Human Capital Theory and Benefit-Cost Analysis in Education

1. Human Capital Theory and Benefit-Cost Analysis in Education Emmanuel Jimenez, DECRG, and Peter Moock, EASED December, 1998

2. Outline • Basic Framework for Analyzing Investments in Human Capital • Relevance for project analysis...not • Issues • Modifying the approach

3. Human Capital Scale -- Weighing Private Benefits and Costs Benefits Costs

4. The productivity chain Education Human capital Productivity Wages Welfare

5. The productivity chain Education Human capital Productivity Wages Welfare

6. Human Capital and Productivity Human Capital Working with Existing Developing Technology Better New Technology Acquiring Processing New Information Knowledge

7. Education raises wages for both men and women:

8. Returns over time Wage ($) S2 D1 S1 D2 W S2 D1 D2 S1 G1 G2 Number of Graduates

9. Education raises wages for both men and women:

10. Education and productivity • Better educated farmers get a higher return on their investments in agriculture: • In Africa, farmers who have completed 4 years of education (the minimum necessary for literacy) produce, on average about 8-10 percent more than farmers who had not gone to school (Moock, Jamison et al., Jamison & Moock) • Technical and allocative efficiency (Welch, Timmer)

11. Education and productivity (cont’d) • Production function may matter: • In simple tasks or in settings where technology slow to change, effect of education small • In traditional farming, techniques passed from generation to generation (T.W. Schultz) • In piece-rate work in the Philippines, wage not related to schooling after controlling for gender and physical stature (Foster and Rosenzweig)

12. Human Capital and Wages Education Human capital Productivity Wages Welfare

13. Education and productivity (cont’d) • But, if task involves new technology whether there is a premium on learning and information acquisition learning may be very important • For example, large effect of education in Kenya after introduction of new hybrid seed varieties (Moock) • In India, areas with relatively few educated farmers at the onset of the green revolution experienced less growth compared to other, high schooling areas (Foster and Rosenzweig)

14. Human Capital Scale -- Weighing Private Benefits and Costs Benefits Costs • Increased market productivity • Private non-market effects (e.g., better personal health, household productivity effects)

15. Human Capital Scale -- Weighing Private Benefits and Costs Benefits Costs • Increased market productivity Direct costs • Private non-market effects Foregone production or earnings

16. Graph on Rate of Return Estimation for University-level Education University graduates Post-tax earnings Age 22 65

17. Graph on Rate of Return Estimation for University-level Education University graduates Returns Secondary school leavers Indirect costs (foregone earnings) Age 18 22 65 Time (years) Benefit years 43 Cost years

18. Graph on Rate of Return Estimation for University-level Education University graduates Returns Secondary school leavers Indirect costs (foregone earnings) Age Direct costs (out-of-pocket expenses)

19. Graph on Rate of Return Estimation for University-level Education University graduates Benefits + + + + + + + + + + + + + + + + + + + Secondary school leavers + + + + + + + + + + + + + + + + + + + + - - - - - - - - - - Costs Age - - - - - -

20. Human Capital Scale -- Weighing Private Benefits and Costs Benefits Costs

21. Graph on Rate of Return Estimation for University-level Education University graduates Benefits + + + + + + + + + + + + + + + + + + + Secondary school leavers + + + + + + + + + + + + + + + + + + + + - - - - - - - - - - Costs Age - - - - - - age 18, t = 0 age 22, t = 4 age 65, t = 47

22. Time Value of Money NowLater Inflation plus real rate of interest

23. Discounting NowLater

24. Interest Rate (Discount Rate) FV = PV(1+r)t PV = FV/(1+r)t

25. Interest Rate (Discount Rate) Future Value ($ in t years) Life of investment FV = PV(1+r)t Principal ($ invested) Interest rate PV = FV/(1+r)t Present Value of FV paid t years from now Discount rate

26. Weighing Private Benefits and Costs --Without Discounting Costs Benefits

27. Internal Rate of Return Benefits Costs The discount rate that equates benefits and costs

28. Returns to Investment in Education by Level (%) -- Private Rates of Return Private Country/Yr. Prim. Sec. Higher Bolivia 1989 9.8 8.1 16.4 Brazil 1989 36.6 5.1 28.2 Greece 1977 20.0 6.0 5.5 Israel 1958 27.0 6.9 8.0 Japan 1976 13.4 10.4 8.8 Mexico 1984 21.6 15.1 21.7 Paraguay 1990 23.7 14.6 13.7 Taiwan 1972 50.0 12.7 15.8 Venezuela 1989 36.3 14.6 11.0 Source: Psacharopoulos (1994).

29. Social Benefits • Private benefits • Increased market productivity • Private non-market effects • Plus ... • Additional social benefits • Taxes on higher earnings • Externalities • Spillover effects (my education increases your productivity) • Technical innovation • Community non-market effects (e.g., lower crime)

30. Marginal Gains in Per Capita GDP Growth per 10% Increase in Enrollment Rate, 1960-1985 Source: Mingat and Tan, 1996.

31. Child mortality and education 100 80 Percent 60 40 20 0 1-3 years 4-6 years 7+ years Mother's educational level

32. Fertility and education 7 6 5 4 Total fertility rate (%) 3 2 1 0 No schooling 4-6 years 7+ years Mother's educational level

33. Human Capital Scale -- Weighing Private Benefits and Costs Benefits Costs • Increase market productivity Direct costs • Private non-market effects Foregone production or earnings • Spillover effects Public subsidy • Technical innovation • Community non-market effects • Reduced fertility/child mortality P R I V A T E P R I V A T E S O C I A L S O C I A L

34. Measurement • Can we measure externalities? • Can we measure monetary value of reduced fertility and reduced mortality? • Can we measure returns to equality?

35. Full (“Social”) Rates of Return Benefits Costs • Increased market productivity Out-of-pocket expenses • Private non-market effects Foregone production/ earnings • Taxes on higher earnings Public subsidy P R I V A T E P R I V A T E S O C I A L S O C I A L

36. Estimated Full Rates of Return by Level of Education and Country Group (%) Low-income Middle-income High-income group group group Level of education (74 countries) (19 countries) (20 countries) Primary 47 39 -- Secondary 8 52 < 0 Higher < 0 < 0 20 Source: Mingat and Tan, 1996.

37. Studies of rates of returnto sector investment Relevant to the economic analysis of projects?

38. Relevant to economic analysis of projects? externalities marginal returns vs. average returns projects more delimited

39. Using economic sector work to diagnose sector issues and design appropriate interventions

40. Cote d’Ivoire: Distribution of Education Subsidies 2 4 All

41. Ratio of Private to Public Spending Nicaragua Primary 1.25 Secondary 2.57 Kenya Primary 2.22 Secondary 0.62

42. Some of the right questions What is the full cost of the project? What are the alternatives to the project? What are the benefits -- to the project? • More students -- what will be the impact of the project on their future productivity? • More efficient education system -- what are the cost savings?

43. More of the right questions What is the appropriate role of government? • Try and estimate externalities • How large would externalities have to be? What are the incentives (and the disincentives) to reform? • Who benefits from the intervention? • Who loses?

44. Human Capital Theory and Benefit-Cost Analysis in Education Questions from Participants?