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EDUCATING AMERICA:
AN INVESTMENT FOR OUR FUTURE

A Report by the
Council of Economic Advisers and the
U.S. Department of Labor

September, 1995

EXECUTIVE SUMMARY

The educational level -- that is, the number of years of completed formal education -- of the U.S. workforce has risen, both over the long-term and over the past twenty years. Test scores have been increasing in the United States, especially for minorities. At the same time, U.S. students compare unfavorably to those in many other nations on tests of math and science achievement.
More educated workers earn more, and the gap between earnings of high school and college graduates has more than doubled over the past 15 years. In 1994, the median full-time worker with at least a bachelor's degree earned 74 percent more per week than the median full-time worker with only a high school degree; this figure was only 38 percent in 1979.
Since education raises the earnings and productivity of workers, it contributes to overall economic growth. Evidence from cross-country comparisons generally supports the conclusion that education contributes to growth.
The weight of evidence indicates that Head Start and other compensatory preschool education programs improve subsequent school achievement. Evidence is not yet available to provide a full evaluation of "school to work" programs, but the initial evidence is favorable.
Education and training pay off for workers who have already entered the labor market. Worker training is generally an essential ingredient of high-performance workplaces.
Programs that make education cheaper or more available appear to increase the amount of educational attainment.

EDUCATING AMERICA: AN INVESTMENT FOR OUR FUTURE

Investments in education yield greater dividends today than ever before. The following is a survey of the overwhelming evidence regarding the benefits of education to American workers and to our nation's economy, and the importance of assuring affordable access to higher education.

I. THE EDUCATIONAL LEVEL OF THE U.S. WORKFORCE HAS RISEN IN RECENT YEARS.

American workers now have more years of formal education than ever before. Recent years have seen the continuation of three heartening trends.

First,

Chart A

Second, more high-school graduates are attending college. Since 1980, the percentage of 18-24 year old high-school graduates who were enrolled in college has increased from 30.5 percent to 41.6 percent. [See Chart B] As new workers have replaced older, less educated workers, the share of the labor force with a college degree has also increased, from 16 percent in 1973 to 29 percent in 1993. [See Chart C]

Third, total graduate-school enrollment has grown almost as rapidly as undergraduate enrollment, in percentage terms, over the past two decades; growth in graduate enrollment for full-time students has been much faster than in undergraduate enrollment.

The result of these three trends has been a more educated labor force: average years of education per worker climbed from 11.8 in 1973 to 13.0 in 1990.¹ [See Chart D]

Test scores have also risen, although they remain unimpressive by international standards. Over the past decade, test scores in mathematics, science, and verbal skills have generally risen for children of almost all ages and racial and ethnic groups. These test-score gains have been largest among African American students. Despite the gains, there remains room for further improvement: U.S. students continue to trail students from most other industrialized nations on international achievement tests in math and science. [See Chart E and F]

II. FORMAL EDUCATION CREATES SUBSTANTIAL ECONOMIC BENEFITS,
BOTH FOR THE INDIVIDUAL AND FOR SOCIETY.

More educated workers earn more, and the gap has doubled over the past 15 years. In 1994, for example, the median full- time worker with at least a bachelor's degree earned 74 percent more per week than the median full-time worker with only a high school degree; this gap was only 38 percent in 1979. The rewards to education and training are one of the most well-established findings in economics.² Positive returns to education and the recent increase in returns have been documented for a wide rangeof foreign nations, as well as for the United States.³ [See Chart G]

Establishments with higher levels of education have higher productivity.⁴ A nationally-representative survey found that an establishment whose workforce has an average education 10 percent (that is, slightly more than one year of schooling) above that of similar establishments has productivity about 8.6 percent above similar establishments.

Labor demand in high-skill occupations is increasing. Taken together, the two trends noted above -- the greater numbers of college graduates, and the increasing earnings gap between college and high-school graduates -- suggest that demand for higher-skilled workers must have increased in recent decades. And indeed, occupational evidence supports this view. From 1984 to 1994, whereas employment growth in occupations whose workers have low levels of education was only 7 percent, employment growth in high-skill occupations was an impressive 32 percent. The increases in employment in high-skill occupations presumably would have been even larger if there had not been an increase in the wages of skilled workers relative to unskilled. [See Chart H]

There is some debate about the cause of the correlation between education and earnings. One problem is that people with high ability are disproportionately likely to receive above- average education, but would also have been disproportionately likely to receive high wages even if they had not received so much education. In addition, education can pay off for an individual because education is a credential that signals high ability, even if little is learned at school.

