Causes of Poverty: Education and Ability

Poverty Lecture 14

Today’s Reading

• Schiller, Chapter: Education and Ability, pp. 156-169

Today’s topics/questions

• Are low educational attainments a significant cause of poverty?

• How much schooling is optimal – from the viewpoint of individuals?– from society’s point of view?

• Will dramatically increasing our investments in schools that poor children attend and in education and/or training programs for poor parents would significantly reduce the number of poor families? Explain.

Years of School Completed by Poor Adults by Sex, Age 18-55 Years, 2004

% of All Poor

Men Women

No High School Diploma 32.9 32.1

High School, no College 37.1 33.7

Some College, < 4 yr dg 20.6 25.2

4 yr dg or higher 9.6 8.9

Total percent 100.2 100.1

Number of people in 1000s 7,528 10,288

Source: Census Bureau, Table Pov29.

Are low educational attainments a significant cause of poverty?

• What is Schiller’s answer?– At the level of the individual:

• “Educational attainments significantly determine who will be poor in a given economic situation.” (165)

• “Those with the least education will end up in poverty.” (164)

Are low educational attainments a significant cause of poverty?, cont.

– In the aggregate:• “Education may influence who get the

available jobs, but the demand for labor will determine how many jobs there are.” (164)

• “Education by itself can do very little to alter the number of jobs available at any given moment.” (165)

Why do “Educational attainments significantly determine who will be poor in a

given economic situation?”

Why the most able are hired first?

• When the conditions of perfect competition are met, single firms are price takers in the labor market.

• Firms will hire only those employees whose value of the marginal product (VMP) is equal to or greater than the equilibrium wage (We)

• This implies that those with the highest VMPs will be hired first.

• VMPs are positively correlated with education and ability.

• “Those with the least education will end up in poverty”

Why do employers accept educational attainments as a measure of potential

productivity on the job?

How employers hire

• What additional information about job candidates influences employer hiring decisions?

• How do the poor fare under these characteristics?

How much education will individuals rationally choose?

• First assume that quality education can be accessed by all. How much education will an individual choose?– Worker’s acquire the level of education that

maximizes the present value of their lifetime earnings.

Earnings Streams faced by a High School Graduate

$

WCOL

WHS

-H

18 22 65Age

Goes to College

Quits after High School

Attend College if:

PVCOL > PVHS

PV of Future Earnings for High School Graduate

Where r is the worker’s rate of discount and depends on: (1) the market rate of interest, and (2) how we feel about giving up some of today’s consumption in return for future rewards.

€

PVHS =WHS +WHS

1+ r( )+WHS

1+ r( )2 +L +

WHS

1+ r( )46

PVHS =WHS

1+ r( )t

t= 0

46

∑

PV of Future Earnings for College Graduate

Where H is the direct costs of college and the remaining 43 terms are the earnings after college.

€

PVCOL = −H −H

1+ r( )−

H

1+ r( )2 −

H

1+ r( )3 +

WCOL

1+ r( )4 +

WCOL

1+ r( )5 +L +

WCOL

1+ r( )46

PVCOL = −H

1+ r( )t

t= 0

3

∑ +WCOL

1+ r( )t

t= 4

46

∑ ,

Earnings Streams faced by a High School Graduate

$

WCOL

WHS

-H

18 22 65Age

Goes to College

Quits after High School

Attend College if:

PVCOL > PVHS

When should an individual stop going to school?

• When the marginal rate of return to another year of schooling equals or falls below his or her rate of discount (r).

• The individual’s rate of return is the individual’s percentage increase in earnings resulting from another year of schooling--note that it is unobservable.

• This “stopping rule” maximizes the worker’s present value of earnings over the life cycle.

Individual vs.. Societal Benefits of Additional Years of Schooling

• Is Adam Smith’s invisible hand at work here? Will the optimal level of education from society’s viewpoint be achieved if each individual pursues the level of education that maximizes his or her PV of future earnings?

• How do we calculate the payoff of additional schooling to society?– The social rate of return is defined as the

percentage increase in national income resulting from an additional year of schooling.

Individual vs.. Societal Benefits of Additional Years of Schooling, cont.

• When will investment in additional years of schooling result in greater national income?– Does education truly increase a worker’s

productivity?– Aside from increases in productivity, does

acquiring educational credentials improve the match between workers and jobs?

Do poor people make rational decisions about years of schooling?

• In was situations could the answer be yes?

• In what situations could the answer be no?

• In general, do you think poor people invest in:– Too many years of schooling?– Too few years of schooling?

Recap

• Education determines which individuals/families are poor

• Aggregate demand determines how many individuals and families will be poor.

• Economic “individuals” make rational decisions about their years of schooling.

• Poor individuals may invest in – Too many years of schooling?– Too many years of schooling?

Will investing in education and/or training programs for poor parents significantly

reduce the number of poor families? Explain.

• On page 160-1, Schiller states that, “Keeping some poor persons in school longer may not effectively raise their incomes.”– How can this be true?

• Think about the roles of ability and environment

– Does his analysis justify the work first approach to welfare?

So what is the society’s optimal level of investment in education for poor

adults, all else equal?

Will bringing the quality of schooling for poor children up to the standards of our best public schools significantly reduce poverty? Explain.

• Can you draw upon some of the material we read previously to help you answer this question?

• What are the relevant determining factors?

What is the society’s optimal level of investment in education for poor

children, all else equal?

• Cost-benefit approach

• Other approaches?

Tradeoffs between Poor Children and Adults

• Confronted with a budget constraint that prevents us from attaining optimal levels of investment children and adults, what principles can guide our choices?