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TECH TALK: Doing Education Right: Thinking ROI

May 3rd, 2007 · No Comments

By Atanu Dey

The absence of universal basic literacy and education is a constraint on present economic performance and future growth. Doubtless, education is costly but the opportunity cost of not having an education is even higher. The old adage about a stitch in time saving nine holds with special force in the case of basic literacy. Heres the argument. At most one generation requires help in becoming literate; the children of literate parents are overwhelmingly literate; and the children of illiterate parents are more likely to be illiterate compared to those of literate parents.

Therefore, the earlier an intervention is made in ensuring universal literacy, the cheaper it is, for a growing population. At Indias independence, of the 350 million about 240 million were illiterate. If a big bang approach had been taken and the entire population were made literate within three or four years, it would have perhaps cost (in todays terms) around US$24 billion, and the problem of literacy would have been solved half a century ago. By going at it half-heartedly and piece meal, many multiples of that sum has been spent over the last half century, and yet the number of illiterates has increased to 350 million. We are forever falling behind by not putting enough resources to solve the problem.

If India had solved the basic literacy issue by the mid-50s, it would have developed more rapidly. It would have had a lower population (population of developed nations grow less rapidly), the aggregate wealth of the country would have been higher, and per capita incomes and wealth would have placed India in the running. Even now it is not too late and it is quite possible to make India fully literate within three years, provided the political will is there. The returns on that investment would have been staggering.

Both at the micro and at the macro level, return on investment (ROI) in education is positive. In other words, the net present value of the increase in the lifetime income of the person is greater than the cost incurred in educating the person. National spending on education is akin to investing in productive assets such as roads, ports, factories and power plants.

One immediate implication of the positive ROI in education is that it makes sense to borrow the money required for education as long as the ROI on education is lower than the interest rate which in most cases it is if the labor markets are not distorted and if there are no information failures.

The other implication is that higher education does not require public financing if the credit market is complete. In the case of a person whose parents can afford to pay for his college education, clearly the credit market is complete: the person implicitly borrows from the parents for the education and the returns accrue to the family. It is easy to see that the ROI must be positive, because it is universally true that people systematically educate their children.

That has an important public policy impact: public financing of higher education is not required; all that is needed is to make credit available to those who face a credit constraint. Give loans to all those who seek, and qualify for, higher education, and which loans are repayable over a suitable period upon employment. Thus, for example, IITs and IIMs can be entirely self-funded instead of being subsidized by the public. More importantly, by removing the subsidies and allowing the capital markets to provide the credit required, the market for education will efficiently provide adequate supply to meet the demand.

Which brings us to the question: if the market can solve a severely supply-constrained education system, why is the market not allowed to function in the education sector? Lets look at that the next time.

Write to atanudey at gmail.com if you have questions or comments.

Tomorrow: The Rent-Seekers


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