Do ‘social returns’ justify higher education subsidies?

In his Henry tax review paper, Andrew Leigh says:

The principle that education subsidies should be increased (or graduate taxes decreased) if there is a social return to education fails to hold only in very special circumstances.

These ‘special circumstances’ are that

1. Subsidies or taxes would be ineffective, i.e. would not increase educational attainment.
2. Everyone is already getting the maximum level of education.
3. Lumpy investments, e.g. where the optimal level might be 1 year of post-compulsory education but only 3-year degrees can be purchased.

But is circumstance 1 really so ‘special’? As noted in an earlier post Andrew’s empirical evidence suggests that circumstance 1 may common rather than special.

The starting point for an argument that circumstance 1 is common is that in many disciplines private returns are at a level that encourages private educational investment, and so there is no need to offer any additional incentives. Subsidies pay people to do what they would do anyway.

Andrew’s earnings data on graduates versus people with year 12 education (p.34 of his paper) shows that graduates have a considerable earnings premium. This premium is an average, for most graduates it is higher because the average is deflated by the quarter or so of people with university qualifications working in less-skilled occupations.

I also think that earnings data tends to under-state the private benefits of education. If we look at what people want in jobs, it’s not just money. Indeed, apart from hoping for the more ‘interesting’ work that education may open up, people already incorporate ‘social returns’ into their private calculations in wanting jobs that help people or contribute to society (there are private psychological rewards in feeling that you make a social contribution).

Education is also a consumption good. Many people give as reasons for attending university things unrelated to future financial benefits, and even those who are primarily motivated by vocational concerns would often place some value on the experience of education aside from generating a qualification.

So we have reasons for supposing that there would be considerable educational participation, and associated social returns, with no subsidies at all.

Under human capital theory, subsidies would influence those who calculate that their private returns are too low to justify investment. However, one possibility is that they mis-calculate those private returns and that a cheaper strategy would be to persuade them to think again rather than to offer them a handout.

But what if they have correctly calculated that the private returns are too low? In this case, the most reliable ‘social return’ – higher tax revenues – will not eventuate or be small. We therefore need to determine whether the remaing social returns of subsidies exceed the social costs of subsidies. After all, there is an opportunity cost with every subsidy dollar, and a large opportunity cost if (as under current policy settings) subsidies aimed at the marginal would-be student are paid to all students.

The trouble with assessing these costs and benefits is that the benefits as described by Andrew – better health, better family outcomes, less crime, productivity spillovers, increased social and political engagement – sometimes have limited evidence and unclear causal mechanisms (and may justify school but not university subsidies).

So I’m really not sure that the social returns argument gets us very far in theory, and Andrew L’s finding that subsidies don’t reliably lead to higher participation suggests that this scepticism is consistent with the empirical evidence.

23 thoughts on “Do ‘social returns’ justify higher education subsidies?

  1. Andrew, thanks for your two careful posts on my Henry paper. Your point is well taken, but I’m not aware of anyone who has done good work on misperceptions about returns to uni (I’d guess the error goes the other way on average, but I haven’t surveyed 18 year olds to find out).

    The thing that struck me when working through the social returns literature was how tenuous the evidence was in many of these areas. As one author neatly put it, the social returns to education are easier to list than quantify. Moreover, when you look at good studies quantifying the returns, most are so small as to be policy-irrelevant.


  2. Andrew – Yes, I suspect you are right that returns are over-estimated rather than under-estimated. But the main difficulty looking at at the statistics here is that while on average graduates do pretty well (which most 18 year olds are likely to know), there is high variability. So the problem is risk, especially as we don’t know all that much about the risk factors. The solution to this problem is surely one we have already: income contingent loans.


  3. all well and good if the investment and the returns are considered only at the level of individuals. The returns at other levels are hard (maybe impossible) to quantify, but real nonetheless.

