Policy Debate: Is a college education a good investment?

From about 1930 to 1970, the typical college graduate in the United States earned about 40 percent more than the typical high school graduate, while the typical high school graduate earned some 40 percent more than the typical high school dropout. These premiums have doubled to between 70 percent and 80 percent. The reasons are not completely clear. Economic studies are fairly convincing that it is not just because this is an increasingly competitive world with low-skilled jobs being exported to Asia and other poorer countries. Although that is happening, the major determinant seems to be technology. Computers are one example. Computer literacy is just a sample of what is going on in every area: The ability to harness and utilize knowledge effectively determines a nation’s success. Knowledge is power in the modern world.
~Gary S. Becker

High school graduates of modest ability or uncertain motivation who are thinking of enrolling in a 4-year college, especially in a liberal arts major, would be well advised to consider enrolling in a community college or an occupational training program such as those offered by the military. A lower-achieving graduate who chose one of these options would slightly reduce his or her (already low) chances of attaining a bachelor's degree but would probably realize the same cognitive development gains and the same or greater earnings at less cost and with less debt.
~National Library of Education

The human capital model introduced by Theodore W. Schultz and expanded by Gary S. Becker (and many others) suggests that education raises a worker's productivity. The higher pay received by college graduates, in this model, is the result of the higher productivity of these workers.

The difference in earnings between high school and college graduates can be appropriately used to compute the return to a college degree only if all other worker and job characteristics are the same. If, however, workers who choose to attend college have higher levels of ability and/or motivation, these workers might have received higher earnings even if they had not attended college. The higher earnings of college graduates, in this situation, are at least partly the result of these differences in ability or motivation and are not entirely the result of investments in education. This results in a bias in the estimates of the return to education known as an "ability bias." If ability bias is present, the observed difference in average earnings between high school and college graduates overstates the average increase in earnings that is received from a college degree.

A second problem associated with measuring the return to a college degree is that college graduates receive jobs that differ in a variety of ways from the jobs that are received by high school graduates. College graduates, on average, tend to receive jobs that involve working in more comfortable, less noisy, and more prestigious occupations. The jobs received by college graduates also generally provide higher levels of fringe benefits (such as health insurance and pension plans) and involve fewer repetitive tasks. Simply stated, college graduates tend to receive jobs that are more pleasant than the jobs that are typically received by high school graduates. The theory of compensating wage differentials suggests that jobs that are more pleasant will, ceteris paribus, offer lower wage rates than jobs that are less pleasant. This means, in practice, that some of the benefits from a college education are realized in the form of more pleasant working conditions rather than as higher pay. The existence of compensating wage differentials suggests that the observed difference in average earnings between high school and college graduates may understate the return to a college degree.

The acquisition of education also generates nonmarket benefits. Increases in human capital may raise an individual's productivity in nonmarket activities as well as in market activities. Classes in literature, history, art, music, and philosophy, for example, may increase the enjoyment that an individual receives from reading, travel, and conversation with other individuals. Economics, political science, and psychology classes provide individuals with a better understanding of the social environment in which they live and allow them to better understand policy issues. There is also evidence suggesting that a college education also results in improvements in an individual's productivity in a wide variety of nonmarket activities. Thus, an examination of only the financial return to a college degree may understate the return that a college education provides to an individual.

It should be noted that there is a growing body of evidence indicating that the return to a college degree varies substantially with the choice of college major. Majors that are often seen as being more challenging by students (such as engineering, economics, and computer science) generally result in higher average salaries than those received by students who select other majors.

In evaluating the return to education, it is important to examine the public as well as the private return. Government, at both the federal and the state level, provides substantial subsidies to higher education. The rationale for these subsidies is the existence of social benefits in the form of: more rapid technological change, lower crime rates, higher rates of voter participation, and lower unemployment levels. These positive externalities associated with education are used to justify public subsidies (since private markets are expected to result in underproduction when positive externalities are present).

