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How Deficit Spending Affects Business Schools

As the pandemic leads nations to incur more debt, academic leaders must understand its impact on higher education.

The global economic slowdown caused by the COVID-19 virus has presented governments with significant fiscal policy and public debt challenges. For instance, in March, the United States passed a 1.9 trillion USD COVID relief plan. Other countries—including Japan, Slovenia, Switzerland, Finland, Germany, Australia, Canada, France, New Zealand, and the United Kingdom—also have put together relief packages in response to the pandemic.

Politicians and economists have long debated the pros and cons of fiscal deficits, in which a government spends more than it brings in and makes up the shortfall by increasing the public debt. But these debates have grown even more heated today as many nations have financed their relief bills through increased deficit spending. These discussions have particular relevance to business schools—and their parent universities.

The Current Financial Picture

The virus has had a significant impact on the financial health of higher education institutions for three primary reasons:

Business school revenue has declined during the pandemic. Because many countries instituted travel lockdowns, required quarantines, or limited visa approvals, fewer international students have applied to or enrolled in programs at schools outside their own borders. Australia and New Zealand in particular have been hurt by the drop in international applications, but schools around the world have felt the effects.

At the same time, some students have pressured schools to refund a portion of their tuition and fees because they didn’t feel they should have to pay the price of a face-to-face experience while they were attending classes online. In addition, according to a November 2020 article in The Chronicle of Higher Education, many small private institutions in the U.S. offered high discount rates to students during the pandemic, leading to net revenue losses.

Many auxiliary revenue sources have been affected. Students who are attending classes from home are not paying to live in residence halls, spending money at on-campus dining establishments, or paying for parking. External stakeholders, who are facing their own financial challenges, have provided less funding for endowments.

Costs have increased. Before COVID-19, many universities did not have the technological infrastructure to scale online delivery to all of their learners, so they had to quickly add capacity when they made the abrupt switch to virtual learning. Many also incurred pandemic-related expenses as they purchased personal protective equipment and put testing regimes in place. For example, in 2020, the University of Wisconsin system spent 36 million USD on testing and 43 million USD on protective equipment, sanitation, telecommuting, technology, and student support, according to a report from Inside Higher Ed.

The result is that many universities and business schools are in financial distress. In many countries, some schools have retrenched their staffing and taken other steps to reduce costs. Government relief bills that include funding for universities have been essential lifelines.


Government support remains an important source of revenue for universities. Therefore, it’s a concern for higher education when outside events divert those funds.

Even in more ordinary times, universities rely on public funding to some extent, although industry observers point out that such spending has decreased since the 2008 global financial crisis. In fact, in their 2012 book Public No More, Gary C. Fethke and Andrew J. Policano question the extent to which the state should support universities and business schools.

Nonetheless, government support remains an important source of revenue for public universities—and, through the provision of research funds, for private universities as well. Therefore, it’s a concern for higher education when outside events, such as the pandemic, divert those funds. For instance, in a May 2020 report called Impact of the COVID-19 Pandemic on Education Financing, the World Bank Group notes that Ukraine and Nigeria were targeting cuts to the education budget to make space for pandemic-related health spending. These kinds of opportunity cost decisions, driven by prevailing orthodoxy on fiscal policy and debt, can be harmful for business schools.

An Overview of Fiscal Policy

So how do debates about fiscal policy inform the current situation? Since the 1970s, the mainstream economic position has been that prolonged deficits and high public debt are harmful to the economy. This type of thinking led to the “austerity” policies some governments instituted during the 2008 global financial crisis. But even though conservatives heralded austerity measures as fiscally responsible, economists Christopher House, Christian Proebsting, and Linda Tesar blame such measures for the slow recovery in several European countries.

Other researchers, including Carmen Reinhart and Kenneth Rogoff, also have examined the negative impacts of ongoing fiscal deficits and high debt. Essentially, they find that a buildup of public debt leads to a decrease in a country’s economic growth. They show that, in developed countries, the growth rate slows once the countries are over a debt-to-GDP ratio of 90 percent. At that point, median growth rates fall by 1 percent, and average growth falls even more. In emerging markets, the effects kick in at an even lower debt-to-GDP ratio.

At the end of 2020, global debt stood at 281 trillion USD, which represented close to 100 percent of the world’s GDP. In some cases, particularly in emerging markets, debt actually exceeds GDP.