    Education trains people for jobs (partially). It also socialises people, particularly – where the public education system is strong – across classes, and so helps minimise social frictions (see the UK experience for failure to invest in cross-class education). And it enables people to understand more complex arguments – so making for more sophisticated choices. The outcomes of a discussion among an uneducated populace of the issues around, say, global warming, refugees or terrorism could well involve very considerable costs.

    Further, the experience is that an individual user-pays education system will dumb down to attract “customers” – something readily evident over the last 2 decades here and in the UK (and probably elsewhere). This will be at the expense of the other systemic inputs from the education system. You end up with an admin-heavy and clumsy research grants system trying to make up for the losses.

    So why not stick with a hybrid and adjust as deficiencies appear?


  4. Peter – ‘Dumbing down’ is a by-product of mass higher education rather than intrinsically user-pays higher education – thought it is true here and in the US (and probably the UK too, though I don’t know that market as well) that for-profits have offered education to the more marginal students excluded from the public system. I don’t have any difficulty with this provided value is being added and people know what the different qualifications mean.

    In practice, we will stick with a hybrid – the political difficulties in major change are too great. But we should resist pressure for further low-return public subsidy for higher education.


  5. Actually, Heckman has done interesting related work in this area. In particular, he points out that looking at average graduate earnings premia can be highly misleading for thinking about the returns to education because of selection bias. Just because the average graduate earns x, does not mean that a non-graduate would earn x if they completed the same qualification and may not be capable of completing that qualification at all. Selection bias is potentially very important.

    In short, one needs compelling evidence both that some individuals are under-investing in university education (controlling for selection bias) AND that the under-investment can be corrected through taxes or subsidies (it may be that constraints other than the financial are more important).

    As a broader comment on Andrew’s paper I think the analysis is very interesting and useful, but I don’t think there are clear policy implications. I’m particularly sceptical of the cross-country regressions because of the potential for regressor endogeneity and I’d rather see micro-econometric evidence of the impact of specific tax-subsidy reforms controlling for the supply side changes that sometimes accompany such reforms.


  6. A smidge off topic, but how much would the commonwealth save if it said next year ‘thats it – no more funding whatsoever for higher education, no more hecs or fee help etc etc’ ?

    Interested to see how much this would come to for each taxpayer – could be a substantial dividend.

    Also- do state governments put much into the university system?


  7. Gluggy,

    Australia spends 4.3% of GDP[1] on all levels of Education.
    GDP is currently about a trillion dollars, so that would be 43 Billion dollars.

    Or about $2000 per person.

    25% of that is for tertiary education. Or about $500 per person.

    BTW any funding given to students is MASSIVELY repaid to the society in the form of greater taxes paid from a higher average income. For an anecdotal personal example, each year I pay more tax then all of the austudy, hecs and other support I received over a long and interesting university career in the first half of the 90’s.

    (All google-fu – the numbers are easy to find if you know what to ask)

    What may surprise you is that the effect on Universities would be negligible, yet brutal at the same time. A lot of the song and dance required to obtain funding from the government requires a level of compliance that eats a significant part of the funding, and many Universities already have the government funding part of their income as a secondary revenue stream. The primary stream being other sources (endowments and foreign students mainly).

    What it would mean is that the Universities could restructure along lines that weren’t dictated by the whims of Canberra, and would give them an excuse to re-engineer their current environments. On the downside you would probably see less competent engineers and doctors with a lag time of about 2 decades.

    [1] Numbers are always fuzzy. 4.3% was 2007-2008. 4.9% for 2001-2002 – it probably moves around a bit. 5% is the OECD average, Australia is already cheap about education.


  8. Ok, thanks Veltyen.

    So a straight off the bat benefit of $500 per taxpayer by abolishing all federal support. This is fantastic. I’m assuming it includes Fee-help as well otherwise that’d be an extra saving.

    Universities would be freed up to find their true value in the market place. Taxpayers better off. Graduates avoid the hell of overqualification and permanent unemployment from useless degrees.

