In order to gain a better understanding of unequal returns
on capital without being distracted by the issues of individual character, it
is useful to look at what has happened with the endowments of American
universities over the past few decades. Indeed, this is one of the few cases
where we have very complete data about investments made and returns received
over a relatively long period of times, as a function of initial capital.
There are currently more than eight hundred public and
private universities in the United States that manage their own endowments.
These endowments range from some tens of millions of dollars (for example,
North Iowa Community College, ranked 785th with an endowment of
$11.5 million) to tens of billions. The top-ranked universities are invariably
Harvard (with an endowment of some $30 billion in the early 2010s), Yale (420
billion), and Princeton and Stanford (more than $15 billion). Then come MIT and
Columbia, with a little less than $10 billion, then Chicago and Pennsylvania,
at around $7 billion, and so on. All told, these eight hundred US universities
owned nearly $400 billion worth of assets in 2010 (or a little under $500
million per university on average, with a median slightly less that $100
million.) To be sure, this is less than 1 percent of the total private wealth
of US households, but it is still a large sum, which annually yields
significant income for US universities – at any rate some of them.
Above all – and this is the point that is of interest here –
US universities publish regular, reliable, and detailed reports on their
endowments, which can be used to study the annual returns each institution
obtains. This is not possible with most
private fortunes . In particular, these data have been collected since the
late 1970s by the National Association of College and University Business
Officers, which has published voluminous statistical surveys every year since
1979.
The main results I have been able to derive from these data
are shown in Table 12.2. The first conclusion is that the return on US
university endowments has been extremely high in recent decades, averaging 8.2
percent a year between 1980 and 2010 (and 7.2 percent for the period
1990-2010). To be sure, there have been ups and downs in each decade, with
years of low and even negative returns, such as 2008-2009, and good years in
which the average endowment grew by more than 10 percent. But the important
point is that if we average over ten, twenty, or thirty years, we find
extremely high returns, of the same sort I examined for the billionaires in the
Forbes rankings.
To be clear, the returns indicated in Table 12.2 are net real returns allowing for capital
gains and inflation, prevailing taxes (virtually non-existent for nonprofit
institutions) and management fees. (the latter include the salaries of everyone
inside or outside the university who is involved in planning and executing the
institution’s investment strategy. Hence these figures reflect the pure return
on capital as defined in this book, that is, the return that comes simply from owning capital, apart from any
remuneration of the labor required to manage it.
The second conclusion that emerges clearly from Table 12.2
is that the return increases rapidly with the size of the endowment. For the
500 of 850 universities whose endowment was less than $100 million, the average
return was 6.2 percent in 1980-2010 (and 5.1 percent in 1990-2010), which is
already fairly high and significantly above the average return on all private
wealth in these periods. The greater the endowment, the greater the return. For
the 60 universities with endowments of more than $1 billion, the average return
was 8.8 percent in 1980-2010 (and 7.8 percent in 1990-2010). For the top trio
(Harvard, Yale, and Princeton), which has not changed since 1980, the yield was
10.23 percent in 19080-2010 (and 10.0 percent in 1990-2010, twice as much as the
less well-endowed institutions.
If we look at the investment strategies of different
universities, we find highly diversified portfolios at all levels, with a clear
preference for US and foreign stocks and private sector bonds (government
bonds, especially US Treasuries, which do not pay well, account for less than
10 percent of all these portfolios and are almost totally absent from the
largest endowments). The higher we go in the endowment hierarchy, the more
often we find “alternative investment strategies,” that is, very high yield
investments such as shares in private equity funds and unlisted foreign stocks
(which require great expertise), hedge funds, derivatives, real estate, and raw
materials, including energy, natural resources, and related products (these,
too, require specialized expertise and offer very high potential yields).
If we consider the important of these various portfolios of
“alternative investments,” whose only common feature is that they abandon the
usual strategies of investing in stocks and bonds accessible to all, we find that they represent only 10 percent of
the portfolios of institutions with endowments of less than 50 million euros,
25 percent of those with endowments between 50 and 100 million euros, 35
percent of those between 100 and 500 million euros, 45 percent of those between
500 million and 1 billion euros, and ultimately more than 60 percent of those
above 1 billion euros. The available data, which are both public and extremely
detailed, show unambiguously that it is these alternative investment strategies
that enable the very largest endowments to obtain real returns of close to 10
percent a year, while smaller endowments must make do with 5 percent.
