Why Education Spending Doesn't Lead to Economic Growth

It is college acceptance season, and letters with financial aid offers attached are dropping on doormats

nationwide. Many students and an even greater number of parents are facing the sticker shock associated with tertiary education. As college prices rise—the average annual cost hit $18,497 in 2010-11, according to the National Center for Education Statistics—the question inevitably arises: Is it worth it? For the average student in the U.S. and worldwide, the answer is affirmative: Education remains a fantastic investment for individuals. The tougher question is whether education at all levels is such a great investment for societies as a whole.

In the U.S., education leads to higher wages. Median weekly earnings in 2013 were $472 for someone with less than a high school diploma, according to the Bureau of Labor Statistics. That number rises to $1,108 for those with a bachelor’s degree and $1,714 for those with a professional degree such as an MBA or J.D. A recent National Bureau of Economic Research paper suggested that the educational payoff for “marginal” college students—the ones who might not attend if it weren’t for government support, for example—may be a lot lower. Still, for most students, the high cost of college is well worth it.
That’s true worldwide as well. Recent estimates (PDF) for Ghana, for example, suggest that each additional year a child stays in school translates into an average annual income 7 percent higher. In China, that figure is 12 percent.

But does that private return on investment in education translate into benefits for the national economy? In the U.S., public education expenditure accounts for more than 5 percent of gross domestic product. (Private spending is about the same size.) In developing countries, including Kenya and Uganda, education takes up 15 percent or more of the government expenditures. Public education spending is justified in part by the idea that it has considerable spillover effects—not only the student, but society as whole benefits when a kid goes to school. The data suggest a more complex story, however.
Analysis by Lawrence Katz and Claudia Goldin suggests that increased educational attainment among Americans from 1915 to 1999 might account for 10 percent of the growth in U.S. GDP over that time. Some commentators contend that this an underestimate (PDF). But at the global level, no relationship has been found between a more educated population and more rapid economic development. There has been an explosion in schooling in developing countries, but many show nothing like explosive growth in GDP per person. By 2010, the average Kenyan had spent more years in school than the average French citizen had in 1985. But Kenya’s GDP per capita in 2010 was only 7 percent of France’s GDP per head 25 years earlier.
What explains the limited impact of increased education on economic growth? A possible answer is that education acts as a filter rather than an investment. A recent study (PDF) in Italy found that test scores had a significant impact on the earnings of employees—but none on the earnings of self-employed people. One interpretation of that result is that schooling signals persons with intelligence and ambition, rather than actually imparting or indicating skills that make them better at their jobs over the long term. Signaling helps as a screening tool for employers, but makes no difference to people who work for themselves. Presumably, they already know how smart and ambitious they are. (Think Bill Gates: Harvard let him in, signaling smarts, but he didn’t finish his studies before going off to become the world’s richest man; apparently Gates didn’t feel he needed to complete the course load to succeed).
It looks as if the developing world may may have a similar problem: As primary schooling has become universal and its signaling power has weakened, analysis in the journal Development Policy Review suggests that the returns to primary schooling have dropped since the 1950s from a near 30 percent wage premium toward a 5 percent wage premium today. That’s in part because lots of kids aren’t learning anything at all in school. In India, for example, only around a quarter of children who complete primary school can read a simple passage, do simple math, tell time, and make change