The human capital model suggests that education may increase both individual and national income. The human capital model, however, is not the only model that explains the observed relationship between wages and education. Michael Spence (and others) have developed a signaling model of education that suggests that education serves as a signal that sorts high-productivity workers from low-productivity workers. Under this model, education does not raise a worker's productivity; it merely allows firms to determine which workers are more productive. If the signaling model is correct, there will still be a positive private return for those who acquire college degrees, but the net benefit to society is negative (since education provides no social benefits and requires the use of societal resources).

• National Center for Educational Statistics
  http://nces.ed.gov
  The National Center for Educational Statistics provides an extensive collection of data, studies, and statistics concerning all levels of education in the U.S. One of the nice features of this site is a link to Educational Statistics Quarterly, a source of some very interesting studies dealing with the costs and benefits associated with college attendance.

• Digest of Educational Statistics, 2005
  http://nces.ed.gov/programs/digest/d05/
  The Digest of Educational Statistics provides an extensive collection of educational statistics. In this volume, you may find information on college costs, educational enrollments, earnings by level of education, and many other related issues.

• U.S. Department of Education
  http://www.ed.gov/
  The U.S. Department of Education provides information on the status of education and educational policy in the U.S. Their research and statistics page is a particularly useful resource.

• Monthly Labor Review
  http://stats.bls.gov/opub/mlr/mlrhome.htm
  The Monthly Labor Review provides a good source of relatively nontechnical studies concerning the relationship between education and earnings.

• Bureau of Labor Statistics, "Occupational Outlook Handbook"
  http://www.bls.gov/oco/
  The Occupational Outlook Handbook provides information on an extensive collection of occupations. Information is provided in this handbook on the educational requirements that are needed for each occupation.

• Bureau of Labor Statistics
  http://www.bls.gov/
  The Bureau of Labor Statistics provides an extensive collection of statistics relating to wage rates, income levels, labor force participation rates, and unemployment rates. Many of these statistics are available for alternative levels of educational attainment.

• Joint Economic Committee, "Investment in Education: Private and Public Returns"
  http://www.house.gov/jec/educ.htm
  This January 2000 study examined the private and public returns to investment in education. It finds that there are relatively large returns to education. Using 1998 data, this report notes that full-time workers aged 25 and older with college degrees earned approximately $20,000 more per year than full-time workers in this age group with high school degrees. It is observed that the return to a college degree varies substantially by college major field. Public returns to education include higher voting rates, lower crime rates, and lower levels of welfare and unemployment expenditures.

• Washington Research Council, "The Economic Value of Higher Education"
  http://www.researchcouncil.org/Reports/1999/...ValueofHigherEducation.htm
  This July 22, 1999 document examines the returns to education. A variety of charts and statistics are provided that indicated that the return to education is quite high. Several empirical studies are discussed that attempt to determine how much of the higher earnings associated with higher education is the result of higher levels of ability resulting from human capital investment and how much is due to ability bias.

• Joop Hartog, "Behind the Veil of Human Capital"
  http://www.oecd.org/publications/observer/215/e-harto.htm
  Joop Hartog discusses the empirical evidence associated with the return to education in this January 1999 article appearing in OECD Observer. He notes that most studies have found rates of return to education that range from 5% to 15%.

• Gary S. Becker, "Human Capital and Poverty"
  http://www.acton.org/publicat/randl/article.php?id=258
  Gary S. Becker discusses the returns to education in this January/February 1998 issue of Religion & Liberty. He argues that the rate of return to education has been increasing in recent years for a variety of reasons. Becker suggests that differences in educational investment is a primary reason for differences in rates of economic growth across countries.

