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The Full Social Returns to Education:

Public Disclosure Authorized

I Estimates Based on Countries' Economic

Growth Performance

Alain Mingat
Jee-PengTan
Public Disclosure Authorized

September 1996
HCDWP 73
Papers in this series are not formal publicationsof the World Bank. They present preliminary and unpolished results of
analysisthat are circulatedto encouragediscussionand comment;citationand the use of such a paper shouldtake accountof its
provisionalcharacter. The findings,interpretations,and conclusionsexpressedin this paper are entirely those of the author(s)
and should not be attributedin any mannerto the World Bank, to its affiliatedorganizations,or to members of its Board of
ExecutiveDirectorsor the countriestheyrepresent.
 The Full Social Returns to Education:
Estimates Based on Countries' Economic Growth Performance

by
Alain Mingat
Jee-Peng Tan
Alain Mingatis a Directeurde Recherche,CentreNational de la RechercheScientific,at the hIstitute de
Recherchesur l'Economiede l'Educationbasedat the Universitede Bourgogne,France. Jee-PengTan is a
PrincipalEconomistin the Human DevelopmentNetworkof the World Bank. This paper has benefited
fromthe generousand helpfulcommentsof friendsand [Link] owe specialthanksto B. Chiswick,
J. Hammer,E. Jimenez,J. Lane, J. van der Gaag, H. Patrinos,L. Pritchettand G. Psacharopoulos. As
authors,however,we are solelyresponsiblefor all remainingerrors. The viewsexpressedin the paper are
ours alone,and shouldnot be attributedto the organizationswith whichwe are associated.
 Abstract

This paper reports new estimates of the social returns to education,using countries' economic
performance during 1960-85to capture the externalitiesfrom education. The results confirmthe social
profitabilityof investingin educationbut indicate that the returns by level of education are sensitiveto
countries' economic context. To interpret our results meaningfullyit is useful to make a distinction
between investmentsto maintainexistingcoverage, and investmentsto expand it. Our findings relate
mainlyto the second type of investmentdecision in the context of the followingobserved initialgross
enrollmentratios: 58 percent in primary education,9 percent in secondaryeducation, and 1 percent in
higher education in low-income countries; 95 percent, 28 percent, and 4 percent, respectively, in
middle-incomecountries; and 109 percent, 53 percent, and 9 percent, respectively, in high-income
countries. Given these initial levels of coverage, our results suggest that low-income countries
benefitedmost from investmentsto expandprimary education,whilein middle-incomecountries,it was
investmentsto expand secondaryeducationthat brought the highest socialreturns. In the high-income
countries, investingto expand coverage in higher educationyielded the best returns. Investmentswith
poor social returns include expansion of higher education in low- and middle-incomesettings and
expansionof secondaryeducationin high-incomesettings.
 Contents

Introduction
................................................................................................. 1

Existing Evidenceon the Returns to Education............................................... 2

Clarifyingthe Costs and Benefits of Investmentsin Education............................................... 3

Toward Incorporatingthe Full Benefitsfrom Investingin Education............................................... 7

Estimatingthe "Full"Returns to Investmentsin Education.............................................. 11

Comparingthe Results with the StandardEstimates of SocialReturns.............................................. 16

Conclusion.............................................. 17
Introduction

That education is a form of investment is now a well-establishedand widely-accepted idea.

Like other investments it is natural to ask whether or not the benefits from education are worth the
costs. Not surprisingly,therefore, a vast literature has emerged over the years documenting the
magnitude of the returns (see Psacharopoulos 1994 for perhaps the most comprehensivecatalog to
date). In this literature, estimatesare reported on the private and so-called socialreturns to education.
Both measuresof returns capture the benefitsfrom educationby using individualwage data to estimate
the increase in productivityfrom an extra year or cycle of education. On the cost side, private returns
take into account schoolingcosts incurred by individuals(or famriieson behalf of the students), while
social returns take into account public subsidiesas well. As calculated,the social returns are in fact
private returns net of public costs (which explainswhy they are always lower than private returns).
Despite the flaws, the empiricalevidencehas had a strong influenceon government and donor policies
regarding investmentpriorities and public subsidies for education. In recent years, however, doubts
about the validityof the findings on social returns continue to be voiced, mainlybecause community-
wide benefitsfrom educationhave not been taken into account.

The purpose of this paper is to report fresh estimatesof the social returns to education based
on countries' economic growth performance. Our approach conforms more closely to a proper
definition of social returns in which costs and benefits are both accounted for from society's
perspective. Specifically,we argue that aggregate growth performancecaptures to a significantdegree
the externalitiesfrom education, unlike conventional estimates based on individualearnings which
ignore them altogether.' This approach is also likely to capture the economic consequences of non-
economic effects, such as faster growth arisingfrom increased political stabilityworking through the
spread of education.

Our estimates confirm the social profitabilityof investingin education, but indicate that the
ranking of profitability by level of education is sensitive to countries' economic context: primary
education is most sociatlyprofitablein low-incomecountries,but its positionis replaced by secondary
education and higher education,respectively,in middle- and high-incomecountries. These results do
not undernine the importance of investingin primary education,particularlyin view of concerns over
poverty alleviationand equity, but they do suggest that as countries develop shiftingthe emphasis of
new investments in education toward the secondary and higher levels may well produce the highest
socialreturns.

1 In a recentpaperRam(1996)makesa similarargumentfor usingcross-country dataforestimatingsocial

returnsto [Link], however,in that we relatecountries'growthperformance to
initialenrollmentratioswhilehe relatesit to averageeducationalattainmentof the laborforceusinga Mincerian
[Link] additionwhereasweincorporateboth directand forgonecostsin ourcalculationof returns,Ram
considersonlyforgonecosts.
 2

ExistingEvidence on the Returns to Education

Table 1 summarizesthe existingevidencebasedon a largenumberof country-specific studies.

