Category Archives: Wages

Why People Don’t Invest in Education

Culture, Education, Information, Life Expectancy, Wages

In the previous post I wrote that education substantially increases individual’s earnings.  Each additional year of education produces a rise in earnings by about 10% in high-income countries, and about 15% in low-income countries.   But, if this the case, why don’t more people invest in their human capital and attain higher years of education?  There are at least four reasons for this, listed below, not in an order of importance.

1) First, there is an information problem.  Most people, especially poor and low-educated people, don’t always know that more education would increase their incomes significantly.  Even though people might recognize that highly-educated individuals earn higher incomes in comparison to low-educated workers, they do not always understand that earnings also go up due to marginal increases in education.  For example, people may recognize that a worker with no high school diploma has a lower income than a medical doctor, but they may not realize how much more income that worker would have earned, had he obtained a high school diploma. It turns out that teenagers are not aware of the income jump they would have had if they had obtained a high school diploma.  If information on the income jump generated by high school diploma is provided to students, their propensity to attend high school goes up.  Similarly, research shows that when households are provided with information about the high returns to education, school attendance and test scores of their children go up. In general, one avenue through which educational attainment can be increased in developing countries is to provide information on returns to education.

2) The second problem is the anti-education culture.  While some societies have  cultures that promote education, critical thinking and intellectualism, the opposite is true in some other societies.  Any keen observer, who has traveled to different countries around the world, can quickly identify societies with a pro-education culture and those with an anti-education culture.  The signs are very visible.  In the first group of countries one would see streets and plazas named after scientists, poets.  One would observe statues of philosophers, artists, scientists, and writers in public spaces.   In the second group of countries one would observe that streets are named after war heroes; one would see the statues of politicians.  In the first group of countries one would see bookstores everywhere and one would find that people have small book collections and libraries in their homes.  This would not be the case in the second groups of countries.  Art and science museums are important and vital institutions in the first group of countries, while most people will never set foot in a museum in the second group of countries.

So, cultural preferences of a country have an impact on the extent to which people are inclined to acquire more education.  This sounds like bad news because most people would think that culture does not change, or if it does, it evolves very slowly.  This belief is not entirely true. Culture is not carved in stone.  As economists have started showing very recently, as economic, political and institutional environment change, cultural characteristics of societies change as well.  This important topic will be a discussion point in later posts.

3) Third, even if people have full information about the returns to education, and even if their cultural heritage has nothing against education, in some cases it may be optimal not to acquire more education. It is true that more education increases the individual’s human capital, and provides a return.  But, like any other investment, the investment in human capital has its costs.  For example, if the life span of people is short, then education may not be a good investment because workers will have a short time period between the end of their schooling and the beginning of their retirement retirement to enjoy the financial rewards of education.

Consider a country with life expectancy is 50 years and where people retire at the age of 43 (there are countries in the world with such low life expectancy at birth, such as Nigeria, Cameroon, and the Ivory Coast).  Consider a person who finished elementary school at age 13.  This person can work in the labor market for 30 years until he is 43 years old.  If the annual earnings of an elementary school graduate is $5,000 per year, his lifetime earnings (ignoring time discounting) will be $5,000 times 30, or $150,000.  Assume that if this person goes to school for another 6 years, his annual income would be $6,000 per year.  But, because he goes to school for 6 more years, by the time he completes schooling, he will be 19 years old.  This means that he will work 24 years until he retires (between the ages of 19 and 43) and his total adult income would be $6,000 x 24= $144,000.  In this case, it does not pay to acquire this additional 6 years of education because the opportunity cost of obtaining the extra education (income lost while going to school) is larger than the financial gain to be obtained after completing school.  If the retirement age were higher (such as 53), workers would have had a longer period of time in front of them to obtain the returns to their investment in education, and going to school for additional years would have been an economically meaningful decision.

This means that when the work-life expectancy is short, it may not make economic sense to acquire more education.  If one’s expected life-span is short and if the probability of dying because of disease, violence, or war is high, or if the duration of work life is short, say due to  low retirement age, the economic incentive to invest in education is low.

4) The fourth problem involves credit constraint and lack of supply.  People would not acquire education if it is not affordable for them. The cost of tuition, books and supplies may be substantial in comparison to the income-level of the student or her family.  Even if education is free, time spent in school is time away from earning money.  This means that investment in education is costly for the student, especially for high school and college students, even if no tuition is charged for school.

