Education and Economics: Disciplinary Evolution and Policy Discourse 0198082258, 9780198082255

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Education and Economics: Disciplinary Evolution and Policy Discourse Saumen Chattopadhyay

Print publication date: 2012 Print ISBN-13: 9780198082255 Published to Oxford Scholarship Online: January 2013 DOI: 10.1093/acprof:oso/9780198082255.001.0001

Title Pages (p.i) Education and Economics (p.ii) (p.iii) Education and Economics

(p.iv) Oxford University Press is a department of the University of Oxford. It furthers the University’s objective of excellence in research, scholarship, and education by publishing worldwide. Oxford is a registered trademark of Oxford University Press in the UK and in certain other countries Published in India by Oxford University Press YMCA Library Building, 1 Jai Singh Road, New Delhi 110001, India © Oxford University Press 2012 The moral rights of the author have been asserted First Edition published in 2012 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, without the prior permission in writing of Oxford University Press, or as expressly permitted Page 1 of 2

Title Pages by law, by licence, or under terms agreed with the appropriate reprographics rights organization. Enquiries concerning reproduction outside the scope of the above should be sent to the Rights Department, Oxford University Press, at the address above You must not circulate this work in any other form and you must impose this same condition on any acquirer ISBN-13: 978-0-19-808225-5 ISBN-10: 0-19-808225-8 Typeset in Bembo 11.5/14 by alphæta Solutions, Puducherry, India 605 009 Printed in India at G.H. Prints Pvt Ltd, New Delhi 110 020

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Dedication

Education and Economics: Disciplinary Evolution and Policy Discourse Saumen Chattopadhyay

Print publication date: 2012 Print ISBN-13: 9780198082255 Published to Oxford Scholarship Online: January 2013 DOI: 10.1093/acprof:oso/9780198082255.001.0001

Dedication (p.v) To my Maa, Baba, and my wife Somdatta In heaven or on earth You inspired me and gave my dreams a flight (p.vi)

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Tables and Figures

Education and Economics: Disciplinary Evolution and Policy Discourse Saumen Chattopadhyay

Print publication date: 2012 Print ISBN-13: 9780198082255 Published to Oxford Scholarship Online: January 2013 DOI: 10.1093/acprof:oso/9780198082255.001.0001

(p.viii) Tables and Figures Tables 3.1 The Spectrum of Private and Public Good 69 6.1 Classification of Public Good: The Conventional Approach 162 6.2 Total Benefits of Education 165 6.3 Revisiting the Concept of Education as a Public Good: The New Approach 167 8.1 Coordinating Institutions and Their Activities 224 8.2 Options for Public–Private Partnership 242 8.3 Structure of Regulation in Education Market: Structure–Conduct– Performance Model 259 9.1 Human Development Index and Educational Attainment: A Comparative Perspective 269

Figures 2.1 Choice of Discount Rate 29 2.2 Equilibrium Levels of Investment in Human Capital 43 6.1 Private Demand and Social Demand: Accounting for Externalities 163 6.2 Triangle of Publicness 170 8.1 Funding Systems 226

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Foreword

Education and Economics: Disciplinary Evolution and Policy Discourse Saumen Chattopadhyay

Print publication date: 2012 Print ISBN-13: 9780198082255 Published to Oxford Scholarship Online: January 2013 DOI: 10.1093/acprof:oso/9780198082255.001.0001

(p.ix) Foreword Over the past two decades, economic concerns have become central to an understanding of educational policy and practice. Some of the major policy issues in education around the world are either driven by or refer directly to economic matters. Issues such as privatization, school choice, and educational access and equality are of course by their very definition economic. But what is now abundantly clear is that such concerns as educational goals, curricular choices, pedagogic approaches, and assessment regimes also involve economic considerations. Educational goals, for example, are now increasingly debated in terms of the contribution they should make to private and public goods. Curricular choices are often predicated on assumptions about knowledge and skills that the changing nature of work and economy demands. Innovations in pedagogic approaches often depend on the ways in which resources are allocated and managed. Assessment of educational outcomes is also now framed within economic terms—in relation to the extent to which an individual has been prepared to meet the requirements of employment. The Organisation for Economic Co-operation and Development’s (OECD) Programme for International Student Assessment (PISA), for example, tests students in more than 80 countries to determine the extent to which they have the skills to be ‘workready’. Reported every three years, national comparisons in PISA score attract much public attention, and serve to (p.x) perpetuate the idea that education is largely about economic purposes and national productivity. A market orientation to education appears to have become globally ubiquitous, foregrounding the economics of education as never before, reinforced through the global circulation of ideas, people, and of course capital. Indeed, globalization itself is often assumed to be an economic phenomenon, concerned with global movement of money and production. Not surprisingly, therefore, comparisons of educational systems conducted by international organizations Page 1 of 3

Foreword such as OECD, World Bank, and United Nations Educational, Scientific and Cultural Organization (UNESCO) are now primarily couched in terms of the extent to which nations are able to prepare their students to become globally competitive. In the developed world, educational reforms are now increasingly structured around a discourse of the global economy. Within the developing world, the language of structural adjustment has become commonplace, as policymakers struggle to devise ways of reforming educational provision in competitive terms. Education is now increasingly framed in terms of the formation of human capital considered necessary for national development and improvements in economic productivity. In current debates about skills formation, it is the ‘economically useful’ skills that are most prized. What is clear then is that a basic knowledge of economics of education is now essential for an understanding of the profound shifts that are taking place in education around the world. Whatever one might think about educational changes driven by a ‘market orientation’, it is no longer possible to engage in debates about educational priorities, structures, and outcomes without an appreciation of the ways in which economic considerations have become globally hegemonic. Of course, the discipline of economics is a complex one, couched in technical terms and analyses. And yet these terms and analyses often mask deeply ideological assumptions about the nature and potential of individuals and society. Disguised in its technicism are issues of social and political values that no social science can entirely avoid. If this is so then what is needed is an introduction to economics of education that is both accessible and (p.xi) honest, which does not hide behind technocratic jargon and makes political contentions about the relationships across economics, society, and education explicit. In a democratic society, such an analysis needs to address the assumptions underlying economic theories of education, such as the theory of human capital, in ways that will encourage political dialogue and debate. This is precisely the main strength of this book. Saumen Chattopadhyay has brought his vast knowledge of the discipline to not only introduce readers to basic concepts in economics of education but also demonstrate how many of these concepts are politically contested. He writes with the aim of encouraging readers to debate the recent market-oriented reforms in education, rather than embrace its key assumptions. Presented in a language that is entirely accessible to non-specialists, this book provides both information and opinions, largely through well-chosen examples of the concepts it discusses. These examples are particularly notable for the fact that they are located within the Indian context, which Chattopadhyay understands with great clarity. In this way, the book is likely to prove useful to both Indian students of economics of education and those readers abroad who want to appreciate the complexities of Indian education, especially the ways in which, in India,

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Foreword economics and education are deeply entangled with social, cultural, and political issues. Fazal Rizvi Professor in Global Studies in Education, The University of Melbourne, Australia; Emeritus Professor, University of Illinois at Urbana-Champaign, USA

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Preface

Education and Economics: Disciplinary Evolution and Policy Discourse Saumen Chattopadhyay

Print publication date: 2012 Print ISBN-13: 9780198082255 Published to Oxford Scholarship Online: January 2013 DOI: 10.1093/acprof:oso/9780198082255.001.0001

(p.xii) Preface Economics of education gained prominence as a sub-discipline of economics with the proliferation of publications and empirical research during the 1950s and 1960s. However, the momentum gained during those years gradually fizzled out in sharp contrast to other areas in economics like economics of health, which has by now occupied a place in the basket of elective courses in many universities. Mark Blaug, who played a stellar role in giving a shape to this subdiscipline during the early years, in fact, lamented a pre-mature demise of economics of education. However, with Nobel prizes in economics awarded to Theodore Schultz and Gary Becker for their contributions in the realm of education and human capital, and important contributions from other Nobel laureates like Milton Friedman, Joseph Stiglitz, and Amartya Sen, the growth of economics of education as a field of study has never really stagnated. There has been advancement in research in the areas of labour economics and growth theory in particular. At the same time, there is an increasing realization based on empirical studies that generation and dissemination of knowledge has become a prime mover of growth and that education should play a larger role in the discourse on development theory. However, economics of education as a unified course weaving various pertinent areas together, where education features prominently at the micro as well as macro level, has not really been able (p.xiii) to carve out a space for itself in graduate programmes in economics. The two major paradigms in this sub-branch, human capital theory and input–output analysis, continue to exercise substantial influence on policymaking in education and human resource development though these two paradigms have been subject to criticisms both from within the discipline of economics as well as outside. Conceptualization of education within economics and application of economic theory to study the various aspects of education have always posed daunting challenges for economists in the tradition of the mainstream neoclassical approach. The limitations of studying education within mainstream neoPage 1 of 4

Preface classical theory to probe deeper into the linkages between education, economy, and society are insurmountable. This in a way exposes the limitations of mainstream economic theory. At the same time, educationists are disgruntled as they find the treatment of education in economic theory to be narrow and demeaning. Relegation of economic theory to study education may also be attributable partly to the tendency to avoid application of economic principles in the realm of school education, which is considered to be a merit good and hence the role of market as the guiding principle is believed to be minimal. However, fiscal crunch and failure of government-funded schools to deliver quality education has goaded policymakers in recent times to repose faith on private providers to ensure efficiency in resource use and encourage installation of the market as an overall framework to reform the education sector. In addition, arguments in favour of treating higher education more as a private good rather than a public good and the growing importance of economic aspects of knowledge has contributed to a growth in the field of economics of education. It is in the context of financing of education that the important questions of economics are addressed such as ‘How is education provided to society and at what price?’ Pricing or funding of education has implications for access, quality, and even expansion of the delivery mechanism. With more and more nations choosing the path of liberalization, the market for education has expanded to the global sphere. The migration of skilled labour and free flow of knowledge has posed challenges for (p.xiv) government policymaking. Globalization has added a new dimension to economics of education. Attaining global competitiveness and finding gainful employment for the increasing number of job seekers in the global labour market are the major challenges faced by any nation, rich and poor alike. However, commodification of education in economic theory arguably ignores that education is deeply embedded in society and is crucial for empowerment, freedom, and equitable growth. It has, therefore, been an arduous task for economists, armed with all their tools and theories, to study this highly complex dimension of social reality. As the education sector world over is undergoing major reforms primarily based on economic principles, it is important that we understand the limitations of market principles and respect how education is placed in society as we grapple for the right path to carry out educational reforms. For a country like India, the crucial importance of education for realizing inclusive growth is being increasingly realized today. This book deals with some important aspects of economics of education as it has evolved over the years and seeks to deal with the emerging concerns. The majority of the issues in the realm of education in India today are laden with serious economic implications. Some of the major economic issues we are confronted with—like achieving growth with equality, tackling unemployment and inadequacy of skill formation, redefining the role of the government in the social sector, and the emerging knowledge economy in the context of Page 2 of 4

Preface globalization—can all be discussed within a framework in which education is an integral part. This book is primarily meant for those students who have had some exposure to economic theory, at least at the undergraduate level, and are interested in studying education from the perspective of economic theory with a critical bent of mind. The book pleads for a revival of economics of education and argues that the conventional way of looking at the area merely from a human capital approach needs to be substantially modified for a meaningful study of education. It has been a journey of eight years of teaching economics of education at the Zakir Husain Centre for Educational Studies (p.xv) (ZHCES) in Jawaharlal Nehru University (JNU), New Delhi. Earlier I was exposed to this sub-discipline in my MPhil and PhD programmes at JNU through the course jointly offered by Binod Khadria and Arun Kumar at the Centre for Economic Studies and Planning (CESP). My PhD supervisor Arun Kumar instilled in me a critical appreciation of economic theory and he has been my source of immeasurable love and support since then. I have had the privilege of interacting with Prabhat Patnaik, Satish Jain, Abhijit Sen, Anjan Mukherji, and many others, who were my teachers at CESP. Earlier in my graduate programme at Asutosh College, Gopal Tribedi and Pranab K. Basu in particular were able to inculcate my love for the subject. However, the person who left an indelible impression on my understanding of mainstream economic theory and inculcated an appreciation for classical political economy was the late Krishna Bharadwaj. In my professional career, I have benefited immensely from my interaction with late Tapas Majumdar, who was the founder of ZHCES. His book and kind words were of great help to me in my initial years of teaching. In my professional career, I had the benefit of interacting with Fazal Rizvi, Simon Marginson, J.B.G. Tilak, Sudhanshu Bhushan, and Stephen Ball, among many others. My understanding of and appreciation for inter-disciplinarity in the study of education is derived from my colleagues at the Centre (ZHCES)—Binod Khadria, Geetha Nambissan, Dhruv Raina, Deepak Kumar, Ajit K. Mohanty, Avijit Pathak, and Minati Panda. I express my gratitude to Geetha Nambissan for her guidance and encouragement throughout my endeavour to giving a shape to my dream of writing this book. Among my wellwishers who stood behind me are Dipendra Nath Das, Srinivasa Rao, Arvind Mishra, Parimala Rao, Bhaswati Das, and many others who continue to encourage me with their support and advice. I am particularly grateful to all the research scholars who are associated with me at the Centre. In particular, Emon Nandi provided me research support and suggestions while I was writing the manuscript. Binay Kumar Pathak has been always a constant source of encouragement and help. Among other students from economics and other disciplines, I would like to (p.xvi) mention the research scholars Debdulal, Jinusha, Jaya, Tirthankar, Sarah, Balbhadra, Reshmi, Gaurav, Anamika, Sonya, Praveen, Francis, Aishna, and Archita Har Simrat who gave insights from their

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Preface active participation in the classroom. I am thankful to my university for generous help with financial and infrastructure support. It was because of my parents and elder brother that I could pursue my higher studies. My sister-in-law and parents-in-law have always been very helpful and encouraging during the most challenging phase of my life. My daughter, Chandrima, I think has been the worst sufferer during the most crucial phase of her school education. But her silent acceptance of my long working hours and extension of her helping hands provided me with emotional support. I am deeply grateful to Oxford University Press (OUP) for taking the initiative to commission this study and encouraging me through its completion. I express my deep gratitude to the entire OUP team for being extremely accommodative of my needs and failures, and for their initiative and support. I am also grateful to the two reviewers who gave very useful suggestions at the time the manuscript was reviewed. However, if errors remain, I am the one responsible. Saumen Chattopadhyay New Delhi

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Abbreviations

Education and Economics: Disciplinary Evolution and Policy Discourse Saumen Chattopadhyay

Print publication date: 2012 Print ISBN-13: 9780198082255 Published to Oxford Scholarship Online: January 2013 DOI: 10.1093/acprof:oso/9780198082255.001.0001

(p.xvii) Abbreviations AICTE All India Council for Technical Education API Academic Performance Indicator AT Agency Theory CPE classical political economy CRS constant returns to scale EFYP Eleventh Five Year Plan EPF educational production function FRBM Fiscal Responsibility and Budget Management GATS General Agreement on Trade in Services GER gross enrolment ratio GoI Government of India GT graduate tax HCC human capital contracts HCO human capital option Page 1 of 3

Abbreviations HDI Human Development Index HEIs higher education institutions ICLs income contingent loans ICRS income contingent repayment schemes IIM Indian Institute of Management IIT Indian Institute of Technology IQ intelligence quotient JNU Jawaharlal Nehru University (p.xviii) MB marginal benefits MC marginal cost MoHRD Ministry of Human Resource Development NCHER National Commission for Higher Education and Research NDPV net discounted present value NKC National Knowledge Commission NPM New Public Management OECD Organisation for Economic Co-operation and Development PAT Principal-Agent Theory PISA Programme for International Student Assessment PPP public–private partnership PV present value SAP Structural Adjustment Policy TFP total factor productivity Page 2 of 3

Abbreviations UGC University Grants Commission UNESCO United Nations Educational, Scientific and Cultural Organization WTO World Trade Organization YPCR Yashpal Committee Report ZHCES Zakir Husain Centre for Educational Studies

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Education and Economics

Education and Economics: Disciplinary Evolution and Policy Discourse Saumen Chattopadhyay

Print publication date: 2012 Print ISBN-13: 9780198082255 Published to Oxford Scholarship Online: January 2013 DOI: 10.1093/acprof:oso/9780198082255.001.0001

Education and Economics An Introduction Saumen Chattopadhyay

DOI:10.1093/acprof:oso/9780198082255.003.0001

Abstract and Keywords This chapter delineates the broad contours of the book, beginning with a theoretical overview of the human capital theory, the endogenous growth theory, and the input–output analysis. A critique of the human capital approach is presented from various perspectives. Economic classification of education is discussed to set the stage for the subsequent policy analysis. This is followed by a critical investigation of the concept of education market to understand the sources of market failure and possible scope for government intervention. A brief critical overview of the rationale behind reposing faith on the private sector and market in the context of various aspects of policymaking in education is presented. The chapter ends with a tour of the Indian education system to identify the challenges and suggest policy responses. Keywords:   education, economics, human capital, endogenous growth theory, input–output analysis, public good, merit good, quasi-market, market failure regulation, efficiency

A meaningful analysis of education in the context of the prevailing social reality entails a study of education within the realm of social sciences. Among all the social science disciplines, sociology, psychology, and history have been dominant in the basket of courses that are offered in the numerous education departments in India and abroad. Notwithstanding the fact that economists have taken interest in the economic analysis of education as exemplified by the number of Nobel Laureates who dealt with education directly and indirectly,1 the economics of education as a sub-discipline of economics does not feature Page 1 of 12

Education and Economics prominently as an optional course offered in economics departments the world over.2 In recent years, education is increasingly being viewed as central to the issues of development, like productivity, income distribution, employment, and knowledge as an input to production. However, policymaking in education is now being informed mainly by mainstream economic theory both in the developing as well as in the developed world. Whether it is governance, financing, regulation, managing global flows of skilled labour and knowledge, or research and development expenditure to make advances in technology, we need to invoke economics of education and/or knowledge to study and analyse the emerging issues. In the education department, economics of education is (p.2) now in the process of staking a larger claim possibly because of the influence of neoliberalism on education reforms. An economic analysis of education has become an imperative today. Individuals need to spend resources both in terms of money and time to pursue education, or, undergo specific training for skill formation. Similarly, imparting education requires dedication of resources both by the private and public sector. Hence, the question how to ensure that resources are utilized in an efficient and just manner both at the individual and institutional level need to be addressed within the realm of economic theory. This book seeks to provide a chronological overview of the major developments in economic theory to conceptualize education and their influences on policy making. As argued by Marginson (1997: 217) what sustains economics of education is not the ‘empirical realism of its analytical assumptions but the practical realism of the power-knowledge relationship between economics of education and government’.3 In a way, this book may be construed as a prelude to the study of economics of education which has to go beyond the conventional and dominant human capital approach as developed and advocated by ‘mainline’ neo-classical economists. The book also seeks to devote considerable space to the art of policymaking in education because policies, in a way, reflect the theoretical underpinning of education.

Education in Economic Theory: The Human Capital Approach There was a great divide in the way economic theory evolved as a discipline. Economists like Smith, Ricardo, and Marx in the tradition of the classical political economy (CPE), were all concerned with issues related to the broader issues of development and the questions they addressed revolved around the question of surplus, its generation, accumulation, and distribution (Bharadwaj 1976). The rise to the dominance of the demand–supply analysis marked a sharp departure from the approach adopted in CPE.4 Even the factors of production, labour, and capital are treated (p.3) at par, and distribution of income was explained in terms of demand and supply of respective factors within the neoclassical framework. This neo-classical approach treated expenditure on education as a form of investment and those who invest in education like Page 2 of 12

Education and Economics students and the parents were assumed to be optimizing economic agents engaged in calculating costs and benefits operating under their respective constraints. However, the idea of investment in man could be traced to the mercantilists (Bowman 1966). Adam Smith, Malthus, and Alfred Marshall among others had different views of education and its relation to man and the economy (ibid.). Economics of education as a sub-discipline of the academic discipline called neoclassical economics emerged in the 1960s as a major field of study and research with pioneering contributions made by Schultz (1961) and Becker (1962, 1964) and with other significant contributions from Mincer (1958) and Denison (1962). In view of the fact that economic theory seeks to address the fundamental question of resource allocation both at the micro level, like choice making by a rational individual as well as at the macro level to deal with the important issues pertinent to the employment, growth, and development of a nation, it appeared inevitable that this sub-discipline would flourish and eventually assume importance as a programme of teaching and research. However, economics of education could not maintain the momentum it gained in the 1960s and 1970s, despite a recent surge in the publications (Dearden et al. 2011).5 Blaug (1989: 331) who played a stellar role in establishing economics of education as a subdiscipline during the 1960s and 1970s, bemoaned the pre-mature death of an area ‘…in the mind of both professional economists and professional educators’. It was Becker (1964) who formally contributed towards the emergence of the sub-discipline of economics of education by incorporating expenditure on education within the framework of optimizing decision-making of an individual. The most important tenet of the human capital paradigm was that expenditure on education should be classified as an investment and it should be treated at (p.4) par with investment in physical capital.6 As an inevitable outcome, education as an investment was construed as one of the alternative options for investment faced by an individual and the nation. But exclusive reliance on the market led to underinvestment in education at the national level.7 However, primary, secondary, and higher education (HE), all the three different levels of education need to be distinguished in any economic analysis of education. Since education generates positive externalities for a society in a variety of ways, it was also realized that there was a need to differentiate between private rate of return and social rate of return for decision-making at the national level for investment in education. The rate of return estimation provided a new social investment criterion, resources are to be allocated to levels of education and years of schooling so as to equalize marginal and social rate of return on educational investment and should not fall below the alternative investment avenues (Blaug 1976a: 830).

