chapter 09 development economics

7/29/2019 Chapter 09 development economics

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Chapter 9 Education, page 1 of 8

why is education important to development?

1. so far, labor has been considered a homogeneous good inthe production function; however, effective labor inputdepends on the skills labor has (human capital), which

depends partly on education (note, however, that it isdifficult to establish a causation between education andhigher income/development)

2. from a policy standpoint, there is under-investment insome education sectors that have a high rate of returnand over-investment in some sectors that have a low rateof return; there is pressure to invest in certain levels ofeducation although sometimes the rates of return at theselevels of education are lower than are available elsewherein the economy

3. even if education were not important for productivity, it isstill an important part of the economy because muchinvestment, labor, etc. goes into it; education isdemanded for greater productivity/income and also as agood for consumption

4. education plays an important social function; througheducation students acquire the idea of citizenship, modernoutlooks, etc.; education could change behavior favorablyfor development (for example, female education is

negatively correlated with fertility, which could be due toan attitudinal relationship)

page 324, table 9-1 statistics about education:

levels of schooling vary as expected with income level

(PPP) in 1995:

GDP percapita(PPP)

adultilliteracy

enrollment ratio in highereducation (beyond secondaryschooling)


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$12,000+ 5% 59%

enrollment in primary education is not as responsive to

income above $1,000 per capita (PPP); all income groups

have net primary education enrollment ratios greater than90% except the


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public expenditure on education across countries (such asfrom $25 to $4,500 on education per pupil for primaryeducation); these differences in expenditure are partly dueto differences in cost among countries but also the quality of

educational resources thus, when assessing education, notonly is the enrollment rate important but also the quality ofeducation

the age-earnings profile:

the age-earnings profile shows the average income at

different ages of workers with different levels of education;

the age-earnings profile for Mexico in 1963:

9 years of schoolingaverageearnings 8 years of schooling

E301 year of schooling

200

10 15 30 60 age (years)

the worker with one year of education (or a primaryeducation, depending on how the graph illustrates schooling)earns 200 pesos per month at age 10, which increases withage (as maturity, experience, strength increase) until it topsout, after which it decreases slightly (as working abilitydecreases)

this graph can also be illustrated using primary schooling,

secondary schooling, and post-secondary education:


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college/post-secondaryeducationaverageearnings secondary schooling

E30 primary schooling

10 15 30 60 age (years)

the different curves illustrate different wages at the same

ages due to different education levels; for example, E 30,marked on the graph above is the difference in wagebetween a worker with 8 years of schooling and a workerwith 1 year of schooling at age 30; the graph can be used todetermine the absolute amount of the expected difference in

wage at all ages this is useful when measuring the returnsto education

estimating the returns to schooling and cost-benefit analysis:

the returns to schooling can be estimated by 1) discounting

to the present earnings over time and 2) considering theforegone income by individuals who enroll in school insteadof working

for example, if one individual enters the workforce at age 10

with primary education and another enters the workforce atage 15 with secondary education, then the vertically shadedarea is the foregone income (the cost) of the individual whoattends secondary school; for the same individual, theadditional income (the net benefit) of attending secondaryschool is the horizontally shaded area:


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averageearnings secondary schooling

primary schooling

10 15 30 60 age (years)

an individual will determine whether to attend secondaryschool by comparing the present discounted value of costswith the present discounted stream of benefits

calculating the present value of the benefits of additionaleducation:

the present value of the benefits of additional education inyear t is given by page 333, equation 9-1:

t

tt

oi

EV

)1( +=

Vot = the present value of the benefits of additional

education in year t

Et = earnings increment in year tdue to the additionaleducation

i = the interest ratet= the number of years the earnings must be

discounted to the present

for instance, the present value of the difference in earningswith a secondary education versus a primary education 30years from the present is given by:

3030

sec

3030

)1( iIIV

primaryondary

o+

=

Vo30 = the present value of the benefits of additional

education in year 30I30

secondary = the income earned with a secondaryeducation in year 30


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I30primary = the income earned with a primary education in

year 30 (note that I30secondary - I30

primary =E30)i = the interest rate30 = the number of years the earnings must be


the overall additional earnings stream of getting additionaleducation must be added up over all years, which is given bypage 334, equation 9-2:

= +

=n

tt

t

i

EV

1 )1(

V= the present value of the total incremental benefitsof additional educationEt = earnings increment in year tdue to the additional

educationi = the interest ratet= the number of years the earnings in year tmust be


similarly, the present value of the costs of getting a

secondary education is given by:

= +

=n

tt

t

i

CC

1 )1(

C= the present value of the costs of additionaleducationCt = the costs of additional education in year t; thisincludes foregone income (the vertically shaded areaabove) and also explicit costs (such as school fees, etc.)i = the interest ratet= the number of years the costs in year tmust be


the analysis of cost can be done on both a private andsocial basis (a social analysis would include costs notborne directly by the family, such as governmentexpenditure, that are not considered in a privateanalysis)


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to determine whether to invest in more education, the

family will compare the present values of the benefits andcosts:

if the present value of the costs is greater than the

present value of the benefits, then the family will notinvest in additional education:

== +

>+

n

tt

tn

tt

t

i

E

i

C

11 )1()1(

if the present value of the benefits is greater than thepresent value of the costs, then the family could investin additional education (although there could be otherinvestments with higher returns they should use theIRR method to determine if additional education is thebest investment):

== +

chapter 09 development economics

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