The Return to Education Isn't Calculated Easily PDF

c o l l e g e The Return to Education Isn’t Calculated Easily By Natalia Kolesnikova I t is almost a given that people with more education make more money than those with less education. But how much more is labor market, result-...

c o l l e g e The Return to Education Isn’t Calculated Easily By Natalia Kolesnikova I t is almost a given that people with more education make more money than those with less education. But how much more is labor market, result- ing in higher earnings. It is possible, for example, that for exam- ple, IQ or aptitude test scores that better education worth? The answer is high-ability people are more likely to go to as a measure of ability; more complicated than many would think. college and are more productive. parental education is used as a measure of The differential between the price of highly So, how can the effect of a college educa- family background. and poorly educated labor is given the suit- tion on earnings be isolated? In an ideal With so many factors to consider, studies ably evocative label “the return to education.” world, researchers would make a copy of a take different approaches and use different The reference to the price differential as a person, sending only one of the two to col- estimation techniques. Although all studies “return” stems, of course, from an under- lege. After the one graduates from college, find that more education is associated with standing that education is a choice; individu- earnings of the two would be compared. higher earnings, the estimates of the return als can place themselves in a position to sell Only in this case could it be said with some to education vary. Most studies estimate their labor services at the higher price by certainty that the difference in earnings was that the return to one year of schooling is, on “investing” in their human capital. due to the college education.1 Of course, this average, between 8 and 13 percent.2 In other The relationship between education and sort of comparison is not feasible. Instead, words, each additional year of education is earnings is among the most widely studied researchers try to compare people who are as associated with an 8-13 percent increase in topics in labor economics. One important similar as possible in everything but the level hourly earnings. For practical applications, goal is to uncover the causal impact of educa- of education they have. 10 percent, on average, is a good estimate of tion on earnings. Just because a person with Studies usually try to control for demo- the return. (It is worth pointing out that the a college degree earns more than a person graphic factors, such as age, gender and returns are somewhat higher for women than without such a degree does not necessarily race, as well as work experience. Other for men.) mean that college education causes the dif- factors that might affect the return to educa- ference in pay. Rather, the person who went tion are family background, school quality Additional Complications to college might have some characteristics and ability. Quantifying any of these factors Complicating these estimates is the fact that make him or her more productive in the is a difficult task in itself. Researchers use, that any returns on investment in human An Individual’s Education Benefits Others, Too Positive spillovers from education have been found in areas other than labor markets, too. E stimates of the private returns to educa- Productivity spillovers also have a positive One study has shown that “higher maternal tion do not account for all the benefits effect on wages. For example, “a percentage education improves infant health, as measured that society receives from an individual’s point increase in the supply of college gradu- by birth weight and gestational age. It also investment in education. Economic theory ates raises high school dropouts’ wages increases the probability that a new mother is predicts that an individual’s education not by 1.9 percent, high school graduates’ married, reduces parity, increases use of pre- only boosts his or her own productivity but wages by 1.6 percent and college graduates’ natal care and reduces smoking, suggesting also that of others. The presence of more wages by 0.4 percent,” according to one that these are important pathways for the educated workers leads to a “knowledge 7 study. Not surprisingly, there is also a posi- ultimate effect on health.”8 spillover,” making other workers more tive impact of education on economic growth Another study found a significant decrease productive. Some recent studies have as people with more education were shown in probability of criminal behavior and incar- found empirical evidence in support of this to be more likely to accept innovation and ceration for people with more education.9 prediction.6 adopt new technologies. The researchers noted that “the externality of 12 The Regional Economist | January 2010  capital must be realized in a specific labor more than a similar white man with a high ENDNOTES market—usually a local labor market. These school diploma in Dallas, but only 50 percent 1 Even in this case, it is not clear if the labor educational investments aren’t like invest- more in Seattle (but he enjoyed all the good market rewards skills a person learned in ments in stock, where a share of General things that Seattle has to offer).4 The cross- college or simply reacts to a “signal” of higher abilities. In fact, some researchers argue that Electric is worth the same in New York as it is city differences in the returns to college there is a “sheepskin effect” in which diplomas photo courtesy of shut terstock in St. Louis. education are even bigger if smaller cities are and degrees matter more than actual number of years of education. See Hungerford and One study, conducted in part by this considered as well. Solon, as well as Belman and Heywood, for author, found that the returns to college edu- more. 2 cation are systematically lower in nicer, more Nonmonetary Returns Card provides an excellent overview of exist- ing studies. expensive cities.3 It is not surprising that Although it is difficult to determine the 3 See Black, Kolesnikova and Taylor. 