• W. Norton Grubb, "The Returns to Education and Training in the Sub-Baccalaureate Labor Market: Evidence from the Survey of Income and Program Participation 1984-1990"
  http://ncrve.berkeley.edu/AllInOne/MDS-765.html
  W. Norton Grubb examines the return to education in this May 1995 working paper. The focus of this study is on the returns to education beyond high school but below the level of a bachelors degree. He finds that there is a significant return to certificate programs and Associate's degree, but notes that 1-3 years of college provides little return without the completion of a certificate or degree program. Grubb find that the return to education of this sort is substantially larger when individuals find employment in related fields. He suggests that this is due to the vocational orientation of sub-baccalaureate education programs.

• National Library of Education, "College For All? Is There Too Much Emphasis on Getting a 4-year College Degree?"
  http://www.ed.gov/pubs/CollegeForAll/index.html
  In this January 1999 survey article, the National Library of Education examines whether a college education pays off for all students. They suggest that while the return to education is reasonably high for those who have high levels of academic ability, the expected return is quite low for students with low levels of academic ability.

• Jean Kimmel, "Rural Wages and Returns to Education: Differences Between Whites, Blacks, and American Indians"
  http://www.upjohninst.org/publications/wp/94-27.pdf
  Jean Kimmel examines the returns to education in rural areas in this June 1994 working paper. She finds that women receive larger returns to education than do males. Black workers receive a higher return to education than do whites (primarily because black workers experience a larger penalty for lower levels of educational attainment). (The Adobe Acrobat viewer plugin is required to view this document. You may download this viewer by clicking here).

• Daniel E. Hecker, "Earnings of College Graduates: Women Compared with Men"
  http://stats.bls.gov/opub/mlr/1998/03/art5full.pdf
  Daniel E. Hecker examines male-female wage differentials for college graduates in this March 1998 Monthly Labor Review article. He finds that a substantial share of male-female wage differentials are the result of gender-related differences in the choice of college major and career. Women are over-represented among those majors and occupations that provide a relatively low rate of return to a college degree. (The Adobe Acrobat viewer plugin is required to view this document. You may download this viewer by clicking here).

• Frederic L. Pryor and David Schaffer, "Wages and the University Educated: a Paradox Resolved"
  http://stats.bls.gov/opub/mlr/1997/07/art1full.pdf
  Frederic L. Pryor and David Schaffer examine the phenomenon referred to as "overeducation" in this July 1997 Monthly Labor Review article. For some time, economists had been observing that college graduates were increasingly likely to fill jobs that were previously filled by high school graduates. Their results suggest that this outcome is related to the level of "functional literacy" of college graduates. Those relatively low-wage jobs are filled primarily by college students who do not possess high levels of reading, writing, or analytical skills. Pryor and Schaffer find that the return to a college degree is substantially higher for college students with higher levels of functional literacy. (The Adobe Acrobat viewer plugin is required to view this document. You may download this viewer by clicking here).

• Eric Dey, Leslie A. Wimsatt, Byung-Shik Rhee, and Ellen Waterson Meader, "Long-Term Effect of College Quality on the Occupational Status of Students"
  http://www.stanford.edu/group/ncpi/documents/pdfs/5-06_collegequality.pdf
  This working paper examines the return to college quality using long-term data on individual earnings. While a significant return to a college degree is found, the effect of college quality is not found to be a statistically significant determinant of lifetime earnings. (The Adobe Acrobat viewer plugin is required to view this document. You may download this viewer by clicking here).

• Robert A. Fitzgerald, "College Quality and Earnings of Recent College Graduates"
  http://nces.ed.gov/programs/quarterly/vol_2/2_3/post_college.asp
  Robert A. Fitzgerald examines the determinants of the return to a college degree in this article appearing in the Fall 2000 issue of Education Statistics Quarterly. He finds that college quality has a significant effect on the earnings of recent college graduates. The effect of major field choice, however, has a substantially larger impact, particularly over earnings later in an individual's worklife.

