Human Capital Theory and Benefit-Cost Analysis in Education Ajou University The Principles of Economics I Presentation by D. Kelleher (Based on a presentation

Human Capital Theory and Human Capital Theory and Benefit-Cost Analysis in Benefit-Cost Analysis in

EducationEducationAjou University

The Principles of Economics I Presentation by D. Kelleher

(Based on a presentation originally delivered by Emmanuel Jimenez and Peter Moock, World Bank)

OutlineOutline

Basic Framework for Analyzing Investments in Human Capital

Relevance for project analysis...not– Issues – Modifying the approach

Human Capital Scale -- Weighing Human Capital Scale -- Weighing Private Benefits and CostsPrivate Benefits and Costs

Benefits Costs

The productivity chainThe productivity chain

Education Human capital Productivity

Wages Welfare

The productivity chainThe productivity chain


Wages Welfare

Human Capital and Productivity Human Capital and Productivity

Human Capital

Working with Existing Developing

Technology Better New Technology

Acquiring Processing

New Information

Knowledge

Education raises wages for both men and women:Education raises wages for both men and women:

In

do

ne

sia

Th

aila

nd

Pe

ru

Co

ted

'Ivo

ire

US

A

Slo

ve

nia

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

Wa

ge

re

lati

ve

to

wa

ge

wit

h n

o

sc

ho

olin

g

Ind

on

es

ia

Th

aila

nd

Pe

ru

Co

ted

'Ivo

ire

US

A

Slo

ve

nia

Men

PrimarySecondaryPost-secondary

Returns over timeReturns over time

Wage ($)

Number of Graduates

D1

D1 D2

D2

S1

S1

S2

S2

G1 G2

W

Education raises wages for both men and women:Education raises wages for both men and women:

In

done

sia

Thai

land

Per

u

Cot

ed'

Ivoi

re

US

A

Slo

veni

a

0

1

2

3

4

5

6

7

Wag

e re

lati

ve t

o w

age

wit

h no

sc

hool

ing

Indo

nesi

a

Thai

land

Per

u

Cot

ed'

Ivoi

re

US

A

Slo

veni

a

Women

Primary

Secondary

Post-secondary

Education and productivityEducation 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)

Education and productivity Education and productivity (cont’d)(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)

Human Capital and WagesHuman Capital and Wages


Wages Welfare

Education and productivityEducation and productivity

(cont’d)(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)


Benefits Costs

Increased market productivity Private non-market effects

(e.g., better personal

health, household productivity

effects)


Benefits Costs

Increased market productivity Direct costs Private non-market effects Foregone

production or

earnings

Graph on Rate of Return Estimation for Graph on Rate of Return Estimation for University-level EducationUniversity-level Education

Universitygraduates

Age22 65

Post-tax earnings


Universitygraduates

Secondaryschool leavers

Age

Time (years)18 22

Costyears

Benefityears

65

43

Returns

Indirect costs (foregone earnings)


Universitygraduates


Age

Returns

Indirect costs (foregone earnings)

Direct costs (out-of-pocket expenses)


- - -- - -- - -

+ + + + + + +

+ + +

+ + + + + + + + + + + ++ + + + + + + + + + + + + +

++

+

Benefits

Costs

Universitygraduates


Age- - -- - -

-


Benefits Costs


- - -- - -- - -

+ + + + + + +

+ + +

+ + + + + + + + + + + ++ + + + + + + + + + + + + +

++

+

Benefits

Costs

Universitygraduates


Age- - -- - -

-

age 18, t = 0

age 65, t = 47

age 22, t = 4

Time Value of MoneyTime Value of Money

Now Later

Inflation plus real rate of interest

DiscountingDiscounting

Now Later

Interest Rate (Discount Rate)Interest Rate (Discount Rate)

FV = PV(1+r)t

PV = FV/(1+r)t

Interest Rate (Discount Rate)Interest Rate (Discount Rate)

