Higher education: returns are high but we need to fund it better


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University students at a laboratory.

Photo: Nafise Motlaq / World Bank

This week I was invited to speak at The Economist’s Higher Education Forum in New York to share my thoughts on how higher education can be expanded. I believe that we need a fair and sustainable cost-recovery model at the university level using future earnings to finance current education.

Over the past two decades, there has been a tremendous increase in the number of university students and graduates worldwide, which should have led to decrease in the rate of return to investment to higher education – if supply outpaced demand, of course.  While there has been some decrease in overall rates of return, investment in education is still a highly profitable investment.  Global demand for high levels skills such as working with new information and problem-solving has kept the returns to schooling high in even the poorest countries of the world. In fact, the returns to higher education are higher in lower-income countries – except in the Middle East and North Africa due to rigid labor market regulations.

There are significant wage returns associated with investments in education.  Yes, this is the case, even though the benefits of higher education are hotly debated.  Private returns to schooling has many benefits:

  • The global average private rate of return to schooling is 10 percent per year of schooling (with the highest returns in Sub-Saharan Africa!);  
  • The returns to schooling are higher for women; and
  • The private returns to university education are now higher than the returns to primary schooling. 
However, these are private returns.  For society’s well-being, one should calculate the ‘social rates’ of return, which include benefits accruing to the country beyond the individual’s wages and corrected for the substantial public cost of providing education.  Typically, social rates of return to higher education are much lower (as a result of high public costs) and the returns to primary are higher (given lower public costs).

See, for example, Psacharopoulos and Patrinos 2004 | Montenegro and Patrinos 2014

High private returns signal that tertiary education is a good private investment. The public priority, however, should not be a blanket subsidy for all.  High returns to tertiary education may be the result of increased regressive funding, whereby the poorer finance the education of the rich.  For society, it is much better to improve cost-recovery and use future earnings to finance current higher education.

Source: Montenegro and Patrinos 2014
Given an environment of high returns to university education, any lowering of the private cost of university actually implies that the general taxpayer (average income) pays for the education of the rich (above average income).  In fact, the same (zero) price for all is inequitable.  Most of the benefits of a higher education degree are appropriated by the graduate.  In other words, higher education is not a public good.

Society still needs higher education graduates.  Before increasing university funding, we need to plant incentives for the efficient and equitable use of funds.  For efficiency, start with user selective fees near the social cost of higher education. For efficiency and equity, institute sustainable student loans; but different from those that have typically been used.

Given the increasing demand for higher education, the high private returns, the scarcity and injustice of increasing public funding, then we need to use future earnings to finance current education.  Typical student loans are unsustainable and penalize graduates too much. The current student debt in the United States is $1.4 trillion, with the average graduate owing $33,000.

It’s much more efficient to use ‘income contingent’ loan payments.  Income contingent loans, which are available in countries like Australia, require payments based on income until the loan is repaid.  Payments are sensitive to the student’s ability to pay through an adjustable repayment period.  The return for the investor is fixed, but it can fall below the initial value of the loan if income is not enough to repay the loan during a long period of time.

A more private sector approach might involve human capital contracts – or income share agreements (see Lumni and Upstart), where payments depend on income until the repayment period ends.  Human capital contracts are a means of financing education through which investors finance students’ expenses in exchange for a percentage of students’ future earnings.  Lumni already provides such contracts for 7,000 students in Chile, Colombia, Mexico and Peru. The percentage of income and duration of payments is based on students’ expected earnings.  Upon graduation, each student will then pay X% of income for Y years for each $100 of support received.

Follow Harry Anthony Patrinos on Twitter at @hpatrinos.
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John Friend-Pereira
October 22, 2015

Harry thank you yet again for interesting analysis on the public/private return to investment in the education sector. Your blogs are always thought provoking. However on this occasion as the application of your RoI approach to higher education funding not massively undervalued the public good (rather return of investment) of higher education a more sociological rather than economic (roI) analysis would show a wide range or correlated social gains in societies which have higher level of higher education graduates including better health outcomes, reduced crime and violence, potentially higher tax revenues (based on higher graduate earning). An purely economic approach to place a value on something as complex as the social transactions related to education can limits are understanding but when combined with other forms of analysis it can be very informative. One key example in your blog you state "High returns to tertiary education may be the result of increased regressive funding, whereby the poorer finance the education of the rich. For society, it is much better to improve cost-recovery and use future earnings to finance current higher education." This leads me to make a point I have made on your pervious blog which is a redistribute progress tax system would ensure the access to higher education does not involve the poor subsidies the rich but would promote great social equality. Thank John C.