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Education and Economics Essentially, the neo-classical approach commodifies education so as to integrate it within the framework of economic theory which essentially deals with marketable goods and services. Therefore, as it is to be expected, commodification of education and the exclusive focus on the market tended to ignore interconnections between education and society which led to the relegation of social issues of vital importance.

Incorporating Education in Growth Theory: Human Capital and Endogenous Growth Theory In Chapter 2, we discuss various aspects of human capital theory where economics of education is argued to have germinated, and in Chapter 3 we discuss how education and higher education had been conceptualized in the new growth theory. Empirical studies (for example, Denison 1962) found that growth in national income could not be explained exclusively by the growth in the two factors of production, labour and physical capital, weighted by their respective shares in national income. ‘Residual growth’ defined as (p.5) the portion of growth which could not be attributed to the growth of labour and capital was sought to be explained by technological advancement alone. It was realized that the simple production function analysis which considers labour as a homogeneous entity over time was a gross underestimation of labour’s contribution as labour became more productive with education and training, and differentiated as well in terms of skill or human capital embodied in the labour. This new brand of growth model identified the factors behind technological growth, argued for a modification of the production function as used in the Solow type growth model, and provided an explanation for investment in human capital as the outcome of optimizing decision-making of individuals. The concept of human capital was related to the concept of knowledge, and the concept of capital innovation and research and development expenditure became integral parts of such a variety of endogenous growth models (Lucas 1988; Romer 1989). We end the chapter with a brief discussion on the salience of the quality of education in the linkage between education and growth.

Input–Output Relations in Education: The Concept of the Production Function In Chapter 4 we take a critical overview of the input–output approach, which is the second major strand in the economics of education, to the study of an educational institution. An educational institution is similar to any other manufacturing unit or factory, and therefore, an important corollary is that there exists an input-output relation in the provision of education. We critically analyse the attempts to propose a production function for a university and estimate cost efficiency and factor productivity (Lumsden 1974). We discuss how the concept of achieving efficiency in resource use within the realm of an institution is often a desirable goal, however, stretching the argument too far create confusions. The paradox is that non-market output in education is measured by costs as in the case of a government funded school. If costs rise, with output remaining the Page 4 of 12

Education and Economics same, efficiency is argued to have deteriorated. (p.6) If costs fall as a result of improvement in efficiency, output is argued to have gone down (Marginson 1997: 216). It is an arduous task to define input and output for an educational institution (Lumsden 1974; Majumdar 1983). If students are the inputs, successful students would constitute the output as well. However, valuation of output as well as input would remain a formidable challenge. If researches funded by universities are considered to be public good, market valuation becomes virtually impossible. However, the most important question is whether there exists a production function which posits a well defined relationship between inputs and outputs. Majumdar (1997) argues that the economics of education suffers from what he calls ‘category mistakes’. Concepts used in economic theory like efficiency, rate of return (private as well as social), and production function are applied to education under certain assumptions. However, assumptions over a period of time were left on the wayside and wider use of such concepts led to errors, resulting in a study of education devoid of its true significance in terms of its implications for learning and for society.8

A Critique of the Human Capital Approach In Chapter 5 we embark on a critique of the human capital approach from the perspectives of the theory of screening, capability approach, social choice approach, and the Marxian perspective. Though the neo-classical theory has come to dominate the landscape of economic theory today, alternatives approaches, or critiques of the so-called mainstream thinking have provided not only different but more importantly meaningful perspectives to the study of education. We provide a brief account of four such approaches which seek to view the human capital theory critically and in the process enrich our understanding of education. The Screening Hypothesis

The proponents of screening hypothesis (Arrow 1973; Spence 1973; Stiglitz 1975) advanced an alternative to the dominant human capital approach that education augments productivity through (p.7) skill formation. Advocates of the screening hypothesis argue that education acts as a screening device which segregates job seekers with varying levels of productivities. The argument is based on the fact that the employers suffer from information asymmetry with respect to job seekers’ potential in increasing productivity. However, the successful completion of a programme, or award of a degree may reveal that the who candidate applied for the job, possesses desirable traits like diligence, tenacity, and honesty which are valued by the employer. A degree or a certificate is, therefore, a proxy that the candidate is endowed with desirable traits and, hence, she would be useful for the kind of job the employer would offer. Since the link between education and productivity cannot be solely Page 5 of 12

Education and Economics attributable to the skill enhancing effect of education, demarcation of the relative contributions of the two theories to explain differentiation in income earnings becomes difficult.9 Capability Approach

Sen’s approach to development (2000) based on the notion of capability provides a credible opposition to the narrow approach to development often adopted by the advocates of income growth. The primacy of education in Sen’s approach to the concept of ‘capability’ and development led to a better understanding of the distinction between income growth and the broader concept of development. Education empowers an individual to be free as the person acquires freedom to decide which lifestyle to choose from among a set of alternatives. Education is thus important for both individual freedom as well as social freedom as it not only enables a person to enjoy a life she has reason to value, she can now fight against oppression, exploitation, and injustice and play an active role to transform society. But Unterhalter (2008) argues that education is ‘untheorised’ in Sen’s approach for failing to distinguish between education and schooling. Social Choice Approach

In addition to a critique of the tenability of the concept of production function for an educational institution, Majumdar (1983) (p.8) provided three distinct sets of arguments against the rate of return approach—the micro–macro argument, the domain-distinction argument, and the collective choice approach —to offer a comprehensive critique of the human capital approach which offers a new perspective to evaluate and decide on societal investment in education against the backdrop of heterogeneity in the structure of investment and of society. Investment in education is uniquely characterized by heterogeneity in the sense that there are two domains of investment, individuals and institutions, which are governed by two sets of objective functions and time horizons though they are complementary in nature. There can arise a conflict between the expected rate of return by a student and its eventual realization at the macro level as the realized rate of return would be determined in the sphere of the market based on prevailing demand–supply conditions.10 It is likely that a particular investment decision may affect different groups differently. Since aggregation of choices is problematic, deciding the quantum and the form of societal investment would pose a social choice problem as with the possible emergence of contradictions and paradoxes and subjectivity involved in interpersonal equity comparisons. While there is no clear cut solution, sensitivity to such problems would help negotiate such conflicts of interest.11

Classification of Education: What Type of ‘Good’ is Education? In Chapter 6 we introduce the concept of public good because it is a core concept in an analysis of policymaking. Earlier, we invoke the concept of public Page 6 of 12

Education and Economics good in Chapter 3 in the context of a discussion on knowledge. In Chapter 6 the focus is more on classification of education. It is not merely commodification of education, but what type of ‘commodity’ education is that has serious implications for policymaking. In view of the widely accepted view that education generates positive externalities (McMahon 2010), treating education at par with a private good is simply not tenable. (p.9) Economic theory of the market, arguably, could as well be applied to an analysis of education which is synonymous with the delivery of a service. However, all three levels of education cannot be treated at par. Primary education should be determined by the state (Musgrave and Musgrave 1989) as it is a subject of paternalistic choices because the government knows better which good/service merits attention for society. With respect to higher education, the debate is not yet settled whether it should be regarded as a private good, a quasi-public good, or a pure public good (Bergan, Sjur et al. 2009; Chattopadhyay 2009; Marginson 2007; Tilak 2008). Since admission to an educational institution is often exclusive in nature, higher education would be better described as a mixed good (or a quasi-public good) as it turns out to be essentially a private good with positive externalities. However, from a normative point of view it can be argued that policymakers should increase the ‘publicness’ of higher education and make the growth process more inclusive. Therefore, Marginson (2004) argued that Samuelson’s approach to classify a good as inherently public or private is inadequate. Whether a particular good is public, mixed, or quasi-public would depend largely on the socio-economic context and the approach of policymakers. Therefore, it is generally accepted that policymaking in higher education is intricately linked with the question of how we define and classify higher education.

The Market for Education In Chapter 7 we make an attempt to bring to the fore the specific features of an education market to set the stage for a critical analysis of policymaking in education in the subsequent chapters. Education policy the world over is increasingly being determined within the framework of a neo-liberal approach which advocates in favour of setting up a regulated market. It is an imperative therefore, to understand the nature of an education market to locate the sources of market failure so as to address the issue of government intervention in the market for higher education in particular.12 (p.10) The market for higher education fails on various counts to guarantee an efficient allocation of resources. Not only is the market an imperfect one because of the differentiated nature of the quality of education delivered, higher education as argued earlier to be a quasi-public good, generates positive externalities leading to a suboptimal provision of education. With focus on efficiency in the market sphere, the question of unequal distribution of resources remains unaddressed. Education leads to social mobility and social cohesion, the provision of which should be guided by social demand rather than by market demand which is essentially determined by the prevailing income distribution. From a broader Page 7 of 12

Education and Economics perspective, market failure provides a rationale for the government to intervene in the market mainly through various forms of regulation. Further, the nature of competition in the market for education is characterized by S-competition (selection based) rather than E-competition (efficiency based) (Glennerster 1991: 1270). This is because as the students (and parents) choose the institutions, so do the institutions choose students and teachers to produce good quality education in the presence of competition.13 This leads to an accentuation of hierarchy in the ranking of institutions as the best of institutions are adequately funded to attract the best minds, both the teachers and the students (Winston 1999). We discuss next some of the policy measures being mooted and which are in the process of being implemented in India. The apparent dominance of mainline economics among policymakers and thinkers means that the reform measures also tend to be guided by market logic.

Market-oriented Reforms In Chapter 8 we seek to build up arguments based on economic theory to understand the rationale behind some of the policy initiatives being contemplated and implemented in India. We structure our discussion along three main issues—how education is funded, how is it delivered, and how is it regulated. With reference to (p.11) the funding issue, we briefly discuss various alternative options for funding higher education. With reference to the mode of delivery, various ways in which the private sector could be roped in, particularly in the form of public–private partnerships (PPPs), are discussed. The rationale behind several policy initiatives mooted or which are in the process of being implemented in the Indian context reek of a neo-liberal smell. The rationale behind PPP is based on two basic arguments. First, the private sector is more efficient than the public sector, and second fiscal stringency which does not allow the government to dedicate adequate resources necessary for the expansion of the sector to meet the growing demand. The first one is based on an understanding that the input–output relationship is valid and applicable for an educational institution and hence through proper policy measures efficiency in resource use and quality can be achieved through competition. There can be many different forms of PPPs and the outcome of such a blend would depend on the kind of partnership arrangement and the character of the private sector in terms of its ownership and objective. In general, imparting education was viewed as an exchange in a market for education and therefore an analysis of the delivery of education could be subject to economic logic as it is applied to the study of a market of any other consumable good or service. Commodification of education (particularly in case of higher education) in economic theory has led policymakers who subscribe to the approach of the neo-liberals to repose faith in the market and its ability to achieve efficiency and quality through competition at the economy level and at Page 8 of 12

Education and Economics the level of the institute through governance reform. This argument is further bolstered by the economic logic of allowing consumers (students) and producers (providers) to enjoy sovereignty to the extent possible in the sphere of the market. The question is how much freedom can be allowed to the students and the education providers to exercise their will in the market for education, which is not akin to a typical commodity as access to higher education in particular should primarily be (p.12) governed by merit rather than ability to pay (Chattopadhyay 2009; Teixeira et al. 2004b). Governance

With the promotion of the market, government funded institutions are also required to be reformed to ensure meaningful participation in the market to achieve efficiency and deliver quality education. The idea is to enforce corporate managerial practices even in government funded institutions so that these institutions function more like privately funded institutions and are able to reap efficiency gains and impart quality education. Further, it is argued that a government funded institution is likely to suffer from all the typical sources of inefficiencies which lead to ‘government failure’. In a world where individuals are mainly driven by self-interest and respond to economic incentives as argued by the mainstream neo-classical economists, governance problem could be explained as possible manifestations of what is called principal-agent problem where the agents are keen to serve their own objectives at the expense of the tasks assigned by the principals. Governance reform is often guided by the main tenets of the public choice theory which is based on the assumption that an individual, irrespective of context, is homo-economicus.

Economic Rationale Behind Recent Policy Initiatives in Education In Chapter 9 we seek to provide a brief account of the Indian education sector focusing mainly on higher education which is followed by a discussion of policy measures in India. Based on our earlier discussion in Chapter 8 and drawing on the relevant points discussed in other chapters, an attempt is made to examine the pros and cons of the policy options being mooted by policymakers. A very big question before policymakers today is how to amalgamate judiciously the private and the public sector without much of a compromise with the three objectives envisaged in the Eleventh Five Year Plan—expansion, inclusion, and exclusion.14 (p.13) With regard to school education, we briefly analyse low cost schooling which is being advocated in the name of economizing resources under the assumption that the quality of education would remain unchanged even if the teachers are not remunerated at par with their counterparts. An attempt is made to understand and evaluate the arguments in support of the bills which have been introduced in Parliament and are currently under consideration from the perspective of economic theory. One such major initiative is the plan to set up a regulatory authority in the form of the National Page 9 of 12

Education and Economics Commission for Higher Education and Research (NCHER) to develop a regulated market for the higher education sector. This would, arguably, help overcome the problem of multiple regulatory authorities with overlapping functions, ensure transparency and uniformity, reduce political interference, and regulate standards. However, balancing social objectives with a penchant for installing a regulated market would remain a daunting challenge for the government. The other bills which seek to rectify the sources of market failure include setting up of a tribunal in higher education which seeks to address the grievances of students studying primarily in privately funded institutions. The need arises because the education market lacks intense competition due to restricted mobility of students and education is an ‘experience good’ (as discussed earlier) which makes students suffer from information asymmetry at the time of choice of their courses and institutions. The institutions are now to be ranked even within the country to facilitate informed choice making which is central to sovereignty and competition (Bill on Accreditation). In effect, a highly differentiated market for education is being created which would in turn create a differentiated and hierarchical society with cohesion in society becoming more and more fragile. It is possible that market elements would continue to gain strength which may deter imparting of value based inclusive education as the teaching-learning process becomes more like an exchange in a market, the students become investors and the teachers become service providers. (p.14) The basic argument is whether profit motive in education, particularly in the context of a weak regulatory regime, has adverse implications for the education-society linkage. In the context of policymaking we seek to evaluate the rationale behind encouraging choice making and competition in the market for education to achieve efficiency and quality. The policy thrust for accreditation and the apparent craze for international rankings to assess the Indian higher education system is critically examined. Globalization and the Entry of Foreign Providers

Education, in particular higher education, is now a global commodity and is argued to be a global public good. However, various provisions under the General Agreement on Trade in Services (GATS) are not yet fully enforced. To understand and assess the possible implications of globalization of higher education in the emerging scenario, the pros and cons of all the four modes under GATS shall be analysed in the context of the three policy objectives as envisioned in the Eleventh Five Year Plan for higher education in India: expansion, inclusion, and excellence. With possible commodification of education under GATS there is a possibility that education as a human right may be compromised. In the absence of a level playing field and opportunities arising out of collaborations across the border, the pros and cons of globalizing higher education entail an objective and detailed analysis. The government is of the opinion that entry of foreign education providers would do enough good to alleviate the problems faced in the higher education sector as a similar policy Page 10 of 12

Education and Economics has ushered in huge transformation in other sectors like telecom. Various aspects of globalization in higher education are discussed keeping in mind how economic concepts like market, competition, and efficiency assume an altogether different meaning for education. We end with an alternative approach to examine the benefits which are likely to arise out of cooperation among individuals and universities in the emerging global knowledge economy. Possibly, cooperation in the production of knowledge across the border holds immense promise for the future of the Indian higher education scenario. Notes:

(1.) Theodore Schultz and Gary Becker were awarded with Nobel Prizes in 1979 and 1992. Milton Friedman, Joseph Stiglitz, and Amartya Sen have contributed to our understanding of education in a broader sense. (2.) Health economics as an optional course seems to have gained more popularity in comparison. However, economists continue to do research on education related topics located within areas of labour economics, welfare economics, public finance, and economic development. (3.) Marginson (1997) examines the economics of education from the perspective of power-knowledge-economy in a Foucaldian framework of a powerknowledge-economy. (4.) The demand–supply approach often called the neo-classical approach or even the modern approach viewed an individual as an optimizing agent operating under constraint(s). The economy was viewed as comprising of markets in goods and services and equilibrium in the market(s) would ensure efficient allocation of resources. (5.) During the 1960s, papers on education published in mainstream economics journals were 3.4 papers per year. This fell to 2.5 during the next decade. In the 2000s, it went up to 9.7 per year. Based on this, Dearden et al. (2011) argue that there has been a resurgence in interest in education. In recent years, some good books in the area of the economics of education are Johnes, G. and J. Johnes (eds) (2004), International Handbook on Economics of Education, Cheltenham, USA: Edward Elgar Publishing; Hanushek, E.A. (ed.) (2003), The Economics of Schooling and School Quality, Vol. I and II, Cheltenham, USA: Edward Elgar Publishing, Belfield, Clive R. (ed.) (2006), Modern Classics in the Economics of Education, Vol. I and II, An Elgar Reference Collection, UK and USA: Edward Elgar Publishing. (6.) Earlier, demand for education was treated more like demand for a consumption good which would depend on its price (fees and associated expenses), income, and ‘tastes’ (Blaug 1987). However, there was a debate whether the entire expenditure could be treated as investment expenditure as

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Education and Economics education yields satisfaction as in the case of a consumption good even beyond the period of study (Bowen 1963). (7.) Positive externalities would result in participatory and democratic decisionmaking, better awareness of health and nutrition, possibly lowering of crime, fighting against injustice in society, and better awareness of rights and policy measures that are available. Externalities raise the social demand curve above the private demand curve. Since market equilibrium would consider private demand rather than social demand, allocation of resources would be lower than what is desirable by society as proxied by the social demand curve. (8.) Marginson (1997) voices similar concern with regard to objects conjured up in the context of economics of education and applied in policymaking. (9.) Researchers used to follow often the so-called ‘two-thirds assumption’ which says that two-thirds of the earnings differential with different amounts of education should be attributed to the ‘pure effect of schooling’ with the remaining to some blend of genetic endowment and social factors (Blaug 1976: 842). (10.) This problem is similar to the problem of identification of demand and supply in the estimation of rate of return calculation as discussed in Blaug (1976). (11.) Majumdar (1983: 61–87) elucidates with various examples to show how aggregation of choice in a situation of conflicts can render policymaking difficult. The human capital approach fails to unravel such problems mainly because of the fact that heterogeneity in investment in education is not recognized. (12.) Since primary education has been argued to be a merit good, we need not invoke the concept of a market for primary education. Higher education being a quasi-public good, neo-liberals advocate for a regulated market. The important question is one of deciding the extent of intervention. (13.) This is different from a typical textbook concept of competition where the quality of inputs remains the same and it is in the realm of technology that the same inputs churn out a different quality of outputs. (14.) It is often argued whether all the three objectives can be pursued together or there exists a trade-off among them. Privatization of any kind will compromise with inclusiveness. There is a big question mark whether excellence in education can be achieved through increasing private participation.

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The Human Capital Approach to Education

Education and Economics: Disciplinary Evolution and Policy Discourse Saumen Chattopadhyay

Print publication date: 2012 Print ISBN-13: 9780198082255 Published to Oxford Scholarship Online: January 2013 DOI: 10.1093/acprof:oso/9780198082255.001.0001

The Human Capital Approach to Education Saumen Chattopadhyay

DOI:10.1093/acprof:oso/9780198082255.003.0002

Abstract and Keywords This chapter initiates a discussion on human capital with a brief historical account of how economists over the years have dealt with education from an economic perspective. The main focus of the chapter is to provide an overview of the main tenets of the human capital approach as a major field of study and research which has been enriched by the pioneering contributions from Schultz, Becker, and Mincer. The concept of private and social rate of return and their usefulness in guiding investment decisions at the micro and macro level are examined critically. Mincerian wage equation and the demand–supply model of determination of human capital are discussed to highlight the linkages between investment in education, earnings, and income inequality. Keywords:   education, human capital, private rate of return, social rate of return, wage equation, income inequality, egalitarian approach, elite approach

The subject of education is amenable to economic analysis since the delivery of education, both formal and informal, entails the use of resources in terms of time and effort, and more importantly, the use of monetary resources. In view of the resource constraint faced by an individual as well as by an economy at the macro level, the pertinent question is one of determining how much resources should be allocated optimally towards education at the two levels, individual and societal. Supply of and demand for education involves economic decision-making in the sense that economic factors play a crucial role in shaping the decisions of the providers, the institutions, and the purchasers, that is, students and parents. The institutions invest resources to set up infrastructural facilities and employ teachers to deliver education. Similarly, individuals invest in themselves in Page 1 of 30

The Human Capital Approach to Education various ways like acquiring skills and health, which entails a sacrifice of current consumption with the purpose of an income gain in the future. This is not to deny that there are factors other than economic which influence both supply and demand. As long as delivery of education entails economic costs and benefits to individuals and institutions, and to society as a whole, delivery of education could be subject to an economic analysis. Further, developments in the two domains of education—institutions (or societal) and individuals—and the benefits arising (p.18) out of education to society drive home the point that valuation of the costs and benefits in economic terms both at the individual and societal levels are critical in determining the resources to be dedicated to the delivery of education. For the economy as a whole, fostering human resource development has remained an important agenda for all nations for long. The state has to make budgetary provisions for the delivery of education and skill development to supplement and encourage individual efforts. It is therefore an imperative that we subject education to an economic analysis both at the micro as well as at the macro level for the study of the education sector in general. In economic theory it is argued that there is no free lunch. Having more of one thing requires giving up of something else. Scarcity of resources means that trade-offs become a basic fact of life. The objective is to understand the tradeoffs involved in the process of delivery of education and guide decision-making for resource allocation both at the micro as well as at the macro level. It is argued in the realm of economic theory that decision-makers respond to incentives mostly in pecuniary terms. For understanding the process of choice making, the underlying incentive structure has to be understood. Economic theory would help in analysing the functioning of an educational institution and decision-making of an individual, student, and parent. In fact, incentivization remains a key to the reform of the education system the world over. The other key aspect of economic theory is exchange of goods and services. Exchange in a market place is crucial for an understanding of how resources are allocated, what is produced, and how it is produced. Exchange is an outcome of decisionmaking by two sets of agents, providers and buyers. Exchange takes place at a mutually agreed price which reflects the opportunity cost of supply to the supplier and marginal benefit to the purchaser. Delivery of formal education is envisaged as an exchange in a market place in main-line economics. Information or its absence plays an important role in determining the nature of markets and the ability of private markets to ensure that the economy’s scarce resources are used efficiently. (p.19) Students need information to make informed decisions. Markets determine how the goods and services are produced in an economy, and how resources are allocated by government institutions, and by private and philanthropic ones for imparting education to the community. However, for

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The Human Capital Approach to Education education, whether the role of the market is desirable and if so to what extent is taken up for discussion in Chapter 7. Economics of education and the development of the concept of human capital can be said to have originated from the contributions of Schultz (1961), Becker (1964), Mincer (1958), and Denison (1962). This chapter focuses on the human capital approach to the study of education. In the next section, we begin with the concept of human capital while the section that follows discusses the important concepts of rate of return and its usefulness in decision-making. The following section discusses a model developed by Becker which gives a comprehensive account of two different aspects of human capital formation, the supply and the demand side to help explain income distribution. The primary aim of the model is to understand the underlying factors behind income differentials among individuals.