FV = PV(1+r)t

PV = FV/(1+r)t

Principal ($ invested)

Future Value ($ in t years)

Life of investment

Interest rate

Present Value of FV paid t

years from nowDiscount rate

Weighing Private Benefits and Costs --Weighing Private Benefits and Costs --Without DiscountingWithout Discounting

BenefitsCosts

Internal Rate of ReturnInternal Rate of Return

Benefits Costs

The discount rate that equates benefits and costs

Returns to Investment in Education by Returns to Investment in Education by Level (%) -- Private Rates of ReturnLevel (%) -- Private Rates of Return

Private

Country/Yr. Prim. Sec. HigherBolivia 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 11.0Source: Psacharopoulos (1994).

Social BenefitsSocial Benefits

•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)

•

•Private benefits•Increased market productivity•Private non-market effects•Plus ...

Marginal Gains in Per Capita GDP Marginal Gains in Per Capita GDP Growth per 10% Increase in Growth per 10% Increase in Enrollment Rate, 1960-1985Enrollment Rate, 1960-1985

Low-income

countries

Middle-income

countries

High-income

countries

-1.4-1.2

-1-0.8-0.6-0.4-0.2

00.20.40.60.8

% Gain in growth

Low-income

countries

Middle-income

countries

High-income

countries

Primary enrollment rateSecondary enrollment rateTertiary enrollment rate

Source: Mingat and Tan, 1996.

Child mortality and educationChild mortality and education

00

2020

4040

6060

8080

100100

1-3 years1-3 years 4-6 years4-6 years 7+ years7+ years

Mother's educational levelMother's educational level

P

erce

nt

Per

cen

t

Fertility and educationFertility and education

0011223344556677

No schoolingNo schooling 4-6 years4-6 years 7+ years7+ years

Mother's educational levelMother's educational level

Tot

al fe

rtili

ty r

ate

(%)

Tot

al fe

rtili

ty r

ate

(%)


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

PRIVATE

SOCIAL

SOCIAL

PRIVATE

Measurement Measurement

Can we measure externalities? Can we measure monetary value of

reduced fertility and reduced mortality? Can we measure returns to equality?

Full (“Social”) Rates of ReturnFull (“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

PRIVATE

SOCIAL

SOCIAL

PRIVATE

Estimated Full Rates of Return by Estimated Full Rates of Return by Level of Education and Country Level of Education and Country

Group (%)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.

Studies of rates of returnStudies of rates of returnto sector investmentto sector investment

Relevant to the economic analysis of projects?

Relevant to economic analysis Relevant to economic analysis of projects?of projects?

externalities marginal returns vs. average returnsprojects more delimited

Using economic sector work Using economic sector work to diagnose sector issues and to diagnose sector issues and

design appropriate design appropriate interventionsinterventions

Cote d’Ivoire: Distribution of Cote d’Ivoire: Distribution of Education SubsidiesEducation Subsidies

Poorest 3 Richest0

2000

4000

6000

8000

10000

12000

14000

Annual subsidy

per capita

Poorest 3 Richest

Quintile PrimarySecondaryTertiary

All2 4

Ratio of Private to Public Ratio of Private to Public SpendingSpending

Nicaragua

Primary 1.25

Secondary 2.57

Kenya

Primary 2.22

Secondary 0.62

Some of the right questionsSome 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?

More of the right questionsMore of the right questions

What is the appropriate role of government?Try and estimate externalitiesHow large would externalities have to be?

What are the incentives (and the disincentives) to reform?Who benefits from the intervention?Who loses?

Human Capital Theory and Human Capital Theory and Benefit-Cost Analysis in Benefit-Cost Analysis in

EducationEducation

Questions from Participants?

Documents

Human Capital Theory and Benefit-Cost Analysis in Education Ajou University The Principles of Economics I Presentation by D. Kelleher (Based on a presentation