The Micro-Macro Paradox of Education

The Paradox

If you’re searching for the least controversial finding in Economics, a strong contender is the observation that people with more education earn higher wages (Pritchett, 2001). This finding holds virtually invariant of time and national borders: from imperial Japan to modern day Addis Ababa, more educated members of society have always tended to earn more money.

A similarly (though not as) well-established finding is that these private returns tend to vastly outweigh the social returns to education investment. In this context, social returns refers to the extent to which education raises the aggregate productivity of the economy of as a whole.

The graph below (from Patrinos, 2004) illustrates this, comparing the private and social return to different tiers of education from a cross-section of countries around the world. Patrinos calculates a private return to primary and secondary education of 26.6% and 17.0% respectively: meaning that a primary school graduate can expect to earn 26.6% more than someone who hasn’t attended school, and a secondary school graduate can expect to earn 17% more than someone who has just completed primary education. Private returns exceed social returns at each stage: a finding that gives rise to the Micro-Macro Paradox of Education.

Source: Patrinos (2014)

The paradox deepens when we consider the significant positive externalities we tend to associate with education. Put simply, my ability to read not only makes me more productive; it also makes you more productive (as you spend less time explaining tasks to me). This implies that we should see a social return to education that exceeds the sum of its individual parts; instead, the opposite occurs.

The policy implications of this paradox are hard to overstate. Education delivery is at the forefront of United Nations Millennium Development Goals, yet these lacklustre aggregate effects make its prioritisation over healthcare or infrastructure investments harder to justify. Of course, there is more to life than productivity and education fulfils many functions beyond this. Nonetheless, the failure of private returns to translate into social returns hints at the presence of market failures that, if rectified, could bring the returns closer together. To help identify these, two compelling explanations are often put forward to explain the paradox: the piracy explanation and the wasteful signal explanation.

The Piracy Explanation

The piracy explanation argues that education equips people to succeed in privately remunerative but socially wasteful activities. If the basic institutional framework is arranged such that piracy/rent seeking is more preferable to chemical manufacturing (for instance), schooling may simple make people more skilled in embezzlement and other anti-competitive, growth-sapping activities. At a less extreme level, graduates may simply be funnelled into bloated public sectors – into sinecures that pay well individually, but have little to no effect on the productivity of the economy as a whole. These instances help square the high micro returns with low macro returns: education enables people to command a greater share of society’s resources, without increasing the size of the pie for all. This explanation points to the need for effective institutions to make privately remunerative activities more aligned with those that are socially useful.

The Wasteful Signal Explanation

An alternative explanation states that in many places, the quality of education is so poor that it equips people with very little productivity-enhancing skills. There is a plethora of dire statistics to support this view: in recent assessments in Ghana and Malawi, more than 4/5 of students at the end of Grade 2 (7 years old) could not read ‘the’ or ‘cat’, while only half of Grade 3 students in Nicaragua could correctly solve ‘5+6’ (World Development Report, 2018). These students probably attended schools characterised by the same universally depressing hallmarks: overpopulated classrooms, absent teachers and insufficient desks/learning materials. Against this backdrop, it is easy to see how education investment generates such disappointing aggregate results.

Of course, to complete this explanation, we must reconcile an ineffective education system with its ability to generate high individual returns. We can do this by introducing the concept of a ‘signal’. Suppose some people are naturally more productive than others. In a world of perfect information, these people earn higher wages. Now suppose that employers cannot identify how productive workers are ex ante. In the presence of this information asymmetry, education may be an effective means to ‘signal’ that you are a high productivity worker – if you graduate from school with a string of high grades, an employer may infer that you are more skilled than someone with no education, even if education itself does nothing to enhance your productivity.

When used this way, investment in education can lead to bad equilibrium outcomes. Imagine a theatre in which people stand to get a better view. This prompts others behind them to stand. If it is possible to stand, doing so is a dominant strategy for any individual. Standing not only has no benefits to society, it also increases the incentive for other individuals to engage in uncomfortable standing. The end result is that everybody is worse off, but no individual has an incentive to deviate – a concept known as coordination failure.

This explanation offers two policy implications. First, if people are using education as a signalling device, we can at least make the signal less wasteful by improving the quality of education. Our understanding of how to do so has greatly improved in recent years, thanks largely to the popularisation of randomised control trials (to be discussed in a later post). Even if we fail in this pursuit, if employers have access to alternative screening technologies this should reduce the incentive for workers to invest in a socially wasteful signal. Examples of other technologies include referral systems, interviews and apprenticeship programmes – all of which allow employers to better assess the ability of workers ex-ante.

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References

This post draws heavily on the work of Lant Pritchett and his seminal 2001 paper, which offers the best discussion of the education paradox. Patrinos’ 2014 paper is (to my knowledge) the best paper in measuring the returns to schooling.

• ·         Montengro & Patrinos (2014), ‘Comparable Estimates of Returns to Schooling Around the World’
• ·         Pritchett (2001), ‘Where Has All the Education Gone?’