Rate of Return

to Education
 • The  education  sector  in  India  has 

Growing witnessed  a  paradigm  shift  in  recent 

times.
Various factors contribute to the growing i
Indian nterest in the education sector:
• Expected Growth in the Market Size

Education • Scalable Investment

• Migration to Quality

Sector • 100% FDI

Concept

• The concept of the rate of return on investment in education is very similar to that for any other
investment. It is a summary of the costs and benefits of the investment incurred at different points in
time, and it is expressed in an annual (percentage) yield, like that quoted for savings accounts or
government bonds.
• Returns on investment in education based on human capital theory have been estimated since the
late 1950s. Human capital theory puts forward the concept that investments in education increase
future productivity.
• The popularity of estimating returns to education stems from the resulting efficiency, equity and
financing implications. The rank order of returns to a level or type of education, and a comparison
with the returns of alternative investments can assist education policy makers to make informed
investment decisions.
• The concept of rate of return to education The rate of return to
schooling equates the value of lifetime earnings of the individual to
the net present value of costs of education. For an investment to be
economically justified, the rate of return should be positive, and
should be higher than the alternative rate of return.
• For the individual, weighing costs and benefits means investing if the
rate of return exceeds the private discount rate (the cost of borrowing
and an allowance for risk).
 • There are numerous benefits of
investment in education. It can reduce
poverty, enhance equality, improve
health, reduce crime, and promote rights,
to name a few.

Rate of • A crucial driver that enables these

benefits is the link between education

Return on
and earnings.
• Even though the roots of this argument
lie in the writings of classical economists
Education like Adam Smith and Alfred Marshall, the
idea was formally conceptualised in the
form of the human capital theory
relatively recently when Theodore Schultz
and Gary B.

More education leads to higher earnings seems
trite. But to make a precise case, studies
estimate the rate of returns to schooling, which
equates the value of lifetime earnings for an
average individual with the cost of their
education.
If the return rate is positive and higher than
alternative forms of investment, it makes
economic sense to invest in education. When
these calculations are made at the individual
levels, it is termed as the private rate of return
to education. But when social costs such as
money spent on schools and teachers are added
to it, we obtain the social rate of return.
• The latest estimates show that the global average of the private rate of return to an additional
year of schooling is about 8.8 per cent.[1] These returns are significantly higher than most
long-term asset investments, which makes spending on human capital a good investment.
• It has been documented in several studies that the returns are higher in developing countries
compared to developed ones.[2] Further, developing countries exhibit higher returns to
primary education while the developed economies experience higher returns to tertiary
education.
Importance of returns to Education

• It is crucial for countries to understand these trends as it informs policymaking. The returns to each
level of education provide information to policymakers about public investment priorities.
• Similarly, the education-wage differentials signal the skills that the market values and provide an
idea about the necessary interventions.
• The necessity to identify appropriate avenues of investment in education have become even more
pertinent as students globally deal with the effects of the pandemic on access to schooling.
• The Institute for Competitiveness has undertaken a study to estimate the returns to education in India using
the Periodic Labour Force Survey (PLFS) data published by the National Sample Survey Office (NSSO).

• It provides some interesting insights, especially when compared to the literature on developing economies.

• Most importantly, it shows the segments of population that require more policy focus on education
investment to ensure equitable development over the long run.
Returns To Education In India

• The Indian case presents a curious anomaly beginning with its overall rate of return to
education.
• The literature shows that the low- and middle-income countries present an average of 9.3 per
cent and 9.2 per cent respectively on the private returns to schooling.
• As per our estimations, India, which is a lower middle-income country, has a private return to
education of 7.6 per cent on an average after controlling for any selectivity biases. There can
be several reasons for the lower return to education in India including issues of quality.
• However, averages are rarely useful to draw meaningful insights in a world of
heterogeneity.
• The returns to education also depend on several heterogenous factors, which has a
notable bearing on policy choices. For instance, if the returns to education are higher
for individuals at the top of the income distribution, maintaining a status quo in
additional education investments would lead to an increase in inequality.
• So, it is necessary to dissect the data to unravel the heterogeneity.
• Returns to education differ across education levels. While developing countries typically have higher returns to
primary education, India has moved beyond that stage. As per estimates, the rates of return to primary (I-V),
secondary (VI-X), higher secondary (XI-XII), and tertiary education stand at 4.2 per cent, 2 per cent, 5.4 per
cent, and 6.7 per cent, respectively.

