The ‘oil curse’ explains Harvard’s puzzling financial choices

By Aaron Brown

Three recent stories suggest financial problems at Harvard University, problems that likely extend to most elite and some non-elite schools. First is the standoff with the Trump administration which has led to a $2.2 billion funding freeze and threatened its tax-exempt status. Second is a Bloomberg News report that it is in talks to sell $1 billion of private-equity investments from its endowment. Third are borrowing plans that would bring the university’s indebtedness to more than $8 billion.

This could be a simple story: Harvard needs cash to replace lost federal funds and pay for university operations — except for one thing. Harvard has a $53.2 billion endowment, much of it in liquid assets, so why the panic over Trump, fire sale of illiquid assets at an unfavorable time and massive borrowings? Why not use the endowment’s liquid assets to buffer any shortfalls at a lower cost than selling private equity and borrowing? Granted, there are many restrictions on specific endowment funds that limit the university’s power to use the entire $53.2 billion for general purposes, but Harvard could extract considerably more cash from the endowment.

Shedding some liquid assets also has a potential tax advantage. The Trump administration’s threat to reclassify Harvard’s tax status is a double-edged sword. On the endowment side, it means assets would be taxed, so selling some now reduces exposure to that threat. On the debt side, it could mean that debt issued as tax-free to investors could become taxable, meaning the university will have to pay higher rates today to compensate investors for that risk. Again, selling assets seems preferable.

The best way to understand Harvard’s puzzling choices, and similar choices before Yale University and other schools with smaller endowments is to think of the situation as a variant of the oil curse. That curse is the observation by economists that countries with valuable natural resources often have unstable economies and dysfunctional political regimes.

There are four main explanations for the oil curse. First is that exploitation of the resource can steal energy and attention from developing the broad economy. Resource sales strengthen the currency, weakening export sectors. It becomes cheaper to import goods and workers, stunting the development of domestic companies and workers. What energy and innovation there is focuses narrowly on resource production and exploitation at the cost of building a prosperous broad economy.

At a university, efforts to nurture and grow the endowment can distract from the core academic mission. The highest-paid staff may be focused on fundraising or investing and perhaps lack academic credentials. Funding of financial aid and research may be cut so more funds can be reinvested to grow the endowment. Projects that produce revenue surpluses — such as business and medical schools and extension programs — or attract donations — such as star researchers in high-profile fields — can be overdeveloped at the expense of important but less-glamorous money-losing programs.

A second reason for the oil curse is it can empower rent-seekers who insert themselves in the resource process. A large endowment can empower fundraisers, donors and the sort of projects that attract donations, overshadowing the basic education and research mission of the school. This phenomenon has been documented in papers such as “Why Are University Endowments Large and Risky?.” One of its more familiar manifestations is when a profitable football or basketball program attracts large alumni donations. Academic standards and other university values can get trampled in pursuit of team success. Another is when a university closes ranks to defend a star researcher accused of fraud or plagiarism, rather than risk the grants and donations he attracts.

Oil curses are sustained for a third reason, people with access to the resource are insulated from external pressures such as winning elections or satisfying taxpayers. Anecdotally, universities with large endowments have more and better-paid administrators, who are somewhat isolated from core university activities. Such staff may hoard the endowment as a source of power, resisting its use to buffer funding variability. This group would rather borrow to grow its empire than cut back the foundation of its power and shrink the university’s financial footprint by selling assets. The large endowment means the university is not dependent on collecting tuition from students and parents.

Finally, resources can lead to conflict and instability, as different groups vie for control of the wealth. Donald Trump is one such external party at Harvard. While universities are famous for conflicts even when no money is involved — Henry Kissinger noted, “The reason that university politics is so vicious is because stakes are so small”— a large endowment can aggregate many departmental disagreements, such as how many dead white male authors is too many for the introductory literature course, into systemic schisms about who gets to choose the mission of the university.

A literature department paying its faculty and overhead from tuition and grants can leave university politics to the people who like that sort of thing. But if all departments are dependent on the same endowment, no one can afford to do their research, teach their classes and go home.

I’m not claiming that Harvard and other elite universities with large endowments and large debt loads are exactly like nations such as Venezuela that exemplify the oil curse, but the thesis offers some useful parallels. A good outcome might be for Harvard to invest more of its endowment in educational and research projects, keeping just enough to buffer cash flow variability and comply with the legal restrictions on use of endowment funds. That would leave the university in a stronger position to resist outside pressure from governments and donors and elevate its academic mission above its financial footprint. It could redirect its energies from money and politics to learning, and make it more responsive to its customers — students and society.