A Simple Explanation of the Economy, and How It Is Effecting Colleges

The following is an article that I wrote for "The Citizen," the Marlboro College official magazine. (I am also editor-in-chief of The Citizen.) The first section of the article is dedicated to explaining the state of the economy, a complicated subject that few people know anything about beyond the fact that it isn't doing very well. It was my goal to be completely lucid.

The second section is about how the economy affects Marlboro College. I believe that it contains information relevant to any college.

I was completely in the dark before I began this article. Like most, I felt completely blind to what was going on in the world of finances. I was afraid for my family, for my country, and especially for my college. Hopefully this article will ease the fears of some, or at least make such fears better-informed.

A Simple Explanation of the State of the Economy
(And How It is Affecting Marlboro.)

by Rachel Knight

These days we hear about how the economy is “in shambles,” but many people have no idea what that means. The news tells us that something terrible is going on, but for those of us with little knowledge of economic terms and concepts there are few ways to learn about what specifically has happened— not to mention how it happened, and what’s being implemented to fix it. Delving into news articles on the subject isn’t always very helpful, because the press often picks up halfway through the story without giving the background.

As usual, there are helpful resources to be found at Marlboro. I interviewed economics professor Jim Tober to get the story of the economic downfall from the beginning and in easily understandable terms. I also spoke with Marlboro president Ellen Lovell, on how the current state of the economy affects both the administration of Marlboro and its students.

PART I: What is Happening in the Economy

When asked about the current state of the US economy, Tober started by defining a word that has been used copiously in news reports and during everyday conversation: “We’re in the midst of a recession. By ‘recession,’ economists usually mean two quarters, or six months total, during which the GDP [Gross Domestic Product], the output of the economy, is declining. So, negative economic growth. We’re now undoubtedly in the third such quarter, but the data isn’t in yet, so the two quarters were from the second half of 2008. There are lots of problems with measuring growth.”
After bringing up the GDP, he went on to say that “Another place to look is the unemployment rate. The unemployment rate is, as of the end of January, 7.6%, which is significantly higher than it has been. When the February numbers come out in a few days there will no doubt be a higher unemployment rate.” He was correct in his statement; according to MarketWatch, the unemployment rate went up to 8.1% for February. “That’s also a somewhat misleading indicator, because it doesn’t measure workers who are underemployed, and it doesn’t measure workers who have gotten discouraged about the prospect of finding work and have decided not to look for work, which means they’re not counted as unemployed, even though they’re not working. If you look just at the unemployment number, you undercount the severity of the recession, or the impact of the recession on people who are not working.”

Another piece of the puzzle, he said, “is the wealth of the economy. That’s been mostly the decline in the value of private housing, and financial assets that have declined by multiple trillions of dollars. Stock market indicators are down 40% to 50% since the highs of the end of 2007. That effects increasing amounts of people in the economy.

“Once upon a time the stock market affected a relatively small number of people that were on the wealthy end of the wealth distribution scale, and now, because people’s retirement plans are so tied up in the financial markets, this decline in assets is affecting a wide range of the population. That partly changes how people think about planning for the future, and partly, just because their wealth is declined, they don’t have the same capacity to spend as they used to. To sort of cover for the fact that they’re not, employed let’s say, they don’t have the assets to put on, because their asset base is also declined. With respect to housing of course it’s a crisis for people who thought that they were in a bubble, who thought that housing prices could only go up, and so they took out mortgages than they could really only afford based on their then-current income, and when the housing market began to crash, many of them were quickly so-called underwater, when the market value of their house was less than what they owed the bank. Often because they didn’t have any income anymore, or their incomes were reduced, they couldn’t afford the mortgages, and foreclosures resulted.”
“And of course,” he continued, “there’s the so-called credit crisis, which is a piece of all that is affecting the current economy.” Wikipedia defines a credit crisis as “a reduction in the general availability of loans (or credit) or a sudden tightening of the conditions required to obtain a loan from the banks.”