Despitethe diversityin methodsand assumptionsacross studies,the overallpattern is consistentin
suggestingtwo broad conclusions:(i) the so-calledsocialrates of return to educationat all levels
typicallyexceedthe usual 10 percentcutoffrate for the cost of capital and(ii)the returnsare, without
exception,highestin primaryeducation. 2 The findingshave had a persuasiveinfluenceon public
debateregardinginvestmentsin educationin generalas wellas acrosslevelsof [Link] World
Bank'srecentpolicypaperon education,for example,reflectsthe generalconsensusthat investingin
primaryeducationdeservesthe highestpriorityin publicexpenditureprograms,particularlyin low-
incomecountries(WorldBank, 1995). Equityconcernsundoubtedlymotivatethe strongemphasison
primaryeducation,but the pattern of returns (such as they are) providesthe added evidenceto
convincethoseinsistingon goodeconomicreturnson publicspending.

Table 1: SocialReturns to Education by Level,percente

Region Primary Secondary Higher
Sub-Saharan
Africa 24.3 18.2 11.2
Asia 19.9 13.3 11.7

Europe/Middle
East/[Link] 15.5 11.2 10.6
LatinArnerica/Caribbean 17.9 12.8 12.3
OECD n.a. 10.2 8.7
Source:Psacharopoulos 1994.
a/ Thereaderis referredto the sourceforsimilarsummariesoftheprivateratesof returnto education.

Yet the empirical evidence is based on an incomplete calculation of social returns that
invariablyexcludes economicextemalities. As Schultz (1988) notes, "... it is rare for studies to assign
monetary values to social externalitiesof education ...". The incomplete calculation has led some
observers to question the use of the available evidencein formulatingpublic policies, especiallywith
regard to allocations of public spending across levels of education. Birdsall (1996), for example,
argues that "[we] do not really know the true rankingof social returns across primary,secondary and
higher education", because the magnitude of externalitiesmay well differ by level of education. In
certainareas of higher education,such as research and postgraduate training in science and technology,
and publicadministration,she points out that the magnitudeof externalitiesmay be sufficientlylarge to
cause the social returns to investingin these areas of higher educationto exceed those from investingin
secondaryor even primaryeducation. In a commentaryon Birdsall'sargument,Psacharopoulos (1996)

2 See below for elaborationof how these rates have been calculatedand problemsassociatedwith
interpretingthem.
 3

notes that while research activitiesin higher education may generate externalities,the probabilityof a
real breakthrough is infinitesimallylow. In contrast, the probability"must be nearly 1" that someone
who has not been to school willremain a life-longilliterate. Based on this comparison,he argues that
even in the absence of specificestimateson the magnitudeof externalities,it would be sociallyefficient
for education investments to emphasize primary education in countries that have yet to secure full
coverage and adequate levelsof studentlearningat this level.

The heuristic arguments on both sides find support among some but not all people, and are
therefore unlikelythe settle the matter. Skeptics will continue to reserve judgment pending concrete
evidenceon the magnitudeof externalities. Such evidenceis not easily obtained because externalities
are notoriouslydifficultto quantify. Below we attempt to make some headway in this regard.

Clarifyingthe Costs and Benefits of Investmentsin Education

There is relativelylittle controversyregarding the concepts of costs and benefitsin education.

It is in estimatingtheir magnitudes and in implementingthe cost-benefitanalysis,and interpretingtheir
results, that problemstypicallyarise.

Defining the concepts. The costs and benefits of educationaccrue to individualsand societyat
large (Table 2). Individuals,or their families, incur two types of costs directly: (i) out-of-pocket
outlays (C. 1 in the table) to pay for such items as books, transportationto school, and school fees; (ii)
and the value of forgone production (C.2), either in household activitiesor in the labor market, while
the student is in school. Costs that are shared collectivelyby society consist of tax-financed public
subsidiesfor education (C.3).3 The full cost of education is the aggregation of the costs incurred
individuallyby the students, or their families,and those that are shared at the societallevel.

On the benefit side, individuals(or their families)capture benefitsfrom education in the form of
increased labor productivity(B. 1). For example,better-educatedworkers may earn more than others
with less education, and farmers with some schoolingmay produce more output than farmerswith no
schooling. In a well-known article, Haveman and Wolfe (1984) identify 19 other benefits besides
increased labor productivity. These non-market effects include the impact of education on personal
health, capacityto enjoyleisure,and efficiencyin makinga variety of personalchoices (B.2). Although
seldom recognized as such, another non-market benefit of education is the option it creates for
proceeding up the education ladder. This benefit applies mainlyto the lower levels of education and
stems from two features of education systemseverywhere. First, admissionto a given level of study is
typically contingent upon prior attendance at the previous level. Second, most course curricula are
designed on the assumption that entering students have already acquired the skills and knowledge

3 Because tax-financedpublic subsidiesmay distort prices and imposedeadweightlosses on the economy,

their true economiccost may be greater than their face value. Making the appropriateadjustmentis difficult in
practice, however, because few empirical estimates exist regarding the magnitude of tax-induced deadweight
losses.
 4

Table 2: Generic Education Costs and Benefits and Their Accrual to Individuals and
the Rest of Society a'
INDIVIDUALS SOCIETY w'

Cl. Direct costs C3. Public subsidy

C (includingschoolfees) (net of cost recovery and adjusted for
O possible deadweight losses of tax-
S financedpublic spending)
T
S

C2. Forgone production

(lost earningsor other production)

B 1. IncreasedmarketDroductivity B3. Spillovereffectsin workerproductivity

(as reflectedin earnings or other work (as when a person's educationenhances
outputs) the work productivityof his or her co-
workers)

B
E B4. Expandedtechnologicalpossibilities
N (such as those arising from the
E discovery, adaptation and use of new
knowledge in science, medicine,
industry,and elsewhere)

