Returns on Investment in Public Higher Education

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Returns on Investment in Public Higher Education
OAIRP Fall Conference, Columbus, OH October 18,
2002

• Henry Y. Zheng, Ph.D
• The Graduate School
• The Ohio State University

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Why Study Return on Investment

• To demonstrate the value of public funded higher
  education to key investors / stakeholders
• Parents/Students
• State/local government agencies
• Elected officials
• Justify continuing public support for higher
  education as a public good
• Tools for economic impact analysis

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What is Return on Investment

• Return on investment (ROI) is a financial
  calculation that indicates the degree to which
  benefits exceed the investment (costs) for a
  given project.
• The calculation of ROI is in the form of a ratio
  where benefits are in the numerator (top) and
  investment/costs are in the denominator (bottom).
  By itself, ROI is just a number.

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ROI in Higher Education

• Based on Human Capital theory
• Higher education improves an individuals
  economic productive ability through his/her
  systematic acquisition of knowledge and skills
• Students invest money and time to acquire such
  knowledge and skills
• ROI is to measure how much a students investment
  adds value to his human capital post-graduation.

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ROI in Higher Education

• Based on Public Goods Theory
• Assumption individuals consumption of higher
  education produces positive externalities,
  including
• increased participation in civil and public
  affairs
• healthier lifestyle and lower health risk
• lower probability to commit crime
• less reliance on public welfare system
• greater inter-generational effects
• The positive externalities are so desirable that
  higher education is should be regarded as a
  public good (meaning government funding)

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ROI in Higher Education

• Assessment of current research
• No consensus on what exactly are private and
  public returns to investment
• Research limited by data availability and
  conceptual ambiguity
• What is a clear-cut analysis in the business
  environment is not so clear in public environment

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Private vs. Public ROI
Private Investments
Public Investments
Financial Aid
Tuition and Fees
State Subsidies
Cost of Producing a College Degree
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Private Return on Investment

• Assumption
• Student pays full-tuition without receiving any
  financial aid
• Method
• Individual costs
• Earnings forgone while attending college
• Tuition, fees, school-related expenses
• Living expenses such as room and board are not
  included
• Individual Returns
• Marginal earnings when compared to a typical high
  school graduate who is working.

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Private Return on Investment
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Private ROI OSU Study

• Wage Data
• from Ohio Bureau of Employment Services --
  matched with OSU FY94 undergraduate degree
  awardees cohort.
• Cost Data
• Tuition and Fees -- 6-year average in 94 dollars,
  varies by TTD quarters.
• Books -- assuming 300 per quarter FT and 150
  per quarter PT.
• Foregone revenue HS Graduate Wages for age group
  18-25 multiply by time to degree (Sum of Quarter
  / 3).

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Private ROI OSU Study
Five Year Rates of ROI
Year to Break Even for Investment
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Example Findings Private ROI
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Implications from findings of Private Return on
Investment

• From an individuals perspective, a college
  degree from a public university is a good
  investment
• Large increases in tuition rates may discount the
  value of college education unless the labor
  market matches the pace of increase
• Rates of ROI associated with academic major which
  is mostly decided by the labor market
• Different rates of ROI may also reflect
  differences in cost structures

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Public Return on Investment
Private Investments
Public Investments
Financial Aid
Tuition and Fees
State Subsidies
Cost of Producing a College Degree
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Public Return on Investment

• A very problematic area of research
• Public investments come in many forms
• Instructional subsidies
• Low-interest loans or loan guarantees
• Low income assistance grants
• Disability assistance grants
• Individual level data are hard to access due to
  privacy protections
• Intangible benefits are hard to quantify

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Public Return on Investment

• My proposal focus on the tangible and
  measurable variables
• State Investments
• State instructional subsidy earned by students
• State-assisted financial aid for qualified
  students (average)
• State Returns
• Marginal tax revenue generated from college
  graduates

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NPV of State Investments

• Because intangible social benefits are not
  measurable, public ROI cannot be accurately
  captured. Alternatively, we may use the net
  present value analysis to see if state
  investments in higher education is a value-added
  activity.
• In business environment, NPV represents the value
  added to the organization by the investment,
  which leads to a net increase in the market value
  of the stockholders wealth
• An investment that generates positive NPV will
  make the stockholders better off by the amount of
  its NPV.

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NPV of State Investments

• Applying the NPV analysis to public higher
  education, we assume
• the taxpayers are viewed as the stockholders who
  ultimately pay for the investment
• the government is the corporation who serves as
  the agent for the stockholders and make the
  investment decision
• state universities are the contractors and
  interactions between faculty and students
  represent the production process.
• When students start paying taxes to the
  government after graduation, the investment by
  the taxpayers begins to generate measurable
  financial returns.

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Net Present Value Analysis

• Definition
• NPV P - I
• where
• P the present value of the projects future
  cash inflows
• I the present value of the projects cost
  (usually the initial outlay)
• NPV IS A MEASURE OF THE PROFITABILITY OF AN
  INVESTMENT, EXPRESSED IN CURRENT DOLLARS.

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Net Present Value Example

• A project promises to return 10,000 after one
  year and 20,000 after two years. The project
  also requires an initial investment of 22,000.
  Calculate its net present value assuming a 12
  discount rate.
• Discount Present Year Cash Flow Factor Value
• 0 (22,000) 1.000 (22,000)
• 1 10,000 0.893 8,930
• 2 20,000 0.797 15,940
• 2,870

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Decision Criteria for NPV

• If the NPV gt0, this indicates
• the present value of future cash flows,
  discounted by cost of capital, at least equal to
  the current cost of the investment it adds
  value to investors
• Therefore, the investment should be made

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NPV Analysis Applied

• Assumptions
• State instruction support per in-state
  undergraduate 1990 1994 (estimates)
• 3300, 3,800, 4,200, 4,500, 5,000
• Average state grants-in-aid per in-state
  undergraduate 1990-1994 (estimates)
• 1,100, 1,133, 1,167, 1,202, 1,238

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NPV Analysis Applied

• Assumptions
• Marginal revenue of OSU graduates is taxed at
  4.8 (Ohio Dept of Taxation)
• A lifetime payback period of 30 years
• Average Marginal Revenue
• Actual wage data from OSU 94 cohort from 1995 to
  1999
• 4 annual increase for OSU grads and 3 increase
  for HS grads

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NPV Analysis Applied
(estimates, please do not cite)
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NPV Analysis Results
(estimates, please do not cite)
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Comments Questions