Monday, November 23, 2009

Return on Investment in Higher Education

One of the major debates in US politics is usually framed like this: Should we spend more on things that are worth doing, or should we maintain balanced budgets by spending less. The underlying assumption of this type of argument is that spending more necessarily worsens the budget outcome. If the budget outcome income minus spending, doesn't it make sense that spending more worsens the outcome? Only if we can assume that the spending does not spur more income. In other words, only if we assume that investment is impossible. Investment is spending intended to increase income.

After reading Mike Hout's recent article on the importance of public higher education, I was left wondering how public expenditure on higher education compared to other investments in purely budgetary terms. Mike points out that education leads to higher personal incomes, higher rates of entrepreneurship and other good things that increase tax revenues. At the same time education leads to lower rates of things that cost the state money, like imprisonment and needing public assistance through social security/unemployment/health expenditure. So I wondered, how does the expenditure function as a investment. If the state of California could either spend an extra Billion on education, or invest that money in the stock market, how fast would the market have to rise to give better returns than the education (ignoring the non-fiscal benefits of education)?

I wrote to Mike to ask him, and it turns out he is scheduled to give a talk on that very subject here in Rostock some time soon. He sent me a copy of a 129 page report he and colleagues wrote on the subject in 2005. A pdf of that report (or a draft of it) is here.

The concluding summary of the report says:

The state devotes a substantial portion of its budget to supporting education in
California. That support is not wasted: the costs of neglecting education are
high, and the return this investment brings to the state is equally high. Laudable
though it may be, California’s investment in higher education is insufficient. If
things stay as they are now, that is, if future students progress through their
educational careers at the same rates as their ethnic counterparts did in 2000, the
state will suffer a net loss, and that loss will increase as years pass. With no other
changes, the state will forgo revenues from the increased earnings that education
encourages, and pay more to support a population in a situation of increased
poverty and incarceration. If, rather than maintaining the per-person level of
educational support and access, the state were to limit capacity, the situation
would become even more dire.
However, based on existing trends in educational demand, we expect that high
school graduation rates and college going rates will increase, and demands on
state support for education will climb commensurately. California will have to
invest in community colleges and universities in the short run, but both the state
and its residents will benefit handsomely from this additional support in the long
run. Our calculations suggest net savings to the state will exceed the additional cost by three-fold or four-fold, while its population will enjoy lower levels of poverty, crime, and dependency, and higher levels of average income and political participation.

(Emphasis mine)

The report also specifies in great detail the time scale on which these returns occur, and the majority of returns are "realized in the first ten years after investment because the benefits it buys -- lower welfare, less crime, and healthier children -- are problems/ benefits that disproportionately affect 18-34 year olds."

Now this suggests that we are getting 300% return within the first ten years. So let's just say our $1Billion turns into $3Billion by the end of ten years. That is about 11.5% annual return on investment (1.115^10= 2.97), better than the 11% average rise in the Dow Jones from 1926 through to its pre-dot com bust peak in 1999.

I am a strong believer in the value of education, and would gladly quadruple expenditure on education, but I find this purely monetary claim incredible. This is such an extraordinary claim that we are forced to consider the background of the person making it. The only one of the authors I know is Mike, and what I know about him is that he is the Chair of the best Demography graduate program in the Western Hemisphere, a member of the National Academy of Sciences and a careful scholar. Mike does not go around spouting grand pronouncements. If he makes a claim like this it is because his analysis tells him it is true. There really is a strong argument to be made that in purely fiscal terms, investment in higher education pays off better and more consistently than investment in stock.

In that light, two things surprise me. First, that I haven't heard that argument made before. I hang around with a lot of people distraught about the direction American (and particularly Californian) higher education is going, and no one has ever mentioned this. Second, I'm amazed that Wall Street hasn't tried to securitize this yet.

I'm eager to hear what new work on the subject Mike will be presenting at his talk.

Finally, and sadly, I've just heard that Berkeley's demography department won't be able to accept any new graduate students this year. The lack of funding makes it impossible for them to hire faculty to replace those who have retired or left for better funded institutions. If this does not improve in the next few years, I would guess the department will have to close its doors.


jte said...

Actually, Wall Street is in the process of commoditizing it. Two of the most successful IPOs of the past two years have been for private, for-profit colleges. This I learned from the manuscript of the book I'm editing, DIY U: Edupunks, Edupreneurs, and the Coming Transformation of Higher Education by Anya Kamenetz. Another thing I gleaned in reading and editing her book (won't be published for a few more months) is the really serious trickiness of the economics of education. That whole correlation/causation thing is just a pisser on this topic. The short retort is that college functions largely as a sorting mechanism: it's not that colleges necessarily do anything to increase the entrepreneurship etc of the students, its merely that it sorts out those who have a drive to do better in our economy from those who don't. (Whether it sorts very well is another question.) If you removed the college from the scene, those students who, under the college scenario went on to earn higher wages and start new businesses, might still go ahead and do those things even without the college, because that's "who they are." (Who they are having been influenced by other things besides higher education, like family background, primary and secondary education, etc.) Fodder for thought.

jte said...

PS: I'm not saying I'm totally won over by the sorting mechanism theory, only that that it exists as a critique and alternative to the more commonly assumed human-capital theory of higher education.

Dan Levitis said...

One counter-argument to the "sorting hypothesis" is that Mike and his authors thought about that, and controlled for the most obvious correlates of eventual success including race, mother's education, father's education, economic status and so forth. Of course there is always the possibility of unmeasured heterogeneity, but the factors that are included in their model seem to explain a large portion of the variance. You wouldn't expect that if they had missed the main drivers.

jte said...