Developments in the Theory of Human Capital The fact that individuals invest in themselves to acquire skills and knowledge failed to draw enough attention from economists notwithstanding the fact that human beings are at the centre of any developmental agenda. Individual demand for education was studied mainly from the perspective of education as a consumption good as price of education (fees), income of the household, and ‘tastes’ among other factors were considered to be the determinants of demand for education (Blaug 1976a). As Schultz (1961: 2) says: Our values and beliefs inhibit us from looking upon human beings as capital goods, except in slavery, and this we abhor … hence to treat human beings as wealth that can be augmented by investment runs counter to deeply held values. (p.20) One way of looking at economic theory as per the neo-classical approach is all about choice, rational decision-making which entails allocation of scarce resources, and arriving at an optimum decision based on marginal cost (MC) and marginal benefit (MB) or, to put it simply, an exercise in constrained optimization. Mincer (1958: 288) was interested in finding out the factors behind income distribution or differential earnings. But, what could be the possible reasons? Is it human capital, or ability and opportunities, and intelligence quotient (IQ), and/ or emotional quotient (EQ)? How do lifetime earnings behave over time? Those with high skills witness higher growth in income or at least slower retardation in income growth than those with low skill employees. It was found that ‘the higher the occupational rank, the higher the level of earnings, the steeper the life-path earnings’. Intra-occupational differences result from experience. But bona fide conceptualizations could be traced centuries ago to Adam Smith (1776/1976), John Stuart Mill (1926) and Alfred Marshall (1890/1920) (Sweetland 1996: 343– 4). However, the idea of investment in man can be attributed to the mercantilists Page 3 of 30

The Human Capital Approach to Education who emphasized the importance of ‘art and ingenuity’ or skilled manpower (Bowman 1966: 103). However, Adam Smith (1776/1976) was the first to characterize expenditure on education as investment expenditure by drawing analogies between men and machines which would contribute to the enhancement of skill and productivity of individuals and hence for the economy as a whole.1 Marshall referred to the socio-economics of ‘talent wastage’ but not explicitly to investment in man and Keynes’s General Theory made labour passive rather than an active agent (Bowman 1966: 108).2 As an illustration of an early awareness, we can see in Adam Smith (1776/1976: 118): A man educated at the expense of much labour and time to any of those employments which require extraordinary dexterity and skill, may be compared to [an] expensive machin[e]. The work which he learns to perform, it must be expected, over and above the usual wages of common labour, will replace to him the whole expense of his education, with at least the ordinary profits of an equally valuable capital. (p.21) Alfred Marshall in his Principles of Economics (1890/1920: 564) echoes a similar understanding of education: ‘The most valuable of all capital is that invested in human beings.’ The enrichment of the theory of human capital has been made possible because of the contributions made from labour economics, public sector economics, welfare economics, growth theory, and development economics. Possibly because the theory concerns people and people are at the centre stage of any economic theory and developmental agenda, education deserves more attention in both academic and policy discourse today than what it has received as a subdiscipline of economics. The human capital research programme witnessed a very rapid growth in the 1960s and 1970s. As mentioned in Blaug (1976a: 827), that a comprehensive annotated bibliography was first published in 1966 recorded 800 entries; the second edition published in 1970 had 1350 items; and the third edition published in 1976 had nearly 2000 items (Blaug 1976b). The growth in research publications was not sustained and the economics of education as a sub-discipline of Economics withered, or at least it can be argued, it did not flourish despite having many linkages with various branches of economics. However, in recent years, there has been a surge in publications in the area of economics of education. Dearden et al. (2011) argue that the papers related to education in mainstream economics journals were only 2.5 during the 1980s, which went up to 5.2 and 9.7 during the 1990s and 2000s, respectively. There are a number of edited volumes in this area such as The Economics of Schooling and School Quality (Hanushek 2003), Modern Classics in the Economics of Education (Belfield 2003), International Handbook of Economics of Education (Johnes and Johnes 2007), and Economics of Education (Brewer and McEwan 2010).

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The Human Capital Approach to Education The Human Capital Approach The emergence of the economics of education as a sub-discipline of neo-classical economics and its relevance even today in (p.22) policymaking can be attributed to the concept of human capital. Recognition of the area also came in the form of two Nobel prizes to those who contributed to the advancement of the concept of human capital and its salience in the economy as mentioned earlier. The connectivity between human capital theory and the Nobel prize for Economics is perhaps more impressive (Sweetland 1996). Theodore Schultz (1961, 1963) and Gary Becker (1964) are the two most prominent scholars who contributed to the development of the human capital theory.3 Arguably, there were notable contributions from Friedman and Kuznets (1945) as well. The growth models developed in the 1980s helped to identify relatedness of education to the aggregate production function (through endogenous growth theory) and growth. Even, Sen (2000), the Nobel Laureate in Economics assigned special role to education in his capability approach to the study of ‘development as freedom’. Becker and Chiswick (1966) applied neo-classical economic theory of optimization to understand various aspects of household decisions and the most prominent of those remain that of investing resources for education. Education expenditure is considered to be investment expenditure as it involves sacrifice of resources for presumably no present benefits but with an expectation of future gains in the form of higher remunerations accruing to an individual than what would have been otherwise with a lower level of education.4 At the national level, education and in particular human capital formation gained more importance to spur growth with knowledge assuming dominance in policy discourse. Empirical studies were undertaken to ascertain the contribution of human capital in growth which are be discussed in Chapter 3.

Defining Human Capital The rationale behind introducing the concept of human capital and its definition comes out clearly but only in few words in Schultz (1960): I propose to treat education as an investment in man and to treat its consequences as a form of capital. Since education becomes (p.23) a part of the person receiving it, I shall refer to as Human Capital … it is a form of capital if it renders productive service value to the economy… Human capital is an outcome of learning which remains embodied in an individual and manifests in the form of augmentation of productivity of the individual. Schultz (1960) argued why acquiring skills and knowledge constitute a form of capital, a part of deliberate investment which was found to be rising at a much faster rate than physical capital. During 1900–56, while assessing the contribution of the factors of production to growth in national income, the

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The Human Capital Approach to Education estimated stock of education as embodied in the workforce was estimated to have grown at nearly twice the rate of reproducible capital. The human capital theory suggests that individuals and society gain substantial economic benefits from investments in people. The hard core of the theory as Blaug (1976a) would argue is that individuals spend on themselves with the purpose of future gains, pecuniary and non-pecuniary, and not for the sake of present enjoyments. An educated population is a productive, creative, and innovative resource for not only growth but also for achieving broad based growth. This means that human capital formation involves both formal and informal education, on-the-job training, and ‘learning by doing’ as all of these contribute to the enhancement of economic capabilities of people. To be precise, Schultz (1960) listed five major categories of investment which would lead to improved human capabilities: (i) health facilities and services including stamina, vigour, and vitality; (ii) on-the-job training including old style apprenticeship; (iii) formally organized education at the three levels, primary, secondary, and higher education (HE); (iv) study programmes for adults (extension programmes including agriculture), and (v) migration of individuals and families to adjust to changing job opportunities. In addition, individuals spend time in searching for jobs or spend to gather information about job opportunities (Blaug 1976a: 829). In fact, education could be treated both as a consumer good as well as a capital good. As a consumer good, it yields satisfaction to say (p.24) a student as she goes through the process of learning in the sense of socialization in the school campus, participation in extra-curricular activities, and even simply enjoying the exposure to the new vistas of knowledge and classroom experiences. But more importantly as per the human capital theory, education is an input to the production of goods and services through the agency of labour. Not only does working with the machines require skill and dexterity acquired in the process of schooling and training but the very production of physical capital today with higher and higher productivities is largely an outcome of new ideas, innovative thinking, and research. So in the sense of the production function, both capital and labour undergo transformation through education and training and the consequent skill development. Further, it can bring about both economic and social transformation. It is in fact a pre-requisite for not only narrowly defined economic growth but also for a broad based notion of development. Benefits may accrue in terms of health and nutrition, a control on population growth, improvement in the overall quality of life, enlightened citizenry to participate in democratic and legal processes, rational decision-making at the level of the community as a concerned member of the society, pursuing values such as equality, fraternity, and liberty at both private and social levels, and lower levels of corruption. Human resources constitute the ultimate basis of wealth of nations and educated citizenry are its active agents.

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The Human Capital Approach to Education Becker’s (1964) contribution to the theory of human capital (HC) has been a path breaking one. He provided a theoretical and empirical analysis of human capital formation with special reference to education by invoking calculational rationality of human agents. As portrayed in the neo-classical theory, the humans are driven by the primary instinct to compete in order to maximize their opportunities in a rational choice model. The basic argument relating to human capital and growth in earnings can be put in the form of a sequence. Human capital: (1) Education and training increase individuals’ cognitive capacity, (2) which, in turn, increases their productivity; (p.25) (3) productivity tends to increase the earnings of educated and skilled individuals and (4) this, becomes a measure of human capital. In short, education becomes a measure of human capital as: education 〉 cognitive capacity 〉 higher productivity 〉 earnings 〉 a measure of HC The major arguments of the human capital approach to education can be put in the form of three propositions as succinctly put forward by Majumdar (1983). A. Concept of human capital, a counterpart to the notion of physical capital formation. B. Spending resources on education is an act of investment: i. investment decision-makers in education are analogous to investors in the capital market, ii. alternative opportunities in education are at par with alternative investment channels, and iii. ‘choice rule’ is similar to returns’ maximization as in the normal capital market. C. Education or the learning process is similar to production carried out by a firm: input–output analysis. While A and B are taken up for discussion in this chapter, Chapter 4 is devoted to C only, arguably the second paradigm in the economics of education. Chapter 3 seeks to add to the discussion of A as well.

Human Capital and the Rate of Return If expenditure on education is treated as an investment and students are rational in the sense of assessing the costs and benefits of education before they decide whether to pursue studies, students’ (and/or parents) decision to spend on education is an act of investment, and hence, it is an act of investment similar to an act of investment in the capital market. Therefore, it is a natural corollary that rate of return from investment in education would be a (p.26) guiding factor for decision-making. Not only so, it is a guiding factor for investment decisions at the macro or national level or a new social investment criterion Page 7 of 30

The Human Capital Approach to Education (Blaug 1976a). We present next the rate of return approach as widely used in empirical studies; a substantial critique of this follows in Chapter 5. Estimating the Rate of Return

Rate of return on a project is a summary statistic describing the relationship between costs and benefits associated with the project. This equates net discounted benefits to zero. Let us take the example of assessing the rate of return from doing higher studies beyond the masters level, say joining a PhD programme. Say the research scholar after completion of her PhD programme intends to find out, based on her estimation of cost and expected pay packages, what the rate of return from investing in her PhD programme would be. Assume she is of 22 years of age and would enter the job market after 5 years to remain employed for 38 years or so to retire at the age of 65 years. She would incur an explicit cost (out of pocket expenses) of say, CP, costs of doing her PhD, for 5 years. In addition, she would also incur an implicit cost in the form of opportunity cost as she could join the job market and earn WM, a pay package with a masters degree for the 5 year period. Looking forward to the future, she expects her remuneration to be WP, a pay package with a PhD degree. Her MB for pursuing PhD is the extra pay she expects to earn when she joins the job market. Since she is expected to join the job market after completing her PhD, her future pay differences are to be discounted to the present time when she is contemplating joining a university. Therefore, costs to be incurred in the next 5 years are to be valued at the present time. Equating costs and benefits, rate of return r which is called the internal rate of return, can be calculated at the point of entry to the job market as: (2.1)

(p.27) In general, if Ch is the resource cost of schooling incurred to achieve a higher level h from a lower level l, Wl,t captures the foregone earnings of a student while the student is engaged in studying, and (Wh−Wl) is the difference in earning attributable to the two different levels of education, high and low, ‘s’ is the years of schooling and let R be the retirement age, and the estimation of costs and benefits being carried out at the entry point to the high level of schooling, then: (2.2)

The internal rate of return rule entails its estimation by equating present value (PV) of benefits with the PV of costs. Investment decisions can be argued to be justified or rational if the internal rate of return is greater than the chosen rate

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The Human Capital Approach to Education of interest or rate of discount which should reflect the opportunity cost of the investment expenditure. And the second investment criterion is to rank alternatives according to their internal rate of return (Vaizey et al. 1972). Ignoring Ch and dividing by (2.3)

Let us assume that equation 2.4: (2.4)

is the sum of non-discounted lifetime earnings of a worker with a lower skill or an unskilled labourer.

, is the proportion of the unskilled

labourer’s lifetime earnings earned in year t. The set of p’s where pi = 1,…,R gives the shape of the lifetime age-earning profile for the unskilled labourer in the form of a distribution function. From the first order conditions for cost minimization, marginal productivities of factors be equal to factor (p.28) prices under the standard assumptions of a perfectly competitive market. Cost minimization requires that (Wh,t/Wl,t) equals MRSt of low skilled for skilled labourer in period t. If we substitute p and MRS we obtain the following (2.5): (2.5)

The internal rate of schooling can be regarded as a function of three categories of variables: (1) marginal rate of substitution through time between labourers with different skills, (2) the shape of age-income profile, and (3) the state of the arts in the production of skill. (2.6)

The other way of doing it is to find out whether net discounted present value (NDPV) of benefit is greater than zero with a pre-determined rate of discount: (2.7)

The investment criteria would be: (i) it makes sense to invest as long as NDPV is positive, and (ii) rank alternatives according to NDPV. The choice of the Page 9 of 30

The Human Capital Approach to Education appropriate discount rate would be informed by the rate of interest, ‘i’, and the discount rate. A Comparison of the Criteria

Vaizey et al. (1972) argue that if the two methods yield different estimates, NDPV is ‘conceptually the correct one’. In Figure 2.1, NDPV is plotted against the different discount rates. There are two NDPVs with the same cost. The curves intersect as the time profiles of the returns from the two investments differ. At higher rates of discount as we move further right along the X axis, curve B offers higher NDPV as (p.29) curve A intersects the X axis before curve B does. If we go by the maximization of the internal rate of return, curve B would be chosen as D2 is the highest which is achievable (as curve A touches the X axis before curve B does). However, at D1, A would be the right choice. Since at higher rates of discount, B has the higher NDPV, B yields greater returns in the near future. As Vaizey et al. (1972) argue, A must be the right choice because it adds more to the resources of the investor.

Figure 2.1 Choice of Discount Rate

Besides these conceptual clarifications, it needs to be remembered that certain adjustments are required to get closer to reality. The following adjustments are suggested in literature. Adjustments in the Estimation of Rate of Return

Earnings standardization: earnings differentials are not entirely dependent on education. Ability, social class, gender, motivation, parental education, region, schooling, and medium of instruction are all pertinent. In the human capital approach, the causal link between education and earnings is established through an enhancement in the cognitive capacity and its impact on productivity. There are two ways of addressing this important issue. (p.30) Generally an adjustment factor to education, α ‘alpha coefficient’ suggested by Blaug (1976a) can be used to account for factors like innate ability other than education. This means, that αΔW will have to be used in the regression exercise rather than ΔW. For example, if α = 0.4, 60 per cent of the change in wage reflects the importance of factors other than education and skill

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The Human Capital Approach to Education embodied in an individual. It was argued that to the extent of two-thirds of the differences in earnings could be explained by education and training. Regression method can be used by including the possible variables which could have an impact on earnings in the regression to apportion the variability in wage in terms of education and all other factors in order to assess the relative contributions of the explanatory variables. The following regression equation can be estimated: (2.8)

Unemployment: The benefit profile needs downward adjustment because of the perennial problem of uncertainty in the job market and a mismatch between demand and supply resulting in underemployment and unemployment. The wage has to be adjusted by the probability of unemployment as follows: UstWst where 0 〈 Ust 〈1. The other way to look at it would be to consider labour force participation: if the labour force participation rate is Pma, expected earnings are equal to Pma*Wma which is typical of women’s education. Probability of survival: The probability that the worker will survive is greater than zero but less than one. Hence, the wage profile is adjusted by multiplying the wage by the survival rate, that is,

where St is the survival rate which

depends on the mortality and morbidity rates for a person of age t. This is similar to what Becker (1975, 71–2) said about the possible length of the period of the activity the individual is willing to invest in because it raises the rate of return. Even if we ignore that young people have a comparative advantage in learning, unencumbered (p.31) by responsibilities and tensions, the incentive to invest would rise simply because of the fact that they would reap the benefits from their investment over a longer period of time. Productivity growth: In the rate of return calculation, we assumed that the wage profile to remain constant for the rest of the working life as the difference in wage remained the same for the entire working period. This needs to be modified as wage would generally grow because of the rising productivity of a worker owing to experience and other intrinsic factors or even independent of them. We need to multiply the given wage profile with (1+g)t where t is the working life of the individual. Else, we can add g to the expected rate of return. Consumption benefits arising out of education are crucial for determining the rate of return. As discussed earlier, the process of learning can be an enjoyable experience thereby yielding consumption benefits not only for the period of study but for the entire lifetime in terms of appreciation of life, culture, arts, and literature resulting in a higher and more satisfactory standard of living. We need to add another stream to income to capture the additional benefits or a percentage of the cost laid aside. For the economy as a whole, non-economic Page 11 of 30

The Human Capital Approach to Education benefits are generally defined to be externalities or external benefits which are not valued in the realm of the market. For estimating a wide social rate of return, sources of positive externalities are to be identified, quantified, and incorporated (Psacharopoulos and Patrinos 2004). Risk and uncertainty: Since the future is always uncertain, estimating future benefits in terms of expected wages is always fraught with uncertainty. A comparison of standard deviations of incomes received by an age-education survey with the mean, would give an idea of the extent of uncertainty faced by a student while taking the decision. A rational investor would make sure before investing that the expected rate of return was greater than the sum of rate of return from risk-less assets plus a term to account for liquidity and risk premiums associated with the investment. In comparison to physical capital, human capital is not saleable, or to put it differently human capital is an illiquid asset. The uncertainty in (p.32) the rate of return on human capital arises due to the differential abilities of individuals and various unforeseen events. The prevailing situation would form the basis of knowledge about the emerging macro situation. It is often argued that imperfections in the capital market for investing in education may be one good reason for explaining underinvestment in education and training. This arises because of an absence of collateral due to the unique character of human capital. Becker provides deep insights into the funding aspects of education such as educational loans as compared to individual sources of funds. Young people on the verge of entering higher studies tend to underestimate their abilities and the investment opportunities available. Investment in education unlike physical capital is difficult to postpone as the earlier one acquires knowledge, the better returns one reaps. Hence investment is often made with less knowledge and without a proper assessment of alternative opportunities as delay in investing may prove costly (Becker 1975: 80). Private versus Social Rate of Return

Assessing costs and benefits can be done at two different levels, at the individual level (micro) and at the societal level (macro). The rate of return estimated earlier can therefore be calculated from the point of view of an individual and society. When resources are used, it has implications for allocation of resources for the society as a whole. The benefits generated do not accrue to an individual only in the form of pecuniary benefits but to society as a whole in the form of non-pecuniary returns. Similarly, from investments in school education, society gains in term of lower crime rates, better functioning of democratic institutions, spreading of health awareness, and inculcation of responsible citizenship. Costs and benefits pertaining to investment in education therefore have important social implications. In view of this, both costs and benefits need to be Page 12 of 30

The Human Capital Approach to Education reassessed. In view of the subsidization of education, social costs should include the extent of (p.33) subsidization as this reflects the resources dedicated to the provision of education by the government on behalf of society in addition to the costs incurred by individuals. Similarly, benefits arising out of education accrue not only to the individuals engaged in higher education but to the entire society in the form of various externalities as mentioned earlier. When social costs and social benefits are taken into consideration, we obtain the social rate of return. The private rate of return is estimated when the cost of education is what is incurred by individuals pursuing higher education and the benefits of education as realized by the same individual as obtained earlier. Social costs would have to be redefined as SUniv = amount of resources devoted to a student by the university or per capita subsidy. If the benefit calculation remains the same as that of an individual, that is, only in the form of a higher stream of earnings, rate of return thus obtained is defined as a narrow social rate of return (Psacharopoulos and Patrinos 2004). If the calculation of benefits includes externalities, the benefits are to be redefined as: (2.9)

where TMA = externalities accruing to society emanating from an individual with a masters degree whereas TPhD refers to the positive externalities accruing to society arising out of an individual who obtained her PhD degree. The rate of return thus calculated after incorporating the externalities is called the wide social rate of return. Social rate of return (narrow) would be less than the private rate of return because it includes the cost of subsidization whereas the estimation of benefits remains the same in the form of higher remunerations accruing to an individual due to a higher level of education. However, for a wide social rate of return, the estimation of benefits is revised upward by the extent of the externalities. It is possible therefore that depending on the valuation of externalities that education (p.34) generates, it is possible that the wide social rate of return would be greater than the private rate of return despite inflation of costs due to subsidization of education. It is unfair to ignore social benefits arising out of education also in view of endogenous growth theoretic literature which supports spill-over effects or externalities (Lucas 1988, discussed in Chapter 3). The nature and estimation of social benefits would depend on the level of education, its quality, and composition. It follows therefore:

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The Human Capital Approach to Education social rate of return narrow 〈 private rate of return 〈 social rate of return wide5 We need to distinguish between marginal rate of return and average rate of return. What we have calculated is a marginal rate of return for the PhD cycle (or from a lower level to a higher level). Whereas, average rate of return pertains to the entire period, say of rate of return of schooling. There can also be a distinction between ex-post rate of return and ex-ante rate of return. The expost rate of return is in the historical sense as it has been recorded in the past or estimated based on real life data from the past, near and far. Ex-ante rate of return on the other hand is good for behavioural analysis and relevant for making decisions both by an individual and by institutions, public and private. In practice, rate of return are neither ex-ante nor ex-post. Based on today’s crosssectional data, rate of return estimates are either extrapolated backward or forward. Becker (1975) compared the social returns of investment in business with that of investment in education in terms of the relative contributions of business capital and human capital to national income (Becker 1975: 197). Becker used Denison’s residual growth to estimate (to be discussed in the next chapter) to arrive at estimates of social rates on college education compared to that of business capital depending on whether residual growth which was argued to be a proxy for ‘advancement in knowledge’ could be attributable to education or business capital or some combination of the two. If advancement in knowledge was due to education (p.35) alone, social rates of investment in education might double. The same could happen to social return to business capital as well if the residual was made attributable to business capital. Becker admits that a comprehensive social rate of return should include effects arising out of cultural advancement and deepening of democracy. What determines whether to go to college or not is private rate of return. However, Becker concludes that ‘… private real rate of return has apparently been higher on college education than on physical capital’ (Becker 1975: 200). However, monetary and psychic costs should be considered while calculating the private rates of return.