B2. Privatenon-marketeffects B5. Communitynon-marketeffects

(better personal health, expanded (greater socialequity, more cohesive
capacity to enjoy leisure, increased i communities,strongersenseof
efficiency in job search and other nationhood,slowerpopulationgrowth
personal choices) I and relatedalleviationof
environmentalstress, reducedrisks
from infectiousdiseases,crime
reduction,and so on)

Source:authors' construction.
a/ Dotted lines in the table indicatethat the identifiedcategoriesof benefitsare not completelyseparable.
b/ Strictlyspeaking,this columnshows the costsand benefitsaccruingto the rest of society(i.e., to people other
than the individualsbeing educated).
 5

taught at earliercycles. Thus, even when admissioncriteriaare not used (e.g., for some programs
offered by open or distanceuniversities),a student may not be able to follow a course of study
effectivelyunlesshe or shehadin fact passedthroughearliercyclesin the system.
Educationalso yieldsbenefitsfor societybeyondthose enjoyedby the educatedindividuals
[Link] Lucas(1988),for example,a worker'sschoolingenhanceshis or her own
productivityas well as those of co-workers,therebygivingrise to classicalexternalitiesor spillover
effects(B3). The generallevelof educationin the workforcealsoexpandsproductionpossibilities, by
facilitatingthe discovery,adaptationand use of more economicallyrewarding,albeittechnologically
more demandingand knowledge-intensive, productionprocesses(B.4). These effectsare probably
closelyrelatedwhichexplainsthe use of a dottedlineto separatethemin Table2.
Besideseconomicperformance,thereare othercommunity-level benefitsfrom education(B.5).
Thesenon-marketeffectsincludethe possiblecontributionof educationto improvingsocialequity,
strengtheningnationalcohesiveness,reducingenvironmental stress throughits effect on fertilityand
populationgrowth, loweringcrime rates, and so on. In a recent article,Olson (1996) makes a
distinctionbetween "publicgood human capital" which affects incomes by influencingpeople's
knowledgeabout and choiceof public policiesand institutions,and traditional"marketablehuman
capital"whichincreasespeople'spersonalincome. To the extent educationproduces "publicgood
humancapital"it alsocontributesto the productionof communitywealth.

The community-wide effectsfrom educationare not alwaysseparablefrom the non-market

benefitsthat accrueto individuals(i.e. B2 and B5 in the table). Using data for the United States,
HavemanandWolfe(1995)foundthat parentswithmoreeducationhavea significantly smallerchance
than other parents that their childrenwill drop out of school,that their daughterswill become
unmarriedteenagemothers,andthat theirgrandchildren will becomeeconomically inactiveas adults.
Althoughparentssufferpersonallywhentheiroffspringfail to grow up well,the effectsextendto the
communityas well,and substantialpublicprogramshaveindeedbeen mountedto addressthesesocial
problems.
The treatnent of costs and benefits in the empirical literature. Two sorts of issues arise in
applyingthe foregoingconceptsin empiricalwork: measurementof the costs and benefits;and taking
proper accountof them in makingthe [Link] the first issue,data on
the direct costs accruingto individualsand to societyas a wholeare usuallyavailable,or can be
estimatedusingrelativelystraightforward [Link] costs canbe adjustedfor
the effectsof repetitionand droppingout. More problematicis the estimationof forgoneearningsor
output, especiallyfor childrenin the lower grades. Althoughyoungchildrencontributeto household
production,it is often difficultto estimatethe value of their contributionbecause childrentypically
receiveno formalcompensationfor theirlabor.

Problemscan also arise in measuringthe benefits. When estimatingthe private retums to

education,personalearningsprovidean appropriatemeasureof the benefits,becauseearningsare all
that mattersto the [Link],however,it is importantthat earnings
reflectthe marginalproductivityof labor. The matchbetweenobservedearningsand productivityis
 6

closestin competitivelabormarkets,but suchmarketsmaynot alwaysexist:in low incomecountries,

for example,most formalsectorworkersare civilservantswhose payare publiclyadministeredrather
than market-determined; and in transitioneconomieswhere marketsare in disequilibrium, observed
earningsare likelyto be contaminated by the effectsof temporaryskillshortagesand surpluses.

Beyondthe measurementproblems,there is alsoimprecisionin the literaturearisingfrom the

inclusionof differentitemsof costs and benefitsin calculatingthe returnsto education. One of the
most commonsourcesof rates of returnestimatesare [Link]
applyregressionanalysisto earningsdata on a cross-sectionof individualsto relatepeople'searnings
and to theirlevelof schoolingandtheirwork [Link] regressioncoefficienton the schooling
variablecan,under certainassumptions, 4 Althoughit
be interpretedas the privatereturnsto education.
is possibleto adjustthe resultto incorporatedata on direct publicand privatecosts, most estimates
assumethat forgone earningsare the only cost of education. Thus, in terms of table 2 only C2
(forgoneearnings)andB1 (increasedearnings)enterthe cost-benefitcalculation.

Anothercommonmethodof computingreturnsto educationinvolvesestimatingthe relation

betweenearningsand agewithineacheducationgroup, andthen combiningthe resultingage-earnings
profileswithinformationon the directcostsof educationto calculaterates of return(i.e.,followingthe
longmethodin the terminologyof Psacharopoulos (1994)). The privatereturnsto educationobtained
in this way take account of direct costs (CI) and forgone production(C2) on the cost side, and
increasedindividualearnings(BI) on the benefitside. The socialreturnsreferredto in this literature
take accountof an additionalitem on the cost side,namelythe public subsidiesto education(C3),
whileonthe benefitsideno othereffectsare included.