• Thus, the rate of returns to education are the highest for post-secondary education. It is, therefore, important
to ensure high transition rates after secondary education since the gains from additional years of schooling
during that period of adolescence can significantly enhance the earning potential of individuals.
• Conventionally, the returns to education were diminishing. The empirical evidence until the 1990s showed
that the returns were highest at the primary education level and progressively lower at secondary and tertiary
levels.

• In fact, the argument that basic education can reduce poverty was based on the notion of diminishing returns
as gains were highest at the lowest level. But recent evidence, which is our finding for India as well, suggests
that this may have changed, which has crucial implications for the poverty-reducing capacity of each level of
education.
• The shift in returns away from primary education might have been led by both supply
and demand side factors. In India’s case, it achieved universal primary enrolment in
2015, and so, the supply of primary graduates has increased substantially.
• On the demand side, with a change in the skill composition of goods demanded and
increased mechanisation, the demand for people with low skills keeps falling. A
combination of these factors drives the returns to primary education downwards.
• Thus, it is necessary that India expands its policy focus on education to adolescents who are pursuing post-
primary education and ensures a reduction in school dropouts at those levels. Moreover, since the returns to
secondary schooling are not as high, the key will be to incentivise enrolment until higher secondary.

• While disaggregating returns to education by level suggest where education investments need to be focussed,
it does not address who requires more investment. Do all Individuals face the same rate of return to
education? If not, who is likely to benefit more, and why? What are the policy implications of that? To answer
these questions, it is necessary to delve into further heterogeneities in education among different groups of
individuals.
 • The primary reason to understand the impact
The Role of of education at the microeconomic level is due
to its relationship with inequality. There has
Education in been a long-standing notion of a “race
between education and technology”, which
Fighting was conceptualised by Jan Tinbergen in 1974.
The idea relates to the skill-biased impact of
Inequality technological progress, on one hand, with the
equalising impact of education, on the other.
Income Matters

• The relationship between education and income inequality is not as straightforward as it seems. By providing growth
opportunities to all the individuals, education impacts their earning capacity.
• In order to understand the impact of education-earning relationship on inequality, one needs to examine two things.
• First, whether the existing patterns of returns are concentrated or dispersed.
• Second, if they are dispersed, which cohorts benefits the most from educational investments.
• If the returns to education are higher for those at the top of the income distribution, investments in education will widen
inequality. In such a case compensatory intervention will be needed to equalise the chances of those at the bottom of the
income distribution.
• Quantile regression method is used to estimate the returns to education
across earning distribution to understand the patterns of returns. Results show
increasing returns by quartiles highlighting that education investments are
more profitable for those at the top of the distribution.
• The returns for the bottom 25 per cent are around 5.5 per cent, which
increase to 6.4 per cent for the 50th quantile and rises further up to 8.5 per
cent for the 75th quantile.
Role of Gender

• There is a vast literature investigating the role of gender in defining labour

market outcomes. For India, such insights are more important given the recent
trends of female labour force participation. Four out of five women are not
working in India. Only Yemen, Iraq, Jordan, Syria, Algeria, Iran, and the West
Bank and Gaza have a lower female labour force participation rate than India.
It is not the low figures but the falling trend that is more worrisome. It is thus
important to investigate investigate why more women are not seeking work.
• Results show that there is significant disparity in the returns to education between males and females. Using the overall
earnings, both corrected and uncorrected measures show that the returns are higher for females.
• The returns are nearly two percentage points higher for females, after controlling for personal characteristics as well as
selectivity bias. One year of education adds 8.9 per cent to female monthly wages while it only adds 6.6 per cent to male's
monthly wages.
• One possible explanation for this can be that education not only enhances female skill and productivity but also reduces the
wage gap between males and females that is attributed to discrimination.
• These results highlight the need for investments in education females since that will not only yield great private benefits but
also results in high social returns for the economy.
Policy Implications

• In a nutshell, empirical evidence suggests that while the overall returns to education are
positive, there exists significant heterogeneity. Indian policymakers will need to ensure that
they keep these disparities in returns to education in perspective.
• The focus needs to be shifted from primary level of education to secondary and tertiary
education. There are incentives to invest in adolescent education since the returns are highest
for tertiary education.
• In addition to focusing on higher levels of schooling, focused interventions are required for
lower income quantiles and the female population so that education plays an equalising role.