Education: Is money spent on students wasted?

Received wisdom is that we need more graduates. They raise productivity and help UK Ltd to compete globally. But economists question that argument, says Andrew Lilico. Perhaps a degree is no more than a signal you're a top person.

Higher education numbers have been increasing in recent years. From the early 1970s until 1988 the proportion of 18 to 21-year-olds going to university was approximately stable, with about one young person in seven entering full-time higher education.

Then the Conservative government decided to increase participation, and now about one young person in three goes to university.

By 1994 the United Kingdom had the highest proportion of new graduates in the European Union. We had more than twice the proportion in Italy, Austria or Greece and about twice that in Germany, France, Sweden, Portugal, and Belgium. The proportion was much higher even than in Korea and Japan. The popular idea that the UK has fewer graduates than our international partners is just incorrect.

At this year's Labour Party conference Tony Blair and David Blunkett promised a significant increase in student numbers, and argued that that was why tuition fees were required. Sir Ron Dearing made the same point. His report recommended that student numbers be permitted to increase from the current one in three to 45 per cent. This was the main recommendation in the Dearing report, and the other recommendations were designed to make this increase possible.

Politicians often claim that we must increase participation in order to compete internationally. But why? We already have more graduates than most of our competitors. Why do we need more? And in any event, does having more graduates really improve a country's economy? Graduates earn more than non-graduates, even allowing for differences in innate talent. Doing a degree increases one's income across a working life. That more than makes up for earnings lost during the three or four years of study. A graduate would expect to earn some 11 to 14 per cent more each year as a result of doing a degree. But why are graduate salaries higher? One view goes like this: students learn new skills which increase their productivity when they come to work. Their higher wages reflect their higher productivity. They have become better workers as a result of studying and hence get paid more. Economists call this a human capital view of education.

If the human capital view is correct then increasing participation would, indeed, improve the UK economy in the sense that overall productivity would be higher. Thus the UK could expect higher growth rates. Expansion would be economically justified as long as these higher growth rates were worth the cost today (in lower GDP) of teaching more students and losing their productive output for three or four years. That calculation is called the social rate of return.

However, there is another view popular among economists, developed precisely to model higher education. On this view higher education does not improve the productivity of students. Rather (given basic skills such as literacy and numeracy) productivity depends on innate features of people, such as conscientiousness, intelligence, health, luck, and instinctive creativity. The point of higher education is to allow students to signal their innate quality to potential employers.

Higher education does not improve innate features. Rather, being intelligent, conscientious, etc, enables one to get on to a degree course and complete it. Hence employers know that a graduate will be of a certain quality, and will expect graduates to be of higher quality than non-graduates. Pay rates will reflect this quality assessment.

An accounting recruiter considering applicants might think to herself, "This candidate was at Cambridge. He must be clever. Let's try him out." Whether the degree was in physics or politics does not matter. The recruiter is not interested in specific skills acquired at university, which are of limited relevance to real-world business anyway. She cares only about the candidate's innate potential. This candidate has signalled that he is of high quality by taking a degree.

If signalling offers a good account of higher education then although the individual student gains a lot from studying, the UK may gain nothing. Since higher education is not improving students' productivity, increasing student participation rates may not increase the UK's growth rate. Then the social rate of return is nil, and all the money spent on higher education is, from an investment point of view, wasted.

There may, of course, be other justifications for higher education. For example, it may improve the general cultural environment, making people more sophisticated and better able to appreciate art and literature. However, if this signalling model is correct there is no economic justification for it.

Signalling might currently contribute to the economy, by enabling employers to match the best people to the best jobs. Then increasing participation could even have a negative social return. As numbers increase, talented people will no longer be able to signal merely by possessing a first degree. Since more people have first degrees, one way to signal oneself as of higher quality is to take a further degree at masters or doctorate level.

Thus, not only does raising participation waste money educating people with little human capital return, but it also encourages the most productive people to stay out of employment for extra years. That problem is well- known in the US (one of the few OECD countries with even more graduates than the UK), where they call it "credentialism".

Surely graduates quote their degrees on their CVs to indicate that they are of "graduate calibre" as well as to indicate the acquisition of particular skills. Forty per cent of graduate vacancies are "any discipline" and many later jobs ask for someone "of graduate calibre". Signalling must be a significant factor in higher education.

In recent years many politicians have portrayed more higher education as an obviously better thing, if only the country could afford it. But that view ignores the economic model of signalling. Since signalling behaviour is so prevalent, raising participation would not only be a waste of money - it would be damaging to the economy. Therefore increasing student numbers further is not economically justified.

Andrew Lilico is a freelance economics writer and was formerly an economist at the Institute for Fiscal Studies and the Institute of Directors.