The returns obtained by Harvard and Yale vary around their
means but not much more so than the returns of smaller institutions, and if one
averages over several years, the mean returns of the largest endowments are
systematically higher than those of the smaller ones, with a gap that remains
fairly constant over time. In other words
the higher the returns of the largest endowments are not are not due
primarily to risk taking but to a more sophisticated strategy that consistently
produces better results.
How can these facts be explained? By the economies of scale
in portfolio management. Concretely, Harvard currently spends nearly $100
million a year to manage its endowment. Thus munificent sum goes to pay a team
of top-notch portfolio managers capable of identifying the best investment
opportunities around the world. But given the size of Harvard’s endowment
(around $30 billion), $100 million in management costs is just over 0.3 percent
per year. If paying that amount makes it possible to obtain an annual return of
10 percent rather than 5, it is obviously a very good deal. On the other hand,
a university with an endowment of only $1 billion (which is never-the-less
substantial) could not afford to pay $100 million a year – 10 percent of its
portfolio – in management costs. In practice no university pays more than 1%
for portfolio management, and most pay less than 0.5, so to manage assets worth
$1 billion, one would pay $5 million, which is not enough to pay the
specialists in alternative investments that one can hire with $100 million.
As for North Iowa Community College, with an endowment of
$11.5 million, even 1 percent a year would amount to only $115,000, which is
just enough to pay a half-time or even quarter-time financial advisor at going
market rates. Of course a US citizen at the median of the wealth distribution
has only $100,000 to invest, so he must be his own money manager and probably
has to rely on advice from his brother-in-law. To be sure, financial advisors
are not infallible (to say the least), but their ability to identify more
profitable investments ( or get access to them) is the main reason why the
largest endowments obtain the highest returns.
These results are striking, because they illustrate in a
particularly clear and concrete way how large initial endowments can give rise
to better returns and thus to substantial inequalities in returns on capital.
These high returns largely account for the prosperity of the most prestigious
US universities. It is not alumni gifts, which constitute a much smaller flow:
just one-tenth to one-fifth of the annual return on endowment. . . . . (*see first three comments)
In all countries, on all continents, one of the main
objectives of public spending on education is to promote social mobility. The
stated goal is to provide access to everyone regardless of social origin. To
what extent do existing institutions fulfill this objective?
In Part Three, I showed that even with the considerable
increase in the average level of education over the course of the twentieth
century, earned income inequality did not decrease. Qualification levels
shifted upwards: a high school diploma now represents what a grade school
certificate used to mean, a college degree what a high school diploma used to
stand for, and so on. As technologies and workplace needs changed, all wages
levels increased at similar rates, so that inequality did not change. What
about mobility? Did mass education lead to more rapid turnover of winners and
losers for a given skill hierarchy? According to available data, the answer
seems to be no: the intergenerational correlation of education and earned
incomes, which measures the reproduction of the skill hierarchy over time,
shows no trend toward greater mobility over the long run, and in recent years
mobility may even have decreased, understanding that sources available for
estimating the historical evolution of mobility are highly imperfect. The most
firmly established result in this area of research is that intergenerational
reproduction is lowest in the Nordic countries and highest in the United States
(with a correlation coefficient two-thirds higher than in Sweden). France,
Germany, and Britain occupy a middle ground, less mobile than northern Europe but
more mobile than in the United States.
These findings stand in sharp contrast to the belief in
“American exceptionalism” that once dominated US sociology, according to which
social mobility in the United States was exceptionally high compared with the
class-bound societies of Europe. No doubt the settler society of the early
nineteenth century was more mobile. As I have shown, moreover, inherited wealth
played a smaller role in the US than in Europe, and the US wealth was for a
long time less concentrated, at least up to World War I. Throughout most of the
twentieth century, however, and still today, the available data suggest that
social mobility has been and remains lower in the United States than in Europe.