Harry Patrinos
October 23, 2015

Thank you John. There are certainly social benefits associated with investments in education. We have reported on those elsewhere and others have done very good work. But I haven’t been able to figure out how to apportion the social benefits by level of education. On your point about taxes, there may very well be other reasons for a more progressive tax system, but in terms of financing higher education one needs more funding, and if we are to further expand access, then the only fair option is to use future earnings. Income contingent repayment programs have been very good at generating resources for higher education while not penalizing the poor. It has worked very well in Australia, for example, see among others: http://www.universityworldnews.com/article.php?story=20150305123821344. Thank you, Harry

Paul Atherton
October 22, 2015

good post - got me thinking of something Paul Romer wrote recently, on how the biggest advance of his 1990 paper was separating out human capital and knowledge for growth theory (with human capital leading to knowledge and vice-versa). This is implicit in your post, but you could expand on it a bit more. Any ideas on how policy makers set it up to maximise knowledge not private capital?

Harry Patrinos
October 23, 2015

Paul, Thanks. To maximize knowledge, finance public goods production. Harry

KP Sharma
October 25, 2015

Returns of higher education are certainly high.But basic foundation education of primary and secondary level with employable skills is mass employment provider.Almost 70-80 percent population can not go for higher studies due to non-monetary reasons and they need skills.Privates and NGOs are efficient at primary & presecondary schooling.

Harry Patrinos
October 28, 2015

Private rate of return to investments in higher education are high. I agree that for most people in the developing world depend on primary and secondary education. In fact, social returns to these levels, especially for primary schooling, are high. I also agree that people need skills to survive in the world of work. One of the most important skills are the cognitive abilities they develop in basic education. Thus, both to capitalize on social returns – and to take advantage eventually of high private returns at the post-secondary level – we need to raise the quality of primary education.

Bong Gun Chung
November 03, 2015

Hi, Harry!
I am glad to meet you here in your blog since the brief encounter at Incheon last May. Certainly,
HE is burgeoning in developing countries but also with lots of unemployed graduates from colleges, universities, and TVET institutions. I am interested how the unemployment is considered in the RoI of the HE. Bong from Seoul National U

Harry A. Patrinos
November 03, 2015

Hi Bong.  Thanks for your comment and for reaching out.  Higher education is certainly growing and the demand is tremendous.  Clearly, unemployment is a concern in some countries, and for the individual affected it is devastating.  However, for most graduates unemployment is a temporary phenomenon.  In the long run, having the higher education degree is a positive outcome and graduates do much better than those who did not go to university.
In our analysis, we do not control for unemployment, since we are simulating a lifetime earnings profile albeit based on a cross-section of the population.   Nevertheless, at the individual level, periods of unemployment will reduce lifetime earnings.  There is great variation in earnings of university graduates.  Attempts to “control” for unemployment should be included alongside the addition of other benefits of higher education.  We will address some of these issues in future blogs.

November 21, 2015

Hello Harry. Thank you for your post, it is very informational. I came across it as I was researching for a paper I am writing for my Business Economics course in my MBA around the impact that technology has had on universities being able to provide online/distance learning education to students in developing countries and how this has affected the market equilibrium and the subsequent impact on the global economy. I would appreciate if you can point me in the direction of other resources that may be helpful.
Thanks much

Harry A. Patrinos
December 04, 2015

Thank you for your comment.  I am not familiar with a literature that would explain the impact on the global economy.  Has there been an impact yet? I am not so sure. Will it in the future – most likely.  Perhaps it is still happening at the margins.  I am sure you are familiar with the literature “blue ocean strategies.”  Anyway, take a look at: https://hbr.org/product/blue-ocean-strategy-expanded-edition-how-to-cre….  Thanks, Harry

Jason Henry
November 14, 2016

Hi Harry,
I stumbled across your post and found it to be an enlightening piece on the way education can make a difference to sustainable development.I agree with you that there are potentially high gains in higher education, especially from a technical and vocational stand point. Do you believe that the goal of governments around the world should be preoccupied with the ways in which citizens may be retooled with skills that are functionable to achieve some economic imperatives needed development?