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Board of Trustees//

October 21, 2014

Boards often confront the issue of sustainability of private-independent schools, now and in the future. One common concern is that private school tuitions have historically outpaced inflation—a well-documented truth. The real question is whether this leads to the demise of private schools. To answer this question, we’ll need to explore several factors.

Consider first the phenomenon called “Baumol’s Cost Disease.”William Baumol, a Professor of Economics at New York University, has written extensively about the rate of productivity growth within any economy. Quite simply, productivity growth in some industries outpaces others. Let’s take for an example, automobile manufacturing. Over the last 100 years, since the invention of the automobile, production time has decreased dramatically. As output has increased, higher wages have easily been afforded. Baumol calls these types of business units “progressive” because productivity is (ever) improving with cutting-edge enhancements.

However, in other parts of the economy, productivity improvements are hard, if not impossible to achieve. He uses the example of a string quartet. Today, the same output is required as in 1800 to perform a Mozart quartet. However, to attract and retain staff, employers must improve wages so they compete, at least to some degree, with those wages found in the progressive sector. Baumol calls sectors that cannot easily (or at all) enhance their efficiency “stagnant.”

All businesses fall into one of these business types, progressive or stagnant. Manufacturing jobs are, generally, progressive—over time, technological enhancements create labor efficiencies, and therefore increased wages are affordable. Examples of stagnant business units include service industries like education and health care. In the stagnant sector, output per worker rises slowly, if at all, however wages must increase at a similar pace as wages of other workers to remain competitive. And this is the crux of Baumol’s cost disease. What’s the solution?

Within the disease itself lies the answer. Inflation is the antidote. Baumol says that, although costs will grow alarmingly high in the stagnant sector, they will decrease at similar rates in the progressive sector. The disease creates its own cure.

So think of it this way—if the American economy grows by 2% annually, in 100 years it will be approximately eight times larger than today. Goods and services in the progressive sector will be much cheaper, and goods in the stagnant sector will be more expensive.

Yet, on the whole, Americans will have more money. Baumol again uses the example of the automobile. In 1908, the average worker labored around 4700 hours to buy a model-T Ford. A century later, the average worker labors 1365 hours to afford an automobile.

This means everything in the stagnant sector will be, in today’s thinking, alarmingly more expensive, but everything in the progressive sector will be equally less expensive. The problem is not the cost disease, says Baumol. The problem, he argues, is our knee-jerk reactions to it.

ISM believes the evidence of Baumol’s cost disease is well-documented. Private-independent school leaders do not need to be concerned that our costs outpace inflation.

That is not to say that we discourage sound fiscal planning, prudent budgeting, and wise strategic planning. We think controlling costs is prudent and required. However, we do not believe that prudent fiscal planning will cure the tendency for cost to outpace inflation. We believe this is our reality, and that the economy itself, as Baumol describes, will correct the problem.

And we concur with Mr. Baumol: There is too much hysteria over this phenomenon. Understanding the reality, explaining it to our constituents, embodying it through prudent strategic planning, and enhancing/communicating the value of our school’s education are the best antidotes to protect our sustainability. But understand clearly, increasing tuitions above inflation is not a sustainability risk.

ISM recently published a white paper titled Full Steam Ahead, Part 3: What Does ‘Sustainability’ Really Mean? From the multiplicity of conversations, published articles, and association discussions that ISM has experienced, we noted five major “sustainability” concerns. The above discussion about inflation, derived from the report, was one of those concerns. Download the free PDF of the white paper to see the other four concerns we address.

Additional ISM resources:
ISM Monthly Update for Trustees Vol. 10 No. 10 A Template for Full-Board Presentations
ISM Monthly Update for Trustees Vol. 11 No. 8 Objectivity and the Board

Additional ISM resources for Gold Consortium members:
I&P Vol. 28 No. 9 Charging the Board Committees: A Recommended Format
I&P Vol. 39 No. 5 Board Committee Structure and Function

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