Classic Under-Investment

A work colleague of mine recently raised a question about why so many young people opt out of school early and never pursue any further education afterwards. For them, any sort of economic reward or incentive to invest in them just won’t be met with enthusiasm. “Why then should governments waste taxpayer’s money encouraging them to do so?” she asked.

It is a classic under-investment problem, I answered, involving the accumulation of human capital where despite the provision of services, an underwhelming take-up rate on the part of students is the response. Of course the irony is that in the developing world, there is no shortage of people that would be interested in training that would lead to better employment outcomes. For example, in this published paper that I wrote back in 2007, I found that the college participation rates in the Philippines were the same as in Australia, despite a lower proportion of GDP dollars being publicly spent there on tertiary education.

Society is worse off if the potential productivity and availability of skills is not realized due to this under-investment in human capital. So back to the original question, should the government spend greater effort in encouraging a larger proportion of young people to remain either in school or post-school education for longer if they apparently do not seem all too keen?

In answering that, it is best to examine the way we frame the problem first. The traditional approach is based on a rational interpretation of human behaviour, in which the choice of the individual must be respected at all costs, in that only he or she can determine what is best for him or her, and if that means less schooling, then so be it. An alternative based on a behavioural perspective however provides a different set of lenses to appreciate the problem more fully. From this perspective, there are several reasons why individuals may behave irrationally.

The first is that humans tend to over-estimate their abilities. This overconfidence leads them to settle for a sub-optimal level of schooling. Youths with an artistic bent might drop out of school believing they can successfully break out in creative careers. Teen couples do so believing too much in their ability to conquer the difficulties of raising a family. Others who are delinquent believe in their ability to lead a lifestyle outside the law. You get the picture.

The second reason is that humans have a present-bias. Meaning, time has a way of distorting decisions that involve the weighing of costs and benefits, especially when costs have to be borne in the near term for some future benefit. Like the problem of saving for retirement or improving one’s health and fitness, under-investment in education and training is the result of people putting more importance to the present to the detriment of the future.

The third reason is the commitment problem. Even when individuals decide to undertake training, they often fail to follow through with their commitment. The phenomenon of starting but never finishing--call it “buyer’s regret”, “cognitive dissonance” or the lack of persistence; individuals face an uphill battle when it comes to sticking to their commitments particularly because of overconfidence (which in this case is the overconfidence to complete what they signed-up for) and present-bias (putting off assignments until the last minute).

Finally, there is the information problem that youths encounter when making career choices. What occupation suits them? Which one will be most rewarding? What type of course to take, and which institution to register with? These are difficult decisions to make because they are infrequently faced, so the person cannot benefit from experience (or hindsight) in making them. Even the potential for social learning or gaining advice from one’s elders who have encountered making such decisions before can be obstructed due to personal biases. 

With all these problems facing the individual, it is probably a wonder why anyone makes the right decision. It certainly provides the rationale for the state to stimulate greater demand for education and training. In this endeavour, there are two possibilities. The state can deal with either the front end or the back end of the cohorts coming through. The back-end involves nudging youths of school-leaving age to persist in school through career advice and greater access to information and varied training opportunities.

The front-end means intervening in early childhood as a way of affecting values and preferences. As this study showed, good quality kindies matter in determining the long-run earning capacity of pupils. The results of such a study are quite controversial, but I think that the reason early intervention works and has a long-lasting impact has more to do with instilling a love of learning and imparting a sense of wonder about the world in kids that sticks with them throughout life and keeps them engaged in school much longer than would otherwise be the case.