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Learning and Earning

There is an obvious link between income and education, but a recent study shows that simply going to school comes with no great financial guarantees, as Dr John Humphries explains.

Education is widely proclaimed to be crucial for the development of any country, and the prosperity of its people. This belief is shared by all sides of politics, business, non-profits, (and especially by the education sector itself), but it is important to understand how education benefits society if we want to ensure the best outcome.

Surprisingly, until recently there had never been a comprehensive study done to measure the financial rate of return on Cambodian education. We know education creates benefits, but exactly how and how much? Which areas of education should be the priority? And besides education, what else helps to explain different incomes? Following several years of research, these questions have now been answered.

The main result is actually the least interesting, but we should start at the  beginning. Based on data gathered in 2012, investing in Cambodian education has an average rate of return of 10.3% for men and 9.9% for women,  which  is broadly in line with the estimates for other developing countries around the world. To put this into perspective, the average investor will get about 5-10% return on their investments, so the return on education is fairly good.

The headline figures are important, but the details of the study revealed four other conclusions that are perhaps more interesting.

Income depends on many factors

While education is important, there are several other factors that also have a noticeable impact on incomes. Unsurprisingly, students who did better at school often end up earning more than their low-scoring classmates, though this effect isn’t very strong and the best students only earned about 20% more than average students. It’s also not surprising that people who work in cities earn about 15% more than people in the surrounding areas.

The data shows that men earn about 25% more than their female counterparts. When we look more closely it appears that men and women start their working life with similar pay, but older men are likely to see continued wage growth, while older women have fallen behind. The raw data cannot tell us the reason for this difference.

Socio-economic status is another important reason for differing incomes. A child of middle­ income parents (~$1000/month) can expect to earn up to double the income of an equivalent person with low-income parents (~$100/month). This is because wealthier parents are able to provide their children with more opportunities and better networks, and it raises the potential problem of some people being caught in a poverty trap.

Education as a gateway to batter careers

There is an implicit assumption in education economics that graduates earn more because of the skills and knowledge they acquire during their study. According to this theory, more educated people will get a “wage premium” because their education makes them more productive.

An alternative theory suggests that education is primarily useful as a signal to future employers, in helping them to choose smart and dedicated workers. People with university degrees (especially difficult ones) have proven to the world that they are able to work hard, solve problems, obey instructions, and meet certain requirements.

At least with regards to university education, the results from Cambodia give more support to the signaling theory. The Cambodian data shows that university graduates do not start their working life with a large wage premium over the rest of society, which is what we would have expected if they were being rewarded for their additional skills or knowledge. Instead, their benefit comes from being in a career that is more productive, which results in faster wage growth over the course of their career. To put this into numbers, university graduates had average wage growth of about 10% per year, while people without a university degree had wage growth between zero  and 3% per year. Graduating university does give people an advantage in life, but that advantage is because they are more likely to work in growth industries, and not because they are being paid extra for the information they learned in class.

School should still be the first priority

There has been an ongoing debate in education economics about whether priority should be given to primary school, high school, or university. Some authors argue that primary school education has the highest rate of return, while others argue that university study produces a larger wage premium. Both are correct. The important thing to note is that “rate of return” and “wage premium” are not equivalent, since the rate of return also factors in the cost of education.

The results for Cambodia echo the results found in most other countries in the world. University graduates do have a significant advantage over non-graduates. But when making decisions about where to spend scarce resources, the evidence shows that finishing school (especially primary school creates a bigger benefit-per-dollar than finishing university.

Not everybody should go to university

This  may  seem  obvious,  but  in  a culture  that (rightly) extols the virtue of university and education in general, it can be tempting for policy makers to fall into the trap of thinking that “more university is always better”. That’s not necessarily true.

The average rate of return is a useful guideline, but averages can also be misleading. If you have one hand in a tire and your other hand in a freezer, your average temperature may be normal, but that conclusion is hiding the reality of extreme heat and cold. Likewise, the  10%  average  rate of  return on Cambodian education is good news, but that one statistic hides the underlying truth that some people will get a much higher or lower return.

School  graduates  who  already  have  access to a  promising  career,  and  who  lack  interest or proficiency in  university  subjects,  may  end up being both richer and happier if they forgo university and pursue  the job already available to them. Different people and different situations will call for different decisions, and only you (and your family) can know what is the right decision for you. University does not only cost money, but it also comes at a significant opportunity cost in time and effort. For many people, the benefit will more than compensate them for the cost and lost opportunities, but there is no single right answer for everybody.

Dr John Humphreys is the executive director of the Professional Research Institute for Management and Economics (PRIME) and economics lecturer at the Royal University of Law and Economics (RULE). Dr Humphreys has worked on a PhD thesis focused on Education in Cambodia.