Summers(1994)is an exampleof a cost-benefitcalculationof educationinvestmentswherethe

benefitsincludeonlythe non-marketeffectsof education. The socialreturnshe calculatesdiffersin
definitionfrom uses of the term elsewherein the literature,however,in that they includeonly public
spendingon education(C3) and non-marketeffects(B4) in the calculus. Althoughthe non-market
effectsquantifiedin thisexample-reducedfertility,as wellas childandmaternalmortality-are strictly
privatebenefits,the author treats them as publicbenefitson the argumentthat societyhas already
definedthemas suchbyusingpublicresourcesto financehealthandfamilyplanningservices.
To summarize,existingestimatesof the socialretums to investmentin educationtypicallyfail
to take accountof extemalitiesin the [Link] extemalitiesare what mattersfor
justifyingpublic subsidies. If the extemalitiesare sizableand differsubstantiallyacross levels of
education,taking accountof them may well modifythe rankingof prioritiesfor publicinvestment
acrosslevelsof education,asBirdsall(1996)has argued.

4 SeeBecker and Chiswick (1966),Mincer (1974), Willis (1986) and Rosen (1987) for further details and
discussionon this issue.
 7

Towar-d Incor-porating the Full [Link] frioii Inivestinig in Education

One possible approach consists of adding up all the benefits identified in Table 2. But beyond
the benefits that matenralizeas increasedpersonalearnings,the other benefitsare likelyto prove elusive
to quanti y fully. The list is long, perhaps even endless, so one is never sure that all the benefits have
been taken into account. And some of the benefitsmaterializeonly after a lag, or take time to unfold.
As a result, the impact of education observed at a particular time may well under-estimate the fill
effectsfrom the investment.

An alternative approach is to assume that all the benefits from investing in education are
internalized in the perforinance of the economy over the medium-term. In other words, if the
education of one person improves his or her own productivity as well as that of co-workers; if
education improvespersonal and communityhealth, leading to increased labor productivity,or indeed
produces the same effect through any of the other routes identifiedin table 2 above, the aggregate
impact is likely to show up in the long-tenn performance of the economy. In this interpretation,the
relation between education investmentsand economic performance at the country level represents the
"reducedform" effect of all the separate influences of education on economic productivity broadly
defined. Economic growth is admittedly a flawed proxy for country performance, since it does not
capture all aspects of socialwelfare. It nonethelessgoes beyond the usual practice of focusing only on
individualearnings.

Given its promise of comprehensiveness,we chose the second approach to estimate the full
benefitsof investingin education. The relationbetween schoolinginvestmentsand economicgrowth is
the subject of a large body of specialized research, and a full discussion of the specificationissues
would tak-eus well beyond the scope of the present paper. For our purpose, we follow the relatively
conventionalregression model adopted in the World Bank's study on 7he Ezat Axian Miracle, using
the same data as in that study.5 Specifically,we relate real per capita income growth (over 1960-1985)
to an array of country characteristics:initialeducation in 1960, growth rate of the population (over
1960 and 1985),investmentspendingas a share of the GDP (averaged over 1960 and 1985), and GDP
in 1960 relative to the U.S. Because we are interested mainly in the role of education, we treat the
non-educationfactors simplyas control variables.

Other authors such as Alesinaand Rodrik (1994) have also included in the regression equation
measures of initial equity (as proxied through Gini-coefficientsfor income and land distribution).
Unfortunately,the scarcity of data on these indicators meant that we could not stratify the sample by
income group-an important step in our analysis-without a drastic reduction in subsample sizes.

5 The data (which are publicly available) relate to 113 countries drawn from Barro (1991), Summers and
Hcston(1991), and Dc Long and Summers (1991). The specification is consistent with models of the determinants
of long-run economic growth which highlighlt the role of hunmancapital, ideas and externalities from education.
See, for example, Lucas (1988), Barro (1991), Azariadis and Drazen (1990), and Mankiw et. al (1992) for specific
applications; and Patrinos (1994) for a review of the "new" growth modcls. Although the use of enrollment ratios
in grow,th models is standard practice in the literature, the work of Benhabib and Spiegel (1994) and Pritchett
(1996), for example, has raiscd questions about their validity. The issues remain unresolved, however, so we
proceed on the basis of the predomiinaiit approach in this area of research.
 8

Dollar (1992), among others, has highlightedthe role of macroeconomicpolicies (e.g. openness to
trade) in economic growth. Again, lack of a good measure of such policies for a sufficientlylarge
numberof countries prevented us from incorporatingthe variablein our regression.

We modifythe basic modelused in 7he East Asia Miracle in two aspects. First, with regard to
initial education, we include enrollment ratios in 1960 for all three levels of education, rather than
limiting it to only the first two levels.6 Second, we examine the data separately for three country
groupings: low-income countries (with per capita GDP below 20 percent of the U.S. in 1960; 74
countries), middle-incomecountries (with per capita GDP in 1960 ranging from 20 to 40 percent of
that of the US; 19 countries) and high-incomecountries(with per capita GDP at least 40 percent that
of the U.S.; 20 countries). The choice of cut-off points separating the three groups of countries is
admittedly arbitrary, but our objective is to allow (within the limitations of the data set) for possible
differencesin the impact of differentlevelsof schoolingaccording to the initialeconomiccontext.7 We
used a linear specificationand estimate it using median regressionto reduce the influenceof outliers in
the sample.8 The regressionresults appear in table 3.

With regard to the non-education variables, the results are largely unsurprising. First, the
negativecoefficienton initialincome relativeto the UnitedStates in 1960 in the regressionsfor all three
country groups suggests that poor countriestend to catch up in per capita income over the two and a
half decades of observation. For low and middle income countries the coefficientsare not statistically
significant,however, indicatingthat a significationproportion of these countries in fact lagged further
behind instead of catching up. Second, the coefficientson investmentin equipment are positive and
statisticallysignificant(and are also of comparablemagnitude)in all three country groups. Finally,the
coefficienton population growth rates is statisticallysignificantonly in the high-incomegroup; in the
other two groups, the coefficientsare opposite in sign and not statisticallysignificant,suggesting the
variable'slack of a systematicinfluenceon economicgrowth.