Tober expressed the difficulty is assessing the “health” of financial institutions. “Clearly, some have been taken over, closed by the federal government. Banks and other institutions have been forced into mergers. But there are many financial institutions whose health is still extremely unclear. The government has sort of been one step behind all along in trying to figure out how to respond, so there’s a lot that hasn’t been resolved. And meanwhile, if the credit markets aren’t working well, it means that even people who have employment or who have collateral assets that they could use to borrow money aren’t able to get loans. That affects people who want to start businesses, people who want to go to college, people who want to borrow for all kind of purposes. It’s more difficult to borrow.”

What, I asked, is the government doing to help? “It’s sort of been unfolding slowly, but since the new administration took over there’s been a flurry of activity, which all seems to be in the right direction… Whether it’s aggressive enough and ambitious enough, and targeted enough to the problems, we just have to wait to see. It depends where you want to look to see how well the administration is doing. If you look to the stock market, although it went up yesterday [March 4] when the administration announced its new housing rescue plan, it’s on its way down again today [March 5].” For one thing, he said, “Some question whether or not General Motors is solvent at all, or whether it’s going to have to fold up.

“Every day there are new sets of problems that make yesterday’s proposed solution not quite enough. So, Congress has passed a rather large stimulus package, and that’s all to the good because it’s going to replace some of the spending that some households and businesses have stopped doing. From that classical Keynesian point of view, that meets demand in the economy which makes producers want to produce more, which means they’ll hire more, or at least not fire as many workers as they would otherwise, which gives those workers spending capacity that may turn around and spend again. It could prevent a further decline in economic activity. But, a lot of the stimulus package doesn’t pay off for another year or two years, and that’s not when the help is needed. It’s needed yesterday. So, it’s a question of not only how big the stimulus package is but how well-targeted it is to get to the hands of people who are going to spend money quickly. That’s where the so-called “shovel ready” phrase came from; the idea that you want to put money into projects, public works projects, that you can start tomorrow, basically.

“Other ways to do that, which are part of the bill as well, increase unemployment benefits, so that unemployed workers get unemployment checks for more weeks. The standard program is usually limited to twenty-six weeks of benefits, on the assumption that if somebody hasn’t found another job in twenty-six weeks they aren’t looking hard enough. But that’s been extended. That’s a fairly direct way of putting spending power in the hands of people who are likely to spend it. Increasing welfare benefits, increasing food stamps, tax cuts or tax credits to lower-income recipients in particular… those are all good ways to get spending back into the economy.

“So there’s the physical stimulus part, and then there are multiple and overlapping financial rescue packages that have been put together and are being implemented in a—I wouldn’t say haphazard, that’s a little extreme—but, the earlier ones that were done in the time of the biggest crisis, during the Bush administration… there was very little transparency, very little clarity as to how that money was supposed to be sent and how it was supposed to be helpful. I think all of the news reports about financial institutions that have used that money have used it, not to extend credit, but to either put it in the bank or pay out as bonuses, or to pay out as dividends to shareholders, or to acquire other companies. Those are not necessarily helpful. [laughs]

“So, it’s very difficult, because it’s such a moving target and because there are all of these pieces that are interacting in unclear ways. It’s very hard to know what the overall liabilities of the government are, because in some cases we’re getting assets back for the money that the government is providing, so those companies were taking an ownership share.”

Then, Tober brought up an idea that some consider radical, and others think to be very sensible. “Other people have argued, and I would tend to agree, that we should have been more aggressive…we shouldn’t be so afraid to essentially nationalize the banks as necessary. The administration has been very cautious in using that term, because it’s politically very unpopular, even though it’s the sort of thing that European governments and other governments have done successfully in the past, and it doesn’t necessarily mean that that’s a permanent situation. Paul Krugmen had a column where he was talking about this nationalizing of the banks, and he was saying that people are so afraid of it that the government needs a new name for it. He suggested that we call that pre-privatization. The government’s taking it over only for the purpose of re-privatizing it, which is I think probably what would happen. The government would take it over, sell off worthless assets, consolidate the valuable assets, create a smaller but more stable financial institution, and then sell it off. I don’t think the government aspires to be the owner of banks, but it really needs to take a more aggressive and forthright role here.”