Policy Implications of Rate of Return Approach to Education As Blaug (1976a) argued, the rate of return calculation has an important implication for guiding resource allocation at the macro level because one could come up with new social investment criterion. Resources are to be allocated to the different levels of education and to the different years of schooling to ensure that the marginal social rate of return across the various avenues are equalized (Blaug 1976a: 830). Rate of return estimated for education is treated at par with rate of return for any other sector in policymaking when it is argued that the equalized rate of return from investment in education should not be lower than the yield on alternative investment opportunities. Though there is indeed a vast literature on the estimation of rate of return for understanding career choices Page 14 of 30

The Human Capital Approach to Education and evaluation of decision-making both at an individual as well as at an institutional level, implications for policymaking are often very tenuous. The basic question is whether rate of return should be used at all for guiding decision-making? What is the use of a private rate of return calculation for schooling? Education can be argued to be so fundamental to a dignified existence, treating it at par with other sectors is tantamount to saying education is no different from power and irrigation, for example. Power and irrigation are no doubt important and so are education (p.36) and health for the government to invest in. For the education sector as a whole, can we use estimates of rate of return to determine level of investment at the three levels—primary, secondary, and tertiary? For example, can we compare the rate of return for college education with that for school education, or compare the rate of return for higher education with other sectors such as power, irrigation, and transport? Education creates externalities, quantification of which would always remain problematic. It does not really matter how large or small the rate of return are. Therefore, both intra-sectoral as well inter-sectoral allocations are not meaningful if they are based on rate of return estimations. Since estimation of externalities and non-pecuniary benefits remains a formidable challenge, estimates vary and so with it, the optimal strategy for investment (Blaug 1976a: 831). Therefore, the pertinent issue is whether investment decisions should be guided by estimates of rate of return for at different levels of education and for different sectors. Or, how much resources are to be devoted in aggregate for education as a whole? How to mitigate the mismatch between the demand for and supply of skill? How does quality matter and by how much? How to subsidize education and how much would be the extent of the subsidization? Without specifying how the government expands education facilities, it is difficult to estimate the demand for the schooling function as a supply function is also involved in the process. There lies the possibility that both the supply and demand functions would have to be estimated in the process.

The General Earnings Function: Becker and Mincer Investment in education or human capital could be one of the major factors to explain differences in income over time and also among persons and families, both within a region or across different regions. The talent required for gaining economic success should encompass some particular kind of personality, persistence, and intelligence. Since ability and differences in education would (p.37) affect incomes, the difficulty lies in separating out the effect of ability from that of education. Becker (1975: 84) suggests one way of capturing the impact of ability on earnings when all other possible variables are held constant. As shown, gross earnings would include returns on human capital (r) as well as amount invested (C) plus that of earnings which is independent of education (X):

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The Human Capital Approach to Education (2.10)

The distribution in Y would be determined by distribution in r and C given that X remains more or less unchanged for all. Ability would be measured by only the average rate of return (r) on human capital when C is held constant if we ignore distribution of X because the same level of C would generate different levels of Y ceteris paribus. Hence differences in r thus estimated will capture differences in abilities intrinsic to the individual’s characteristics. But the new dimension Becker adds is the interdependence between r and C. Individuals with higher ability would have a greater tendency to invest more on education compared to others if they perceive a higher marginal rate of return keeping all other personal sources of variations being held constant. So, ability as indicated by average r and investment in education are positively correlated. Thus, even if ability and investment are symmetrically distributed, their product would be skewed. Therefore a strong positively skewed distribution in earnings can be reconciled with, presumably, a symmetrical distribution of abilities. It is also generally observed that earning distribution of the skilled and older people would be more skewed than that of younger people. In the last equation, the investment cost was ignored. But at a younger age, the cost of investment would be higher. Net earnings would be given by: (2.11)

Let Y j refer to the net earnings and C j to the investment cost at an younger age j. Let C i measure investment cost at the age of i and r i the rate of return on C i. As is seen, the distribution of (−C j) (p.38) would impact the distribution in Y j as C j tends to be larger at the earlier stages of an individual engaged in studies. So the skewness would rise over time. The impact of X tends to dominate at younger than at older ages. In addition, the negative correlation between (−Cj) and ΣriCi would negate the positive correlation between r and C resulting in a more skewed distribution in earnings at older ages and among the skilled persons with higher rC than X. Becker (1975) adds a new dimension to the debate on income distribution with the incorporation of the argument that investment in human capital can shed light on (inequity in) income distribution purely in the realm of economics.

The Mincerian Approach to the Determination of Wage and Rate of Return Mincer (1958, 1970) identified education as one key determinant of income or wage in his empirical investigation of factors responsible for differentials in earnings. He took years of schooling in the earnings function to estimate rate of return on education for a cross-section of workers. Mincer assumed the opportunity cost of student’s time as the only cost of an additional year of schooling and further, it is assumed that a proportional increase in earnings Page 16 of 30

The Human Capital Approach to Education attributable to education remains the same over the years. It was shown that the logarithm (log in brief) of earnings would be linearly related to an individual’s years of schooling. The regression coefficient could be interpreted as the rate of return on investment in schooling. The model was augmented to include a quadratic term for work experience to allow for returns for on-the-job training. Assume that the total cost C to an individual investing in a year of schooling is the opportunity cost of not joining the job market, or annual earnings foregone to pursue education in that year. Let Wt be the annual earning after t years of schooling be equal to the annual earnings with t – 1 years of schooling plus the cost of education (Ct = W t−1) times the rate of return on investment in education: (2.12)

(p.39) Following the rule of mathematical induction, it follows that earnings after ‘s’ years of schooling are given by: (2.13)

If we take natural logarithms and apply the approximations that for small values of r, ln(1 + r) ≈ r, (2.13) yields: (2.14)

For r = rt being constant across the levels of schooling, this is equal to: (2.15)

Or equation 2.18 could also be written as: (2.16)

Equation 2.15 is also the logarithmic version of equation 2.16. The relationship between earnings and investment in education measured in monetary units is converted to the relation as in equation 2.12 where natural logarithms of earnings and investment in education measured are in time units. Logarithm of earnings is a linear function of years of schooling. The interpretation that each additional year of schooling raises earnings by r per cent is made possible by the log linear formulation of the wage function. Mincer (1958, 1970) estimated the rate of return across countries by controlling for work experience of the individuals. It spawned many empirical studies only to reconfirm the faith reposed in the Mincerian wage equation. Since Ct equals Page 17 of 30

The Human Capital Approach to Education W t−1, there is no scope for direct costs such as tuition, school fees, books, and other stationeries. As indicated earlier, the age earnings profile (Wössmann 2003) are assumed to be constant for different levels of education otherwise the regression coefficient would be a biased estimate of the rate of return on investment in education. However, there are problems associated with the treatment of average years of schooling as a proxy of human capital other (p.40) than the data related problem including a problem with recording average years of schooling. There could be two major criticisms (Wössmann 2003: 249, 265). An increase in the years of schooling by one year would not necessarily lead to an augmentation of the stock of human capital irrespective of the level of schooling. What this means is that different years of schooling contribute to the enhancement of the human capital stock by different degrees. And secondly, quality of education matters. Merely by saying that the average years of schooling have gone up by one year means very little, unless the education imparted was of good quality. This is a typical problem with education that focusing on the number of years would not be able to capture what education essentially is and what it does to an individual. To refer to the first criticism, assigning the same weight to any year of schooling to quantify human capital by average years of schooling implies productivity differentials among the workers are assumed to be proportional to their years of schooling. But empirical studies which are micro-econometric in nature show that there are decreasing returns to schooling (Psacharapoulos 1994). Ideally a year of schooling should be weighted depending on how many years of schooling the individual has acquired. The familiar Mincerian wage equation for i can be written as: (2.17)

where ln W i is the natural logarithm of individual i’s, earning Si is the number of years of schooling, ‘exp’ is the experience in years and exp2 is the squared of experience and ε is the error term. The coefficient of schooling is the rate of return obtained as the discount rate obtained by equating two PVs of earnings of cost and benefits. The estimate of β 1 ranges from 0.05 to 0.15. The usefulness of the Mincerian equation is that the semi-log formulation captures the relevant data in countries with sharp differences in socio-economic conditions (Krueger and Lindahl 2001: 1104, 1108). Wage is assumed to rise with a gain in experience but with a decreasing rate. (p.41) The issue is whether the coefficient reflects unobserved ability and other variables which are correlated with education or the ‘true reward that the labour market places on education?’ (Krueger and Lindahl 2001: 1104). There can be two ways to interpret this. Either it is a signal for ability (Spence 1973) or it is a measure of increases in productive capabilities (Becker 1964), and in all Page 18 of 30

The Human Capital Approach to Education probability it is a blend of the two. Further, would all the individuals gain equally in their earnings or would these vary systematically with individual characteristics? Evidence suggests that education is more than a proxy for unobserved ability. From 2.15, it follows: (2.18)

The inequality in earnings is large when σ(r) and the average level of schooling s are large other than the contributory factors r and σ(s). Other than r, which is a proxy for individual ability, and variances in the level of schooling, that is, σ(s) contributing to the larger inequalities in earnings, variances in ability, that is, σ(r) and the average level of schooling would also cause larger inequalities in earnings. To be more precise, we can make the following observations based on (2.18): (a) for a given level of schooling (s), invidual differences in ability would cause larger realitive and absolute differences in earning at higher levels of schooling and (b) for a given level of r, larger differences in schooling would generate larger differences in earnings at higher levels of ability (Mincer 1970: 10).

Becker’s Approach to Human Capital and Income Distribution Becker (1975: 94) proposed a model which essentially captures the centrality of human capital in determining income distribution, but in a somewhat broader framework incorporating various other non-economic aspects, individual cognitive capabilities, and family environment other than the economic factors such as financing of education. Becker (1975) made his intention clear in the (p. 42) beginning that the objective was to advance a comprehensive explanation of the factors behind personal income distribution, particularly focusing on why a representative individual undertakes different levels of investment in education which he analysed within a framework traditionally used to deal with investment in physical capital. Becker sought to explain actual income differences across regions, countries, and time periods with the help of a comprehensive economic model. The key to understanding personal income distribution was to address the basic question of why the rate of return and investments vary substantially among persons. Rate of return is viewed as the outcome of two forces, demand and supply, which though have different connotations in the present context. The demand curve shows MB or rate of return for different levels of investment whereas the SS curve shows the MC of financing to her or simply the rate of interest (Figure 2.2). So both the demand and the supply curves pertain to the same individual who mobilizes her finances to invest in education with the purpose of gaining in the form of a marginal rate of return akin to MB obtainable from the consumption of a good. In Figure 2.2, we depict human capital along the X axis Page 19 of 30

The Human Capital Approach to Education measured in rupees and marginal rate of return or cost along the Y axis. The equilibrium at the intersection between the demand and the supply curve ensures equality between rate of return and rate of interest for financing education. Given the differences in the underlying factors generating the demand and supply curves, it is an imperative that we deliberate on the factors responsible behind the two curves. Generally, the demand curve slopes downward but in the present context the reasons behind this are different. One particular aspect of the distinctions between human capital and physical capital is crucial here. In the case of human capital, capital is embedded in the person investing. Since memory capacity, physical size, etc., are limited, as the person keeps on investing, eventually diminishing returns would set in. Indispensability of time and the universal time constraint faced by an individual contributes (p.43) further to the negativity of the curve. As Becker argued, the factors contributing to the formation of human capital are not a single entity but constitute indispensable elements like time which are fixed for all individuals. In the case of an upward sloping supply curve, MC rises for producing a rupee of returns as cost of financing goes up. A large part of human capital is the own time of a person investing which is equal to foregone earnings. Optimal combinations of inputs over an optimal investment period to maximize PV of benefits may justify spreading out of capital in view of the fact that time as an input for human capital accumulation is both essential and expensive. However, it can only partially mitigate the decline in the MB as the MB curve continues to be negatively sloped. The value of own time increases and time is spread out but essentially time remains an important ingredient, as without it, the relevance of all other factors cease to matter. In the long run, there exists an optimal combination of such inputs to human capital formation which would maximize PV of future streams of earnings.

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The Human Capital Approach to Education (p.44) So, the later investments become less and less profitable because of high mortality, and a decline in the PV as it is similar to a postponement of an investment decision. The capital accumulated becomes increasingly valuable and so does a person’s time associated with increasing risk aversion at the margin. The supply curve reflects an MC of financing which is equal to the rate of interest of borrowing funds or the opportunity cost if own funds constitute the source of funds.

Figure 2.2 Equilibrium Levels of Investment in Human Capital Source: Becker (1975).

This can also be explained as the annual repayment on an additional rupee borrowed for funding investment in education. In reality, the capital market for funding education is segmented. Local subsidies, borrowings, transaction costs, imperfections in the education loans market, and rationing of funds may all lead to a rise in the cost of financing education. In fact, the higher the segmentation, the higher is the cost as one’s intention to invest rises. Subsidy is in effect zero cost to the borrower in the form of cheap loans, subsidized loans, commercial loans, etc. But accumulation of time matters. The longer the time period, the costlier are the loans. At equilibrium, a rational decision entails choice of a path that maximizes the PV of profits. As per convention, the question is how do we ensure uniqueness and independence of the DD and the SS curves? Becker assumes that own time and hired inputs are used in a fixed proportion. Time has a fixed cost and has got a maximum limit. At equilibrium, MB = MC. The model implies that the total amount invested differs because of differences in either demand or supply conditions. Therefore, the model provides an explanation of why different individuals invest different amounts in themselves, thereby causing incomes to change with the variation in the rate of return. A higher demand curve in the form of a rightward movement of the DD curve and lower supply curves in the sense of a rightward movement lead to greater investment than others. Given the supply curves one can find out that the higher the demand curves, the higher are the returns. If the underlying conditions determining the cost of education remain the same, some individuals would (p. 45) invest more and some would invest less depending on their rate of return. Page 21 of 30

The Human Capital Approach to Education Similarly, given the demand curves, as the supply curves shift rightward, returns from investment fall. This happens because with a rightward movement of the supply curves, as formation of human capital takes place, rate of return fall along the downward sloping DD curve. As we can see both the demand and the supply conditions are possible factors to explain the differences in earnings. We will now focus on one aspect at a time. Egalitarian Approach

Becker (1975) distinguishes between the two approaches based on the demand and the supply curves to explain the rate of return based on the DD and SS curves. In the egalitarian approach, as Becker (p. 106) defines it, ‘Demand conditions are the same for everybody and that only cause of inequality is differences in supply conditions’. Same demand conditions imply that everyone has the same capacity to benefit from investment in human capital but opportunities differ amongst all to invest in human capital and so there would be different supply curves for different financing conditions. To bring equality in the distribution of incomes, the policy should target eliminating the differences mostly in terms of availability of funds. Given the segmentation in the capital market, cost of financing is likely to go up. Availability of subsidies may also differ for different individuals and with respect to different state policies.6 Investors may be from wealthy families which will enable people with favourable conditions to invest large amounts and the SS curve will be lower implying cheaper sources of financing. So the underlying differences in the supply conditions explain why the supply curves vary among individuals. As shown earlier, one can write: (2.19)

If demand curve was negatively sloped, as it has been argued to be so, the impact on E due to a change in C will get muted. E will now be more equally distributed compared to C because E (p.46) will change by a smaller percentage in response to any change in C as average rate of return (ravg) and c move in the opposite direction. However, if the demand curve was more elastic, both E and C would be more unequally distributed. Thus, the students with favourable supply conditions would be encouraged to invest more in response to higher ravg, whereas the students with unfavourable supply conditions would be willing to invest even less in response to lower ravg. ‘Elite’ Approach

The ‘elite’ approach also portrays the analysis to be an extreme one for the purpose of contrast. As defined by Becker (1975: 109–110), ‘Supply conditions are identical and the demand conditions alone vary among the individuals.’ The underlying assumption is that earnings differ primarily because of differences in the capacity to benefit from investment in human capital in different individuals: Page 22 of 30

The Human Capital Approach to Education some persons are able to do this more and would form an elite group. To reiterate, opportunities are measured by the SS curves and capacities are by the DD curves. The DD curves can be higher only if more units of capital are produced for a given expenditure which implies that the human capital formed has more capacity and ability to gain from a given investment as reflected in a higher rate of return. Ability is measured by earnings received when the investment in human capital is held constant as discussed earlier. There can be two definitions of ability: (i) in terms of IQ, personality, and motivation, without regard to earnings (attention to form and not to results), and (ii) in terms of earnings without regard to opportunities (confounding in the process ‘nature’ and ‘nurture’). Becker’s approach emphasizes on the relationship between ability or capacity as perceived by the student as an investor in education and expected earnings given the underlying supply of finances as indicated by the given SS curve. As is evident from Figure 2.2, if the cost rises, the rate of return rises as we move up the common supply curve and along the (p.47) higher demand curves. With the same cost, rate of return rises as DD shifts up. If we combine these two, earnings would tend to be more unequally distributed and skewed than investments as the rate of return rises with a rise in investment along the positively sloped supply curve. In the egalitarian approach, marginal rate of return is lower, the larger is the amount invested in human capital as the DD curve is negatively sloped. Whereas in the elite approach, marginal rate of return is higher, greater is the investment in human capital as the SS curve is upward rising. Inequality in earnings tends to be less than that in supply conditions and greater than that in demand conditions because the former implies a negative and the latter a positive correlation between rate of return and investment. In the egalitarian approach, inequality in earnings is more serious because it indicates a larger extent of underlying inequities. This has relevance for the present debate in India. Therefore, a skewed distribution of income with a presumed symmetrical distribution of abilities can now be explained. A More General Approach to the Rate of Return

Investment in education and the return earned therefrom constitutes the core of the model which seeks to explain income differentials among individuals. In line with the neo-classical approach to resource allocation in terms of demand and supply, Becker in an ingenuous way provided a sound rationale for looking at the determination of the rate of return in a supply–demand framework by focusing on the same individual but from two different perspectives—funding education by linking interest costs and the amount borrowed for investment and return from investment in education. How to explain the variability in earnings among Page 23 of 30

The Human Capital Approach to Education the people who invested the same amount in human capital? Neither the special case, nor variations in DD nor SS alone are sufficient to provide an explanation. There is a new parameter other than distribution of cost and earnings and the elasticity of DD and SS curves. (p.48) A Comparison between the Egalitarian and Elite Approaches