Focusingnow on the influenceof educationon growth, the results are consistentwith previous
studies showingthat initiallevels of investmentin educationaffect subsequent economnicgrowth. But
the impact appears to differ widely both by initial level of economic development and by level of
schooling. For the full sample,the results reported in the East Asia Miracle indicate that only primary
education is statisticallysignificant,with a magnitudethat impliesthat a 10 percentagepoint increasein

6 WCsupplementthe WorldBank data by adding data on higher educationenrollment ratios in 1960 from
UNESCO(1968). For countries for which enrollment ratios were not availablein that source, we computedthe
ratios by dividing the number of studentsby the populationin the 20-24 age group, based on WorldBank data. In
the few countries for which the computationcould not be accomplished,we obtained the enrollment ratio by
converting data on the number of higher education students per 100,000population, based on the average of
conversion indices for a sample of countries for which data are availableon both the number of students per
100,000populationand the higher educationenrollmentratio.
7 The expectationthat the impact of, and thereforereturns from, educationinvestmentare likely to differ
according to context is consistentwith evidencefrom micro-levelstudies (see for exampleRosenzweig(1995))as
well as the broad cross-country patterns documented in Psacharopoulos (1994).
8 We also estimated the equation using ordinary least squares. The results proved to be largely consistent
with those reported in Table 3.
 9

the primary enrollment ratio in 1960, other things being equal, leads to a 0.26 percentage point gain in
the rate of econonic growth over the period 1960 to 1985.9

Table 3: Relating Per Capita GDP Growth (1960-85) to Selected Country

Characteristics
Country characteristics Low-income Middle-income High-income
countries countries countries
Primaryenrollment rate, 1960 0.033 *** 0.031 *

Secondary enrollment rate, 1960 0.034 0.070 *** -0.008

Tertiary enrollment rate, 1960 - 0.129 -0.100 0.062 **

Per capita GDP relative to US, - 0.085 - 0.072 - 0.021 **

1960 0.064 * 0.085 * 0.073 **
Average investment/GDP, - 0.175 0.490 - 0.670 **
1960-85
Growth of population, 1960-85 - 0.002 0.029 0.024
Constant
Number of observations 74 19 20
Pseudo R2 0.273 0.546 0.493
Source:medianregressionsbasedondatafromWorldBank(1993).
Note: one star (*) denotes statisticalsignificanceat the 10% level; two stars (**) at the 5% level; and three stars
***) at the 1% lcvel; full regression results are available on request from the authors.

In the sub-sample regressions, the coefficient of primary education is positive and statistically
significant in both low and middle income countries, with a comparable magnitude of 0.33 and 0.31
respectively.1 0 In other words, a 10 percentage point advantage in the 1960 primary enrollment ratio
would boost the annual growth rate of per capita GDP between 1960 and 1985 by an average of 0.32
percentage points in these countries. Thus, if we compare two countries starting from the same initial
per capita income in 1960 but with one of them having a 10 percentage point advantage in the initial
primary school enrollment rate, their average per capita GDP in 1985 would differ by about 8 percent.

9 One potcntial sourceof bias in the estimate arises from the omissionof a mcasurefor educationalquality
in the regression. If countries with vider coveragealso tendcd to be the ones wvitha stronger commitmentto
educational quality, the coefficicnt on the education variable would overestimatethe impact of educational
expansion. On the other hand, if those countriesare also the oIIesoperating under constrainedpublic spendingon
education,the bias would work in the oppositedirection.
10 In the high income group, all countirieshad already achieved universal primary education in 1960.
making it meaningless to include the cnrollmiienitratio in primary educationas a regressor.
 10

The coefficienton the variableis statisticallysignificantat the 1 percent level in the low income sub-
sample whereas it is so only at the 10 percent level in the middle-incomegroup; we interpret the
difference to mean that a larger share of countries in the first group conforms more closely to the
overall pattern of a positive relationshipbetween initialcoverage of primary education and subsequent
economicgrowth.

The impact of secondaryeducation is less consistent across the three groups of countries. The
coefficient is positive and statisticallysignificantonly in middle-incomecountries. In low-income
countries, it is positive but not statisticallysignificant,implying that although expanding secondary
education tends, on average, to boost subsequent economic growth, the impact is highly variable
across countries. For the high-incomegroup of countries,the enrollmentratio in secondaryeducation
in 1960 has had no impact on economicgrowth during 1960-85.

With regard to higher education, the coefficientis positive and statisticallysignificantonly in

the high income group. For the other two groups of countries, it is negative but statistically
insignificant,makingit safe to conclude that higherlevelsof initialinvestmentsat this level of education
would have had, on average, no impact on economicgrowth during 1960-85.

Summarizing the regression results, we indicate in Table 4 our interpretation of their

implicationregarding the impact of initial enrollmentratios and subsequent economic growth across
the three countrygroups. We base our judgment on the magnitudeof the regression coefficientas well
as the level of its statistical significance. The symbol "0" indicatesthat there is basicallylittle impact,
while the symbol "+" indicates a positive impact, with the strength of the impact indicated by the
number of times the symbolis repeated. It is importantto recallthat the regression coefficientscapture
marginal effects. In other words, they do not reflectthe absolute impactof educationinvestments,but
rather the effect of expansionin coverage beyond the averages observed in 1960 in the three groups of
countries.