One possible explanation for this is the fact that access to
the most elite US universities requires the payment of extremely high tuition
fees. Furthermore, thesev fees rose sharply in then period 1990-2010, following
fairly closely the increase in the top US incomes, which suggests that the reduced
social mobility in the past will decline even more in the future. Research has
shown that the proportion of college degrees earned by children whose parents
belong to the bottom two quartiles of the income hierarchy stagnated at 10-20
percent in 1970-2010, while it rose from 40 to 80 percent for children in the
top quartile. In other words, parents’ income has become an almost perfect
predictor of university access.
This inequality of access also seems to exist at the top of
the economic hierarchy, not only because of the high cost of attending the most
prestigious private universities (high even in relation to the income of
upper-middle-class parents) but also because admissions decisions clearly
depend in significant ways on the parents financial capacity to make donations
to the universities. For example, one study has shown that gifts by graduates
to their former universities are strangely concentrated in the period when the
children are of college age. By comparing various sources of data, moreover, it
is possible to estimate that the average income of the parents of Harvard
students is currently about $450,000, which corresponds to the average income
of the top 2% of the US income hierarchy. Such a finding does not seem entirely
compatible with the idea of selection based solely on merit. The contrast
between the official meritocratic discourse and the reality seems particularly
extreme in this case. The total absence of transparency regarding selection
procedures should also be noted.
It would be naïve to think that free higher education would
resolve the problem. In 1964, Pierre Bourdieu and Jean-Claude Passeron analyzed
more subtle mechanisms of social and cultural selection, which often do the
same work as financial selection. In practice, the French system of “grandes
escoles” leads to spending more public money on students from more advantaged
social backgrounds, while less money is spent on university students who come
from more modest backgrounds. Again, the contrast between the official discourse
of “republican meritocracy’ and the reality (in which social spending amplifies
inequalities of social origin) is extreme. According to the available data, it
seems that the average income of parents of students at Sciences Po is
currently around 90,000 euros, which roughly corresponds to the top 10 percent
of the French income hierarchy. Recruitment is thus 5 time broader than at
Harvard but still relatively limited. We lack the data to do a similar
calculation for students at other grandes ecoles, but the results would likely
be similar.
Make no mistake: there is no easy way to achieve real equality
of opportunity in higher education. Tuition fees create an unacceptable
inequality of access, but they foster the independence, prosperity, and energy
that make US universities the envy of the world. In abstract, it should be
possible to combine the advantages of decentralization with hose of equal
access by providing universities with substantial publically financed
incentives. In some respects this is what public health insurance systems do:
producers (doctors and hospitals) are granted a certain independence, but the
cost of care is a collective responsibility, this ensuring that patients have
equal access to the system. One could do the same thing with universities and
students. The Nordic countries have adopted a strategy of this kind in higher
education. This of course requires substantial public financing, which is not
easy to come by in the current climate of consolidation of the social state.
Such a strategy is nevertheless far more satisfactory than other recent
attempts, which range from charging tuition fees that vary with parent’s income
to offering loans that are to be paid back by a surtax Added to the recipient’s
income tax.
If we are to make progress on these issues in the future, it
would be good to begin by working towards greater transparency than exists
today. In the United States, France, and
most other countries, talk about the virtues of the national meritocratic model
is seldom based on a close examination of the facts. Often the purpose is to
justify existing inequalities while ignoring the sometimes patent failures of
the current system.
In 1872, Emile Boutmy created Sciences Po with a clear
mission in mind: “obliged to submit to the rule of the majority, the classes
that call themselves the upper classes can preserve their political hegemony
only by invoking the rights of the most capable. As traditional upper-class prerogatives
crumble, the wave of democracy will encounter a second rampart, built on
eminently useful talents, superiority that commands prestige, and abilities of
which society cannot sanely deprive itself.”
If we take this incredible statement seriously, what it
clearly means is that the upper classes instinctively abandon idleness and
invented meritocracy lest universal suffrage deprive them of everything they
owned. One can of course chalk this up to the political context: the Paris
Commune has just been put down, and universal
male suffrage had just been establish. Yet Boutmy’s statement has the
virtue of reminding us of an essential truth: defining the meaning of equality
and justifying the position of the winners is a matter of vital importance, and
one can expect to see all sorts of misrepresentation of the facts in the
service of the cause.
