Atanu Dey On India's Development

Education Matters — Part 2

I think it is fair to make the claim that development and economic growth are positively correlated with how educated the population is. It is also fair to say that the returns to education are positive. There are important implications which arise from the latter.

Positive returns mean that the total stream of benefits arising from an activity exceeds the cost incurred. That is the most succinct economic reason for undertaking an activity: the benefits – psychic, economic, social, public, private, etc. – summed over an appropriate time scale exceeds the total costs. Easily enough stated but sometimes all the variable are not trivially accountable. It is hard to figure out the various components of the costs and benefits, and more importantly it is hard to figure out which is the appropriate time horizons over which the calculus should apply. A short-term calculation may show that a certain activity is not recommended, which conclusion could well be reversed when considered in the long run.

Let’s start off with a specific case of a specific activity and explore it to lend support to some general points. At the risk of sounding ego-centric, I will use my education as the activity. It had a cost – both private and public – and it has yielded (and will continue to yield) stream of benefits both private and public. First, the costs. There were some private costs which were borne by my family. They spent their private time and money out of their pockets to pay for part of my education. I too spent time; time which has an opportunity cost. I could have been doing some menial work and adding to my family income instead of going to school. That needs to be added to the account for the private costs.

Aside from the private costs, there were public costs. My family did not pay full price for my education. The government picked up part of the tab. Of course, the government did not actually pay since the government does not have a private source of income. The government took resources from others and subsidized the cost of my education. In other words, the general public paid for part of my education and I think the major part of the cost was paid for by the public. I, and indirectly my family, benefited from this subsidy which was achieved through a transfer of resources (taxes.)

Adding up the private and public components of the costs gives us the “social” cost. A rough estimate of the private costs in my education is (in today’s terms) about Rs 1 lakh (or $2,000) and the public costs around Rs 60 lakhs (roughly $140,000). The public subsidy, I estimate, was around $60,000 (five years in engineering and a masters degree in computer sciences) given by the Indian taxpayer, and around $80,000 given by the taxpayers of NJ (I studied computer science at Rutgers for 2 years) and CA (got my PhD in economics at Berkeley). The social cost of my education was mostly public, therefore, since very little of it was private.

{Disclaimer: The numbers are approximate and the exact figures do not materially alter the conclusions I wish to draw. Also, it may be tedious to go through all this, I assure you that there is a point to all this.}

Now on to the benefits. Like the costs, the benefits can also be distributed as private and public, and the sum of the two is the social benefits. The private benefits are easy to account for. Had I not acquired the skills during all those years in school, I would not have been able to earn the mega bucks (just kidding) I earn today. Let’s just say that the difference between my lifetime earnings I would have had had I not gotten all those degrees, and the expected lifetime earnings after the degrees is perhaps in the millions of dollars – far greater than the private costs of around $2,000. The returns to the private investment in my education, thus, is not just positive, but astoundingly positive.

What about the public benefits? Because of my education, I am a more productive worker and hence create more stuff than I would have had I not been educated. Though it is hard to quantify, I add some amount of wealth to society. It is trivially true that I must add more wealth to the society than what I am paid as salary. This is so because what I produce must be worth more to my employer than my salary. (I am fudging just a little bit because otherwise this already long discussion will become even longer.) The difference between my salary and the total wealth I produce is what is the public benefits of my existence. Add the private and public benefits, and we arrive at the social benefits.

Now here is the punch line. If the social benefits exceed the social costs, then society is better off investing. And, if private benefits exceed private costs, then a private person is better off investing. In my case, both conditions obtain. Society is better off for having subsidized my education and my family is better off for having invested a little in my education.

This brings us to the stage where we can do some “what ifs.” What if, for instance, private costs exceeded private benefits but the social benefits exceeded the social costs? Clearly, society would have benefited from the activity, but the private person would not have undertaken the activity. That is, the private party is unable to “capture” sufficient amount of social benefits to offset the private costs. The policy prescription is then that society must subsidize the private costs so that the net benefit to the private party is positive.

Illustrative numerical example:

* Private Cost: $1,000
* Private Benefit: $800
* Social Costs: $2,000
* Social Benefit: $8,000

The private person will only lose $200 if he makes that investment. But if he does not make the investment, then society will lose $6,000, the net benefit to society foregone. So it would be better for society to give a subsidy of at least $201 so that the private costs come down below $800. Note that giving this subsidy does not change the net benefit to society. By reducing the private cost, society gains $6,000.

