The following article is from our recently-released Education Special Issue from April 2020. More information about this issue is available HERE.

What is education? What is its purpose, its value? Many readers may already have an opinion on the answers to such questions. But in economics, the answer is not clear. Indeed, there are two main competing theories and bodies of evidence, both theoretical and empirical.

Some economists would tell you that the purpose of education is to increase the ‘human capital’ of the student, which a normal person may refer to as skill. An educated citizen should, therefore, emerge from education as a more productive worker than they would otherwise have been. Thus, they can earn more in a better job, and society as a whole benefits because its average labour productivity has risen. 

On the other hand, we have the increasingly popular ‘signalling’ theory of education. Under this explanation, a citizen has an underlying ability – and therefore productivity – level, and education does not change this. Instead, education is obtained merely as a signal of a citizen’s productivity level. 

Those of higher ability find education naturally easier to progress through, and therefore obtain more education. Firms then prefer to hire those with more education because it is impossible for a firm to observe a worker’s true level of productivity. 

Applying some common sense, it should not be controversial to claim that both theories contain an element of truth. I would contend that the younger an individual is, the more the human capital theory applies; a PhD student probably is not becoming more productive through education as quickly as a child learning to read and write. 

What is controversial is the extent to which each theory does apply. Attempts to determine this are readily available in the economic literature, and, unfortunately, require more depth than your columnist has space for in this issue of Bournbrook. However, it is interesting to discuss what the implications of different answers to that question are. 

Putting aside for a moment the nuanced middle ground, and considering the extremes, what would we infer from the human capital model being the correct theory of education? Well, in this case, we would expect that having a widely more educated society would raise the overall productivity of society, bringing benefits in the form of better living standards to everyone. 

Education for one person would improve the lives of others, too. Moving to the signalling model, we would attain a different result. Education would not raise productivity, and, therefore, the gains from being educated would accrue primarily to the recipient of education rather than to the whole of society. 

From a policy perspective, the human capital explanation implies that the taxpayer should fund a lot of education in order to ensure the positive spillovers benefit society. The signalling explanation implies students largely derive the benefits from their own education, and thus the taxpayer should fund less of it. 

So to what extent does each explanation hold? Obviously, this question is partly subjective and does not have a clear-cut answer. The OECD have previously published research into the private net benefits (those accruing to the student) and public net benefits (those accruing to wider society) derived from tertiary, or higher, education. The data was for 2010, and showed that the private net returns were significantly greater than – almost double, in fact – public for the UK. 

Since then, the tuition fees paid by UK undergraduates have more than tripled, however taking this into account, the figures would still show significantly larger net private than public returns. This appears to contradict the idea that the government should fund more of higher education, while validating, to some extent, both models of returns to education. 

The dominance of gross private returns over gross public returns suggests signalling does indeed play a large role in education, but the significant public returns imply that education for one person does still improve the productivity and welfare of society as a whole.

There are, of course, many other factors to consider when attempting to determine what level of funding the government should give to education. Culture, equality of opportunity, and education as a positive thing in and of itself should all be mentioned.

Additionally, the evidence considered in this article relates only to higher education – and, as mentioned previously, I believe there is a strong case that earlier education has a significantly stronger human capital effect, and thus should be funded much more generously by government. 

There is also to be strong heterogeneity in the returns to higher education depending on the university or other institution, as well as on the course. Nobody would contest that degrees which often see their students become doctors offer unusually high levels of social benefits. 

Despite the limitations of the frame-work and evidence, the strong case it makes for some level of signalling being present in education poses interesting questions. Can the signalling process be simplified, made shorter, or less costly? Can education, particularly tertiary education, be transformed to build human capital more than it does? 

These questions do not have obvious answers. Figuring them out could revolutionise the education system – and, perhaps, society – forever. 



Photo from Pxhere.