In the egalitarian approach, as the SS curves move rightward, marginal rate of return falls with an increase in investments, whereas in the elite approach, higher the investments, greater is the marginal rate of return as the DD curve shifts rightward. In the former approach, the variations in earnings would be less than that of inequities in the supply conditions because of the negative correlation between the rate of return and investments made in education. In the elite approach, because of the positive correlation between r and C, the inequities in capabilities get exacerbated in earnings. This model can help explain why a symmetrical distribution of capabilities would result in a positively skewed distribution of income under constant elasticity of supply and constant and identical elasticities of demand curves. As opposed to the egalitarian approach, the elite approach is better enabled to explain income inequities as it takes differences in capacities into account. This is interesting because the supply curve is amenable to the funding policy of the government. The government through subsidization, cheaper education loans, and ‘scholarships to the needy’, can bring about equality in the SS side but variations in the demand conditions are intrinsic and person specific, differences in intelligence, and other factors not amenable to direct policy interventions. Focusing on supply conditions would also effect better allocation of resources to human capital. So the inequities would remain ‘even’ if the supply curves are made almost horizontal by policy interventions. Unlike the conventional DD and SS analysis, there exists a correlation between the DD and SS curves. Individual represents the DD curve as an investor in human capital in response to the rate of return and at the same time the individual would constitute the SS curve as someone, who is faced with the locus of marginal cost of financing and availability of funds to finance her decision to study: (i) Abler persons are more likely to receive scholarships or grants from public and private schools, shifting the SS rightward, (ii) children from higher income families on an average are more intelligent and receive greater psychic benefits from human (p.49) capital, and (iii) government measures to tackle poverty lowering the SS curves. If the first two dominate, we would get a positive correlation between the SS and the DD curves. It increases the skewness further by increasing earnings and investment of persons who would have high earnings and investment anyway. Becker uses the same framework to discuss the important issue of an efficiency– equity trade-off. Equalization of a marginal social rate of return across all the persons would ensure efficient allocation of the total investment in human Page 24 of 30

The Human Capital Approach to Education capital if attitudes towards risk are ignored. If we assume that marginal social to private rate of return are equal, the equality of the social rate of return would also ensure equality among the private rate of return. Nature versus Nurture Debate

Though in the human capital theory it is the levels of education which determine earnings, the role of ability is clearly brought out in the demand and supply framework as discussed earlier. However, the relative impact of ability on return is not really apportionable in empirical literature. Even conceptually distinguishing the relative contribution of attributes and schooling is difficult. We again engage in this debate in Chapter 5 after we conclude our discussion on the theory of screening. Generally it is believed that the human capital approach undermines the impact of pre-school factors on lifetime earnings whether it is in the form of native ability or time spent by the family or the family background. The impact of these factors like native ability, family background, and schooling cannot be added to gauge their total impact as in that case we would ignore the interaction effect. The combined effect would be greater than the sum of the impact of individual factors. Strictly speaking, as argued by Blaug (1976a: 843) the human capital theory does not deny the interaction but emphasizes more on the additive effect. It is of course a matter of concern that it is difficult to get reliable data on preschool factors and family backgrounds. The unconvincing empirical results can emanate from three factors: the identification problem, problem related to proxy variables, and data related problems. (p.50) Since earnings depend on wage which is market determined, an earning function could be considered as a reduced form equation in which the estimated coefficients are biased as the simultaneous equation model is not specified and therefore estimated.7 The impact of home environment can be in the form of parental education, income, parental occupation, both before school or during schooling or postschool influences, or may be because of attitudinal changes or aspirations and encouragement. For measuringnative ability, the use of IQ is often contested. Instead achievement motivation may be a better proxy. It can be argued that schooling does exercise a strong impact and in a way it mediates the family background and pre-school cognitive ability, which on their own would not mean much to an individual in the skilled segment of the job market. Not only is it schooling, but quality schooling which transforms family backgrounds and cognitive abilities into marketable assets. It follows therefore that schooling by itself would not suffice to equalize income without adequate attention given to family support and pre-school development. Otherwise a school would be a stratifier instead of being an equalizing force.8

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The Human Capital Approach to Education Valuation of Human Capital If valuation of physical capital remains problematic, valuation of human capital has also been a formidable exercise. However, economists have not shied away from its valuation because it is a first step towards conceptualizing human capital and subjecting it to the rate of return analysis. The general criticism levelled against even valuation of physical capital remains valid for human capital to a large extent. The measurement of human capital is highly sensitive to the rate of discount applied. As argued by Wössmann (2003) adult literacy rates, school enrolment ratios, and average years of schooling of the workingage population are all poor proxies for human capital. The concept of obsolescence is not important as it is for physical capital, but mortality rates need to be considered. Further, the relation between earnings and productivity is central (p.51) to the measurement of net human capital. There are two problems associated with it. One, the entire rise in earnings cannot be attributed to contributions from human capital as innate ability, race, sex, and other socioeconomic factors do count. Two, investment in human capital is constrained by various socio-economic factors. It remains debatable whether quantification of human capital should tilt more towards an earnings-based approach or a costbased approach. Further, the consumption-investment apportionment of expenditure on education complicates the process. The delineation of the future profile of earnings and cost is based on the assumption that steady state or steady growth equilibrium persists in the long run (Vaizey et al. 1972) which is, realistically speaking, untenable.

Evolution of Human Capital Theory The human capital theory has evolved over time. There have been changes in methodological issues, focus, and their subsequent impact on the practice of policymaking. Marginson (1997: 221–2) traced the evolution of the human capital theory in three phases. This chapter dealt basically with the first phase (during the 1960s) with focus on education augmenting productivity and therefore income. For policymaking, the emphasis was on ensuring equal access to education with the social rate of return being regarded as a measure of investment on economic growth in a broader sense. In the second phase during the 1980s, the linkage between education and growth was re-envisaged with technological change being considered as the mediating factor. The focus then was on how education could be an enabling factor in the development, generation, and dissemination of knowledge as embodied in technology to spur income growth (discussed in Chapter 3). Shrinkage in the size of the government against the backdrop of the structural adjustment policies underpinned the approach to education reform. With the coming of the third wave by the early 1990s, termed as the ‘market liberal human capital theory’ (Marginson 1997), the economic logic of free market gained importance which (p.52) became a compelling reason to undertake reform in education. For a change in focus, the importance of social rate of return waned even though the private rate of return emerged as a guiding factor for individualized investment in education. The role Page 26 of 30

The Human Capital Approach to Education of the government was to facilitate private investment with the aggregate leading to the optimum level of social investment. However, all three waves share one core element, expenditure on education is investment in human capital, but they differed in terms of their methodological approaches and in different ways they informed policy practices in education.

Concluding Remarks This chapter dealt with the concept of human capital and the rate of return approach to investment in education. The development of human capital constitutes the core of economics of education and it is a critical concept in the theory of growth and broad based participatory development. The theory has had influence over government policies with regard to skill development in the West. Expenditure for the purpose of acquisition of skills and knowledge is argued to be no different from investment in physical capital. The advocates of human capital theory have also argued that the choice of investing in education should be guided by the same principle applied in the case of investment in physical capital. The concept of the rate of return was developed in the case of education and this idea was broadened to include other relevant factors determining earnings. At the micro level, the Mincerian equation posits a relationship between wage and a set of independent variables including education and work experience. The human capital approach can be argued to be located within the mainline economics of ‘methodological individualism’. So the criticisms levelled against this approach question the very foundation of this theory which is based on the methodology of neo-classical economics. Fitzsimons and Peters (1994) quote Fred Block (1990) to point out two fundamental building blocks of (p.53) neo-classical economics. One, the economy is analytically separate from society. But an economy is indeed influenced by politics, society, and culture. Two, individuals act rationally to maximize their utilities. However, individuals do behave differently but in order to lay bare the dynamics of the core of the economy, other behaviours are relegated from the analysis. Fitzsimons and Peters (1994: 252) say that ‘These assumptions are cast in universal and ahistorical terms’. The neo-classical perspective simplifies the entire gamut of social events that are significant in education and quantifies all qualitatively different aspects of social, cultural, and historical phenomena. Though this is indeed the approach of this dominant paradigm, the human capital theory has been very well supported by empirical studies. Sometimes, in order to understand the core, a lot many aspects, even though they are important, have to be relegated otherwise an analysis of the entire system becomes almost unmanageable. We have seen in Becker’s model how other socio-psychological factors could be recognized and made part of the demand– supply model to determine the rate of return from investment in human capital. In order to probe in to the relationship between education and earnings, the model developed by Becker, as discussed earlier, seeks to explain income differences in terms of demand and supply factors. Page 27 of 30

The Human Capital Approach to Education Blaug (1976a: 828) in his review of the human capital approach raised a fundamental question which has remained valid even today. He says, ‘Has it progressed, in the sense of grappling ever more deeply and profoundly with the problems to which it was addressed, or are there signs of stagnation and malaise?’ Though the human capital approach has led to the emergence of many new areas of research in many branches of economics, but in terms of empirical support, Blaug argues that the theory ‘… is not very well corroborated.’ (Blaug 1976a: 833). While concluding, Blaug quotes Oulton (1974) to make a point which questions the very root of the demand and supply approach. Accumulated human capital in the earnings function is supposed to be determined by two exogenously determined distributions, ‘abilities’ (p.54) and ‘opportunities’. But these two are mere reflections of early cognitive ability and family background. These two are actually: … endogenously determined variables in any intergenerational view of the process of human-capital formation. Thus, at best, the schooling model is incomplete and, at worst, it is misleading (Blaug 1976a: 845). Linking education with income earnings requires a study of the role of education in the process of selection in the job market which remains outside the ambit of the human capital approach. Education may act as a signalling device for employers to segregate job applicants as potentially more productive from the low potential ones which opens up a new channel to explain the positive correlation between education and productivity and/or earnings. The importance of education has to transcend its mere role in enhancing income. Education by itself is intrinsically important to a person irrespective of its positive impact on income earning capacities. This aspect of education that it empowers an individual to participate in the larger socio-political context and overcome constraints to live life with more freedom and dignity have been stressed by Sen (2000) in his capability approach. From a Marxian perspective, the human capital approach scores points but falls short of giving a fuller analysis of socio-economic dynamics. It extends the notion held by classical economists like Ricardo and Marx that labour is a produced means of production as distinct from labour being treated as a mere commodity. Labour is heterogeneous and differentiated as it embodies different levels of skills. An analysis of the process of production of education requires social institutions, schooling, and family to be put together rather than relegating family to the background of the analysis. But the notion of schooling needs to be deconstructed along with an attempt to understand and trace out the implications of education imparted within a social context in a typical capitalist order.

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The Human Capital Approach to Education The focus on individuals as decision-making agents in education ignores the other agents (government and the private sector) in decision-making, thereby ignoring their roles in capacity creation (p.55) for delivery of education and policymaking. Choice making from society’s perspective is often insightful and meaningful as argued by Majumdar (1983). An overall critique of the human capital approach located within the neo-classical theory entails a much broader canvass to appreciate how education has been dealt with by economic theory and various other theoretical perspectives over the years. Some of these points are taken up for a detailed discussion in Chapter 5, which revisits the contributions of human capital theory from four different perspectives— education as a screening device, Sen’s approach to education in his approach to development, Majumdar’s critique of the human capital approach from the social choice perspective, and the Marxian critique. Notes:

(1.) Because of Adam Smith’s emphasis on division of labour, economic progress would reduce rather than raise supply and demand for human skills. Malthus like Smith treated education for the betterment of man and not for the creation of human resources (Bowen 1963: 104). (2.) Sustained investment in physical capital was necessary to sustain the demand for labour as aggregate demand determines output and hence employment. (3.) Specifically, Schultz was awarded in 1979 and Becker was awarded in 1992. (4.) To the extent acquisition of skill and knowledge and being a part of an institution gives satisfaction to the individual in the form of socialization and realization of one’s potential, expenditure on education would better be classified as consumption expenditure. (5.) It is assumed that while estimating the social rate of return, the valuation of the externalities as a proxy for social benefits would be large enough to outweigh the social costs. (6.) If scholarships are given on the basis of merit or income, only those who fulfill the defined criteria become eligible for the scholarships. The supply curve will also vary from individual to individual depending on the family’s income and wealth conditions. (7.) This issue appears in the discussion in the context of a critique advanced by Majumdar (1983) in Chapter 5. He argues that the human capital approach focuses only on one domain of investment—the individual domain—and there may arise differences between micro and macro estimates. Both these put

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The Human Capital Approach to Education together show that supply responses in the education sector matter for realization of returns as wages are essentially market determined. (8.) Blaug (1976a: 844–5) quotes Fägerlind (1975) to drive home the point that schooling after all does matter.

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Technology, Knowledge, and Growth

Education and Economics: Disciplinary Evolution and Policy Discourse Saumen Chattopadhyay

Print publication date: 2012 Print ISBN-13: 9780198082255 Published to Oxford Scholarship Online: January 2013 DOI: 10.1093/acprof:oso/9780198082255.001.0001

Technology, Knowledge, and Growth Saumen Chattopadhyay

DOI:10.1093/acprof:oso/9780198082255.003.0003

Abstract and Keywords This chapter inquires into the different ways in which education can promote technological advancement and spur growth. The new brand of the growth theoretic model seeks to understand the process of growth on the basis of optimizing individual decisions to invest on education, research, and development. It is in this context that the economic characteristics of knowledge become crucial. Since generation of knowledge entails investment, knowledge ceases to be a pure public good. This chapter relates the concepts of education, knowledge, and human capital in the context of growth. The challenge is to identify and measures various forms of human capital to incorporate in the models. This chapter ends with a discussion on how quality of education matters for growth. Keywords:   education, production function, technology, knowledge, human capital, endogenous growth theory, externalities, ‘learning by doing’

In this chapter we are concerned with the question whether schooling, or broadly speaking education, contributes to the process of income growth, and if so, how. Identification of the factors that help an economy to achieve high growth has been a major policy concern for nations, rich and poor alike. Conceptualization of the linkages of education and human capital with growth and its empirical investigation has posed formidable challenges for economists. Further, the character of growth achieved by a nation is also important because it has serious implications for income distribution, and hence, for equity. As Stevens and Weale (2004) argue, the enormous improvement in the standard of living witnessed in the rich countries could not have been possible without the Page 1 of 26

Technology, Knowledge, and Growth scientific advances achieved in those countries. It seems rather obvious to claim that education not only played an important role in the creation of knowledge but also in its dissemination. Further, empirical studies indicate that earning and education are positively correlated at the individual level as discussed in Chapter 2. However, the extent of correspondence varies across the different levels of education and across different courses or disciplines. Based on such robust empirical studies, one could argue that at the macro level as we study an aggregate of individuals, education and income growth would also be (p.57) positively related. However, the macro picture is not merely the sum of micro behaviours, because as in the realm of the macro there are many other factors which play their respective roles and contribute to the complexity of the growth process. In this chapter we review some select empirical studies which examined the relationship between education among other factors and the process of growth. In the course of this chapter we discuss how education in the form of human capital and knowledge has been conceived of in the evolution of various growth models so as to relate various manifestations of education with growth in many different ways. The various forms of education as incorporated in growth models throw light on the complex and multifaceted relationship between education and growth. We begin with a brief review of the origin of the growth model as it originated in the form of Solow’s growth model. We embark on a tour of the various models which have sought to capture the relationship between human capital and growth. We discuss knowledge and its interface with the market to understand what fosters the generation of knowledge. In the end, we highlight the various ways in which education can contribute to the growth process.

Growth Accounting Framework Can we explain income growth achieved in terms of the contributions made only by the factors of production—labour and capital? It was empirically observed that a part of the income growth rate could not be explained solely by the growing contributions made by the factors of production which could be called ‘residual’. Denison’s empirical work (1962, 1964) sought to ascertain the sources of economic growth and compared output growth and input growth for USA for the period 1929–57. Empirical estimates showed that real national income witnessed a growth of 2.93 per cent per annum whereas the total factor inputs grew by 2 per cent per annum implying that there was a ‘residual’ growth of 0.93 per cent per annum. This residual was sought to be explained by restrictions on optimal resource use, factors moving out of (p.58) agriculture, economies of scale, national and local, and delayed application of knowledge. Ultimately a ‘final residual’ of 0.58 per cent per annum emerged, which was attributed to the ‘advance of knowledge’ including research and development. Denison (1962, 1964) used factors’ shares in national income as weights in line with the marginal productivity theory of distribution. If education and training contribute to the process of dissemination of knowledge, labour productivity Page 2 of 26

Technology, Knowledge, and Growth would go up and the accumulation of knowledge in contrast to ‘advance of knowledge’ would be embodied in the labour force and would appear as an increase in labour input (Vaizey et al. 1972: 42). If we accept Denison’s estimation, nearly a quarter (0.67 per cent out of 2.93 per cent per annum) of the growth in output in the USA during 1929–57 could be attributed to the increased education of the labour force. The decomposition of the growth process to assess the relative contributions of the factors of production is shown subsequently. The production function, where technological progress is exogenous and affects the capital and labour symmetrically is: (3.1)

where At represents the impact of technical progress on the productivity of capital and labour and is called total factor productivity (TFP). Since the production function exhibits constant returns to scale (CRS), an increase in x per cent growth in TFP is equivalent to an increase in capital and labour both by the same rate, that is, x per cent.1 The growth rate of income can be apportioned into the growth of capital, labour, and technical progress as proxied by A as: (3.2)

Under perfect competition, the factors of production are rewarded by their marginal productivities: (3.3)

(p.59) where g is the rate of technical progress, sK and sL are the shares of capital and labour income in national income, respectively. For a homothetic production function, we can write (sK.r) and (sL.w) are equal to α and (1 − α) respectively. These are the exponents of capital and labour, respectively in the production function and these are also the output elasticities. The value of g has to be ascertained from the data on shares of income of labour and capital in national income and the actual growth rates attained by the labour, capital and output as: (3.4)

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Technology, Knowledge, and Growth The measure of technical progress is determined residually from equation 3.4 to find out the extent of growth which could not be explained by the factors of production labour and capital or what is called Solow residual. However, the presence of distortions and/or extent of externalities would make this way of finding TFP residually erroneous. Solow (1988) made the observation with reference to Denison’s 1985 study that education per capita accounts for 30 per cent increase in output per worker and growth of knowledge accounts for 64 per cent. Thus technology remains the prime mover of the growth process. The model assumes Hicks’s neutral technical progress (McCombie 2006). It is difficult to accept that labour and capital shares would remain independent of the nature of technical progress and the elasticity of substitution (Arestis and Sawyer 2006).

Solow’s Growth Model and Technology Education and training were incorporated in the growth models mainly through the concepts of human capital and knowledge. In the process, various facets of education and their implications for giving a stimulus to the process of income growth have been probed and discussed both theoretically and empirically. One major theme of empirical research has been the relative growth of nations which would exhibit a tendency for the growth rates of various (p.60) countries to diverge or to converge. The origin of the production function approach to study the growth process could be credited to Solow’s pioneering growth model (1956). Subsequently, new developments in the endogenous growth theoretic approach highlighted the salience of human capital in the growth process. Solow (1956) assumed a CRS production function.2 The model showed that the per capita income of a nation would reach a steady state indicating that the nominal growth would match the growth of population in the wake of diminishing marginal productivity of capital. There is a strong likelihood that all the nations would eventually converge towards a steady state growth path as they share the same mechanism of growth particularly in terms of technology. The possible convergence was shown to be feasible as in the neo-classical growth model capital exhibits diminishing marginal returns as the Solow model assumed a CRS production function. Since marginal productivity of capital (MPk) rises at a slower rate, the rate at which MPk rises would depend on the initial level of capital. Hence the poorer nations were assumed to grow faster as they would begin the process of catching up with a lower stock of capital. Further, it was also assumed that technology would be available to all the nations. The production function was assumed to be of Cobb-Douglas type: (3.5)

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Technology, Knowledge, and Growth where Y is the national output, A is a proxy for technology, K and L are physical capital and labour respectively. It was assumed that labour grows at the rate of n per cent per year and the rate of growth of physical capital equals net investment I, but it gets depleted by the depreciation rate, δ: (3.6)

In equilibrium, saving sYt equals investment I t. The production function can be expressed in per capita terms. Capital–labour ratio k is equal to the addition to the capital stock being boosted by saving which is the product of average saving propensity and per (p.61) capital income. At the same time, there are two forces which pull down the ratio, population growth (n) resulting in a decline of capital stock in per capita terms and the depreciation rate (δ): (3.7)

At steady state growth, the capital–labour ratio ceases to grow, and we obtain: (3.8)

If we continue to keep the determination of technology out of the framework as given by the constancy of A in the production function, the capital–labour ratio (k) reaches a steady state and so also the output–labour ratio. Labour grows at the rate n, as does income, and as a result, per capita income approaches a stable value. The model does not provide an explanation for dispersion in growth rates across the countries in terms of per capita incomes, and the fact that poor countries fail to grow at faster rates to make convergence possible as predicted by the model. Moreover, saving affects the level of per capita income but not growth rates. Population growth rates and technology once included in the production function, can affect growth rates. The capital–effective labour ratio (k*), and income–effective labour ratio (y*) reach steady states. Income grows at the rate g which is also the rate of growth of technological progress. But the model does not explain the mechanisms that generate steady state values and therefore it does not say anything about policies that can contribute to the growth mechanism. A Critical Assessment of the Solow Model

Per capita income could grow in the long run in the Solow model if the effectiveness of labour, that is, A could grow. However, A was not exactly specified and was taken to be exogenous in the sense that the factors which could influence technological progress were not under the purview of the model. Moreover, differences in capital intensity across the nations could not account for cross-country differences if we assume that rate of return on capital (p.62) Page 5 of 26

Technology, Knowledge, and Growth reflects its contribution to output and its value is set at reasonable levels. Considerable amount of research has been devoted to understanding what explains the growth in A over time so as to figure out the sources of growth and the divergent patterns of income growth observed across the nations. More on the Solow model follows later in this chapter.