At this point, Tober had summed up the state of the American economy as well as such a complex issue can be summarized. What, then, is happening with economy around the world?

“Clearly one of the challenges of the current crisis arises from the fact that the global economy is more financially interconnected than it probably ever has been. There’s a lack of transparency there. Historically and in other circumstances it might be that a recession in one economy could be countered by the economic strength in another country. If prices fall in a country that’s in a recession, than its goods and services become more attractive to buyers in other countries, and then they may come in and, in effect, prop up demand. But if demand is falling simultaneously everywhere, then countries can’t rely on one another so much to make up the spending that’s missing in a single economy. And so what sometimes happens and what threatens to happen now is that countries are trying to detach themselves from the global system to protect themselves against the contagion of these sorts of things.

“That is understandable, but it’s pretty dangerous if it means trade restrictions, and countries becoming less integrated. History has generally shown us that when countries respond to this kind of problem, like they did in the 1930’s when they put up tariff laws to protect domestic industry, it really shrinks the global economy. Whatever one might think about NAFTA [North American Free Trade Agreement] and the WTO [World Trade Organization] and the criticisms that are made of those sort-of free trade global initiatives, mutually beneficial trade between countries simply is… beneficial! [laughs] It can’t be carried out without any regulation, but to say that the solution is for countries to put up tariff laws to protect their domestic industries, I think would be a real disaster for the global economy. But I understand the felt pressure to do that, because it seems like a solution.

He put the US economical issues in perspective. “There are economies that are significantly more impacted than the US. The US economy is huge, and it has the special advantage, at least now, of operating in a currency that the world has decided is going to be a global currency of account, basically. And so, even though we’ve been running these huge budget deficits, which are only going to get bigger by an order of magnitude in the next couple of years…” Tober paused to give background. “We finance those by selling bonds. The fear has been as our debt gets bigger and bigger it’s going to get harder and harder to sell these bonds because people are going to be worried that they’re not going to be able to pay them off, and that therefore the interest rate that people are going to demand for those bonds is going to grow. That’s going to be a real burden on this economy, because as the interest rate gets bigger the debt’s going to get bigger, fast, and that’s debt to the extent that the money is owned by people outside the country, that’s money that’s flowing outside the economy, and that’s going to put pressure on the dollar, but at least as of yet, that hasn’t happened.” Continuing where he had left off, he explained that “The rest of the world is willing to buy, so far, as much debt as the US government is trying to sell, and it’s not asking very high interest rates for it. They’re happy to have it at low interest rates. That’s a surprise to a lot of people who are really worried about the stability of the dollar, but people are still anxious to have dollars even if they’re only earning half a percent interest rate on government debt. They’d rather have that, because they still think that the dollar is more secure than whatever else they could do with their money. So, despite these huge, seemingly unsurmountable challenges, the US economy in terms of its global place seems to be holding up.

“There are certainly other countries, particularly smaller or less-mature-as-industrial-economy countries that are having more serious problems.” He gave Iceland as one example. “And there was an article in the paper recently about Ukraine— countries that have only recently transitioned to market economies that don’t have the institutions as securely in place as the US. So, there are some serious issues for sure.”