    The extremely lazy staff employed by Universities can stop going to FBT courses in packaging their salaries and get real jobs.

    The total abolition of higher education funding (and also year 11 and 12) is a concept growing stronger by the day.


  9. gluggy,

    it looks like you still can’t admit to yourself that, despite data to the contrary, that you’re the exception and not the rule. Get over it. In addition, as Veltyen notes, the actual amount of money universities take from the government is fairly limited, and if they could charge anything they want and not be forced to worry about equity concerns, Australian students losing them money etc. . it would make far less difference than you would image to them — indeed, I’m surprised some haven’t tried to fully privatize already.


  10. Andrew, my prior is actually that people underestimate the returns to uni. As you and several commenters have astutely noted, there is heterogeneity and selection. But let’s take my result that the average uni grad earns 49% more than the average year 12 graduate. Say that part of this is selection (uni grads would’ve earned more anyhow), and that the average causal impact of uni is really only 40%. My hypothesis is that if you surveyed a representative sample of 18 year olds, their mean estimate of the wage returns to uni would be below 40%, not above. Still, it’d be nice to have some data…


  11. Andrew – Sorry, I misread you. A question on what they think their chances of earning incomes in various brackets might be the best way to go about it. I’ve been doing some more work on the census. Arts graduates for example have only a low chance of ending up in a job paying $100K a year or more even if they find managerial or professional work, but medical graduates have a high chance.


  12. Andrew

    On dumbing down – yes, mass education plays a part. But user pays does too – many (not all ) users want a degree as an entry to a job, not necessarily a high level of competence. Two examples that come to mind are the Indian university system (which is not for the masses, but a degree is a ticket to the social ladder) and the English universities of the 18th century. In both cases the users (students) exerted strong pressure to lower graduation requirements.

    There are pitfalls with the opposite approach too – I think the pressure on universities to teach better has led to improvements there. My point is that to keep a balance you have to lean against the prevailing tendency, not indulge it.


  13. ‘Dumbing down’ assumes some worthwhile standard that is being diluted. Offering a fit-for-purpose course is not in my mind dumbing down, it is offering a different product which should have standards appropriate to the desired outcome.

    What we see in practice is that user-pays leads to both higher and lower standards (or various kinds, this is a complex concept including admission requirements, curriculum, teaching methods and quality, and assessment) than the prevailing state alternatives, depending on where they are at and what is demanded in the community.

    In schools, user-pays leads on average to higher standards. In the vocational ed sector recent evidence shows some low standards in the for-profit sector (though some of this has come about because of an unusual set of circumstances, in which neither the students or the provider have any great interest in quality, since migration is the desired outcome). However, the government TAFEs have also been subject to much criticism over a long period of time.


  14. Conrad – can we at least agree that humanities courses are a waste of time and should be closed down. Then we could work together to achieve that goal.


  15. Gluggy,
    I wouldn’t even agree with you on that. Most humanities graduates have reasonable outcomes (look at the data — I know this is hard for you, which is why you think law graduates don’t have good outcomes despite the fact they do).
    On this note, I saw a great talk on skills needed in the US labor market a few years back, but where skills were broken down into things like mathematical skills, verbal communication and so on (rather than categorized by profession). One of the things there was supposedly a big shortage of was people with high literacy and high verbal communication skills (I wish I could remember the speaker!).
    On this note, my first degree was in one of the areas people like to disparage these days (computing & maths), from an average university, yet the outcomes were fine, I learnt a lot (as did most people in the course), and it’s been of use to me all my career, even though I don’t work in that area. Most people I’m still in contact with (almost 2 decades later) are making lots of money and have always been making lots of money. Perhaps some of them are your boss.
    That of course is just an anecdote, which is why you need to look at the data, which obviously you don’t. The problem with this is that people have this stereotyped idea of the types of jobs people do, those that make money, and so on. Everyone thinks that the jobs people do are those that come to mind first (engineers, teachers…). However, this is a well known bias in human information processing — people think that what comes to mind easily is also what is most common, which unfortunately isn’t true in many circumstances. Personally, I doubt I could even think of three quarters of the jobs people do, or what skills they entail, but that doesn’t mean they arn’t important and don’t exist. If many of them happen to require high verbal communication and literacy skills, I’m sure humanities degrees are just fine.


