On the monetary value of an education, and bad statistics

The case that education pays is often made by comparing the income of people who graduated against the people who did not. The result is compelling.

But there are numerous problems with such naive statistical analysis:

  • Kids from wealthy families are much more likely to attend college. Moreover, we expect kids with wealthy parents to earn more than their peers irrespective of their education. So you have to compare the income of individuals with similar backgrounds.
  • While I have apparently the same economic background of many of my peers, I pursued a Ph.D. because I was ambitious. Meanwhile, ambition is probably a great predictor for income, irrespective of your level of education. This personal drive is difficult to measure statistically, but you should at least compare individuals with similar expression of ambition (such as grades in high school).
  • Even with the same ambition and background, kids have different genetic material. Thus, not only do we want to compare kids with the same background, and the same internal drive, but we must also compare individuals with similar genes.
  • Is it fair to compare the yearly salary of a lawyer who has been working 60 hours a week, sacrificing his family and personal life, with that of a secretary working 40 hours a week? Minimally, you should compare the hourly rate.
  • Going to college is costly, both in a loss of potential income and in tuition. The cost of the education must be deducted from future income. This explains why earning a Ph.D. is usually a bad financial investment.
  • Going to college is costly, both in a loss of potential income and in tuition. The cost of the education must be deducted from future income. This explains why earning a Ph.D. is usually a bad financial investment.
  • Arum and Roksa careful document in Academically Adrift that students are not really learning much in college.

Nevertheless, the historical value of education as an investment has been great, even though most naive studies overestimate its value.

But one critical error remains: Can you predict the future based on the past, by naively assuming that the past will be like the future? My bank still claims in its brochures that I can expect yearly returns of 8% on my investments. They have nice plots showing how much investing a little bit right now is enough to become a millionaire in 30 years. And indeed, the annual return on investment from 1950 to today is around 7%. So anyone who invested massively in the 1950s is probably wealthy right now. But the return on investment in the first decade on the twenty-first century has been negative. Some people have made a fortune with their investments lately, but most people have lost money! Is it safe to predict that, eventually, the 1950s will come back? Nobody knows.

Maybe the job market is different? Maybe the market for young college graduates is relatively static and easy to predict? No. The number of university graduates has doubled in the West since 1990, and tripled in Asia. We are undergoing a massive transformation. Brown et al. (2008) warn us that the fast expanding supply of highly trained graduates, both locally and worldwide, will soon push the wages down:

Investment in high skills will not create the high skilled, high waged economy of the future.
The equation “higher education” = “high wages” may fail. Effectively, this has already happened with Ph.D.s in many fields (see Don’t become a scientist by Katz). The promise of good jobs to those who study hard may be broken:

(…) the competition for good, middle-class jobs is now a worldwide competition—an auction for cut-priced brainpower—fueled by an explosion of higher education across the world and a fundamental power shift in favor of corporate bosses and emerging economies such as China and India. These drivers of the new global high-skill, low-wage workforce threaten the livelihoods of millions of American workers and their families. Fighting for a dwindling supply of good jobs will compel Americans to devote more time, money and effort to set themselves apart in a bare-knuckle competition that will leave many disappointed.

With the financial market, the solution is to change our expectations: you risk becoming very unhappy if you expect a rate of return of 8%. Similarly, I think we will soon need to change our expectations regarding degrees. More and more smart graduates will be unemployed, or underemployed. They will need to work long hours to keep lesser jobs. The college degree may become merely one of the assets a brilliant kid may use to succeed.

16 thoughts on “On the monetary value of an education, and bad statistics”

  1. Really not sure about this, Daniel. Your argument at the end, for example, seems to rely on an assumption that the supply of highly skilled people increases while demand stays constant, which seems like quite the assumption.

    In general, it’s unclear what you are attempting to argue here. There is economic inefficiency when people do not have the skills and education to work at their full potential, correct? Are you trying to argue that it is a more common and serious problem that people are educated beyond the point of diminishing returns than people not getting a chance to get an education that allows them to work to their full potential and level of productivity?

    If I am still missing your point, can you clarify?

  2. Your argument at the end, for example, seems to rely on an assumption that the supply of highly skilled people increases while demand stays constant, which seems like quite the assumption.

    Let me quote Brown et al. :

    “The problem for the proponents of the knowledge economy is that the evidence fails to support the argument that today’s economy requires a significant, let alone exponential, increase in demand for high skilled workers.”

    I urge you to read their paper for yourself (I link to it in my blog post).

    In general, it’s unclear what you are attempting to argue here.

    Firstly, that people overestimate the value of higher education by comparing apples to oranges.

    Secondly, that the assumption that the college is a great investment may fail to be true in the future, just like investing in the stock market has stopped being a great investment.

    Are you trying to argue that it is a more common and serious problem that people are educated beyond the point of diminishing returns than people not getting a chance to get an education that allows them to work to their full potential and level of productivity?

    I am not saying that you should not invest in the stock market. I am also not saying that you should not get an education.

    However, I am saying that getting a degree, and then expect to have an easy time on the job market, may be risky. Maybe you should tame your expectations and plan for a tough job market in 2030 for college graduates.

  3. The core assumption of the argument is exponential growth in supply and non-exponential growth in demand for highly skilled workers. That seems like quite an assumption.