Endogenous Growth Theory Exogeneity of technological progress turned out to be the major drawback of the Solow model which had to be circumvented. There emerged a new set of approaches which could be clubbed together as endogenous growth theoretic models. There are two basic approaches towards an exploration of various types of endogenous mechanisms that promote economic growth. The first perspective adopts a broader view of capital to include the notion of human capital to argue that possibly an all inclusive concept of capital could explain the differences in income growth. The second set of models seeks to examine mechanisms through which knowledge is produced and how resources are allocated to the production of knowledge. The opening up of the ‘black box’ of A(t) to understand why A(t) grows and therefore to find out the origins of growth appeared to be the biggest challenge. A series of attempts were made in the 1980s and 1990s to suggest ways to endogenize TFP growth. It was felt that focusing on a single firm to study the improvement in productive efficiency in isolation would not capture the forces behind technological progress. The firms interact and benefit from each other, from agglomeration, attraction of skills, specialization in supply, and organization of markets. This explains why firms tend to operate in a cluster. Secondly, technical progress would be the natural outcome of inventions and innovations but it would depend on serendipity (luck) as well. Application depends on incentive and institutional constraints. Why individuals invest in education and why firms invest in research and development (R&D) could be understood by the profit maximizing behaviour of economic agents.

(p.63) Distinguishing between Technology and Human Capital Economics of Knowledge Creation

Romer’s (1990) search for the origin of technology led him to probe the economics of knowledge. Increase in productivity cannot be explained merely in terms of a rise in effective labour force and capital. Technological change is crucial. Technological change has been conceptualized in various ways. For Romer, technological change can be interpreted as the new ways of combining raw materials which have not undergone any significant change over the years. Such new and the better ways of processing the raw materials are essentially ‘ideas’ or instructions which have been developed through trial and error, experimentation, and research.

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Technology, Knowledge, and Growth Endogenization of the growth model is achieved by introducing the search for new ideas by researchers who are interested in return from their investment in knowledge creation. Romer (1990) proposed three premises. One, an improvement in the instructions for mixing together raw materials is the core of technological change as raw materials remain unchanged; two, intentional actions taken in response to market incentives to develop ideas: academic scientists funded by the government are also to be considered along with research and development expenditures invested by the industry/corporate sector; and, three, instructions for working with raw materials are different from conventional economic goods. While MC of instructions once created being almost equal to zero as cost of replication is negligible mainly due to the advancement achieved in computer technology, fixed cost of creating instructions remains genuinely positive and substantial. This is the defining characteristic of technology. This makes economics of ideas different from the economics of objects. These three premises are elaborated in the next section. Knowledge as a Commodity: A Public Good or a Private Good

Since economic theory deals with commodities which are tradable in the market, subjecting knowledge to an economic analysis (p.64) would therefore require a possible commodification of knowledge. In economic theory, the value of research (or knowledge) is arguably assessed in the market, where people reveal their preferences in terms of the prices that they are willing to pay (Aranson 1995). A market economy would be concerned with the type of knowledge that leads to the production of new products and processes, an improvement in the existing ones, or even in a reduction in the costs of production. However, this does not lead us to classify knowledge as a tradable private good as knowledge has certain features, which vary with reference to the particular character of knowledge. So, an important question which continues to pose a challenge for economists is what type of commodity is knowledge? Is it a private good similar to a typical commodity as discussed in the realm of economic theory? Or, is it a public good? Or, is it a sort of blend of the features of private and public good? Goods are classified on the basis of the degree to which they are rivalrous and on the degree of excludability. As per the neo-classical definition, a public good has two main characteristics, non-rivalry in consumption and non-excludability. The first feature means that the benefits of consumption accrue to many as consumption by one individual does not lead to a reduction in its availability for others.3 Rivalry and excludability are often linked as the extent of non-rivalry leads to non-excludability. Rivalry in consumption is purely a technological attribute. However, excludability is a function of both technology and the legal system, for instance, the use of software or music CDs is ideally excluded to those who do not pay for it, though both technology and the law continue to be subvberted by free-riders. Technology is generally classified as a non-rival input. Knowledge in its conceptual or immaterial forms (an idea or information or concepts) is argued to be non-rivalrous in consumption as an idea or a design or Page 7 of 26

Technology, Knowledge, and Growth a formula could be used again and again without there being any decline in its usefulness. It is a durable commodity as well which implies that knowledge can be used an umpteen number of times without there being any diminution in its quantity. In fact with use, a piece of knowledge may become more valuable with refinement and modification. But if consumption benefits (p.65) accrue to all, pricing becomes difficult as technically it may not to be feasible to exclude those who are not willing to pay. This leads to a failure of the market if exclusion is not feasible for those who would prefer either to free ride (use knowledge for free) or would undervalue the benefit of knowledge deliberately to pay less for the product. However, if exclusion is feasible, exclusion of the user of the knowledge who is not willing to pay would not be an efficient outcome as transmission of knowledge would be virtually cost less and the MC of provision to a consumer is negligible or zero. There is a need to distinguish between pure non-rivalry from the low cost of its dissemination owing to an advancement in electronic media and technology, particularly computer technology.4 Given non-rivalry of knowledge, often it is a matter of policy to make exclusion possible through codification and/or material embodiment and sell knowledge at a price. It requires some form of legal protection or patenting to give incentives to producers of knowledge and recover the costs of knowledge production. However, knowledge in its conceptual form is like a mathematical formula which is an input to research. In general, knowledge in this form should not be patented, as restriction in its use would seriously deter research and the pace of innovation. Moreover, knowledge can generate extensive externalities paving the way for more innovations in other fields. Therefore, knowledge can ideally be argued to be a mixed good as the extent of ‘publicness’ becomes a matter of policy decision as the degree of excludability is subject to the discretion of the policymakers. This leads to the consideration of the second premise, which states that there must exist individuals capable of responding to market incentives and willing to invest. These individuals who are willing to invest are essentially self-interested optimizing economic agents. This in turn leads to the first premise—growth is driven by accumulation of non-rival yet partially excludable inputs. Distinguishing between Knowledge and Human Capital

Human beings embodied with human capital (that is, skill, expertise) who create knowledge are however rival inputs, as opposed to (p.66) ‘ideas’ or instructions, that is their creations are non-rival inputs. Skilled human beings enter into the production process as unique factors and hence they are neither replicable nor usable anywhere at any point of time. This distinction between human capital and knowledge as rival and non-rival inputs is essential to understand the growth process. An idea or knowledge therefore differs from human capital. An idea or a design is non-rival (at least the cost of replication is small) but the ability to add is not as it is tied to a human object or human Page 8 of 26

Technology, Knowledge, and Growth capital. Time and space constraints mean that human capital embodied is rivalrous and thus excludable (cost of replicating human capital is education and training) as follows (Jones 2001): • Ideas come from skilled and trained people. • These ideas are translated into tools. • Ideas are non-rivalrous; many people can use them simultaneously and they can be found in books, journals, manuals, papers, and reports. Romer’s concept of human capital is ‘literally a set of connections between neurons’. Once produced an idea becomes a non-rival good. As each one of us reads, it is converted back into human capital which is a rival. Romer (1990) makes a sharp distinction between the two concepts, an ‘idea’ or design and human capital. Creation of ideas is a time consuming activity which can be used many times in many productive activities. But the ability to utilize the idea is rival as it is tied to the human body in the form of human capital. Better tools allow production of more and high quality goods. Examples are cars, computers, trains, aeroplanes, medicine, televisions, phones, internet, rockets, and high yielding varieties of crops. All this leads to the fact that a firm cannot be a price taker. Non-rivalry has two important implications for the theory of growth. One, non-rival goods could be accumulated on a per capita basis in an unbounded fashion, whereas human capital cannot be. Two, since knowledge is a non-rival, it has spill-over effects which means that knowledge is only partially excludable, or incompletely excludable. (p.67) The Dilemma: To Price Knowledge or Not

Since the use of knowledge can be made exclusive by restricting its use to those who pay, taking recourse to legal provisions and patenting for incentivization becomes critical in sustaining the tempo of knowledge production. There arises a crucial trade-off between knowledge being patented and knowledge being made free. Patenting seems to be inefficient as economic theory tells us to make knowledge free to exhaust all possibilities of use without incurring any extra cost (or small amount of resource cost) so as to maximize efficiency. However, if knowledge is made free, sustaining the funding of knowledge creation would not be possible. This is the dilemma. However, Correa (2002) argues that the patent law can be so designed so to increase both static and dynamic efficiency. Market structure and national innovation systems would also determine the impact of the law.5 An understanding of the linkage between pricing of knowledge and its creation is an imperative. If a non-rival input is productive which need not be replicated in production, then the production function cannot be of CRS type. Let a production process be represented by F (K, X) where K is non-rival and X is rival. Page 9 of 26

Technology, Knowledge, and Growth We obtain F (K, λX) = λ · F (K, X) by the replication argument, where λ is the proportion by which the level of employment of X is raised. For example, a 5 per cent rise implies that λ will assume the value (1+ 0.05). Since, K is non-rival, employment of K does not need to go up. If K is productive as well, F(λK, λX) 〉 λ · F (K, X). This type of production possibilities imply that if the firm were a price taker, it would be difficult for the firm to make profit and survive. The annual revenue would get used up to pay for capital and labour as per their respective marginal productivities and knowledge creation would remain unfunded. With CRS, and perfect competition, wage is equal to the value of the marginal product, that is, w = P · MPL and r = P · MPK with the value of output is entirely exhausted. Here, w and r equal wage rate for the labour and rental cost of capital, respectively. Therefore, value of the product would be equal to the value of the rival input X. Real (p.68) value of the output is exhausted in remunerating the rival inputs as per their marginal productivities. Therefore: (3.9)

There are two reasons why too little human capital is devoted to research: (i) additional design raises productivity, and the benefit is mostly non-excludable, which means there is no market price to realize the benefits in cash for possible reinvestment; and (ii) the buyer of the input is a monopolist. Equating MC with MR would result in an equilibrium with lower output than what would have been the case if MC were equated with price. However, the issue of how to recover the cost of knowledge generation remains. Further it is argued that pricing would act as an incentive for the producers of knowledge. If knowledge is made free, we are in the realm of intellectual commons, rather than intellectual property. Policy changes the extent of exclusion and hence ‘publicness’ of knowledge is subject to policy decisions. Knowledge can therefore be classified as a mixed good as it is partly private because of patenting but it continues to generate externalities for society as a whole. The moral of the story is that perfect competition is not compatible with sustained knowledge creation as investors in knowledge creation should have a leverage on pricing to extract profit over and above the normal profit in selling a differentiated product. This profit would give space and scope to the firm to invest in R&D and sustain knowledge generation. Under perfect competition, there is no scope for profit making over and above normal profit and hence it is difficult to continue funding of knowledge generation. Human Capital, Knowledge, and Growth: The Linkage in Romer’s Model

The earlier discussion can be shown schematically as in Table 3.1. It shows how the initial process begins with thinking and ultimately leads to greater production. Table 3.1 shows how ideas or (p.69) Page 10 of 26

Technology, Knowledge, and Growth

Table 3.1 The Spectrum of Private and Public Good Rivalrous Good

Non-rivalrous Good

High degree of Medical services, human Encoded satellite TV transmission excludability capital (memorized (idea) command for using software) Low

CD player, floppy (it could be stolen)

Computer code for a software application (software code could be used without the owner’s knowledge)—less excludable and difficult to control

Fish in the sea Insecticides

Defence, basic R&D, E = mc2 (public good)

Source: Jones (2001: 81); figure in Jones (2001) is modified version of figure 1 in Romer (1993). knowledge could be characterized by rivalry in consumption and degree of excludability.

thinking → new ideas → formula/design → tools (e.g., machine) → application (e.g., car) This classification of knowledge as a non-rival input has serious implications for growth because non-rival goods can be accumulated without bound on a per capita basis which is not true for human capital which is a rival input. The person with embodied human capital may cease to be creative but her creation remains forever. If knowledge is non-rival, the excludability is incomplete. Newly produced knowledge which Romer (1986) considers as stock can only partially and temporarily be kept secret and the production of goods and services be made dependent on stock of knowledge. Benefits can be reaped only partially and therefore market equilibrium would result in a lower growth rate. Once we take these three premises for granted, it is difficult to sustain that price (P) is to be equated to P*, a price given under perfect competition (Jones 2001: 80). ideas → non rivalry → increasing returns → imperfect competition (p.70) We now briefly spell out the relevant features of various attempts to endogenize the growth mechanism and in the process we bring out the distinction between incorporation of human capital vis-à-vis knowledge in the new growth models. Page 11 of 26

Technology, Knowledge, and Growth Introducing Human Capital in a Growth Theoretic Model Based on Aghion and Howitt (1988), Krueger and Lindahl (2001) classify the endogenous growth models with regard to the different roles human capital plays in these models. The first type of models expands the notion of capital to include human capital. Accumulation of human capital sustains the growth in these models. Lucas (1988) belongs to this first type of models. In the second category, growth is sustained by the prevailing stock of human capital which fosters innovations. Romer (1990) is an example of this type. We begin with the AK model, which is the simplest of all such models. The AK Model

This is a simple growth model that considers production as exhibiting constant returns to scale to a composite measure of capital (physical and human capital together). Production of inputs are viewed as reproducible capital. Assume α = 1 in equation 3.1: (3.10)

where K is the measure of composite capital. The production function is linear, but CRS does not exhibit declining MPk which is equal to A = APk = Y/K.6 Growth rate of Y (gy) = growth rate of K. Growth rate of capital would be determined by:

Rate of growth in capital stock is the rise in net investment which equals gross investment after accounting for depreciation at the rate d. In equilibrium, gross investment equals gross saving which is the product of average saving propensity (s) and income (Y): (3.11)

(p.71) Growth depends on saving propensity, s and s.Y does not decline as it is a straight line. Convergence is not predicted even if the poor nations have the same technology and propensity to save, s. It accords well with empirical evidence. Government policies should increase investment. If α 〈 1, there will be a curvature in the production function and the economy will approach a steady state. There are various ways of exploring how education affects growth. Education could be conceived of in the form of experiences gained from working to skill

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Technology, Knowledge, and Growth development and training including schooling and vocational training and all the way up to R&D, innovation and inventions. Mankiw, Romer, and Weil (MRW 1992) made an important piece of contribution to the literature on growth. They assumed a CRS Cobb-Douglas type production function, and full employment of resources. One significant difference is the large differences in real income across countries due to small differences in formation of physical and human capital. The production function is given by: (3.12)

where H is the stock of human capital, L is the number of workers and AL is the effective labour force. There are decreasing returns to K and H but constant returns to K, H, and AL. MRW provided an explanation why growth rates among nations differ. Since there are two types of capital, physical and human, rate of change in the stocks of physical and human capital per unit of effective labour are given as: (3.13)

(3.14)

where y = Y/AL, k = K/AL, and h = H/AL are defined in terms of per effective unit of labour. The steady state Solow model (p.72) augmented by human capital can be expressed using the cross-section regression, as: (3.15)

The rate of accumulation of human capital was proxied by the fraction of the working-age population enrolled in secondary schools. The objective of the paper was to provide an explanation for differences in output per person in nonoil producing countries. They showed that the restrictions on the coefficients of ln(sk), ln(n+g+δ), and ln(sh) should add up to zero and could be accepted with a p-value of 0.41. A value of 0.31 for α and 0.28 for β was argued to be consistent with the share of capital income of 1/3. Omission of human capital churns out an unacceptable value of α at 0.6. The approach has been subject to a critique by Stevens and Weale (2004). There are problems associated with the nature of the production function, the constant elasticity of substitution between capital and with each of the two types of labour, educated and uneducated. Also, approaching steady state values is an assumption not often tenable in the context of developing countries.

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Technology, Knowledge, and Growth Lucas Model

The Lucas model also focuses on accumulation of human capital. Human capital can be narrowly conceived of as abilities, skills, and knowledge of individual workers. Human capital is rival and excludable. In Lucas’s growth model (1988) the aggregate production function is: (3.16)

where y is output per capita, k is the stock of physical capital per capita, u is the proportion of time devoted to production, and therefore (1 - u) is the remaining fraction of time spent on accumulation of human capital, h is the human capital of the representative (p.73) agent and ha is the measure of average human capital in the economy. There are external benefits arising out of human capital as proxied by the average education level in a community apart from the direct effect of human capital embodies in a person. If the logarithmic version of equation 3.16 is differentiated, one can see that the growth rate depends on the growth of two forms of capital, physical and human. Positive externalities would be reflected in λ being greater than zero. It is assumed that human capital would grow at the following rate: (3.17)

where δ is the maximum achievable growth rate of human capital. In steady states, output and human capital would grow at the same rate and would depend on δ and the determinants of u. CRS in h generates sustained growth rate. The role of h in the production function is akin to labour augmenting technical change in the context of the original Solow model (Jones 2001: 161). Therefore, in this model a growth in the output per worker entails greater time devoted to learning of skills by individuals. dh/dt = (1 − u)h, (1/h)dh/dt = (1 − u), (1 − u) equals time spent accumulating skill. It is similar to the labour augmenting Solow model. Now g depends on u. Another common production function is: (3.18)

Knowledge Accumulation Growth of knowledge could be conceived of as a by-product of economic activity or a separate sphere of production activity. Arrow (1962) argued that an important source of technological progress is ‘learning by doing’. Experience which could be quantified in many ways contributes towards a rise in labour Page 14 of 26

Technology, Knowledge, and Growth productivity over time. A simple way to capture this would be to relate the level of productivity, that is, relating ‘A’ to the absolute size of capital stock and an autonomous factor. Romer (1986) suggested a (p.74) similar approach where the TFP ‘A’ was made to depend on total capital stock. Romer (1986) argued that the size of the productive sector creates a positive network externality through the exchange of know-how or ‘learning by doing’ which raises productivity. The specification of ‘A’ is: (3.19)

where

where Kit is the stock of capital of the ith firm. When a

firm invests, the benefits do not remain confined to the firm only but go much beyond the firm which makes the social return higher than the private return reaped by the firm. Mobility of labour, who are trained in new technology and contacts in supply chains help disseminate technology to other firms and this constitutes a key source of exchange of know-how. Thus, externalities enable a firm to wriggle out of a trap of diminishing return to capital. It may be noted that network externalities and know-how remain unremunerated as they assume public good status in the process. In Arrow’s model, an increase in K necessarily leads to an equi-proportionate increase in knowledge through ‘learning by doing’ but knowledge still remains a public good. ‘A’ is responsive to the market. Increasing returns to scale are achieved through incorporation of positive externalities with the assumption of perfect competition being retained. It is debatable whether ‘learning by doing’ proposes a real life scenario of knowledge accumulation or as an outcome of desirable entrepreneurial endeavour (Jones 2001: 163). In research, externalities play a larger role as knowledge created by researchers in the past contributes in a big way towards research today as any research takes into consideration the existing valid research output as accumulated from the past (Jones 2001).

Incorporating the Knowledge Producing Sector Based on Romer (1990), consider an economy with two production sectors: a goods producing sector which uses physical capital, knowledge, and labour in the production process and a knowledge (p.75) producing sector where knowledge is produced using inputs. A certain fraction of the labour force, say θL of the labour force, is used in the knowledge producing sector and the remaining share, (1− θL) is employed in the goods producing sector. Similarly, θK and (1 − θK) of capital are used in the knowledge and goods producing sector respectively. Knowledge is non-rival in the sense that both the sectors can use the same component of knowledge. The conventional production function of the Cobb-Douglas type is: (3.20) Page 15 of 26

Technology, Knowledge, and Growth

Equation 3.20 implies constant returns to both capital and labour for a given level of technology A. Once we recognize that ideas (A) also contribute to the production process as an input, it would result in increasing returns to scale (IRS). Once a particular idea is created (or an invention made), say doubling production would entail doubling of inputs other than the idea which can be used again and again. With regard to all the three inputs, IRS is the outcome. The production of knowledge could be shown as: (3.21)

The production function of knowledge does not exhibit CRS to capital and labour, as (β + η)〉1. The underlying assumption is that more researchers assisted by a greater amount of capital would produce more ideas. The number of new ideas produced would depend on the rate at which the researchers generate new ideas which can be assumed to be a function of the existing stock of ideas created in the past: (3.22)

If κ = 1, dA/dt is proportional to A. The effect would be stronger if it is greater than one and vice versa. If κ = 0, productivity of research is independent of the stock of knowledge. (p.76) This formulation of knowledge generation can be compared with the model of ‘learning by doing’ developed by Romer (1986) and Arrow (1962). One can consider Aκ as external to the individual researcher. As explained earlier, if the value of κ 〉 1, there is a gain from a knowledge spill-over. Individual researchers take the existing stock of knowledge as given while deciding how much resources are to be devoted to research and they are not compensated for their contribution to future researchers that they make through the knowledge spill-over. Since there are two production functions for the two sectors, the dynamics of the model can be captured with the help of two differential equations. Romer (1990) showed that population growth rate was crucial for determining the growth rate and the fractions of labour and capital employed in the knowledge producing sector as well as saving would have no impact on the growth rate. The model suffers from the same limitations that the Solow model suffers from. In a model developed by Romer (1990) the production for a multi-sector economy is given as:

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Technology, Knowledge, and Growth (3.23)

where H is the human capital employed in ith non-R&D sector and L is labour. X(i) represents disaggregation of physical capital into separate inputs which are used in the production of Y. Technology A determines the level of capital stock employed. Each capital good is assumed to have a distinct monopolistically competitive firm: (3.24)

where HA is the human capital employed in the R&D sector. The greater the human capital employed in the R&D sector, the faster would be the production of designs fostering technological forces and higher would be the accumulation of physical capital. The second implication is that the larger the total stock of design and knowledge, greater would be the productivity of the engineer. (p.77) In the steady state, rate of growth equals the rate of technological forces which is a linear function of total human capital in both the sectors.