The other “what if” is more important and has tremendous relevance for a country like India. What if there is a credit constraint? Let’s do the numbers again but this time have benefits exceed costs in both private and social accounting.

* Private Costs: $1,000
* Private Benefit: $4,000
* Social Costs: $2,000
* Social Benefits: $8,000

Clearly, the private person will invest and society will be better of for that. But what if the person does not have $1,000 to invest? Then the person will not do the investment and society will have a net loss of $6,000. The policy prescription is therefore simple: loan $1000 to the person to invest in the activity at an interest rate such that the total interest cost is below the net private benefit.

If you have stuck with me so far, I think it is only fair that I conclude this one for now with this thought. People do gain net benefits from investing in education, and so does society at large. In our case, we who are fortunate enough to be surfing the web and reading blogs, we have the money to invest in education or we have been privileged enough to get subsidized education, and are reaping the benefits of that education. But unlike us, the poor are credit constrained. They too would privately benefit from investing in education, and society too will benefit from having them being educated, but as it happens, the poor cannot afford to make that investment.

The way forward is straightforward: give loans to people so that they will invest in education.

The next time I will go into where the resources for these loans should come from, and why it should be priority number one.

  • http://kshetrajna.blogspot.com Acharya

    Dear Atanu,

    Lovely analysis!

    I too have been thinking of subsidies in education these past few days, what with the IIMs going in for fees hikes of Rs. 20K a year.

    Why did the IIMs settle on such a paltry hike when it is public knowledge that most students go in for bank loans to pay the fees and that what they earn in one year (post-degree) is more than enough to write off the loan twice or thrice over?

    Will there be a credit shortage if the IIMs decide to hike the fees to the level where there is no subsidy (and gasp, even a margin)?

    Regards.

  • An investor

    Would appreciate a straight answer on this question – Is for-profit primary education ( Standard 1 thru 10 ) illegal in India ?
    ie. is there a law in IPC that prevents somebody from opening a primary school in India as a for-profit company ?

    I know India has the largest for-profit education giants in grad, postgrad, professional & exam-tutorial fields eg. NIIT, Aptech, Brilliants, Agarwal etc. NIIT I am told is the largest for-profit IT education chain in the whole world. So what prevents them from opening a for-profit primary school ?

  • Patel

    Insightful post. Am I correct to assume that you have included all the risk associated with investing in a person (ex. they could die on graduation day) in the private and social costs?

    If so then you would have to create something similar to say a car insurance company that determines who gets loans and what size they would be. Trusting the government with such a complex task is probably not the best course of action. Subsidies can work, just not in India.

    I look forward to reading about where these resources should come from and who should be responsible for distributing them.

  • http://www.suhitanantula.com Suhit Anantula

    To An Investor:

    My understanding is that according to the laws in India you cannot start a for-profit school in India.

    Suhit

  • Patel

    Insightful post. Am I correct to assume that you have included all the risk associated with investing in a person (ex. they could die on graduation day) in the private and social costs?

    If so then you would have to create something similar to say a car insurance company that determines who gets loans and of what size. Trusting the government with such a complex task is probably not the best course of action. Subsidies can work, just not in India.

    I look forward to reading about where these resources should come from and who should be responsible for distributing them.

    I have a weird idea of my own. Create something similar to a bond. Say a person, who doesn’t have to be indian, invests a 100 dollars in this certificate. This 100 will be distributed amongst the educational costs of say 10,000 students. As these 10,000 individuals move into the labour force they begin paying taxes. A percentage of this tax revenue can be given to repay the 100 dollar investment. Or perhaps this certificate can be thought of more as a stock that pays dividends for as long as the person who holds it (many ways to tinker with this).

    This will give people in other countries an incentive and a means to educate indians!

  • Abhijat

    Dear Atanu,

    I hope you do incorporate temporal and population scales into the analysis. You are quite aware of the overall costing weaknesses as put in the second paragraph. The extra characteristics I would seek in the solution are below.

    (a) Most of us are not perceptive enough to appreciate the intangibles that actually suggest the strongly positive returns of Education. To turn this around introduces the time factor to gauge the effectiveness of any proposed solution.

    (b) Those who perceive are usually already educated. This fraction must increase. A multiplier effect must be introduced into the solution to make it effective.

    Provisions can be introduced into the overall solution to provide private and public incentive to address these independent of any appeals to ideals. For instance, one way would be to convey the knowledge in local languages rather than teaching the populace into English and making knowledge accessible. That this could be a way to increase the gain by reducing the cost needs to be thought over as a possibly another “what if’s”.

