 2% surplus or deficit, which is also in the right ballpark. A 2% budget cut can be difficult to implement in one year, if most of your costs are "fixed" costs.

But usually youcut costs by deferring maintenance. No visible effect at first but you live on your fat. One day you wake up in a derelict world and the wall just fall.

Interesting. I guess I figure that they should hit 2% under as often as 2% over, so that tight of a range wouldn't require adjusting the budget in the short term at all. I don't know universities, for not for profits I've worked with typically try to carry a cushion of 6-12 months of operating expenses. That's at least 25 years of 2% misses, ample time to make structural changes. I would think that the larger risks for a university, like a not-for-profit, is that government would reduce operating grants, not that people will fail to show up.

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