Is A University Degree A Good Investment?

The EconomistThe EconomistThe returns to investing in a university education vary enormously.

IS A university degree a good investment?

Many potential students are asking the question, especially in countries where the price of a degree is rising, as a result of falling government subsidies. Recent research suggests that the conventional wisdom remains true: a university degree pays handsomely. In America and the euro zone, for example, unemployment rates for graduates are far below average. Yet the benefit of university varies greatly among students, making an investment in higher education a risky bet in some circumstances.

The value of a degree, like so much else in economics, boils down to supply and demand. The gap between average pay for university graduates and those with secondary-school degrees is commonly called the “college wage premium”. When firms are hungry for skilled workers their demand for university graduates grows, and the premium tends to rise. When the supply of graduates grows faster than that of less-educated workers, in contrast, the premium will stabilise or fall.

Though the demand for graduates varies slightly from country to country, the trend across the rich world is clear. For at least a century firms have sought to hire ever more of the best-educated workers. The college wage premium, however, has bounced around, as the number of graduates has not grown so evenly. In America, the big premium graduates earned in the early 20th century melted away in the post-war years as universities churned out ever more of them. In the 1970s things shifted again. The supply of university graduates had been growing roughly five percentage points faster each year than that of high-school graduates; by the 1990s the gap had shrunk to less than two percentage points. The wage premium duly began to rise again.

The share of people attending university was slower to rise in other rich countries but has caught up rapidly in recent decades. Older American workers are much better educated than their peers elsewhere in the rich world, according to data from the OECD, a club of rich countries. Younger Americans are comparatively undistinguished (see chart). Elena Crivellaro, of the University of Venice, notes that from 1990 to 2005 university enrollment rose by almost 50% in Nordic countries and by more than 30% around the European periphery. In America enrollment growth was about 26%.

So rapid was the change in some European labour markets that they became “saturated” with new graduates, reckons Ms Crivellaro. This saturation has combined with generous minimum wages to keep the college wage premium relatively flat in Europe. Graduate premiums rose in the 2000s in France, Ireland and especially Britain, she calculates, but fell in Germany. In 2011, the OECD says, American graduates earned 77% more a year than those who completed secondary school, compared with 57% in Britain, 47% in France and just 25% in Sweden.

Over the course of a working career these premiums add up impressively. Christopher Avery of Harvard University and Sarah Turner of the University of Virginia estimate that between 1965 and 2008 the discounted present value of a college education in America, net of tuition fees, rose from $US213,000 to $US590,000 for men, and from $US129,000 to $US370,000 for women in 2009 dollars. Most of the increase occurred before 2000. A number of studies conclude that most of the past generation’s rise in inequality within the American labour force (that is, among all workers, and not just between the top 1% and the rest) is attributable to the rising premium on a college education.

Yet despite these impressive statistics university may still look a gamble. In many rich countries students are paying more for their education–and borrowing more to do so. Between 1993 and 2012, the share of American graduates taking out student loans rose by 25 percentage points and average debt per borrower doubled, after adjusting for inflation.

That is worrying, in that investment in higher education, though lucrative on average, yields highly variable returns. The pay-off hinges on many factors, beginning with the name of the institution issuing the degree. A recent study by Payscale, which monitors trends in compensation, calculated the expected financial return from graduating from almost 1,500 institutions of higher education. For grand places like Caltech and MIT the 30-year return on a bachelor’s degree is around $US2m. But attending institutions near the bottom of the list actually diminishes earnings. Graduates of Valley Forge Christian College can expect to be made $US148,000 worse off for their trouble.

Graduated risk

The subject of a degree also matters. Jonathan James of Cal Poly, San Luis Obispo, found that the college premium in America ranges from 125% for engineering graduates, for whom demand seems endless, to 40% for students of psychology or social work.

And at least some of the college wage premium reflects the rising importance of postgraduate study. The premium earned by biology graduates is relatively small once those with postgraduate degrees (often in medicine) are stripped out. A recent study reckons that the premium earned by postgraduates relative to college graduates was virtually nil in America in 1963 but had risen to roughly 27% by 2010. Much of the increase occurred in the 2000s, when the premium for a bachelor’s degree leveled off whereas that to postgraduate credentials kept rising. Recent figures from Britain show a similar trend.

On the whole, a university education remains a reliable money-spinner. But as with most investments, it pays to be discerning. There is no guaranteed windfall for all who don cap and gown.

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