Comment on “Higher Education in the United States: Laissez-Faire, Differentiation, and Research”

I read Urquiola (2023) with a keen personal interest as well as an academic interest. In my 47-year professional life, half was spent in US academia and the other half in Japanese academia. From time to time, I have compared Japanese universities with their US counterparts. Table 1 is a summary of my experiences.

Indeed, the Japanese research universities now are like US universities in the mid-1800s as described by Urquiola (2023). According to the 2023 Times Higher Education university ranking, the University of Tokyo, a top-ranked Japanese university, places only at #39 in the world.¹

Urquiola (2023) explains how the leading US universities became globally leading research universities in the late 20th century, while they did not have such a reputation in the mid-19th century. There are interesting questions of why and how it became possible for them to make such a transition. Urquiola attributes the success of US universities to a “laissez-faire orientation,” namely, “thousands of institutions largely left to compete with each other, even if most enjoy some form of state financial support.”

Urquiola argues that “selectivity appeared in the USA is not surprising from the point of view of economic theory” and that “economic models fully predict this in a laissez-faire educational market.” There are two mechanisms at work: a “peer effect” and an “information effect,” that is, graduating from prestigious schools carries information of a high caliber. In addition, “network” effects can be expected.

The information effect here seems to be a variation of signaling theory (Spence, 1974). In a signaling model, high-caliber (high productivity) students are willing to do extra (possibly unproductive) tasks that incur costs, if the extra task is used to screen students and the cost of the task is negatively correlated with the caliber of students. If high-caliber (research-oriented) students can perform well in entrance exams (in Japan) or in the preparation of admission documents and course work in college (in the USA) more easily than ordinary students, then the entrance exams, admission process, and course grades can be used as a signal of high-caliber students destined to be researchers (and other high paying jobs).

Citing Epple and Romano (1998) and MacLeod and Urquiola (2015), Urquiola (2023) predicts that a laissez-faire school market will have two kinds of universities: Selective schools with the highest prestige being small and in a strict hierarchy and a larger segment of non-selective schools. Most public (state) universities in the USA belong to the latter. The existence of two types of schools makes it different from Spence's original signaling model.

Once a university has established its status as a top-notch research university, its reputation attracts researchers with excellent publication records who can be recruited and high-caliber students will be attracted. High tuition can be charged without losing applicants and ample overhead revenues from grants to faculty members can be earned. This makes it possible to pay high salaries to faculty members. High-caliber graduates of the university will be able to take well-paying job. The university can count on donations from rich alumnae.

This is a virtuous circle, or an equilibrium. Once it is established it is relatively easy to maintain, and it would be difficult for a new comer to break into the ranks of top-notch universities and to establish the virtuous circle. On the other hand, it would be hard to get back to the high status, once the reputation is lost for some reason. Financial resources are an important part of keeping the reputation.

Education has an externality. Providing education to a mass of population is beneficial to the society as well as to students, who can raise the value of human capital in exchange for tuition. It is commonly believed that more young people having high-quality education is good for society, too. Industries will locate in this country when more highly educated people are available as managers and researchers. Research output, say vaccines discovery and production, will make a whole society better than otherwise. This externality justifies government aid.

Although Urquiola emphasizes “laissez-faire,” competition among educational institutions cannot be completely laissez-faire. State (public) universities receive state aid. Even research universities receive an “overhead” from government grants to individual researchers. Research universities have an incentive to hire high-caliber professors who receive research grants and corporate donations. What would be an appropriate level of government subsidies? This is an important question in the future.