• Robert S. Chase, "Markets for Communist Human Capital: Returns to Education and Experience in the Czech Republic and Slovakia"
  http://www.econ.yale.edu/growth_pdf/cdp770.pdf
  In this January 1997 study, Robert S. Chase examined the rate of return to education in two transition economies. He finds that the rate of return to investment in education increased from 2.4% in 1984 to 5.2% in 1993 for Czech men. Chase argues that the attempt to maintain equity under a communist regime resulted in a lower return to education. (The Adobe Acrobat viewer plugin is required to view this document. You may download this viewer by clicking here).

• Isabel Gödde, Reinhold Schnabel, "Does Family Background Matter? - Returns to Education and Family Characteristics in Germany"
  http://www.sfb504.uni-mannheim.de/publications/dp98-60.pdf
  In this August 1998 study, Isabel Gödde and Reinhold Schnabel examine the return to education using data from Germany. They use a sample containing siblings to control for the effects of unobservable differences in family background. Controlling for these unobservable characteristics substantially lowers the estimated rate of return to education. This paper contains some relatively technical material. (The Adobe Acrobat viewer plugin is required to view this document. You may download this viewer by clicking here).

• Sholeh Maani, "Private and Public Returns to Investments in Secondary and Higher Education in New Zealand Over Time: 1981-1996"
  http://www.treasury.govt.nz/workingpapers/1999/twp99-2.pdf
  Sholeh Maani examines the magnitude of the private and public returns to education in this 1999 New Zealand Treasury Working Paper. He finds that estimates of the rate of return vary depending on the method used to compute the return to education. Maani also finds that the social rate of return was positive in the years that he examined. (The Adobe Acrobat viewer plugin is required to view this document. You may download this viewer by clicking here).

• Nancy Birdsall, "Education: the People's Asset"
  http://www.brook.edu/ES/dynamics/papers/education-tpa/education-tpa.htm
  In this September 1999 working paper, Nancy Birdsall discusses the effect of education on economic growth and development in Latin America. She argues that investments in education are needed to reduce income inequality and raise living standards.

• Daron Acemoglu and Joshua Angrist, "How Large are Human Capital Externalities? Evidence from Compulsory Schooling Laws"
  http://www.nber.org/~confer/2000/mas00/cslnber3.pdf
  Daron Acemoglu and Joshua Angrist use examines the relationship between education and wages across time and across U.S. states to investigate the social return to education. Their estimates suggest that the externalities associated with higher levels of educational attainment are small (approximately 1%) and are not statistically significant. Parts of this study are relatively technical. (The Adobe Acrobat viewer plugin is required to view this document. You may download this viewer by clicking here).

• Willis Peterson, "Overinvestment in Public Sector Capital"
  http://www.cato.org/pubs/journal/cj14n1-6.html
  Willis Peterson, in this Spring/Summer 1994 Cato Journal article, suggests that the rate of return to investments in human capital have fallen because there has been too much public investment in education (and public capital) and too little investment in private physical capital. He argues that economic growth would be increased if more resources were devoted to the production of physical capital.

• Susan P. Choy, "Debt Burden Four Years After College"
  http://nces.ed.gov/pubs2000/2000188.pdf
  Susan P. Choy examines the debt burden of college graduates four years after the completion of college in this article appearing in the Fall 2000 issue of Education Statistics Quarterly. She finds that approximately 50% of all 1992-93 college graduates had relied on borrowing to finance part of their education. The average borrowing of these individuals was $10,100. Choy finds that students who had borrowed larger amounts were less likely to immediately enroll in post-baccalaureate educational programs. Those who were did not enroll in further education faced monthly loan payments that were approximately equal to 5% of their monthly income.

• Concetta Mendolicchio, "Gender and Private Returns to Education: A Cross-Europe Analysis"
  http://www.ires.ucl.ac.be/DP/IRES_DP/2005-56.pdf
  Concetta Mendolicchio, in this December 2005 working paper, examines gender differences in the private return to education in 14 European countries. She finds that the rate of return to education is higher for women than for men in most countries. (Parts of this paper are relatively technical.) (The Adobe Acrobat viewer plugin is required to view this document. You may download this viewer by clicking here).