Why Is the National Return to Education So Low?
By Bryan Caplan
Like Garett, I’m a huge admirer of Lant Pritchett’s “Where Has All the Education Gone?” (World Bank Economic Review, 2001). My favorite part of the paper is when Pritchett presents three stories that might explain his results:
I discuss three possibilities for reconciling the macro and micro evidence and explaining the differences across countries. The first possibility is North’s (1990) metaphorical piracy: Education has raised productivity, and there has been sufficient demand for this more productive educated labor to maintain or increase private returns, but the demand for educated labor comes, at least in part, from individually remunerative yet socially wasteful or counterproductive activities. In this case, the relative wage of each individual could rise with education (producing the micro evidence), even while increases in average education would cause aggregate output to stagnate or fall (producing the macro evidence). The second possibility is that expansion of the supply of educated labor when demand is stagnant could cause the rate of return to education to fall rapidly. In this case, the average Mincer returns (Mincer 1974) estimated in the 1960s and 1970s overstated the actual marginal contribution to output from educational expansion in those instances where the demand for educated labor did not expand rapidly enough. Third, schooling quality may be so low that it does not raise cognitive skills or productivity. This could even be consistent with higher private wages if education serves as a signal to employers of some positive characteristics, such as ambition or innate ability.
Conventional labor economists predictably gravitate toward the straightforward “low-quality schooling” explanation. It’s the easiest to reconcile with their human capital extremism: “Sure, schooling is great for building human capital, but it’s got to be done right.” The whole problem is incompetent, corrupt, and/or under-funded schools – the very kind that so often dismay development economists when they visit the Third World.
Before you buy the conventional take on Pritchett’s results, however, you should ask yourself, “Does the low-quality schooling theory have any other predictions?” Indeed it does. If the problem is low-quality schools in the Third World, the private return to education in the Third World should be low as well. For human capital extremists, schooling increases income – national and private – by teaching useful skills. So if low-quality schooling fails to boost national income, it should also fail to boost private income.
This prediction is the opposite of the truth. In low-income countries, the private return to education is unusually high. As Hanushek and Woessmann explain in “The Role of Cognitive Skills in Economic Development“:
The [private] rate of return to education is centered at about 10 percent with variations in expected ways based largely on scarcity: returns appear higher for low income countries, for lower levels of schooling, and frequently, for women… (Journal of Economic Literature, 2008)
This finding also contradicts Pritchett’s second explanation – oversupply of education. If there’s too much education on the market, it should raise neither national nor private income. This leaves just one and a half of Pritchett’s stories standing:
1. The rent-seeking story: Education successfully teaches socially wasteful job skills.
2. The signaling story: While education teaches few useful job skills, strong academic performance convinces the labor market that you’ve got the Right Stuff. (Later in the article, Pritchett points to evidence against the Pure Signaling Model. Unlike most labor economists, though, he’s careful to distinguish this polar case from empirically sensible signaling stories).
I’ve obviously spent a lot of intellectual energy defending #2, but I’m open to the possibility that #1 is a big deal, too. My main doubt: Rent-seeking is intensely practical – and most of the curriculum is far too impractical to train students to do anything in the real world. How on earth do history, higher mathematics, foreign languages, or Shakespeare make you a more effective lobbyist or bureaucrat? I just don’t see it. The same goes for “soft” college majors. While carefully selected political science classes might enhance your rent-seeking ability, most of their coursework is, as usual, purely academic.
Bottom line: The signaling model is by far the most promising explanation for Pritchett’s results. Signaling fits every students’ first-hand experience. Signaling fits the global data. The only thing signaling doesn’t fit is conventional labor economists’ love affair with education.