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
Number of Graduates
G1
G2
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 (contd)

• 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 (contd)

• 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

• Now Later

Inflation plus real rate of interest
23
Discounting

• Now Later

24
Interest Rate (Discount Rate)
FV PV(1r)t
PV FV/(1r)t
25
Interest Rate (Discount Rate)
Future Value ( in t years)
Life of investment
FV PV(1r)t
Principal ( invested)
Interest rate
PV FV/(1r)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
  lt 0
• Higher lt 0 lt 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 dIvoire Distribution of Education Subsidies
All
2
4
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?