Table 4: QualitativeInterpretationof the Impactof Initial Education Levels on

Subsequent Economic Growth During 1960-85
Levelof education Low income Middleincome High income
Primary ... ++ 0
Sccondary + +++ 0
I-lighcr 0 0 ++
Source:authorsconstruction
basedon regressionresultsin table3.
 11

Taken as a whole the results suggest that education indeed yields tangible economic benefits
for society."I The evidenceis consistentwith the idea that educationproduces valuablehuman capitaL
and not merely "pieces of paper" whose only use is to help employers select prospective employees.
Analyses based on individual data may be open to this interpretation because people with more
education may be selected for their innate ability. Aggregate country-leveldata are free from this
possible difficultybecause it is unlikelyfor countriesto vary systematicallyin the average innate ability
of their workers.12

The regression coefficientson the education variables do differ, however, in magnitude and
statistical significance,accordingto country context, suggesting that not all education investmentshad
been equally productive. The lower the per capita income of the country in 1960 the more productive
was expansion of primary education. It was only in the middle income countries that increased
coverage at the secondary level made a difference to growth. Expanding coverage in higher
education-again from the average level observed in the sample-mattered for economicgrowth only
in the richest countries. One explanationfor the differencesacross country settingsis that the benefits
from education are effectivelyrealized largely when opportunities exist for exploiting the potential
advantages of having skilled labor. In low-income economies, for example, production technology,
economic processes, and commercialand legal institutionsare relatively simple and opportunities for
specializationof labor are probably limited. These conditions may explain why an increase in the
availabilityof highly educated people in such economies would have had little or no impact on
aggregate economicperformance.

The foregoing results are interesting in themselves, but they bring us only part of the way
toward identifyingwhat would have been in retrospect sociallyefficient investmentsin educationthe
context faced by countries in the 1960s. For this purpose we also need to take account of the cost of
the investments. We compute the full rates of return to education below, using the foregoing
regression results and incorporating data on the direct and forgone cost of education. Although our
calculationconforms more closelyto the theoreticaldefinitionof a social rate of return, we eschew the
term in favor of "full rate of return" because it has by sheer force of habit acquired a somewhat
ambiguousmeaning in the empiricalliterature.

Estimating the "Full" Returns to Investmentsin Education

We calculatethe returns to educationusing the full discountingmethod which involvessetting

up the relevantbenefit and cost streams over an assumed investmentlife-time(Psacharopoulos, 1994).

11 The omissionof suchvariablesas initialincomeequityand opennessof the economymayhavebiased

estimatesof the [Link] recognizethis possibilityexplicitlyby performingthe rate-of-
returncalculationsunderaltemativeassumptions aboutthe magnitudeof theregressioncoefficients.
12 See Weale(1993)for an elaborationof the biases to which analysesbased on individualdata are
subjected;and Ram(1996)for a discussionof howthesedifficultiesare addressedto a largeextentby the useof
aggregatecountry-leveldata. Within-country aggregatedata can presumablyalso be used to overcomethese
problems,but analysisof the datamaybe hamperedbysmallsamplesizes. See,however,Lauet. al (1993)for an
analysisof the relation betweeneducationand growthusing state-leveldata from Brazil.
 12

For our purpose, we specify a life-time of 25 years, matching the duration of our data on growth
performance. For each country group we construct the benefit stream by level of education following
these steps. First, based on the observed average rates of growth in per capita income and population,
we project a stream of aggregate GDP over 25 years indexed on a arbitrary base. Next, we project
what the streamwould have been had the per capitaincome growth during the period been hastened by
a 1 percentage point increase in the relevantinitial enrollrmentratio in 1960.13 The differencein GDP
between the two projections gives the benefit from expanding by 1 percentage point the education
system'scoverage at the relevantlevel.

Regarding the cost stream, we note that three types of costs arise with the 1 percentage point
increase in initial enrollment ratio: public direct costs, private direct costs, and forgone earnings or
production. Data on the magnitudeof each of these componentsare scanty, but we can obtain rough
estimatesby weavingtogether several pieces of information. We make separate estimates for each of
our country groups in order to allowfor well-documenteddifferencesamongthem in this regard.

On the public direct cost of expanding education coverage, we base our estimate on the
followinginformation:(i) public spendingon educationas a share of GDP; (ii) the distributionof public
spending by level of education; and (iii) the initial enrollmentratio.'4 In low-income countries, for
example, public spending on education averages about 2.8 percent of GDP, with about 45 percent
going to primary education,28 percent going to secondaryeducation, and the remaining27 going to
higher education. Given that primaryenrollmentratios in low-incomecountries averaged 58.2 percent
in 1960, it would cost an extra 0.022 percent of the prevailingGDP to sustain a one percentage point
increase in the 1960 level of primary education coverage. With regard to the magnitude of private
spending on education, we have assumed on the basis of a variety of ad-hoc evidence for such
countries as the Philippines,Sri-Lanka,India, Indonesia,Kenya, and Venezuela, that it averages about
20 percent of total government and private spendingat the primary level, and about 30 percent at the
secondaryand tertiary levels(WorldBank 1995).

Forgone earnings or production, the third component of cost, refer to what students at each
level of education forgo while they are in school. We obtain estimates on the basis of the following
assumptions and data. For investments in higher education, the forgone costs correspond to the
earningsof those with secondaryeducation. We assume that secondary school leavers earn about the
same wages as primary school teachers, on the observationthat in most countries during the sixties
teachers at this level tend to be recruited with secondary education. The earningsof primary school
teachers in high-incomecountries (the only country group for which we will compute the returns to
higher education)are about 1.8 times the per capita GNP.'5 To make the cost-benefitcalculationswe

13 The calculationis basedon the regressioncoefficientsreportedin Table3.

14 UNESCO (1993) provides data on the first two indicators, while our regression data set provides
informationon enrollmentratios.
15 This estimate relies on data for individual countriesreported in Mingat (1995) and ILO (1995). In the
presence of externalitiesin production,averagewages-which reflectthe returns only to private individuals-may
underestimatethe forgone earnings associatedwith education investments. While we do not correct for this
possiblebias directly,we take accountof it by performingsensitivitytests on the baselineforgonecosts assumedin
the rate of return calculationsbelow.
 13

need to generate a stream of forgone cost based on this information. We do so by noting that the
annualforgone costs are roughly 2.4 times the annualdirect publiccost per student in higher education
in high-incomecountries.'6 Applyingthis ratio to the stream of direct costs already calculatedabove,
we obtain the requisite stream of forgone costs associatedwith expandinghighereducationcoverage.

