Positive Returns on Investment
Education has positive returns. That claim is certainly not the most extravagant generalization about education that one can make. It is true unless of course hundreds of millions of people over centuries have been systematically paying for education and not fully recovering their investment.
An investment is an expense in the present which pays benefits in the future. The discounted net present value of the future benefits has to exceed the present costs for an investment to be rational. The fact that people invest in education – whether their own or their children’s – strongly indicates that this is so. If it is individually rational to invest in education, then collectively as a society it is also rational to invest in education. These are obviously reasonable propositions. So why do some people and some societies fail to invest in education is a question worth asking.
One factor that enters the calculus of cost/benefit analysis of activities that have a temporal dimension is the discount factor. A discount factor is like a personal interest rate which is distinct from the interest rate that one gets from, say, putting money in the bank. If the discount factor is greater than the bank interest rate, then it is rational to not put money in the bank and instead just consume it in the present. In other words, the more present consumption is weighed heavily relatively to future consumption, then you can say that the future is discounted heavily. If one faces a very uncertain future, then one has to discount the future. Or if the present needs are extremely pressing, then also one has to discount the future.
Let’s take a concrete example. Should I plant that tree? Suppose it will cost me Rs 100 today to buy the seed and all the resources that will be needed for growing the tree. Suppose further that when fully grown in 20 years, the tree will sell for Rs 1000. Assume that I have only two investment options: plant tree or put the money in a fixed deposit. If the bank interest rate is less than 3.5 percent a year, clearly I should plant the tree. Now let’s introduce uncertainty. What if there is some chance that the tree will die before reaching maturity? What if I were to die before 20 years? Each such factor will increase the discount rate that I will use to calculate whether to plant the tree or not.
Someone who is not well-off (however defined) in the present is likely to have a high discount rate for the future. But even when one does not have a high discount rate, it is possible for the person to not make the investment because of what is called a “credit constraint.” Indeed, my definitive test of a poor person is whether the person is credit-constrained or not. The sufficient condition for someone to be poor is to be credit-constrained. Only he is poor who is unable to borrow. You could even be in heavy debt but as long as you have the ability to borrow money (and this will only happen if the lenders know that you will be able to repay the loan), you are not poor.
Back to education and the question of why some don’t invest in education.
Education has positive return on investment as one suspects from just looking around. So if some fail to do so, it could be for a number of reasons. First, incomplete information. That is, one does not know that it pays to invest in education. This is “information failure.” Second, one knows but one does not have the money to invest in education. This is “credit constraint due to incomplete credit markets.” Third, one knows the benefits and has the money but the schools don’t exist. This is “education supply constraint.”
Each of these failures bear a bit of investigation. And I hope to make the case that in the present world, none of these are unsurmountable. Indeed a bit of pondering will reveal that our dismal education system and its pitiable results are quite fixable if only we have the right policies in place. Let me get to that the next time.