The Returns to Education

Education is one of the most powerful instruments for reducing poverty and inequality and for laying the basis for sustained economic growth. The importance of an educated population is well established. Recent evidence points to the need to make sure that the increasingly “schooled” population is also effective in terms of competencies and abilities. Studies show that students with high academic achievement earn more.

Theodore W. Schultz studied the process of economic development for farmers in low-income countries. He made significant contributions based on his views that farmers in developing countries were rational and made efficient use of their resources. This realization led Schultz to study the importance of learning and the development of the theory of human capital. Schultz also gave us the idea that education produces returns when there is a shock to the system, such as technological change – or disequilibria – which puts a premium on learning.

Formal modelling by Jacob Mincer, Schultz, Gary Becker and Barry Chiswick led to the production of estimates of the returns to education. Since that time, countless estimates have been made in countries around the world, beginning with George Psacharopoulos.

Are There Returns to Schooling?

To estimate the rate of return to investment in schooling we usually rely on cost-benefit analysis. The return to schooling equals the value of lifetime earnings to the net present value of the costs. An economically justified expenditure has a positive return which is higher than the alternative. Typically, the costs are the student’s foregone earnings while studying, and fees or expenses. The benefits are how much extra a person earns compared with someone with less education.

The latest attempt to compile comparable estimates from a large global databased puts the global rate of return to schooling at 10% for every year of schooling. This recent estimate comes from data from 139 economies. The global pattern is for slightly decreasing returns over time, but an incredible steady return in the last few decades despite a revolution in access to education. That is, the returns to schooling stay relatively high despite massive increases in schooling levels.

Globally, the returns to tertiary education are highest, followed by primary and then secondary schooling; this represents a significant reversal from many studies’ prior results. Policymakers can learn much from such estimates. For instance, further expansion of university education appears to be very worthwhile for the individual, meaning that governments need to find ways to make financing more readily available. Also, there are higher rates of return for women than men, thus giving further justification for investing in girls’ education.

Rates of return to schooling are undisputable. They are used to explain individual behavior with respect to choices and to measure productivity. They can be used to analyze the distributional effects of education finance programs, which can guide public policy with respect to the design of programs and the crafting of incentives that promote investment. A good example is student finance.

Critiques

The relationship between schooling and earnings does not necessarily imply causality. The earnings premium associated with level of education suggests that productivity increases as people acquire additional qualifications. An alternative view is that earnings increase with education due to credential effects. This refers to the idea that higher levels of schooling are associated with higher earnings, not because they directly raise productivity, but because they certify that the worker is likely to be productive. In this sense, education merely sorts workers. While some level of screening will likely exist, at least at the entry level, and perhaps also influence the decision to enroll, the earnings function can be used to examine the case for or against screening. Most tests of the screening hypothesis do not find strong evidence of screening.

More rigorous tests of the screening hypothesis involve taking advantage of “natural experiments” such as changes in the school leaving age or college openings. By and large, while some evidence of weak screening is revealed, education is generally associated with higher earnings due to productivity rather than to screening. Thus, investment in schooling continues to be a worthwhile activity for individuals and societies to undertake. Estimates of the returns to education based on advanced econometric techniques that control for different characteristics come to an average rate of return that is similar to the global average presented in most reviews.

Extensions

Typical estimates of the returns to education refer to the quantity of schooling. Several studies have shown the importance of school quality in determining earnings. A counter-argument could be that rates of return to investment in education, as conventionally estimated, refer to the average level of quality across all schools in the sample. So, if school quality is important in determining earnings, improving school quality must yield even higher returns to education.

Impact of Automation

As economies mature and the level of education rises, the skills demanded change. Jan Tinbergen described it as a race between education and technology. Over time, the demand for cognitive skills – brain-based abilities we need to carry out a task and how we learn, remember and problem-solve – has increased. So has the demand for non-routine skills, while the demand for routine and less skilled jobs has declined. Increased technological change will put an even higher premium on skills that are not easy to automate. This presents a significant challenge for most education systems.

Implications for Policy

I commented on the policy implications of the returns elsewhere, namely:

1. There is a continuing need to focus public investment on the poor

2. We need to focus investment on education quality

3. Higher education should be expanded – but in a fair, equitable, and sustainable manner

One could also add the following:

4. Countries need to continue efforts to invest in girls’ education

5. Information is key – for policy makers to make informed decisions and for students and their families to be aware

This brings us to the fundamental question of the association between education and earnings and whether there are returns to schooling. Schultz made the case that times of change are crucial for investing in knowledge. What other time than the Fourth Industrial Revolution is more appropriate for continuing the education revolution? More than two decades ago Mark Rosenzweig showed exactly how there are returns to schooling by empirically proving that the green revolution was a momentous occasion for the application of knowledge. He showed that farmers with more schooling could benefit significantly from new seed varieties. The current industrial revolution could yet again prove the need for massive investments in learning. For most countries, sadly, school systems are not well equipped to handle this change. Along with a renewed need for higher skills, today’s students need to improve social and emotional skills to make them immune to automation and able to take advantage of the new economic reality.

What specific investments do you think countries need to make today to prepare students for the world of work?

Follow Harry Anthony Patrinos on Twitter at @hpatrinos.

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