For investmentsin secondaryeducation,the forgone costs correspond to the earningsof people

with primaiy education. We assume that the earnings of unskilled laborers provide a reasonable
estimate. Accordingto ILO (1995), they range from 1.43 times the per capita GNP in low income
countries, to 0.66 times in the high-incomegroup. Following the same boot-strap procedure as for
higher education, we derive the stream of forgone costs by multiplyingthe corresponding data on
direct costs by a ratio of 2.0 in low-incomecountries and a ratio of 2.2 in middle-incomecountries,the
two groups for which the calculationsare relevant.'7 Finally, for investments in primary education,
forgone earningsrefer to the work production of young children. We assume that they average about
0.25 times the per capita GNP (rising from 0 in the first grade to 0.5 times in the fifth grade), which
imply that they are about 2.0 times the direct public cost of education at this level. As before we
multiplythe stream of direct publiccost by this ratio to obtain the desiredstream of forgone costs.

Based on the foregoingassumptionson benefits and costs we compute the "full"rate of return
to educationby level of educationfor each of the three countrygroups. The results appear in Table 5
as the base case. We also report a range in the estimatescorrespondingto a 25 percent variationin the
assumed opportunity cost. We focus on this item of cost for two reasons: it is subject to greater
uncertaintythan the other two items; and it is the singlemost importantcomponent of cost. The table
also shows how the estimates of returns would shift according to a one standard error change in the
regression coefficientson which the benefit streams are based. For context, the table also shows the
average enrollmentratio by level of educationin the three groups of countries in 1960.

Before discussingour interpretationof the findings,we note two important points. First, the
retums calculatedin Table 5 correspond to the historical profitabilityof investingin educationover the
last three decades; and second, the returns reflectthe marginalprofitabilityof expandinginvestmentsin
education (i.e., the economic gain from increasing the education system's coverage from the levels
prevailingin 1960). If the returns to a particularlevel is negativeor low, we interpret this to mean that
new investmentsto increase coverage were in retrospect probablynot economicallyjustified. Strictly
speaking, a negative rate of return in fact implies that it would have been economicallyefficientto
reduce coverage. Recallthat coverage (i.e., enrollmentratios) is definedin our analysisas the number
of students relativeto the population in the relevantage group. In the context of growing populations,
a reduction in coverage would not necessarilyimplyan absolute contraction in the size of any part of
the educationsystem, only that it grows more slowlythanthe relevantpopulation group.

16 The ratio is basedon data for 1993from UNESCO(1995). In our cost-benefitcalculationall the data are
measuredin relational rather than absolute units. This justifies using current rather than historical cost data.
There is also the added advantagethat recentdata are more plentiful.
17 As before, the ratio betweenforgonecosts and direct public cost per student is based on data on unit cost
reportedin UNESCO(1995).
 14

Table 5: Estimated FuOlRates of Return by Level of Education and Country Group (%)
Low-income Middle-income High-income
Level of education group group group

(74 countries) (19 countries) (20 countries)

Primary: Base Case 47 39

25% change in opportunity cost 41 -- 55 34 -- 46

1 s.e. change in regression coefficient 32 -- 61 21 - 56

Secondary: Base Case 8 52 <0

25% change in opportunity cost 5 -- 12 45 -- 61

1 s.e. change in regression coefficient <0 -- 23 37 -- 66

Higher education: Base Case <0 <0 20

25% change in opportunity cost 17 -- 25

1 s.e. change in regression coefficient 7 -- 30

Average enrollment ratio in 1960 (%)a

Primary 58.2 95.0 109.3
Secondary 9.4 28.4 53.1
Higher 1.2 4.4 9.4

Source:authors'calculationbasedon assunptionsdiscussedin text. Data on enrollmentratios in 1960correspondto the

averagesforcountriesincludedin theregressionanalysisforthe indicatedsub-samples.
a/ Enrollmentratios are definedas the numberof pupilsenrolledat a givenlevelof educationrelativeto the populationin
the age groupwhichofficiallycorrespondsto that levelof [Link] presenceof over-agestudentsmakesit possible
forenrollmentratiosto exceed100percent.
 15

Bearing in mind the clarificationsabove, we may summarizethe pattern of returns by level of

educationas follows:

* For low-income countries, investingin pfimary educationproved to be the most sociatlyprofitable

of the three levelsof education. In such countries, productive processes and economictransactions
are relativelysimpleand primary educationprobably suppliesthe skills for most jobs (even though
the curriculumtypicallydoes not have an explicittechnical content). We also computed a rate of
return for secondaryeducationdespitethe lack of statisticalsignificancein the regressioncoefficient
on which it is based. The resulting rate of return is positive but low, implying that expanding
secondaryeducation(beyond the level observed in 1960 in the sample) in such countries did not, in
retrospect, prove to be a priority. For higher education, we made no estimate of the returns
because the regression coefficientwas negative,which in itselfwould have implieda negative social
rate of return; moreover the costs for this level of education, both in direct spending and forgone
production, are typically quite substantial in low-income countries. It is interesting to note in
passingthat East Asian countries'investmentstrategiesin educationduring the sixties and seventies
were consistent with the implicationsof these patterns in the returns (Mingat, 1995). Whereas
primary education was heavily subsidized to stimulate rapid increases in coverage at this level
higher education (and to a lesser extent, secondary education) was financed largely by private
resources which tended to restrainthe growth in coverage at this level.