  16. Conrad. Look I’ll be honest I’m being a bit of a troll here. But its making for interesting debate. And there are grains of truth in what I’m saying.
    I was interested in your comment about the ‘needed skills’. I think this is whats missing from the whole ‘we need more education’ debate, what are the actual hands on skills that are needed by employers out there.

    A big problem is that many courses are extremely ‘lumpy’ as someone here said. For example, some parts of a law degree are somewhat useful – you could mount an argument that contracts has some uses, whereas international law is just a waste of time.
    A big problem seems to be quantifying the needed skills of a society. Not sure if anyones done this in any systematic way. Perhaps you could have say a 100 categories of skills ie ‘excellent english’ ‘maths to minimum year 11 level’ ‘basic calcululs’ or something like that and then get employers to tick how many of these skills are required for positions, together with the salaries for those positions. You could then see what the most valuable would be.

    To be fair you should also include blue collar skills in here, because their just as important ie ‘ability to fix airconditioner’ ‘ability to fix hot water service’ etc etc.


  17. “A big problem seems to be quantifying the needed skills of a society. Not sure if anyones done this in any systematic way.”
    Gluggly, I’m sure there’s a billion and one needed skills, which is why it’s important that people have the basics (which I can safely confirm the average high school leaver with a score of 70 doesn’t), so they can learn to learn them. So, with some exceptions, it’s pointless trying to teach one specific aspect of something if it doesn’t lead to something else. Think about jobs you have done. I bet you didn’t know most of the stuff you do in IT before you started (you couldn’t — it changes too quickly), so you just learn stuff as you go along. If you’re programmer, for example, it’s pretty easy to pick up any old language if you know how to program another, and I assume that’s what most people do.
    More generally, an alternative way of looking at this all is to compare what the difference is between rich and poor countries. What you’ll find is that it’s human capital, not just physical infrastructure. If you only have the latter, you won’t get anywhere. In addition, this idea that you can just produce people that are instantly needed in a small number of fields (like engineers) is wrong. In China, for example, this exactly what they do — everyone wants to be an engineer — but that’s not what they need — the universities produce to far too many of them, and the other courses they have are generally very limited compared to here (some of the humanities courses I’ve seen, for example, are engineering like). What they really need is a broader balance of people that think different ways, do different stuff, and hopefully they’ll recognize that one day.


  18. Conrad, surely its worth it doing some studies and looking at the results. For example, we might find that ‘basic calculus’ is a skill set thats crucial, and is featured in a high proportion of high paying jobs.

    We could then publish that, and then you could select a course that features that skill in it.

    I agree its all very difficult, I just get the feeling that people are doing very very large ‘lumpy’ courses with a lot of fat they really dont need.

    I wonder what Andrew thinks?


  19. gluggy:

    Why not look at humanities as an education rather than an opportunity to find your first job.

    I think we look at tertiary ed here as an route to a job. I admit that important, so don’t me wrong, but an education is also one of life;’s pleasures.

    The American system of doing a undergrad is an excellent way of achieving that. Work can come later.


  20. “Conrad, surely its worth it doing some studies and looking at the results.”
    Gluggy, there are journals full of results, most of which I don’t have time to read.


  21. “The American system of doing a undergrad is an excellent way of achieving [life’s pleasures].”

    This is the Animal House view of higher education. There is a lot to be said for it.


  22. Ah my fav. movie of all time.

    Hoover: We’re in trouble. I just checked with the guys at the Jewish house and they said that every one of our answers on the Psych test was wrong.
    Boon: Every one?
    [looks at Bluto and D-Day]
    Boon: Those assholes must have stolen the wrong f..king exam!


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