Knowledge in the New Growth Theory: An Assessment The importance of knowledge in fostering economic growth is theoretically well argued and empirically verified. In the Solow type neo-classical growth model, technology was treated as exogenous and its contribution to economic growth was residually determined after accounting for the contribution of two factors of production, labour and capital. The assumption that the production function exhibits constant returns to scale implied that marginal productivity of capital would diminish with the rise in the use of capital. This feature is responsible for reigning in the continuous growth of a nation, and therefore the economy is expected to eventually reach what is often referred to as steady state growth path.7 What could be inferred from this model is that all countries would eventually attain the same steady state growth and there would be, as a result, convergence among the nations in terms of per capita income as exogenous technology would be available to all. However, this approach failed to reconcile itself with the divergent growth experiences of the nations. The model did not provide any explanation as to why countries grow at different rates during different periods. In Solow’s model, technology is assumed to be a pure public good, rather a public input (Romer 1990) with two major characteristics, non-rivalry and nonexcludability.8 Firms are free to exploit the knowledge base A (proxy for the level of technology, as in equation 3.1). Further, perfect competition is assumed to be the defining feature of the market where revenue would be exhausted in paying the factors of production as per their respective marginal productivities. Page 17 of 26

Technology, Knowledge, and Growth Advancement in technology was assumed to be exogenously determined outside the system. So a mere assumption that A(t) would grow is not tenable and cannot explain the growth differences among the nations in terms of (p.78) different levels of technological advances. This is not in sync with the reality that people as optimizing agents are involved in production of ideas or broadly speaking knowledge production uses up resources. Romer (1990) presents his argument for endogenous technological change on the basis of three premises: 1. Technological change is the primary engine of growth. 2. Technological change is an outcome of the optimizing behaviour of the individuals in response to the market incentives. 3. Technology is a non-rival good. Since it is conceived of as an ‘idea’, though, MC of replication of an ‘idea’ is zero, but the cost of developing an ‘idea’ or a new set of instructions entails use of resources which may be substantial. In the Solow model, technology which is both non-rival and non-excludable drives growth. So the model is consistent with premises one and three. But technology is in the form of a public input which needs to be provided by the government, makes it inconsistent with the second premise that optimizing individuals invest in technology. For Lucas (1988), production of human capital rather than physical capital, generates knowledge—which is a non-rival and non-excludable good. Both these models make production of a non-rival, non-excludable good like knowledge an unintentional side effect of the production of a conventional good. In endogenous growth theory the concept of capital is very broad and inclusive of human capital, social capital, intellectual capital, public infrastructure, as well physical capital (Arestis and Sawyer 2006). This takes us into a direct confrontation with a variety of conceptual and measurement issues, albeit nebulous, of what constitutes human capital: education, skills, marketable skills, and the difficulty associated with treating social capital at par with physical capital are some of the issues involved. The second issue is whether we can have an aggregate measure of capital. There are returns to capital arising out of externalities which do not accrue to individual owners. Some capital has no owners like social capital or (p.79) capital owned by the government (ibid.). Further, growth models are in the mould of a typical neo-classical model where the rate of interest brings about equality between saving and investment. Optimizing decision-making is carried out in an inter-temporal framework. Labour is assumed to remain fully employed either in production or in research and development.

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Technology, Knowledge, and Growth In Arrow’s model, the endogeneity achieved is not through self-optimizing decision-making agents but on the basis of the assumption that there exist ‘… strict proportionality between knowledge and physical capital or knowledge and education as an unexplained and exogeneously given feature of technology’ (Romer 1990: S77). Further, the non-rival input in the form of experience and knowledge generated by learning by doing must be entirely nonexcludable. An increase in the physical stock of capital leads to an equiproportionate increase in knowledge through ‘learning by doing’ where knowledge continues to be a public good. Lucas focuses on investment in human capital to create knowledge which is non-rival and non-excludable (Romer 1990: S76–S77). In ‘learning by doing’, productivity gains come from the process of the product and it emerges as a free good. Generally different institutional structures are conducive to learning by doing (Arestis and Sawyer 2006). They cannot be measured and considered in regression. It is a case of reverse causality as growth would affect education and health. They argued that it is surprising that education and growth were found to be related not in a robust manner as it is so for positive relationships. Investment in technology is a function of demand pull as well as capacity utilization, profitability, and liquidity (Arestis and Sawyer 2006). In contrast, new growth models (for example, Romer 1990) made technological progress endogenous to the economic system and therefore it sought to explain why different nations witness different rates of technological progress. It was argued that labour cannot be treated as homogeneous over time as education and training made labour more and more skilled which led to an increase in the productivity of labour. Since the concept of simple labour was no more tenable, it was replaced by the concept of human capital. Productivity enhancing education and training would be embodied (p.80) in human beings. It was a form of capital because education and training needed investment in education and training just like any other investment which leads to capital formation. Formation of human capital through skill formation and dissemination would contribute to innovation and technological advancement. The decision to spend on education and training was argued to be the fallout of optimizing decisions of an individual to invest in human capital formation. This made possible the replacement of the constant returns to scale production function with diminishing productivity of capital by increasing returns to scale production function. Empirical studies have verified the role of human capital and knowledge in the growth process. It has policy implications in the sense that knowledge about technology and levels of information would make important contributions to the growth process and overall economic development (Olssen and Peters 2005) and the gaps between nations in terms of development would be located in the gaps in the knowledge base. The other form of endogenous theory is that of increasing returns to scale which may take various forms like Page 19 of 26

Technology, Knowledge, and Growth economies of scale, learning by doing, or the hypothesis that the cost of innovation is independent of the size of the market but the rewards are proportional to it which spur innovations. Essentially what Romer (1990) argues is that new ideas propel growth by way of reorganizing physical resources, natural, human, and capital, in a more efficient and productive manner (Peters and Besley 2009: 78). This approach ushered in a fresh perspective to look at the sources of growth where the contributions towards generating growth from the traditionally fundamental categories like land, labour, and capital declined and instead ‘people, ideas, and things’ gained prominence. Non-rivalry and partial excludability of knowledge made the economics of knowledge different from the traditional economics of people with human beings with all their expertise, skills, and strengths and capital, natural resources, and even financial assets (Warsh 2006, as cited in Peters and Besley 2009). Knowledge goods create new dynamics because they are not scarce but are characterized by hyper-abundance. Romer shows how public knowledge goods could become intellectual properties (p.81) and help sustain the momentum of innovation of technologies and products. However, knowledge is a global public good. Marginson (2009a: 192) argues that Romer in a way underestimated the scale potentials of public knowledge goods and the potential of open source ecology, which defies economic theory whose central focus is the allocation of scarce resources. Mankiw, Phelps, and Romer (1995) define knowledge as the sum total of technological and scientific discoveries, what is written in textbooks, scholarly journals, websites, and higher education (HE) as the stock that has been transmitted from these sources to human being via studying. This brings out the distinction between the concept of knowledge and human capital. Endogenous growth should focus more on understanding the process of fundamental research and technology development than human capital accumulation as it can be accumulated indefinitely.

Market, Competition, and Knowledge As discussed earlier, economics of knowledge creation challenged the assumption of perfect competition. In this section various aspects of the linkage between market structure and knowledge creation are discussed. Characterizing macroeconomic conditions which seem to foster innovation and spur growth in a market economy is an old question with reference to the degree of competitiveness of a market structure of monopoly or competition. In conventional economic theory, a market is lauded because of its ability to generate efficient outcomes albeit under certain assumptions. The underlying assumptions of a perfectly competitive market are a homogeneous product, a large number of buyers and sellers who take the price as given, free mobility of Page 20 of 26

Technology, Knowledge, and Growth resources, and perfect information, particularly about the product. To reiterate, since the product is homogeneous, competition is based on price. The market for knowledge is an imperfect one as every piece of knowledge or information differs from every other piece. For transactions in non-patented knowledge, reputation and trust become crucial.9 The question we need to address is what kind (p.82) of relationship prevails between the knowledge and competitive elements of a market. As opposed to the traditional understanding of price competition as mentioned earlier, Schumpeter (1943) talks about the pertinence of technological competition in a market dominated capitalist economy. In the discussion of an evolutionary process of a capitalist economy, he identifies the impetus for capitalist evolution in: ‘… not that kind of competition which counts but the competition from new commodity, the new technology, the new source of supply, the new type of organization … competition which commands a decisive cost or quality advantage…’ (Schumpeter 1943/1980: 84). The notion of innovation as the driver of economic growth is central to his theory of ‘creative destruction’. In Schumpeter’s theory, an invention is an idea that might be used in production and an innovation is the process which involves resources and entrepreneurship, which converts an invention into a new product. Firms play a role in effecting changes in the economic, social, and institutional landscape through innovations which has to be understood in a broader context which encompasses new knowledge, scientific inventiveness, technology, enterprise, and entrepreneurialism. The role of competition for the knowledge economy is argued to be necessary because knowledge gives an edge to make the product differentiated in the eyes of the clients to survive stiff competition through exercising control over price. Leveraging of price is feasible only when the product is differentiated from the perspective of the consumers. Schumpeter’s theory of ‘creative destruction’ brought to the fore the role of innovation and technology towards making profit under competitive conditions. Arrow (2007: 22) argues that since production of knowledge requires resources which are to be rewarded by the market, ‘…creation of productive knowledge is partly explained by a system in which market incentives are not allencompassing’. The state of progress in scientific knowledge is not produced by profit making entities. Size of the market (high pressure economy as mentioned (p.83) by Solow 2006) and science (or knowledge) in a social system would determine the pace of innovations. Arrow argues that there is a need to distinguish between large scale innovations (for example, computers or internal combustion engines) which can raise the productivity or market scope and smaller scale piecemeal innovations which assume the form of learning-by-doing, or learning-by-imitating. Solow wonders (2006: 17) ‘Can one model major

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Technology, Knowledge, and Growth innovations?’ It is not the efficiency of the price system but property rights (the legal system) in a broader sense which would constitute the macro-environment. However, as argued by Solow (2006: 15) ‘… the process of innovation is still treated rather mechanically in the new generation of “endogenous” growth model’. It is because of a possible lack of collaboration between those who construct macro-models with technical change and those who research ‘the inner workings of the “innovation machine” in industrial research groups’. Arrow (2007: 20) reminds us that a standard microeconomic analysis entails how an individual’s behaviour is influenced by his or her understanding of the macroeconomy.10 The other problem is that these models based on the aggregate production function do not consider the change in consumption patterns which may stimulate an innovative activity. There is enough evidence that competition fosters innovation but ‘pure’ competition may not provide the reward so market power is desirable. Benefits arising out of market power can also be reaped in terms of the mere time advantage which may be an adequate compensation for the resource costs and risks involved. In a high pressure economy, in the sense that there exists a pressure of demand on capacity, there will be more innovations to create and extend their markets. A high pressure economy provides funds, improved products, and more efficient production as this entails increased spending on R&D (Solow 2006). An open economy with trade may further contribute to the pressure to innovate. ‘But for major innovations, macroeconomic conditions are not a key factor’ (Solow 2006: 18). Knowledge is not a typical product we encounter in standard economic theory because it could be used for production or for (p.84) transfer without using it. The cost of reproduction is also low and that is why the appropriability of benefits is limited. Cost is independent of its use like other standard inputs but value depends on the output. The firm may reap monopoly profits from selling the new product or it can sell knowledge through licensing or selling the firm. By definition innovated goods would lead to imperfect competition which leads to IRS. Since many firms spend on developing new products to compete, it may result in over-investment in innovation and the net social value may fall (Arrow 2007: 24). Competition may also be a barrier to innovate because of uncertainties. Background knowledge and its application are important social determinants. The market only plays a partial role in explaining the knowledge input in innovation. The mobility of a knowledge worker is crucial because labour possesses experienced knowledge even if a labourer is not allowed to share specific knowledge with his new employer (Arrow 2007). Knowledge is also disseminated through informal exchanges among knowledge workers outside the workplace and display of innovative products for the sake of advertising. This part is unavoidable.

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Technology, Knowledge, and Growth Rosenberg (2007: 82) argues that both changes in incentives and associated changes in organization have made science and technology endogenous in the sense of being more responsive to the changing economic needs of capitalist economies. Rosenberg argues that even science is increasingly being determined by market forces, which has led to underfunding of many fields of research like particle physics, astronomy, and cosmology, what are called ‘bluesky research’. The relationship between education and growth at the micro level has been studied extensively by Mincer as discussed in the last chapter. The change in a country’s average level of schooling is an important determinant of income growth. Empirical growth literature has been sceptical about considering the Mincer model. Benhabib and Spiegel (1994) did not find that education was a key determinant of growth. Barro and Sala-i-Martin (1995) also conclude that change in schooling has an insignificant effect (p.85) if it is included in a GDP growth equation even though it is in sharp contrast with the success of the Mincer equation and some endogenous growth models such as Lucas (1988). As Krueger and Lindahl (2001) show, there was no signal in the education data that they use conditional on the growth of capital. Krueger and Lindahl (2001: 1109) showed two important findings different from micro literature. One, initial stock of human capital matters and not the change in human capital, and two, secondary and post-secondary education have greater influence on growth than primary education (Peters and Besley 2009). Creative Economy

It is in the context of the knowledge economy, that the concept of creative economy is introduced (Peters and Besley 2009: 79–80). It is important to see how education plays a different but important role in the creative economy and its relationship with entrepreneurship and the primacy of ideas. Educational institutions can be regarded as primary knowledge institutions which foster creation and transmission of new of ideas (ibid.). Along with the role of sciences, technology, and engineering, arts, humanities, and social sciences gain importance in the creative economy which contribute to the high growth of creative industries. The knowledge economy cannot simply be captured by intensity of knowledge quantified by the embodiment of skills in the workforce. What is important is ‘effective participation of people in the communities of knowledge’ which will include social and moral competencies along with technical ones (Peters and Besley quoting Ásgeirsdóttir 2005). It is therefore an ethical economy as it involves the cultivation of norms underlying social infrastructure. It is not merely universities but the entire gamut of knowledge institutions which now includes research institutes, libraries, archives, and museums. The networked environment promotes entrepreneurship to take the lead. Institutions with norms and values evolve within the changing social and

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Technology, Knowledge, and Growth cultural ecologies and advancing technologies to conjure up new paradigms of social production (Peters and Besley 2009).

(p.86) Measurement of Human Capital This is in continuation of the discussion in Chapter 2 on the issue of measurement of human capital. The issue is whether the micro evidence obtained from the log linear Mincer equations can be used to specify the aggregate human capital stock in the growth models. Bils and Klenow (2000) have suggested (as given in Wössmann 2003): (3.25)

where HM refers to the stock of human capital based on the Mincer specification, L is the measurement of the number of workers, and h ≡ H/L is the per capita stock of human capital. The function φ(s) indicates the efficiency of a unit of labour with s years of schooling as compared to no schooling. If φ(s) equals zero, we get back to the earlier formulation of the growth accounting model with undifferentiated labour. The first order derivative of the function is the rate of return φ′(s) = r. In its simple form it implies, φ(s) = rs, a product of rates of return and years of schooling. In view of the decreasing returns to education, one year of schooling should be subject to differentiated weighting depending on whether the level of education is undertaken by a student in primary school, in high school, or college which correspond to primary, secondary, and higher education level.

Quality of Human Capital Matters For international comparisons of measures of human capital such as enrolment in primary or secondary school to provide an explanation of growth differences amongst the nations, we encounter a serious drawback as pointed out by Hanushek and Kimko (2000) and that is quality. It is not really possible to compare enrolment in say Class VIII in USA with that of enrolment in the same class in say Uganda. If ideas and innovation are the drivers of growth, then the underlying factors would be development in cognitive capacity which would have bearing on advances made in (p.87) science and research at a later stage. Differences in resources spent on education would only be a part of the story. Further, there is a conceptual issue. The continuous growth in income requires often continuous growth in the measures of human capital. It is unlikely that years of schooling would rise commensurately with income growth. However, continual quality growth is conceivable and interpretations of the underlying causal mechanism of the growth process become comprehensible. Hanushek and Kimko (2000: 1203) conclude that the quality of the labour force as measured by comparative tests of mathematics and scientific skills ‘has a consistent, stable, and strong relationship with economic growth’. Though the influence of quality on growth appears to be on the higher side as Hanushek and Kimko (ibid.) Page 24 of 26

Technology, Knowledge, and Growth argue, one plausible explanation could be that the externalities arising from stock of human capital would be stronger in terms of quality than quantity within the framework of endogenous growth theory. Hanushek and Wössmann (2010) intend to send out a strong message for giving more attention to learning outcomes as a proxy for quality education particularly in the context of the developing countries where enrolment and time spent in the classrooms often receive all the attention from the policy makers. As, people’s knowledge and their ability to utilize their education depends on quality of education they have been imparted with.

Concluding Remarks This chapter explored the relationship between education and income growth focusing particularly on the role of knowledge in the process of growth. In the course of the discussion an attempt was made to unravel the various forms of education in the economy in the form of schooling to research and development and how they could contribute to the growth mechanism. The distinction made in literature between human capital and knowledge is essential to understand how they could spur growth in different ways. Learning by doing and knowledge generated by externalities also lubricate the growth process. The economics of knowledge and, in particular, (p.88) classification of knowledge as a public good is important in this context. Despite knowledge being non-rivalrous, the feature of partially excludability adds a new dimension to the dilemma of pricing of knowledge. While competitive elements in a market economy could stimulate knowledge production, one has to see what kind of knowledge is generated and the costs associated with it. Mode 1 knowledge makes space for Mode 2 knowledge as market elements gain dominance in the economy. The fact that the economics of knowledge is different from the economics of private commodity poses a big challenge to policymaking. However, some studies indicate that empirical support for education as an important factor for growth is not robust. In response to this, there have been attempts to suggest different formulations of the production function incorporating education and subjecting them to a modified empirical analysis. Measurement of human capital has also posed a serious challenge to economists. In the process, understanding of the concept of human capital, and in a way how does education matter in an economy and to what extent, could only get enriched. What is noteworthy is the realization that a mere reference to education would not suffice but it has to be quality education. Notes:

(1.) CRS prevails when the exponents of labour and capital add up to one. It implies that if the employment of labour and capital is raised by x per cent, output will also go up by x per cent. (2.) Marginal productivities of labour and capital for a CRS type production function rise with the increase in employment of respective levels of labour and

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Technology, Knowledge, and Growth capital but they rise at a decreasing rate because the exponents of labour and capital are less than one. (3.) Beyond a certain limit, congestion may reduce the benefit available. (4.) There may be congestion effects and waiting time, say for example, downloading from the net. (5.) Correa (2002) argues that strict standards of patentability, a limited breadth of patent claims, and a narrowly defined doctrine of equivalents can promote static and dynamic efficiency. (6.) dK/dt = sY − dK; 1/K(dK/dt) = s(Y/K) − d; 1/K(dK/dt) = s(Y) − d; since Y = AK, taking log and differentiating, 1/Y (dY/dt) = 1/K(dK/dt) = gy, since A is constant. (7.) This is defined by a steady growth in per capita income which means that the income growth would be equivalent to population growth, if we ignore depreciation. Focusing on steady state growth paths fails to capture the process of innovation and uncertainties (Solow 2006). (8.) As opposed to a private good, a public good is characterised by non-rivalry in consumption and non-excludability in access. Since the market fails to arrange for any private provision of a public good, therefore, government has to garner resources to fund the provision of public good. (9.) As we can see that in light of this non-tenability of homogeneity assumption, the other assumptions underpinning a perfectly competitive market become shaky. (10.) It does not refer to macro fluctuations which may be caused in the short run. High rates of productivity growth in the 1950s and 1960s in Europe and the USA could be attributed to accumulation of knowledge which had not found productive or rewarding in the times of the Great Depression and the Second World War (Arrow 2007: 21).