Nevertheless, much of the evidence indicates that the economic rewards to education accrue because schooling actually makes students more productive as employees, and not primarily because schooling screens out low-ability students.

One recent study

⁵

Another study examined identical twins, who obviously share similar family characteristics and identical genes, and found that each year of additional schooling raises later earnings of the more-educated twin by about 13 percent.⁶

A third study found that each additional year of schooling due to compulsory-schooling laws raises earnings by 8 percent (although statistical problems limit the precision of this estimate).⁷

III. EDUCATION CONTRIBUTES TO ECONOMIC GROWTH.

New evidence emphasizes that education is an important determinant of the speed at which the economy as a whole grows. A large body of literature has shown that countries with the highest initial levels of education in 1960 or 1965 typically grew the fastest in subsequent decades.⁸ One recent study, in trying to pinpoint just how education makes its contribution, has shown that countries with better-educated labor forces are better able to take advantage of technologies developed in other countries;⁹ this factor is likely to have contributed to the growth successes of Japan and the East Asian newly industrialized countries. Sketchier evidence suggests that even within countries, states and regions with better-educated labor forces grow more rapidly.¹⁰ A well-educated workforce can also raise the productivity of R&D (for example, because new innovations are implemented more quickly), encouraging the technological improvements that are the crucial ingredient in long-term growth.

The cross-country evidence for an education growth effect can best be thought of as augmenting the other evidence on the returns to education. The central difficulty with these cross- country analyses is that countries that "got education right" also got many other things right. That is, countries with high levels of education tended to be those with high investment rates, low inflation rates, a strong export orientation, and stable political systems -- all of which are believed to contribute to growth. As a result, disentangling these factors to determine which of them has contributed most is no easy matter. Still, most growth economists believe that in combination with other factors, education plays an important role.

Educational improvements have contributed significantly to postwar economic growth in the United States. If we accept the proposition that more educated workers are paid more because their education makes them more productive, then we can estimate education's growth effects directly by measuring increases in the educational attainment of the workforce. Using this method, the Bureau of Labor Statistics estimates that between 1963 and 1992, improvements in education added 0.3 percentage points per year to the growth rate of GDP -- meaning that education accounted for about 20 percent of per-capita income growth over that period. This estimate depends crucially on the assumption that the earnings effects of education equal its effects on the economy's productivity. To the extent that returns to education are associated with credential screening and signalling, then 0.3 percentage points is an overestimate; but if education has positive spillovers, then the actual contribution of education may be even greater. Training and on-the-job learning also contribute to economic growth, although we have no estimates of the magnitude of these effects.

Educational improvements for lower-skilled workers can help ensure that they benefit fully from economic growth. Factors that contribute to growth, such as technological advancement and increased trade, sometimes benefit higher-skilled workers disproportionately. The computer advances of recent years, for example, have probably contributed to economic growth while simultaneously shifting labor demand toward the high-skilled workers who can best use the new technologies. To keep lower- skilled workers from being left behind by growth, it may therefore be necessary to increase their levels of education and training.

IV. LEARNING THROUGHOUT THE LIFE CYCLE HAS HIGH PAYOFFS.

Head Start and other compensatory pre-school programs have substantial economic payoffs. Pre-school programs, such as Head Start, can give a persistent boost to academic achievement. Compared with other students with similar characteristics, graduates of Head Start-style programs are less likely to be held back in school, less likely to be classified as special-education students, and more likely to graduate from high school. As a result, the program appears to yield net benefits not only for participants but also for the taxpayer.¹¹ Critics of Head Start- style programs have noted that although the programs substantially increase the IQ test scores of participant children relative to non-participants, this test-score advantage disappears by the end of grade school. But studies that have looked beyond this narrow measure of intelligence show that despite the erosion of IQ test-score effects, these programs do raise future academic achievement.

School-to-work programs can improve student outcomes. Recently, substantial governmental efforts have been devoted to strengthening the link between high schools, community colleges, and the workplace. Although these efforts are in many cases too recent to have produced results that can be evaluated rigorously, preliminary results are encouraging. For example, California's vPartnership Academies, which combine high-school education with career-focused training and work experience, have apparently been quite successful in reducing dropout rates among program participants.¹² More definite results are available for established programs targeted at high-school dropouts, such as the highly successful Center for Employment Training in San Jose.