PART II: How the Economy Is Affecting Colleges, and Particularly Marlboro

How is the economy affecting colleges? “Well, colleges in general, it’s hard to say,” said Tober. “The usual story that is in the press, which I’m sure it true, is that college endowments are hit just like other individuals and institutions have. So, colleges that have large endowments and that depend on the income from those endowments as a big part of their budget are in serious budget trouble. They still have a lot of wealth, but they’re restricted in terms of how much endowment they can withdraw. So if they’re taking a fixed percentage of their endowment and their endowment’s down by 40%, the income that they can take, even if they have a rolling average of calculating it like Marlboro does, is falling, and that impacts their current budget, which is an enormously serious problem.

“Colleges are suspending faculty searches, and they’re cutting both academic and non-academic staffs, and they’re tightening their belts all around. In some cases they’re trying to recruit more students, to generate more revenue without necessarily increasing the faculty and staff that they have to serve those students, so it’s a real challenge.

“On the other side, there’s the question of how well students can afford the education that colleges offer if their own family’s financial situation is weakening or there’s been a job loss in the family, if the student loan market isn’t functioning very well… those are all concerns for current students, perspective students, colleges. No doubt about it.” There is an aspect of the economic crisis that may keep potential students going to school, however.

“From the student point of view, this sort of narrow economic assessment is that part of the cost of going to college is the is the so-called ‘opportunity cost.’ It’s the value of the job that you could have if you weren’t in school. So, in a perverse sort of way, when the job market is bad, the opportunity cost for students goes down. In effect it’s cheaper to go to college, because you’re not giving up that high-paying job on the outside, because you can’t get that job anymore.

“So the cost of coming to college is coming down, not the out-of-pocket cost but the opportunity cost part. That could lead more students to want to be in school, and could be beneficial for colleges generally. It will play out differently for different schools for sure. But then there’s the out-of-pocket cost side. However much the opportunity cost falls, if you can’t borrow the money or you don’t have the wherewithal, because you don’t have that summer job or you don’t have that part-time job to supplement, then that’s a problem for students, no question about it.”

According to Tober, Marlboro is doing well despite the circumstances. “We’re going forward with three faculty searches. I think that that’s highly unusual. Most colleges have suspended their faculty searches, or at least many of them. And that’s partly the nature of the institution, how dependent we are on having a full complement of teachers in the fields that we teach. So it hasn’t effected Marlboro in terms of the curriculum.

“The other consideration is that, although Marlboro has been very fortunate in building an endowment over the last few years, and has been very successful, we’re not as endowment-dependent as many other private liberal arts colleges are that have longer-standing endowments than we do. Our budget might be 10% endowment-dependent, and a sort of well-heeled liberal arts college might be 40% endowment dependent. So, if you’ve got a budget that depends 40% on your endowment income and your endowment income drops 25%, that’s 10% of the entire institution’s budget you don’t have anymore. If you’re 10% endowment-dependent, then the same decline might mean only a 2% reduction in the budget, or in that source of income. So, in that sense Marlboro is in a stronger position, in a sort of perverse way I guess.

“And the other concern, of course, for colleges generally is the ability of donors to continue to support the institution, and Marlboro has an extremely loyal and generous donor base. That’s a good thing. It speaks highly to how we’re regarded by those people who support us. Of course, we’d like to have a bigger donor base! “

Tober concluded the interview by contemplating how this recession might impact those who are now affected by it. “One of the things that happened in, say, the depression of the 30’s was that there was a whole generation of people who came of age during that time whose whole life was effected by the depression experience in terms of their attitudes towards savings, their attitude towards risk, and all of these things. You know the stories about grandparents or great-grandparents who did this or that during the depression and how they forever on stockpiled toothpaste whenever it was on sale. It really affected people’s attitudes about saving, and about risk, and I think that a similar thing could happen.