The mainstream economic view suggests that governments need to be aware of the risks associated with increased fiscal spending at this time, for two key reasons. First, if the risk premium of investing in government bonds goes up due to ongoing fiscal deficits, the government will incur even higher costs as it borrows funds to finance the debt. This cycle is not sustainable, and the debt becomes a burden for future generations. Second, there is the risk that government can “crowd out” private sector activity because it is raising the cost of borrowing by competing for funds in the market.

However, compelling evidence suggests that neither of these possibilities is a major concern. In the first instance, sustainability of debt depends on inflation expectations, the interest rate, and the growth in nominal GDP (that is, GDP not adjusted for inflation). Inflation expectations are an important driver of the interest rate. Current inflation expectations are very low, and long-term interest rates are forecast to be close to zero. As long as the nominal growth in GDP is higher than the interest rate, then the debt-to-GDP ratio does not increase. Under these circumstances, analysis suggests that a fiscal deficit is not a problem and the debt remains sustainable.

In the second instance, “crowding out” assumes that financing the deficit drives up the interest rate. However, interest rates currently are near zero and have not been driven up by deficit spending. The crowding-out theory also assumes that the state draws resources at the expense of the private sector. But when there is significant unemployment in an economy, there is little evidence that government deficit spending crowds out private sector activity.

A logical conclusion is that, currently—and given the medium- and long-term view on interest rates—there is not a major problem with running deficits, even those of a significant size.

No ‘Free Lunch’

Modern monetary theory posits that governments have more room to spend in times of low inflation and should borrow as much as they need to reach full employment. However, they cannot spend endlessly and recklessly. There is no infinite “free lunch” enabled by deficit spending, and for three main reasons.

First, government borrowing can continue only if inflation expectations and interest rates remain low. Several possible factors may cause both to go higher:

  • Inflation may rise over time, even though wage pressures are currently low.
  • Consumer spending stalled during COVID-19, so there is pent-up demand for goods. Once the pandemic is over, that demand may well flood the market.
  • The pandemic disrupted many supply chains, causing bottlenecks that could result in price spikes as demand grows.
  • Many central banks around the world have become less hawkish on inflation as they focus on a wider mix of policy priorities.

Second, some businesses should fail. Many industry observers adhere to the idea that a strong economy requires creative destruction. One proponent of this theory is Raghuram Rajan, a former chief economist of the International Monetary Fund, previous governor of the Reserve Bank of India, and currently a finance professor at the University of Chicago’s Booth School of Business.


Higher education is one of the key investments that create the human capital necessary for countries to develop.

Rajan and others believe that businesses that are not meeting the needs of consumers, or that cannot do so in a way that covers costs, should fail over time and be replaced by other businesses. When deficit spending provides ongoing support for most businesses, it prevents the dynamic nature of an economy to take place. In other words, “zombie” firms will continue to be supported and survive.

Third, ongoing fiscal deficits are problematic in emerging markets. In those countries, governments frequently have to finance debt by borrowing offshore, often in hard currency (i.e., money issued by an economically stable nation). This is only sustainable if there isn’t an increase in the value of the hard currency. For example, if an emerging economy has borrowed U.S. dollars, and the value of the dollar goes up, then the debt cost for the emerging economy also has risen. Furthermore, there is a risk that investors will become “flight risks,” abruptly pulling money from investments in emerging markets.

Investing in the Future

As the world recovers from the ravages of COVID, it makes sense that governments should run fiscal deficits where they need to and where they can. They should focus their deficit spending on pandemic-related costs such as improving health outcomes and providing safety nets to those in need. It is more effective to predominantly fund consumers than to essentially choose winners by funding businesses.

But governments also should invest in sectors that will strengthen their economies in the future—and that brings us full circle. Higher education is one of the key investments that create the human capital necessary for countries to develop. It is a mechanism for improving equity across societies. To this end, funding tertiary education is just as essential as funding pre-school and K-12 education.

Under current fiscal policy, the question is not just whether a government should run a deficit, but where it should spend its borrowed dollars. Academic leaders need to recognize both these points so they can make decisive arguments in favor of deficit spending for higher education.


Geoff PerryGeoff Perry is AACSB International’s executive vice president and chief officer of Asia Pacific.