Returns to Education

Background: Individual’s Perspective

• Education is an important decision for many people– Higher levels of education can increase income

streams– Higher educational attainment could also reduce

the likelihood of unemployment– Higher levels of education are also associated with

higher levels of health status

Background: Government’s Perspective

• Government’s also face a decision about whether it should allocate more resources to education as well as which part of the education sector (e.g., primary/elementary, secondary, post-secondary).

Two Perspectives

• Government– How to allocate scarce

resources to education and within the education, which segment ?

• Individual– How to pick an

education level to maximize lifetime earnings?

• How would the government or individual make their decisions about education?– Can view these decisions as investment decisions,

so pick a “project” that has the highest return.– Calculate the rate of return (internal rate of

return) that makes the present value of net benefits of schooling zero

• Recall that the IRR is computed as follows

– , …, are the benefits of education– , …,are the costs of education– For the government, if IRR > social discount rate then

undertake investment in education; for an individual if IRR> interest rate undertake investment in education

• Costs of Education:– Direct Costs:

• Tution• Books

– Indirect Costs• Lost wages

• Benefits of Education:– Level of earnings associated

with a particular level of schooling • Might also include health, but

we’ll focus on earnings as a measure of benefits

• Costs– Need to distinguish between the private and social cost

• Private costs will not reflect the total costs for an individual because the government subsidizes education in Canada; the private share of costs of education does increase as level of education increases (e.g., university education requires tuition, but high school and elementary education does not)

• For lower levels of educations, private costs are about 0, since government subsidizes education (e.g., no tuition or text book expenses)

– Costs measure the resource costs required by the economy to produce a given level of education

Examples of Costs of Education

• Tuition fees are much lower in 1985-86 then they are today.

• Textbooks were a lot cheaper then too.

• Public costs exceed private costs

• Public costs for graduate degrees are also highest

Examples of Rates of Return to Education

• Social rates of return tend to be about 3 percentage points smaller than the private rates of return.– This reflects differences in

private and social costs of education

– Suggests that individuals may overinvest in education because they don’t take into account the social costs

Examples of Rates of Return: Public vs Private

• Rates of return by level education.– Highest rates of return are for

secondary (high school), which suggests policies that reduce dropouts (e.g., compulsory schooling) could be quite important.

– Can have some negative rates of return; e.g. the Ph.D.; might get an overinvestment in PhDs, some students would be better off stopping with the master’s degree (would increase return to a PhD)

• By major, can see highest rates of return tend to be for Commerce, Engineering and Health Degree (doctors and dentists); reflect higher wages that individuals earn in these fields.