“I think there was such a tremendous amount of wealth that was lost, it seems now in retrospect that people were taking excessive risks and the government was being insufficiently watchful, and people have suffered as a result. I think that when the economy recovers—and I think that it will, in 1-2 years let’s say—there will, I think, generally be more financial oversight and regulation, less inclination to take risk on the part of individual businesspeople and individual citizens, and more inclination to save and less to borrow. All of those things may be good, and they’re also all understandable in terms of the experiences that people have had, but I think that it also will mean, probably, a lower rate of growth in the economy in general, which people might think has its upside as well as its downside, but I think that risk-taking typically has an average higher rate of return than is has more variability, because of the risk. I think that people will be more interested in the safety of their assets than in the potential for high rates of return. So there’ll probably be less innovation, less risk-taking, slower growth, and different attitudes on the part of a whole generation of people who are now coming of age as independent actors in the economy and society.” Though he did not mention it, this idea might apply to college students who are hesitant to perform the risk of taking out loans, and who opt instead to go to an institution where they do not receive an education adequately suited to them.

Ellen Lovell had this to say about how the state of the economy is affecting college students: “I think students are affected in a number of ways. One is, maybe it’s obvious, but, worry. Worry about what you hear about the economy. Where’s it going, and what can it do to a student’s future? What can you expect when you graduate? How are you going to find your place in the economy? I think it’s probably made people, not only at Marlboro but all over, think ‘how am I going to make my way in this economy?’

“For me it confirms even more the value of a liberal arts education, because I think those skills of critical thinking, and creativity and problem solving and clear writing, clear expression, being able to work together in teams, understanding how groups work, are the skills that everybody’s going to need in order to adapt as the economy changes. However, I know that for some people, it’s increasing their concern about ‘what professional or vocational skills am I going to have?’ So it might, for awhile, put pressure on a liberal arts institution like ours. I’m prepared to make lots of fierce arguments about why this is the kind of education we need, why this is necessary for our future, but I do know that some people are thinking that way.

“Secondly, because it puts economic pressure on parents, then families worry about paying for a college education, and I know that that’s a concern as well. And there are reasons to be concerned, because there are fewer lenders out there. We’ll have more pressure on our financial aid funds at the college, and people who are planning on drawing from savings or from home equity are finding that the value has gone down, so of course that makes it harder. Again, when I talk to students, or prospective students as I’ve been doing all these Visit Days, I say ‘Don’t let that stand in your way. If you really want a Marlboro education, come talk to us and we’ll try to work it out, case by case.’ That will be my message to our returning students.

“The thing we want most of all is for the students who are here who want to be here to return…I want people to be able to come to us with their concerns. The other thing I want to mention, when you ask ‘how is the economy affecting college students’— Obama’s stimulus bill actually has some good news in it for college students. The Pell grant has gone up for people who are eligible for Pell. They’re also encouraging more direct lending with the US Department of Education and Colleges, so we’re investigating how we might take advantage of that, if it’s a good idea for us.

“As you know,” she shared, “I’ve been thinking about [how the economy affects Marlboro] pretty much around the clock for the last couple of months. [laughs] I’ve been talking to the Board about it and watching and seeing where we go, and I think it’s good to be candid about the state of the college.

“The last community letter I wrote, it was awhile ago, and it still contained the basic message, the basic information, which is that we’re in a hard time with a lot of strengths. And mostly I think that’s the commitment of all the people who are here, including students. But also, because we’ve been really careful with our spending, we’ve been able to build up a modest cash reserve. So we have kind of an insurance policy here—a reserve to fall back on if we don’t get all the revenues that we need. The endowment, which had risen very nicely, had fallen 22%. Now that’s something that everyone believes will regain eventually, we don’t know how long it’s going to take. But the immediate impact is that there’s less of what we call a draw. In other words, every year the Board sets a particular percentage that they will take from the earnings of the endowment, not from the basic endowment gifts, so the whole idea is it’s supposed to earn money and then you take a certain percentage of that money and that goes into our general operating fund, and that helps support everybody. You know we can’t charge the real cost of a Marlboro education, so we subsidize it with the earnings from the endowment, and unrestricted fundraising that we do every year. So those are two really critical elements, and because there will be less of an endowment there’ll be less of a draw. So we’re now in our budget processes trying to figure out, ‘how do we compensate for that, how do we take that into account?’

