Tertiary education was quite a theme in the recent election campaign. In my household – with three kids likely to go to university in the next decade – promises to reduce the direct costs of tertiary education were tempting. But resisting temptation remains a virtue.
A few days ago I noticed (thanks to Jim Rose) this chart
It isn’t a new result. These OECD data have shown for some time that the economic returns in New Zealand to getting a degree are pretty low relative to those in other advanced countries. Such results even prompted Treasury to commission some external research on the gap in private returns.
In the chart – from a few years ago – whoever put it together has highlighted two groups of countries: the Nordic and Benelux countries on the one hand, where there are already lots of skilled people, and high income taxes, and former eastern-bloc countries which are now catching up to the rest of the advanced world, and where skills are in high demand, and able to command high returns. I’m, of course, more interested in the contrast between New Zealand and those central European countries. As I’ve written recently, 25 years ago both we and they were looking to reverse decades of poor performance and catch-up with the other advanced countries. They’ve made progress in that direction. We haven’t.
Since the net benefits are shown in dollar terms (rather than, say, as a per cent of GDP per capita or of lifetime earnings), it is probably reasonable to expect that poorer countries will be bunched towards the left of the chart. And there one finds Turkey, Greece, New Zealand and Italy. But that clearly isn’t the bulk of the story. After all, even though they are now catching up, all six of the former eastern bloc countries shown still have levels of GDP per hour worked and/or GDP per capita similar to or (generally) below, those of New Zealand.
I had a look at a few background documents from the OECD. If anything, as we shall see, the New Zealand numbers may be even worse than what is shown in this chart.
It is important to recognise the distinction the OECD draws between private and public costs and benefits. Some of these things can be easily measured (eg upfront private fees, or direct public grants to institutions or individuals). Others are more approximate. (The other aspect, which I’m not sure any of these particular indicators attempts to account for is the selection bias, in which the typical person who undertakes tertiary study has other traits – eg intelligence – that mean that they would probably earn more in the labour force than the average person who does not undertake tertiary study.)
This chart is from a few years ago, and tries to break down the costs of tertiary education (in this case for a man). In New Zealand, as in most countries, the largest private cost by a considerable margin, is the foregone earnings of the student themselves.
These OECD indicators assume that students do not work while studying. In the latest OECD Education at a Glance they show estimates for 15 countries as to how much difference it would make to include reasonable estimates of actual student earnings. For New Zealand, doing so would lift the estimated returns to tertiary education by around 15 per cent, more than for most of the other countries shown. However, as you can see from the first chart above, a 15 per cent lift in returns to tertiary study in New Zealand would not alter our relative position on the chart.
The other aspect of the calculations which often doesn’t get much attention is the appropriate discount rate to use in making these calculations. It matters a lot – the costs are mostly incurred between, say, ages 18 and 22, and the economic benefits accrue over decades. A decision by an individual is a very long-lasting investment project, with significant irreversibilities (the years spent on education can’t be reclaimed).
The OECD at present adopts a very low discount rate.
The NPV results presented in the tables and figures of this indicator are calculated using a discount rate of 2%, based on the average real interest on government bonds across OECD countries. However, it can be argued that education is not a risk-free investment, and that therefore a higher discount rate should be used.
I’d say there was no ‘it can be argued” about it. No sensible government would do a cost-benefit analysis of building more schools or universities using a discount rate of 2 per cent. The New Zealand Treasury, for example, uses a default discount rate of 6 per cent real. And as an economic proposition, an individual’s tertiary education is a pretty risky proposition, with few effective diversification options for most people.
As it happens, in the latest Education at a Glance the OECD presents a table illustrating, to some extent, what difference it makes to use a higher discount rate.
Using a discount rate of 5 per cent (real) reduces the estimated benefits by around 60 per cent (relative to the 2 per cent baseline) – and these numbers are for a man, and in most countries the net benefits to tertiary education for a woman are (on average) lower than for a man.
This issue matters particularly for New Zealand which has a higher risk-free interest rate on average than any of the other countries in the table. The gap is large. On Friday, the real interest rate on the New Zealand government’s longest (23 year) inflation-indexed bond was 2.39 per cent, while that for the US government’s 20 year indexed bond was 0.77 per cent (and US yields are far from the lowest in the world). A margin of 1.5 percentage points above “world” rates hasn’t been a bad guide for New Zealand interest rates over recent decades.
Even a 5 per cent real discount rate appears too low to evaluate a personal decision to invest in a tertiary education in New Zealand. But if one takes the results for New Zealand in the table above when evaluated at a 5 per cent discount rate, and then compares them against the results evaluated at 3.5 per cent for other countries (to capture that persistent difference in real interest rates), only Latvia would offer lower returns to tertiary education than New Zealand does.
And bump up the discount rate a little more and the estimated net returns to tertiary study will soon be approaching zero or going negative. And, remember, those estimates are for a man. The average female returns are even lower.
People will have a range of reactions to these sorts of numbers. Some will take them as supporting proposals to reduce tertiary fees or increase student allowances. Such changes might increase the net private returns to tertiary education, but they won’t (of course) change the all-up net returns (someone still has to pay). Others seem to see tertiary education as some sort of “merit good” that people should have the opportunity to undertake, at moderate expense, whether there is an economic return – to them, or the public more generally – or not. And, of course, for some people and some courses, a tertiary education is more akin to consumption than investment (which is not intended as a criticism).
For me, I see them as yet another marker of the failure of the economic strategy pursued by successive governments over recent decades. Our remoteness means it is very difficult to generate consistently high returns to anything much in New Zealand for very many people. The determination of our governments to quite rapidly increase the population here, despite those apparently limited opportunities, just compounds the problem. It does so directly – the limited natural resources (our one distinctive advantage) are spread over ever more people – and indirectly, through a persistently overvalued real exchange rate and high real interest rates.
Returns to tertiary education in New Zealand are probably quite reasonable for those New Zealanders who get an education here, and then leave (but that is probably a poor investment for the taxpayer). For many of those who stay, it looks like a distinctly marginal proposition. Attempting to bring in lots more skilled people from abroad – most of whom aren’t that skilled anyway – just compounds the economic problem, even if the New Zealand taxpayer doesn’t have to pay anything for their tertiary education. There just aren’t the good economic opportunities here for a rapidly growing population, and increasing subsidies to tertiary education would seem likely to further exaggerate the evident imbalances.
In an economy that was making progress towards reversing decades of relative economic decline, there is good reason to expect that returns to investment in tertiary education (like other prospective investment returns) should be consistently high relative to those in other countries. Sadly, those returns appear to be consistently low in New Zealand – especially when evaluated at an appropriate discount rate. And, of course, we are making no progress at all in closing those productivity gaps.