Education and training for experienced workers have economic benefits as well. One recent study concluded that each year of education provided through a Pennsylvania program for older displaced workers increased earnings by some 7 percent.¹³ And a recent study of the Job Training Partnership Act, a Federal program providing training for economically disadvantaged clients, found that participation increased the earnings of adult males by 10 percent and the earnings of adult female participants by 15 percent. These earnings gains were one and a half times greater than the costs invested to produce them.¹⁴ [See Chart I]

Firm-provided vocational training has positive economic impacts for participants and employers. For workers, a year of either on-the-job or formal training raises wages by about as much as a year of college education.¹⁵ There is also evidence that firm-provided training leads to productivity gains. A survey of small manufacturing firms in Michigan that received training grants from the state government found that the additional training provided by manufacturing firms significantly raised productivity.¹⁶ Another study of formal training programs in manufacturing firms found that firms that introduced training programs in 1983 had productivity growth that was 19 percent faster, on average, than at other firms.¹⁷

Some evidence suggests that training is most effective when combined with other innovative workplace practices. In practice, companies that train their workers well tend also to have adopted other innovative practices -- for example, pay systems that reward productivity, as well as management structures that give frontline employees the ability to suggest and implement improvements in the product and workplace.¹⁸ Several studies suggest that taken together, these policies are particularly effective.

Evidence of the effectiveness of these human-resource practices comes from a variety of industries. In manufacturing, a multiyear study of steel finishing lines showed that plants using highly innovative human-resource management systems (i.e., that had incentive-based pay and employee involvement as well as training) had the highest productivity: these plants were in operation 98 percent of scheduled time, compared with only 88 percent of the time at companies with traditional work practices.¹⁹ Another study concluded that high-involvement steel minimills not only excel in quality and productivity but also enjoy lower employee turnover.²⁰ Moreover, these results are not unique to the steel industry. A comparison of productivity in several industries in the U.S., Germany and Japan found that adopting best-practice production processes generally required extensive worker training.²¹ A worldwide study of the automobile industry found that a coordinated change to an involvement-oriented human resource system can simultaneously improve product quality and productivity.²² Studies of the electrical components industry and of companies with flexible manufacturing systems have found similar results.²³

Although most of the detailed studies are in manufacturing, these policies also appear to yield benefits in service industries. One study of 850 publicly held service companies discovered that these work practices correlated with a significant reduction in employee turnover and with 16 percent higher sales per employee (controlling for capital per worker and research and development spending), higher annual cash flow, and increased market value of the company.²⁴

V. FAMILY INCOME AND TUITION COSTS AFFECT EDUCATIONAL OPPORTUNITIES.

Borrowing constraints mean that college costs may have a particularly large effect on educational attainment. If capital markets functioned perfectly, any student for whom the expected returns to education were greater than the interest rate would be able to borrow enough to cover tuition and living costs. Thus low- and high-income students with similar abilities would be expected to enroll in college at similar rates. But in practice, future earnings are far less effective as collateral than are physical assets such as houses. As a result, before federal guarantees, students could not generally borrow enough to cover the costs of education. Thus college costs matter more than they should: even when costs are low enough to make education a good investment for a low-income student, they may be too high for him or her to stay in school. A variety of evidence suggests that by easing the borrowing constraint, government can substantially increase educational enrollments.

Lower college tuition leads substantially more students to enroll in college. The net cost of college education appears to have a substantial impact on the likelihood of college enrollment for low-income students. For example, one recent study has found that students from states with low public-university tuition levels are more likely to attend post-secondary education than students from other states, even after controlling for a wide variety of other factors that could cause this difference.²⁵ The effect is stronger for low-income students than for high-income students, consistent with the hypothesis that borrowing constraints do indeed constrain educational attainment.

Government aid can also play an important role in driving down the cost of college, and thus inducing more students from low-income families to attend. For a variety of reasons, students from low-income families may be particularly averse to taking on the high level of indebtedness associated with borrowing for college. Consistent with this, there is a substantial amount of evidence that for low-income students, the availability of grant aid strongly increases the likelihood of participation in further education.²⁶

The low levels of educational attainment of low-income students (caused both by borrowing constraints and by other risk factors) are costly in terms of lost future productivity. For poor children, rates of school completion and advancement to post- secondary education are much lower than for other children. For example, children who experience poverty between the ages of 6 and 15 years are two to three times more likely to drop out of high school than are students who never experience poverty. A recent study commissioned by the Children's Defense Fund, which added up the costs of low educational achievement for the 14.6 million poor children in 1992, estimated that each year that these children spend in poverty costs the economy somewhere between $36 billion and $177 billion in reduced future productivity and employment. (Again, these estimates assume that the productivity benefits of a year of education are as large for poor students as they are for the average student.)