    - Abhijat

  • http://reason-blog.blogspot.com Subhas

    Atanu,

    I see the maestro of analysis at his best! So analytical, and so lucid, it may be called, “The Case for Loans in Education”

    Some people know in general that education benefits society. But, how exactly and in what way, they are not sure. Not fully the case for those in development circles. Your article elucidates how education benefits, with beautiful examples. I always like examples with numbers!

    I wish you write incisive analysis on everything that matters for India – the more on matters that matter the most, leaving away superficial posts. Even if you post a gripping analytical article once a week on a fixed day, you would be doing a lot.

    I would suggest a topic: “Productivity of a person is what makes him and his country well off. Why does then, a teacher, a lawyer, a doctor, and any person in service sector of the economy in India, earns many many times lesser than their US counterparts, despite performing the same work?”

    Warmly,
    Subhas.

  • http://rebuildindia.blogspot.com Subhas

    Atanu,

    ‘Education and Economics’ might be another good title/tag.

    Subhas.

  • http://kartik.sulekha.com kartik kannan

    Hi,

    I am Kartik Kannan at Sulekha.com (www.Sulekha.com) and I’m writing to you about your blog.
    Before I proceed, let me apologise for this unsolicited comment in your blog. I googled for good Indian blogs and found yours.
    Ok, now to why am I writing to you? I’m compiling a list of the best writings in Indian blogosphere and showcasing them on Sulekha.com. Sulekha (means ‘good writing’) has been encouraging good writers and showcasing great writing for well over 6 years.
    I want to include your blog entries on Sulekha by creating a parallel blog for you. By creating a parallel blog on Sulekha Blogs, you can dramatically boost the number of people viewing your posts and commenting on them.
    To know more click here

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    Team Sulekha

  • RPatel

    Hi Atanu,

    Really nice analysis.

    But one thing I want to address here is the fact that, what if a person work for other country like (USA, UK, Australia etc) after pursuing his/her study in India. Does our society get benefit from this?

    -RPatel

  • Anon

    Restoring Bengal – by Sitaram Yechury

    http://www.hindustantimes.com/news/181_1667876,00120001.htm

    He defends the CPI(M)’s work in Bengal.

  • Pingback: Intellect » Blog Archive » Education in India

  • vishal

    Mr. Kartik Kannan

    You people are commenting on all Indian blogs, you say you are compiling a list. What you are doing is just to make money out of the good bloggers work, go and do some productive things.

  • JP

    An Investor,

    The Govt perpetuates poverty and all other problems with its pernicious policies.

    Regarding your question on primary education, Suhit is right, Education has to be non-profit. However, Kerala uses a different model, which allows private participation, hence the highest literacy. Details at: http://ccsindia.org/people_pjs_lae.asp

    Regards,
    JP.

  • JP

    Dear Patel,


    Am I correct to assume that you have included all the risk associated with investing in a person (ex. they could die on graduation day)

    My 2 paisa on this.. there is no risk involved in investing in a person. Even if there is, it is insignificant and imperceptible. When you consider a single individual, yes, a person might die, but, if we invest in 100 people, what is the probability? I’m sure it would be less than 10 power -20.

    When talking about risks in investing, we should cover the entire gamut of investments to put things in proper perspective. Lets say the Govt wants to spend money on a bridge. What is the risk involved in that? It might collapse due to natural calamities. It might collapse due to extremely poor construction standards. What is the probability of the death of a single individual vs the collapse of a bridge – with the same investment?

    Lets say, a bridge costs 100 crores, if that 100 crore is spent on education, how many people can be educated? A few thousand? What would be the economic output of these people vs the economic output of the bridge. And it is single bridge – the probability of a collapse (equiv to death) is incomparably higher than the probability of death of a few thousand people.

    I’m not saying that bridges are totally unnecessary, but the most important resource for a country is education. Bridge is just an example. This *theory* can be extended to everything that we invest on. Putting things in proper perspective, will set our focus. What we should concentrate on.

    Investment = evaluation of risks and returns

    Please do note that I know nothing about economics, hence if my arguments sound absurd, please do forgive. Everything about economics, I learnt on this blog, from the inimitable analysis of Atanu. Just trying to use Atanu’s methods. The master would be a better judge whether I am learning correctly or not. :)

    Warmest Regards,
    JP.