Although there might be high demand for education in a society, in some instances the supply of education, either by public provision or by the private sector, may not satisfy the demand for education.

Why education may be supplied insufficiently either by the public  or the private sector, and what can be done about the credit constrained-students will be the subject of a separate post.  The answers involve the motivation of politicians as agents of voters, and the problems in the financial and credit markets.  In that framework, I will answer questions such as “Why is basic education compulsory in most countries?”  “Should education be free for all?”  “Can the banking sector and credit markets help resolve market failures in education?”

 

Education and Personal Income

Education, Personal Income, Productivity, Wages

In the previous post, I have written about the impact of the education level of a country on that country’s income level.  But, countries are a collection of individuals, and “country income” is nothing but the value of goods and services produced by these individuals.  So, at the heart of the issue is the question of whether the productivity of individuals and their personal incomes go up when they are more educated.

When we analyze data obtained from large samples of individuals around the world, we always find that more educated people have higher incomes than those who are less educated.  Most people won’t be surprised by this finding, but it could be surprising to realize the magnitude of the income jump created by extra education.

The two graphs below display the average before-tax wages of workers with different levels of education in a high-income county (U.S.) and in a developing country (Turkey).

Blog2_USwages_English

United States is a country with high average education (13.4 years). Turkey is a country where the average level of education is half of the U.S.  But in both countries, people with more education earn higher wages in comparison to those who have less education.  In the U.S. average hourly wages of those with no high school diploma is $12.  Wages of workers with high school diploma is 33% higher ($16). And, people with a university degree earn 75% more per hour than those with a high school diploma ($28).

Blog2_WagesTurk_English

The same pattern exists in Turkey.  Workers earn TL 5.1 per hour if they have a middle school education or less.  Workers with a high school degree earn TL 6.4 per hour, or 25% more.  Those with a technical (vocational) high school degree earn fifty percent more than the group of workers who have middle school education or less.  College graduates earn more than twice the hourly wage of high school graduates.

These are quite substantial differences in earnings between people with different levels of education.  This pattern exists in every country in the world, from China to England, from Indonesia to Israel, regardless of the country’s level of economic development.

The important question of course is the following: Do these differences in wages really reflect the impact of education, or do they represent something else?  Perhaps more educated people come from wealthier families who have connections in their community, so that children of these families would have earned higher incomes even if they have not attained more education.  In other words, kids from wealthier families obtain more education than poorer kids and these wealthier kinds earn higher incomes when they grow up, but this is not because of their education but because of their family wealth, and connections.

There is another possibility.   A person’s attributes such as intelligence and discipline have an impact of their productivity and earnings.  Therefore, wages of those who have more intelligence and more discipline will be higher.  At the same time, more intelligent and more disciplined people will find it easier to succeed in school.  This means that people who are smarter will have more education because school is easier for them, and they have higher wages because they are more productive in general. If this is true, people earn higher wages not because they went to school for more years, but because they are smarter than those who stopped going to school.

Economists use statistical techniques to take into account these and other potentially confounding factors in order to isolate the true causal impact of education on earnings.  These studies show that one additional year of education increases workers’ earnings by about 10%.

This means the following.  Take two individuals who are identical in every respect: they have the same age, same sex, same work experience, same family background, same intelligence, and so on, and they work in the same industry. If the first worker has three more years of education than the second one, his wages will be 30% more than the second worker.   This is the direct, causal impact of education.

This 10% returns to an additional year of schooling is realized because schooling enhances both the skills of the workers as well as their cognitive ability.  As a result, more educated workers are more effective at their jobs and they earn higher wages.

The impact of education on earnings is larger in low-income countries.  An additional year of education increases workers’ earnings by about 15 % in developing countries.  Similarly, additional years of schooling impacts the earnings of women more than it impacts the earnings of men, both in high-income and low-income countries.

Furthermore, the returns to education have been rising in recent years. More educated and more skilled workers are getting rewarded increasingly more in the labor market, and wages of less educated workers are getting stagnated.  This is because improvements in technology require workers to be equipped with better skills to be able to utilize these new technologies.

All this means is that education is a great investment to increase both the skill level and income of workers.  This investment is even more important for economic development of countries that currently have low levels of education.