    In my read, the paper makes strong claims off weak evidence. It admits highly skilled labor demand grows with supply for most of the last few decades, but then extrapolates from a short-term trend during the recession of 2007-2009 to argue that the demand has stalled (e.g. Figure 8). Again, that seems like quite the assumption. The author assumes the long-term trend is gone based on a few years of data during an abnormal economic period.

  4. I agree with your fundamental concepts: there might not be as many desirable jobs in the near future, stock returns might be anemic. The problem is one of alternatives, though: as bad as it may become for the educated, it’s likely to be worse for the uneducated. Similarly, pulling savings out of the stock market doesn’t remove risk, it just exposes you to different ones (inflation).

    I don’t think the lesson is “college might not be worth it”, but “college is necessary but not sufficient in most cases”.

  5. @Benjamin

    a very small percentage of high-wage earners skew the many of the higher numbers

    I should have addressed this point. We are not only interested in the average income, but also in its distribution. If you are risk-averse, you will want to know how the lower 10% are doing.

    Multiple professional degrees in multiple disciplines make a person often uniquely qualified for particular types of work and invaluable – taking them off the standard pay scale altogether.

    Right. This may be a good strategy. As degrees become commonplace, you go and you earn several of them. Of course, it increases the cost of your education dramatically. If you end up making an “ordinary” salary, you will lose out in the end.

  6. There are significant outliers in these kinds of statistics as well, like the fact that a very small percentage of high-wage earners skew the many of the higher numbers, and these people tend to get professional degrees of some sort. This is a symptom of the higher-income families. Consider an executive at a private, possibly family-owned firm making $20K – $30K / month and the impact that has on some of these numbers. That situation is predestined.

    There is an enormous argument that a large part of the reason most education succeeds is exposure to the industry and peer-group that will be the eventual target of employment. In other words, it isn’t what you know or even what grades you get – but who you know. This is especially true after about 2 – 5 years post-graduation – where many young people find the head-start additional or superior education may have given them evens out with a lot of other people.

    Finally – I have a lot of personal experience with people who have more than one professional degree and are considered experts in multiple disciplines. This multi-disciplinary education strategy is, in my experience, the best way to get your money’s worth out of an education. Multiple professional degrees in multiple disciplines make a person often uniquely qualified for particular types of work and invaluable – taking them off the standard pay scale altogether. My brother, for instance holds degrees in Economics, Law, and Biochemistry.

  7. Totally agree with you here. Getting a PhD for more money is most certainly a bad decision. Just as buying a house is a poor way to save money. In both cases you may benifit, but on average you will lose and end up in frustration.

    It is only worth if you are scientifically minded person with proclivity to research, who can ENJOY an academic type of job.

    There is also another problem: degree inflation.
    As one commenter astutely noted:

    The problem is one of alternatives, though: as bad as it may become for the educated, it’s likely to be worse for the uneducated.

    Actually, this is already happening in many professions. E.g., in economics, they all want either masters with experience, or the PhDs without.

    The Wall Street tycoons would hire people with PhDs in math and physics.
    PhD is becoming a professional degree.

  8. @Ranku

    Everyone should have a plan B and a plan C, and heck!, a plan D, these days. This is especially true if you want to study Physics. There are fields where getting a Ph.D. makes sense, by the way. Get a Ph.D. in accounting or marketing and I can assure you that you will get a good job.

  9. @gregbo

    many young kids entering the computer field view forming their own companies as a practical alternative to earning advanced degrees

    Here is an interesting experiment. Let us compare individuals who completed a degree with those who started a company of their own. Both require a lot of work, initiative, and learning.

    How do the entrepreneurs fare compared to the college graduate?

  10. There is a growing movement towards entrepreneurship as part of education. Certainly, many young kids entering the computer field view forming their own companies as a practical alternative to earning advanced degrees (and even baccalaureates in some cases).

  11. The income and unemployment statistics are misleading IMO. One thing these statistics don’t take into account, particularly for science, is that PhDs spend longer times in grad school and post-docs than ever. Sure, they get a job at the end with an above average income, but it hardly makes up for the opportunity costs. Some people I know with PhDs in the sciences are barely getting their first job in their mid 30’s. This is after up to 7-8 years in graduate school at $25K/y then years in post-docs at $30-35K/y. If we work out the opportunity costs, the graphs could take on a different meaning.

    These people stuck in the science pipeline are treated as little more than hands in the lab. They have little time to learn much else than their narrow subject and have little entrepreneurial spirit. Their only hope is a salaried position, running a company is something they don’t even think about.

  12. Good article. Good food for thought. Overall very well written and positive. Only one caution: stay away from the argument about genetic inheritance. It’s a slippery slope to arguments about racial superiority. Excellent presentation of concepts and my opinion about ‘genes’ in no way detracts from the astute observation you make in regard to statistics.

  13. 1. While we would expect children of wealthy families to earn more money than others, such is not necessarily the norm. They tend to be much less ambitious than their parents.

    2. When it comes to wealth, grades tend to be a poor indicator of success. If we accept the definition of a millionaire as (value of total assets – value of primary residence)>$1,000,000, then most millionaires in this country are small business owners. Yes, many come from the professions that require advanced degrees, but a large portion have just a high school diploma and some college. Their ambition is shown in their net worth and not their income.

    (This comment was edited.)

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