4 when a city has attractive amenities people monetary return to education, it is practically The reported numbers represent an increase in hourly earnings from obtaining college “pay” for these amenities in the form of high impossible to quantify the numerous non- education (relative to having only a high property prices. However, people with low monetary returns. Studies have shown that school diploma), rather than a return to levels of education, and therefore low lifetime “experiences and skills acquired in school 5 one year of schooling as before. See Oreopoulos and Salvanes. income, find these cities’ high property prices reverberate throughout life, not just through 6 In particular, see the work of Acemoglu and to be a greater deterrent than do individuals higher earnings. Schooling also affects the Angrist and that of Moretti (2004a,b). 7 See Moretti (2004b). with high levels of education. Well-educated degree one enjoys work and the likelihood 8 See Currie and Moretti. people (cardiologists, for example) might of being unemployed. It leads individuals to 9 See Lochner and Moretti. even accept a lower salary to work in these make better decisions about health, marriage REFERENCES cities than they would in less-attractive cities. and parenting. It also improves patience, On the other end of the scale, less-educated making individuals more goal-oriented Acemoglu, Daron; and Angrist, Joshua. “How people (janitors, for example) might have to Large are Human-Capital Externalities? and less likely to engage in risky behavior. Evidence from Compulsory Schooling Laws.” be paid more to work in these nice cities than Schooling improves trust and social interac- NBER Macroeconomics Annual, Vol. 15, elsewhere because of the higher cost of living. tion, and may offer substantial consumption pp. 9-59. New York: National Bureau of Economic Research, 2000. Therefore, the discrepancy in pay between value to some students.”5 Belman, Dale; and Heywood, John. “Sheepskin those with more education and less education Despite the difficulty in assessing the Effects in the Returns to Education: An is smaller than elsewhere. It is important Examination of Women and Minorities.” returns to education, there is little doubt The Review of Economics and Statistics, 1991, to point out that even though measured that the importance of education will not Vol. 73, No. 4, pp. 720-24. “monetary returns to education” are lower in disappear from the public policy arena. As a Black, Dan; Kolesnikova, Natalia; and Taylor, Lowell. “Earnings Functions When Wages more-attractive cities, cardiologists are not at result, continued economic research on the and Prices Vary by Location.” Journal of Labor any disadvantage when they choose to locate subject will hopefully guide effective public Economics, 2009, Vol. 27, No. 1, pp. 21-47. there. They are simply “paying” for an access policy. Card, David. “The Causal Effect of Education on Earnings,” in Orley Ashenfelter and David to amenities of a nice city by accepting lower Card, eds., Handbook of Labor Economics, returns to their education. Vol. 3A, pp. 1801-63. Amsterdam: Elsevier Science, 1999. The study also estimated the returns to Natalia Kolesnikova is an economist at the Currie, Janet; and Moretti, Enrico. “Mother’s college education for white men living in Federal Reserve Bank of St. Louis. For more on Education and the Intergenerational Trans- major U.S. cities. In 2000, a white man with her work, see http://research.stlouisfed.org/econ/ mission of Human Capital: Evidence from kolesnikova/index.html. College Openings.” Quarterly Journal of a college degree earned as much as 85 percent Economics, 2003, Vol. 118, No. 4, pp. 1495-532. Hungerford, Thomas; and Solon, Gary. “Sheep- skin Effects in the Returns to Education.” The Review of Economics and Statistics, 1987, education is about 14-26 percent of the Vol. 69, No. 1, pp. 175-77. Lochner, Lance; and Moretti, Enrico. “The Effect private return to schooling, suggesting A percentage point increase of Education on Crime: Evidence from Prison Inmates, Arrests and Self-Reports.” The that a significant part of the social in the number of American Economic Review, 2004, Vol. 94, return to education comes in the college grads raises: No. 1, pp. 155-89. form of externalities from crime Moretti, Enrico. “Workers’ Education, Spillovers and Productivity: Evidence from reduction.” Plant-Level Production Functions.” The Research done to evaluate American Economic Review, 2004a, Vol. 94, No. 3, pp. 656-90. the social returns to educa- _____. “Estimating the Social Return to Higher tion is extremely important for Education: Evidence from Longitudinal and a variety of policy questions, Repeated Cross-Sectional Data.” Journal of Econometrics, 2004b, Vol. 121, No. 1-2, such as assessing the efficiency pp. 175-212. $ of public investment in education. Oreopoulos, Philip; and Salvanes, Kjell. “How Large Are Returns to Schooling? Hint: Money The issue remains one of the Isn’t Everything.” National Bureau of Eco- frontiers of labor economics. nomic Research Working Paper 15339, 2009. The Regional Economist | www.stlouisfed.org 13