EC-112Current Issues in Economics

Economics of Education(continued)

Lecture 4

The results from numerous studies of the rate of return to a graduate education are well above 6% which has been used by the Treasury in deciding whether a public investment is appropriate.

This is before making any allowance for benefits which may arise to the wider economy, some of which may be difficult to quantify.

However, it should be future returns rather than past returns which should determine an individual’s investment decision in a university education.

Historic rates of return may be an imperfect prediction of prospective rates of return.

Future premia to a university education are likely to be determined by a number of factors:

• growth in the supply of graduates• growth in the demand for graduates• the impact of any shift in the balance between supply and

demand on the graduate pay premium• the impact of any changes to the capability of entrants to Higher

Education• elasticity of substitution, the flexibility for profitable substituting of

graduates with non-graduate labour

Trying to forecast future labour market needs for highly qualified workers cannot be done with any precision

Given the recent large increase in students attending university returns may be lower that for earlier generations

However, whilst the supply of graduates is increasing, so is the demand for graduates as new technologies are introduced and patterns of work change. There is an increasing demand for higher level of skills and forecasts expect this trend to continue.

Changes in industrial structure is also likely to influence demand for graduates

• decline in manufacturing employment which traditionally employs relatively few graduates

• increase in employment in business and finance sector which traditionally employ relatively large numbers of graduates

However, changes in occupational structure likely to be more important

• fewer clerical workers• more professional workers

Within all occupations demands for skills are increasing

Social Demand for Education

So far we have focused on the individual as the main purchaser of education. However, some of the reasons why society wants education are distinct from those of individuals.

 • Necessary for the functioning of democracy• Increase in welfare from technical progress can be immense

 

Endogenous growth theory suggests the rate at which the economy grows will depend on the level of education undertaken

• Robert Barrow finds a 10% increase in education attainment increases growth by 0.2% per year

• Becker estimated the social rate of return to education at 25%

The size of these figures might explain why education is provided by the state.

 

But why does education have to be provided by the state. Couldn’t education not be produced by the private sector and purchased by consumers on the free market?

Education is likely to be susceptible to market failures: • Externalities• Information problems• Constraints on individual investments

If there were no state intervention in the market for education, individuals would enter further/higher education only if the private benefits of education exceed the private costs.

 

This can be shown in the following diagram.

£

pmc

pmb

Np No. of students

In this case, equilibrium number of students is given as Np where private marginal cost (pmc) is equal to private marginal benefit (pmb).

However, the possibility arises that social marginal costs and social marginal benefits may be different from the private shown above.

As a result the private market may result in too few students entering higher education. Np less than Ns.

 

A subsidy however could result in the socially optimal number of students being educated – shifts pmc to the right to pmc’

Capital Constraints

Capital markets allows people to transfer wealth between different periods by borrowing and lending so that profitable opportunities for education should be fully exploited.

£

smc

smb

Ns No. of students

However, there may be severe problems for many people due to reluctance on the part of lenders to lend as much as individuals might want.

• Default especially a problem given the timing of expenditures

 • Long-term financing for house is possible because a

house itself acts as a security for the loan.

SignallingCritics of human capital theory argue that education does nothing to increase productivity, rather it signals to an employer that an individual is talented.

To be effective the screening process must separate the high-ability workers from others.

Important to test human capital and signalling theories. Both predict that education effects earnings.

What we need to know is – does education determine productivity? Problem arises because on many occasions we can’t observe productivity.

If schooling is purely a screening device we might expect that the self-employed would invest less in education as they are likely to know their own productivity so do not need to acquire signals to testify this.

There is evidence in both the USA and UK that the self-employed do acquire less schooling than employees.

However, no perfect test as those self-employed may not know when deciding whether or not to invest in education that they will become self-employed. So still may need to acquire a good education – the signal.

Also self-employed may need to acquire certificates as a testimony to their competence.

If schooling is only a screening device would expect schooling to be less important as years with an employer increases as they would have more information on an employee – appears not to be the case.

If schooling were only a screening device would expect other cheaper screens than education to come into existence – IQ testing stations!

If education is only a screening device this would dramatically reduce the social rate of return to education but not the private.