The other element is that we have to keep our fundraising really strong to be able to keep our programs strong, and for a small institution we raise a pretty remarkable amount of money every year in unrestricted gifts. And a little bit more than a quarter of that comes right from the Board of Trustees, and that comes from a wide array of alumni, parents, parents of alumni, friends of the college, you know, people who really are committed to our form of education. So that’s another thing that we have to keep strong, and some people are rethinking their giving. So,we’re concerned about whether we’ll be able to keep up the level of giving that we’ve been able to enjoy so far. And then I guess the other factor is affordability. ‘What will we be able to work out with returning students and new students?’ Hoping people will still value a Marlboro education and make that choice, and that we’ll be able to help them to put together a package of resources to be able to do it.”

“I think,” said McCulloch-Lovell, “it will mean more pressure on financial aid, and I think one of the things the Board and I are absolutely certain we’re committed to is maintaining a level of financial aid, even if we’re making other cuts—or even increasing it.”

The recent slight increase in tuition was a major topic during the interview. “Well,” McCulloch-Lovell began, “the whole comprehensive fee, if you count tuition fees, room and board, is 4%. As I said in Town Meeting, that’s the lowest increase in six years. I have been trying to keep them low every year. I think last year was 4.8% or something like that, and the year before was just over 5%, because Marlboro had done a big hike a number of years ago. The reason we did that is that it had been the strategy some years back to not only lower tuition but to then keep it flat for three years, and we just didn’t pay for the college doing that. So, there was a pretty hefty increase I think in 2004, and then another smaller one in 2005, and then we really tried to keep it, as I said, as low as we could, and still have a strong program, but still a very frugal budget.”

What does the increase cover? “It’s mostly the costs that we can’t control. That’s the part that’s hard to contend with. You look at everything you want to do, but then you look at the things that you have to do, that are very hard to control. The costs that are hard to control are all of the really inflationary ones, like energy. We’re still dependent on fossil fuels, and those will go up. It also depends on how long and cold the winter is, and we’ve had a doozy this year. So, it’s energy, it’s utilities, it’s the cost of electricity, food prices, insurance—all kinds of insurance. Those are the basic inflationary costs.

“And then Marlboro’s been committed over a number of years while I’ve been president to paying wages to our staff and faculty that are at least commensurate with other small colleges and institutions. We don’t want to be behind. We probably can’t be way ahead, but we really have been trying to catch people up. And even at that, we probably aren’t meeting the standards we’d really like. About 75% of our total costs are salaries and benefits. If I were an economist I’d say we’re a labor-intensive industry. We want to be. We want our investment to be in people. As you know, it’s certainly not in buildings! “

Agreeing with the words of Tober in relation to Marlboro’s continuing faculty searches, McCulloch-Lovell said “I think one of the things we’ve done that’s important is making that commitment to people. All around you hear about lay-offs or freezes, and we looked at those three positions and said, we need to have strong curriculum and we need those three people. It says something about our strength if those searches are for tenure-track faculty, not filled by adjuncts, or part-timers. So we kind of just had the confidence to go ahead and do that hiring. The important part is that we are staying strong in our academic program and going ahead with these three searches.”

I continued to inquire as to the increase in tuition. “When we raise our tuition fees and room and board,” McCulloch-Lovell replied, “we’re trying to do that in relation to where we think we’re going to go with the budget. Now at 4% for the comprehensive fee, that doesn’t begin to cover the gap, either. It’s a percentage of it, but it doesn’t come close to paying for everything we need to pay for, so we still have to look at a combination of fundraising and budget control. We’re even cutting budgets. One of the strengths of Marlboro is—I remember Travis Norsen [physics professor] said this to me a couple years ago—we make frugality a virtue. So, we’re approaching it with that spirit"