VI. CONCLUSION

A quality education is a key determinant of an individual's future economic well-being and is a critical ingredient for this nation's future economic health and strength. The evidence on this score is overwhelming.

The economic returns to education for America's working men and women have risen dramatically. In 1979, the median full-time worker with at least a bachelor's degree earned 38 percent more per week than a worker with only a high school degree. By 1994, that difference had grown to 74 percent.
Since education raises the earnings and productivity of workers, it contributes to overall economic growth.
The evidence shows that compensatory preschool education programs such as Head Start improve subsequent school achievement. The evidence is not yet available to provide a full evaluation of "school to work" programs, but the initial evidence is favorable.
Education and training pay off for workers who have already entered the labor market. Worker training is generally an essential ingredient in the adoption of high performance workplaces.
Programs that make education cheaper or more available appear to increase the amount of education.

In the words of Benjamin Franklin: "An investment in knowledge pays the best interest."

Given the strong evidence pointing to the positive impact that education has on the lives of American workers and our economy, our nation must renew its commitment to these investments. Abandoning our commitment to education -- especially at a time when the future standard of living for American workers and the strength of the American economy depends on an educated workforce -- is shortsighted and could have long- term damaging consequences to this nation's economic health and strength.

¹ U.S. Department of Education, National Center for Education Statistics, Digest of Education Statistics, 1994; and U.S. Department of Labor, Bureau of Labor Statistics, Labor Composition and U.S. Productivity Growth, 1948-90, December 1993.

² Willis, Robert, "Wage Determinants: A Survey And Reinterpretation of Human Capital Earnings Functions," in Orley Ashenfelter and Richard Layard, eds., Handbook of Labor Economics, Volume I, Elsevier Publishers, 1986.

³ Psacharopoulos, George, "Returns to Education: A Further International Update and Implications," Journal of Human Resources, Volume 20, Fall, 1985; and Freeman, Richard B., and Lawrence Katz, "Rising Wage Inequality: The United States vs. Other Countries," in Freeman, Richard B., ed., Working Under Different Rules (New York: Russell Sage Foundation), 1994.

⁴ Lynch, Lisa, "The Other Shoe: Characteristics of Human Capital Investments and their Pay-offs to Employers," working paper, National Center on the Educational Quality of the Workforce, University of Pennsylvania, 1995.

⁵ Kane, Thomas J. and Cecilia Rouse, "Labor Market Returns to Two and Four-Year College: Is A Credit a Credit and Do Degrees Matter?", American Economic Review, Vol. 85, No. 3, pp. 600-14 (1995).

⁶ Ashenfelter, Orley, and Alan B. Krueger, "Estimates of the Economic Returns to Schooling From a New Sample of Twins," American Economic Review, December 1994. Other studies of twins have found smaller, but still positive, effects.

⁷ Angrist, Joshua and Alan Krueger, "Does Compulsory School Attendance Affect Schooling and Earnings?," Quarterly Journal of Economics, Vol. 61, No. 4, November 1991.

⁸ See, for example, Barro, Robert J., "Economic Growth in a Cross Section of Countries," Quarterly Journal of Economics, Volume 106, May 1991; and Mankiw, N. Gregory, David Romer, and David Weil, "A Contribution to the Empirics of Economic Growth," Quarterly Journal of Economics, Volume 107, May 1992.

⁹ Benhabib, Jess, and Mark M. Spiegel, "The Role of Human Capital in Economic Development: Evidence from Aggregate Cross- Country Data," Journal of Monetary Economics, Vol. 34, 1994.

¹⁰ Holtz-Eakin, Douglas, "Solow and the States: Capital Accumulation, Productivity, and Economic Growth," National Tax Journal, Vol. 46, No. 4, 1993.

¹¹ Barnett, W. Steven, "Benefits of Compensatory Preschool Education," Journal of Human Resources, Vol. 27, No. 2, Spring 1992.

¹² Hayward, Becky, and G. Tallmadge, Evaluation of Dropout Prevention and Reentry Projects in Vocational Education, draft final report, Research Triangle Institute, November 1993; and Stern, David, et al., "Benefits and Costs of Dropout Prevention in a Program Combining Academic and Vocational Education: Third- Year Results from Replications of the California Peninsula Academies," Educational Evaluation and Policy Analysis, Vol. 11, No. 4, 1989.