* For middle-incomecountries,expanding primaryeducation continued to remain sociallyprofitable;

this result is obviouslyrelevantonly for countrieswhere full coverage had still not been reached by
1960. But expansion of secondary education would have yielded, in hindsight,the highest social
returns. Thus, whereas the economicjustificationfor expandingsecondary educationwas weak in
low-income settings, it became strong in the context of middle-incomecountries.18 The high
returns suggest that investing in this level of education offered the most appropriate support for
boosting economicgrowth in countries at this stage of development. Investing in higher education
did not prove to be sociallyefficient.

* For high-incomecountries, the returns turned out to be highest for expanding higher education.
Investing to boost coverage at this level by 1 percentage point would have yielded an estimated
social return of 20 percent a year, based on the pattem of countries' economicperformance during
1960-85.19Primary schoolingwas alreadyuniversalby 1960, so there was no basis for computing
social rates of return to this level of education. For secondary education, the benefits from
expanding coverage were insufficientto outweigh the costs of expansion, leading to negative
returns. As indicatedbefore, investingto maintaincoverage in primaryand secondaryeducation-
averaging 100 and 50 percent respectivelyin 1960-continue to be justified, not least because these

18 Of coursecountriescould still have placedthe highest priorityon universalizingprimary education. The

choice would have been valid for equity reasons only, however, since the full economic returns to primary
educationare exceededby those to secondaryeducation.
19 As a matter of interest, we note that our result is close to Becker's (1975) upper bound estimate of 25
percent for the social rate of return to college educationin the United States. His calculation was based on
evidencefrom the sources-of-economic-growth literature.
 16

levels provide the pool of candidates for higher education. But given the impact on the growth
process and the magnitudeof costs, new investmentsto expand coverage in higher educationwould
have offeredsocietythe best returns.

Comparing the Results with the Standard Estimatesof SocialReturns

The results presented above differfrom the standardestimatesreported in the literature in two
respects: (i) the structure of returns across levels of education and country income; and (ii) the size of
the estimates. The differencesarise for two possible reasons. First, the standard estimates typically
rely on earnings data for individuals,and these data may not provide accurate measures of costs and
effective social benefits, particularly in low- and middle-incomecountries where wages are often
influencedto a large extent by factors (e.g., social institutions)other than market forces. Second, the
earningsdata refer to a cross-sectionof people who are already employed. Because of possiblerigidity
in wages arising from legal and other constraints,the observed structure of earnings may not capture
the relative scarcity of new entrants to the labor market. Our estimates escape both these flaws
(although they may suffer from other shortcomings) because they relate to aggregate rather than
individualdata, and because they relate to actual growth performance of economies over the entire
period for which the calculationsare made.

For the comparisonof results, recallthat conventionalestimatesreveal a systematicstructure in

which the returns are typicallyhighest for primary education, followed by secondary education, and
then highereducation. At all three levels,the returns exceed the traditional 10 percent cut-off rate for
the cost of capital. Our results suggest that the pattern of returns is sensitiveto the economiccontext
in which the investmentsare made. The returns to investingin primary educationwere highest in low-
income countries. They remain high in rniddle-incomecountries, but were exceeded by the social
returns to investing in secondary education in such settings. In the context of the most advanced
economies,highereducationofferedthe best socialreturns of the three levels.

With regard to the size of social returns to investing in education, we may summarizethe
differencesbetween our estimates and those reported in the literature as follows: where our results
suggest a strong economicjustificationfor investing,the estimatedmagnitudeof the socialreturns was,
on average, about twice that of conventionalestimates;but where they suggest a weak justification,
our estimateswere much lower than the conventionalestimates. If we accept that aggregate growth
performance is a more complete measure of the economic productivity of investment in education,
encompassingbenefitsfor individualsas well as for society at large, our estimatessuggest that the size
of externalitiescan be very large indeed under certain conditions. 2 0 It is common practice in policy

analysisto invoke the existence of externalitiesas a blanket argument for justifying investments in
education. Our results suggest that the argument is not universallyapplicablebecause the existenceof
externalitiesis highlysensitiveto the context in which the investmentsare made.

20 That the returnsto schoolingis sensitiveto the economiccontextis consistentwith Schultz's(1975)

observationthat schoolingis more valuablewhere opporturitiesexist for exploiting the advantagesof being more
educated(or having more educatedpeople). Recent work by Rosenzweig(1996) among others using micro level
data provide additionalsupportfor this expectation.
 17

Conclusion

We have attempted in this paper to estimate the 'flill" economicreturns to education by level,
with benefits definedto include externalitiescaptured in economic growth performance. Because we
use country-leveldata to compute the returns, the estimatesrefer to the "macro"returns to education.
Given the cross-countryperspectiveof our analysis,limitationsin the data, and issues regarding model
specification,the results remain tentative. They nonetheless go beyond the conventional literature
which by and large ignores externalitiesaltogether.

Our findingssupport the view that investmentsin human capitalthrough formal educationcan
produce high economicreturns to society. Our results thus find no support for the view that education
is useful only for the purpose of screeningindividualsby ability. But they also suggest that the impact
of education investments on aggregate economic productivity depends critically on the context in
which they take place.

What implications for policy emerge from the results? The fact that our results rely on
historical data suggests obvious caution in using them to set investmentpriorities in the context that
countries face today. The process of economic development is nonetheless relatively stable, so
experiencefrom the past, especiallywith regard to such a basic investmentas education, may continue
to offer useful insights. To support economic growth a socially productive investment strategy in
educationwould place more emphasison expandingbasic education at early stages of development,
shiftingthe focus of expansionto secondaryand higher educationonly as the economymatures.
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 Human Capital Development Working Paper Series
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Schools in Developing Emmanuel Jimenez 34821
Countries
HROWP44 Integrated Approaches to T. Paul Schultz November 1994 M. Espinosa
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