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
𝐵1 − 𝐶1
𝐵𝑇 − 𝐶𝑇
𝐵0 − 𝐶0 +
+ ⋯+
=0
𝑇
1 + 𝐼𝑅𝑅
1 + 𝐼𝑅𝑅
– 𝐵0 , …,𝐵𝑇 are the benefits of education
– 𝐶0 , …,𝐶𝑇 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.
Reconsidering Earlier Estimates
• The rates of return considered on the previous
slides were based on earlier data, reaching
into the 1980s. Unfortunately, this is not an
active area of research so there rates of return
based on more current data are not available.
• One question is whether the estimates based
on earlier data are still relevant for today? If
they are not, would the estimates be smaller
or larger than?
Changes in Funding of Post-Secondary
Education
• In Canada, funding of the university and other
post-secondary institutions is a provincial
responsibility.
• In many provinces the funding allocated to
post-secondary education has declined in
relative terms
– Government funding for the healthcare sector has
generally increased at a rate greater than GDP
growth; Post-secondary education funding has in
most provinces not kept pace with GDP growth.
• For example, in 1990 about 80% of the
University of Toronto’s operating budget was
provided by the provincial government; today
only 27% of the University’s budget is funded
by the provincial government
• Tuition represents a much larger share of the
University’s revenues then in the past.
• These changes have implications for rates of
return to education.
Analysis of Changes to Funding
• Assume we hold everything else constant.
• Since the government subsidy to post-secondary
education has fallen, it would be likely that the
difference between social and private rates of
return to education have narrowed.
• The social rate of return to education will be
lower than the private rate of return, but the
difference between the two should be narrower
than observed in the estimates listed earlier in
these slides.
• But is everything really held constant?
• Obviously, not; there have been changes in
demands for certain skills; greater supply of
university graduates; economic shocks
(recessions); increases in tuition and other costs
of education.
• Without an analysis of more recent data we
cannot say for sure what happened to rates of
return to education; We can only hypothesize
about the potential impacts.