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Input–Output Analysis

Education and Economics: Disciplinary Evolution and Policy Discourse Saumen Chattopadhyay

Print publication date: 2012 Print ISBN-13: 9780198082255 Published to Oxford Scholarship Online: January 2013 DOI: 10.1093/acprof:oso/9780198082255.001.0001

Input–Output Analysis The Concept of Production Function in Education Saumen Chattopadhyay

DOI:10.1093/acprof:oso/9780198082255.003.0004

Abstract and Keywords The chapter probes deeper into the meaning of an educational production function. It is argued that an educational institution is not similar to any other manufacturing unit or a factory as portrayed in economic theory and, therefore, an important corollary that there exists a well-defined input–output relation in the provision of education is hardly tenable. Though an educational institution produces many products and uses a variety of inputs of varied quality, it is difficult to define input and output for an educational institution. Concepts used in economic theory like efficiency, rate of return, cost, and productivity which are applied to education are, therefore, questionable. So policy conclusions which follow from the measurement of cost and productivity are to be considered with extreme caution. Keywords:   education, economic theory, input–output analysis, production function, cost, productivity

Production Function and the Productivity Debate in Education One major area where economic theory has been used quite extensively is the application of the concept of production function which claims that there exists a technical relationship between different combinations of inputs and outcomes of an educational process in an educational institution. This is also called the second paradigm in the sub-discipline of economics of education (Marginson 1997). An economic analogy is drawn between the conventional production function of a firm along with the concepts of productivity and efficiency as used in microeconomic theory and the relationship between inputs and outcomes of a Page 1 of 22

Input–Output Analysis school, college, or a university. This can also be viewed as the third proposition of human capital theory (Majumdar 1983) as discussed in Chapter 2. If the concept of production function has to be made applicable, the concepts of productivity, efficiency, cost, and revenue are to be conceptualized, albeit differently, for education provision, notwithstanding the fact that an educational institution in all possibility would not have a profit maximizing function a la a typical ‘for-profit’ firm in standard economic analysis.1 We discuss how the very concept of education is questioned in this exercise. It is argued that ensuring efficiency in resource use within an institution should also have wider (p.91) ramifications for determining the extent of resource allocation for different levels of education—school education and higher education (HE). As argued by Attiyeh (1974: 4), without a study of how resources can most efficiently be deployed at the institutional level, any line of enquiry to study education from an economic perspective would remain incomplete and inadequate as the resources allocated to any level of education at the macro level should be jointly studied with the question of achieving internal efficiency. Therefore, what needs to be probed in depth is whether the delivery of education or the teaching-learning activity which takes place in an institution is similar to the manufacturing activity as carried out by a firm. The teachinglearning activity is arguably governed by an educational production function and, so, it can be subject to an input–output analysis. In the process of drawing analogies, it is argued how starting with the problem of conceptualization of inputs and outputs for an educational institute, and even if the analytical and statistical problems are well negotiated, obsession with the application of an input–output analysis strictly speaking is neither desirable nor feasible in the realm of an educational process. However, a critical analysis will surely unravel many salient features of education as well as the relative importance of educational inputs on educational attainment to inform policymaking regarding funding and reallocation of inputs at the institutional level. We begin with a brief analysis of human capital as compared to the conventional analysis of physical capital in economic theory to understand how formation of human capital deserves special attention. This is expected to set the stage for the study of delivery of education. We then go on to discuss discuss the possible forms of the objective function of a university. In the following section we deliberate on what are the outputs and inputs and the most important problem of valuation of the identified inputs and outputs.

Human Capital and Physical Capital To begin with, the contentious issue is whether we can draw parallels between physical capital and human capital before we can (p.92) even consider a possible application of the concept of production function in the context of a school or a college/university. Though the concept of production function may be useful to begin with, the similarities tend to disappear soon after. One has to Page 2 of 22

Input–Output Analysis understand and emphasize on those special features which are associated with human capital formation. Essentially, there are two kinds of capital: one embodied in a machine, the physical capital and the other that of an educated mind, the human capital (Majumdar 1983). Physical machine depreciates, which is, generally speaking, not applicable to the concept of human capital.2 A machine churned out by a capital goods factory could be treated as a finished product. Whereas human capital grows as long as the person, the embodiment of human capital remains an active learning agent, knowingly or unknowingly. In fact, it depends on how it is used and what it is used for and there can even be an appreciation in the value of human capital in sharp contrast to the unmistakable fate of physical capital, the inevitable depreciation in its value. Linked with this is the concept of pricing of human capital. In microeconomic theory, wage is viewed as the reward for the disutility arising out of labour. The pain and monotony of work is compensated by the reward of wage in a workleisure trade-off. But such an interpretation is not exactly tenable if the worker enjoys her work when strictly speaking remuneration ceases to be a compensation for the loss of leisure. Majumdar (1983) gives the example of a teacher who enjoys teaching. Pricing of human capital, therefore, depends on how a teacher perceives teaching. If a teacher is being worn out, the price is positive, but if the teacher enjoys teaching and feels enriched in the process, price is zero. If we may recall, in the Becker’s model (Becker 1964) discussed in Chapter 2, the rate of return falls with human capital accumulation as it is embodied in a person. For a factory one could think of buying more machines as investment takes place, whereas for an individual, as one spends on education, it boils down to the investment in the same person despite the fact that one could procure as many books and journals, computers and other accessories as she (p.93) wants to develop her human capital. For optimum utilization of investments in all other inputs, the person remains an indispensable input though she has a limited capacity to benefit from sustained investment. Further, production needs time along with other inputs even if time as an input becomes costlier with the passage of time. But time is not substitutable or it is an irreplaceable input. All other inputs become valuable only when time is spent by the person concerned without which learning would not take place as all other inputs remain irrelevant. Time constraint and the ability to learn make the formation of human capital through learning a smooth function of other inputs. Romer (1986) adds a new dimension to the specific characteristic of human capital as compared to physical capital in the context of knowledge as discussed in Chapter 3. While an idea can be a main source of innovation, it is the person who is an embodiment of human capital, who creates ideas. There is rivalry in human capital as a person cannot work at two different places at any point of time but an idea or a design once produced by the person is non-rivalrous and Page 3 of 22

Input–Output Analysis partially excludable. It is non-rivalrous as the same idea, say a formula or a design, can be used as an input umpteen number of times. So a distinction has to be made between a person and her creation. Further, due to the indestructibility of an idea, which is an input in a production process, the overall production function with incorporation of physical capital and labour, would exhibit increasing returns to scale as discussed in the Chapter 3. Sen’s (2000) perspective on education adds another dimension to the distinctive feature of human capital vis-à-vis physical capital.3 Physical capital assumes importance for its instrumentation role in augmenting productivity whereas human capital is intrinsically important for the person who is an embodiment of human capital irrespective of its role in raising productivity and earnings. The value of human capital embodied need not be derived from its productivity enhancing role only but human capital embodied is important by itself as it empowers the person in many known and unknown ways and yields satisfaction for a much longer period of life to appreciate life and beauty. It gives a sense of dignity and (p.94) it liberates the individual to take a decision by herself to exercise freedom of choice without there being any connection whatsoever with the ability to earn money income (discussed in Chapter 5). After undertaking an exercise of appreciation of how differently the concepts of human capital compare with the notion of physical capital, we make an attempt to elaborate on the concept of input and output of an educational institute in the next section.

Concept of Input and Output in the Delivery of Education In a formal sense, an educational institute is engaged in the delivery of education as a service and helps in the formation of human capital. In line with the application of economic theory in the field of education, there have been attempts to treat an educational institution at par with a firm and therefore, an institute is subject to economic analysis in terms of production function and cost functions. There have been many systematic quantitative investigations to estimate the production and cost functions for an educational institute (Hanushek 1979, and others). If production of any good or a service is to be subject to an economic analysis with the purpose of ensuring efficiency in resource use, in a similar fashion resource use at the institutional level can be subject to the same treatment to make it more efficient, of course, with the underlying assumption that there should be no compromise with the quality of education. Generally in microeconomics, production function is a deterministic relationship between inputs and outputs where inputs and outputs are measurable and inputs are substitutable. There have been many papers which try to fit production function to an institution (EPF) and estimation of cost functions of both schools and universities. Hanushek (2010: 133) mentions that there were 377 separate production function estimates in 90 publications that appeared before 1995; Lumsden (1974)4 is an example of such an attempt for Page 4 of 22

Input–Output Analysis the universities. However, we would like to address the basic question in the case of a university: whether its functioning is similar to that of the functioning of a firm and hence the same set of economic principles could be applied to study (p.95) efficiency and productivity of a university and broadly speaking of an educational institution.

University as a Not-for-Profit Organization One fundamental way that the market for higher education is supposed to differ from the market for a commodity, say chocolates, is that providers/universities are generally considered to be not-for-profit organizations. In a majority of the countries, education is not meant for business as profit making is generally not permitted in education. In the context of a market, it is important to know what drives institutions to strive for the best, or what is their ‘objective function’. Massy (2004: 17) describes non-profit behaviour as ‘maximising a subjectively determined value function by adjusting outputs and output prices, subject to market, production and financial constraints’. The value function seeks to capture the mission of the institution. The demand functions of the purchasers and the supply function of the factors of production constitute market constraints. The delivery of service is supposed to be guided by an input–output relation presumably in the form of a production function. Further, the institution is also subject to a financial constraint which essentially defines the major characteristic of the institution as revenue from all sources minus cost is zero. The value function for the non-profit however cannot be specified quantitatively and even the specification would remain unambiguous. The institute may have more than one value function and may not be well articulated from the very beginning (Massy 2004). So the non-profit behaviour entails equalization of MC with the sum of marginal revenue and marginal value (MC = MR + MV). Strictly speaking MV implies contribution to the fulfillment of the mission of the institution expressed in currency units.5 A non-profit institution should ideally have the capacity for discretionary spending to pursue the mission. In absence of such financial autonomy, the institution eventually succumbs to market forces and attention towards institutional values is undermined in the process (Massy 2004). Not only is it a question (p.96) of subsidization but the mode of funding institutions also assumes importance in this context. Marginson (2009a: 208) analyses the objective function of a university from the point of view of what is often referred to as ‘status competition’. Top ranking universities command respect because of the superior quality of their produce, top quality education, and research. Further, a degree from a high ranking university commands high value because the number of degrees produced is finite or the seats are scarce in these institutions of learning. The competition for status adds an altogether different dimension to the nature of competition and the objective function of the university. ‘Non-profit universities are prestige maximizers, performance maximisers and revenue maximisers’ (Marginson 2009a). To strive for a higher rank or even to maintain status is an end in itself Page 5 of 22

Input–Output Analysis which has a bearing on the financial health as high ranking universities are financially well-off which is discussed in Chapter 7 in the context of the nature of the competition. In a market set up, when the objective of a firm is to maximize profits, the pay structure will also be so designed so as to achieve internal efficiency and accordingly the employees will be rewarded for their extra efforts. Forces which operate for a firm to attain efficiency are likely to be absent in any educational institution. A subsidized educational institute is a very different type of economic organization. Prices (or tuition fees) are kept much below the average cost or social marginal costs. Information such as prices and time spent and use of inputs is not readily available. Even if information can be collected and collated, valuation remains a daunting challenge. Aggregation of inputs and outputs poses another set of problem. Notwithstanding this aggregation problem, there have been attempts to undertake this exercise. Possibly these show how difficult it is for the economists to shy away from the problem of efficiency in their very own institutes where most of them are engaged in teaching and research. If educational institutes are not-for-profit, the question is how would they ensure efficiency in resource use. Corporates are under the compulsion of distributing dividends but institutes are not. (p.97) However, broadly speaking they are required to balance costs with receipts. Universities can compete for awards and reputation, academic prestige or distinction, or they may vie with each other to attract the best minds, students, and faculty which is often referred to as the objective of ‘prestige maximisation’ (Winston 1999: 16; Bok 2003: 158–62). However, the objective may depend on the sources of funds. As Winston (1999) has shown:6 (4.1)

where p equals commercial revenue, dr is donative revenue, g is the extent of grants, c is the cost of education, v is retained profit or surplus, and d is dividend. For a government aided institution, d = v = 0. Even dr equals zero for a typical government college or university in a majority of the cases. In that case: (4.2)

Grants g may also be classified as the extent of grants or explicit subsidies. If p is recovered from students and c is the cost incurred on them, c − p is the extent of subsidies. If c were scholarship, (c − p) could be defined as the net tuition fees. For a privately funded institution, where g = 0: (4.3)

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Input–Output Analysis The higher the dr, the greater would be the leverage that the management has on the costs and the fees that they charge. If dr is low, as it would happen for a majority of the private professional colleges, given c, p would be higher, or given p, there would be pressure on the management to compress c. After all, ensuring balance in the accounts is also a constraint. There would be a tendency to fudge the accounts with inflated costs and rewards to siphon out the surplus without actually making profit on paper, something they are not supposed to do. If the management is concerned with the objective of equalization of opportunities and (p.98) equity, it may soften the incentive to take advantage of a partially informed buyer (Winston 1999). For top ranking universities, dr can be high and/ or there can be another source of revenue from projects and research output. This would enable the university to offer higher pay packages to the faculty (higher c) and more scholarships (lower p) to students.7 Since it is difficult to predict the quality of education that will be imparted, there may be a tendency among some providers to take the students for a ride as once admitted, they will not find it easy to change from one institution to another. Generally speaking, information asymmetries prevail in the purchase of services from non-profit organizations as they do not operate in a market where customers pay the true price for goods and services. There is an element of trust involved in the purchase. Education is, after all, an ‘experience good’ which is discussed in Chapters 6 and 8.

Identification of Inputs and Output Before we take up the issue of existence of production function we need to address the issue of identification of inputs and outputs in the case of education and subsequently deal with the task of measuring them. Hanushek (1986: 1150) brings to the fore the unique feature of input–output for an institution succinctly: ‘Education is a service that transforms fixed quantities of inputs (i.e., individuals) with different qualities. Educational studies concentrate as they should on quality differences.’ The question is what can be regarded as an output for an educational institute? Is output well defined and measurable? For all practical purposes, generally a university is regarded as a multi-product firm because there could be at least two major types of outputs: successful students and research output/publications produced by both the students and the teachers. For a school, output is often considered to be simply educational attainment as measured by test scores obtained by the students. A university is hypothesized to maximize net social product subject to a set of production relations (Bear 1974). The output of a university is multi-dimensional and a majority of its components (p.99) can also be subject to joint production or there can be external effects. It implies that the university’s output cannot be readily decomposed into sub-firms or divisions to apply optimization at the decentralized level. Further, it needs to be assumed that the prices of outputs and inputs are reliable proxies for social marginal opportunity costs. Since Page 7 of 22

Input–Output Analysis externalities accrue over a period of time, values are to be discounted. The analysis therefore needs to remain confined within a single period without being concerned about costs of capital formation. Bear (1974) suggests a conventional model which seeks to capture the specific features that education signifies.

A Proposal for Educational Production Function There have been several attempts to formulate and estimate an educational production function (EPF) for schools and institutes for higher education. We begin with a discussion on EPF for schools. One way is to define educational output for an individual student i at time t is her test score (standardized) Ait, which is hypothesized to be a function of educational inputs.8 The set of educational inputs comprises both family inputs F and school inputs S (Harris 2010) from the past and present. It has been empirically found that variation in test scores can be explained more by variation in family inputs rather than variation in school inputs (Coleman et al. 1966). Let Iit be the contribution made by a student, EPF could be written as: (4.4)

Iit is the innate ability of the student similar to what Becker conceptualized and it could, arguably, be proxied by the general level of intelligence. In practice it is difficult to distinguish innate ability from environmental factors. It is also difficult to measure family inputs or the home environment. However, if a student is observed and studied for a period of time, it is possible to gauge the contribution of family environment as each student serves as her own control group (Harris 2010). The past and the present (p.100) are counted in the EPF because a student’s achievement is not a function of inputs for the present period only, as for education attainment in any period depends on accumulated learning and culmination of all past efforts and learning. But the impact is supposed to diminish over time as the present tends to matter more. It may be noted that since family characteristics and school characteristics are positively related, estimated coefficients are likely to be biased (Hanushek 1986: 1152). The function is assumed to be ‘age independent’ in the sense that the functional form remains unchanged for a student over a period. EPF is assumed to be additive as the interaction between or among the inputs is assumed away. Further, family inputs remain fixed. The decline in the impact in the past is hypothesized to decay in a geometric fashion. The estimable functional form would look like: (4.5)

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Input–Output Analysis One could encounter quite a good number of problems in estimating such a functional formulation. The set θ represents contributions made by the current and past school inputs. This set could also be interpreted as the marginal products of inputs (see Harris 2010: 128–9 for details). For a university where the institution produces multiple products, EPF will have to be formulated differently. We give an example of such an attempt by Bear (1974). Let y(.) be the non-negative vector where the components pertain to quantities of educational output like the number of undergraduates, post-graduates, and doctoral students and the quantity of research in each of the disciplines per period. Let x(.) also be the non-negative vector of input quantities in terms of hours per period of faculty time in various disciplines, non-faculty labour, hours per period of lab equipment, hours of students’ time, and material inputs. Let p(.) be the vector of prices of output and w(.) be the price of inputs. The dimensions of all the vectors are required to be greater than 2. (p.101) The value of the net social product of the educational firm can be expressed as follows with V as the net value added: (4.6)

The firm should maximize V with respect to (y(.), x(.)) subject to the production or technological relation linking outputs and inputs as: (4.7)

So the objective problem can be stated as: (4.8)

Subject to: (4.9)

(4.10)

(4.11)

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Input–Output Analysis The output is categorized into three branches of education delivery, the bachelors (UG), the post-graduate, and research (b, p, and r respectively). Administration is denoted by ‘a’. The constraints recognize the interdependence in teaching and research. While administrative output is essential for all three lines of production, we can see that teaching experiences of the faculty teaching at the UG and PG level are not only important for the other levels of teaching, but they also contribute to research. Similarly, research activity strengthens teaching programmes. Bear (1974), Attiyeh (1974) and Archibald (1974) provided a list of outputs produced by a university. They can be classified into three broad categories: (i) Educational output which raises a student’s cognitive and social skills which would eventually get translated into higher productivity and the ability to earn higher income; (ii) Informational output: reporting of a student’s academic (p. 102) performance and other attributes to prospective employers and the student. The employers could use this for their rational hiring decisions as the students could use their grades for career choices, (Stiglitz 1975 discusses the relevance of this as well. See Chapter 5); (iii) Research output: developments in knowledge, theoretical as well as empirical, creation of arts which may directly and indirectly contribute towards the economy’s productivity; and (iv) Consumption benefits classified as entertainment services (Bear 1974, and many others). Archibald (1974) lists five objectives a bit differently: (a) investment in a consumer durable, (b) investment in a source of future externalities, (c) current consumption activity, (d) investment in a producer good (human capital), and (e) research output. While (i) would subsume (a), (b), and (c), treating human capital as the producer good is also implicit in (i). Valuing Output

The problem of valuation arises from the fact that all the different components of output carry different weights depending on the objective of the institution and the institutional characteristics. Historically, there has also been a change in the method of valuation of outputs. For education as a consumer good, Archibald (1974) categorizes the current and future benefits. In a classification exercise done by Bear (1974: 80–81), educational output could be further classified into: (1) increments in human capital comprising a yield which accrues to the embodiment of human capital, the educated person, and externalities which accrue to society as a whole, (2) entertainment services enjoyed by students, and (3) increments in the stock of knowledge. It has two components. One is the stream of incomes accrued to an individual who invested in education, and two is the stream of benefits which accrue to society.

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Input–Output Analysis Increments in the Stock of Knowledge

A calculus of the optimization exercise can be applied to the determination of optimal amount of output for each category of an education firm if the technology and the preferences are known (p.103) to an educational planner. While technology can be captured in the form of a production function, preferences would indicate the terms on which the consumers are willing to exchange one for the other. Here we may remind ourselves that preferences in the substitutability for even higher education are difficult to conceive of because getting admission in an institution is not akin to purchasing a consumer product in the market. The largest share of value addition made by a university will belong to the first category. In absence of any units of measurement, the valuation problem is of a very serious nature. There are many kinds of human capital in terms of disciplines. Human capital is like a black box, as for example, human capital formed in the realm of Physics is unobservable. Bear (1974) suggests a grade point average as a possible surrogate for assessing output in a particular discipline. In an educational institute, output in the form of students is also the main input of the system. That is why the technical relationship in an educational institution is characterized by what is called customer-input technology (Teixeira et al. 2004a; Winston 1999). There can be two ways. One is the ‘educational’attainment of the students in terms of grades/marks. The other would be their valuation in the job market. In the first case, there has to be a benchmarking of the distribution of grades. But comparison over the years becomes difficult if the grades of a batch of students are subject to some kind of standardization. The university may have its own method of evaluation and gradually there could evolve a national level test. But given that the university at the highest level of teaching and research should have some autonomy and therefore standardization may ultimately interfere with the autonomy of the departments in terms of curriculum and pedagogy. Even if students are valued in the sphere of the job market, the problem of valuation cannot be wished away. Valuation would vary across the specialization or streams depending on the respective situation in the job market. The prevalence of unemployment may further complicate the scenario. One thing may be noted that despite the students’ valuation being considered as some sort of measurement of output, (p. 104) returns would always accrue to the students and the nation and not to the university required for the recovery of cost of operations/delivery. Vaizey et al. (1972) argues that the number of years that students spend studying should be counted as this is the objective of an educational institute (Vaizey et al. 1972). However, the problem is one of lack of correspondence between human capital formation and the grade point average, and whether differences in the grade point average would also reflect similar differences in the stock of human Page 11 of 22

Input–Output Analysis capital. This is because getting a higher grade becomes increasingly difficult. It may so happen that the failure rate is high as the institution is strict about the quality of students produced (Majumdar 1983). Higher the failure rate, better is the quality but output may suffer a dip as the number of ‘successful’ students decline. However, the problem of valuation seems to be insurmountable. How to determine a set of relative prices which would assign values to the quantum of human capital produced remains a challenge. Price can be set equal to the PV of the stream of future returns arising out of human capital. Again, the rate of discount to be applied would vary as it should take, the variation in the risk associated with the investment in consideration. Measuring non-pecuniary benefits remains all the more difficult. It is expected that a student acquires tastes and an enhanced ability to enjoy literature and culture all of which contribute towards an improved lifestyle. Attiyeh (1974) seeks to measure educational output on the basis of an increase in student’s knowledge of literature and the ability to analyse the problems faced in the real world with the application of generalized knowledge. And three, students’ ability to formulate problems and their solutions. Now to argue that grades obtained in an examination would be a good proxy to evaluate students on all these three counts would be tenuous. As suggested by Attiyeh (1974) measurement of all these three becomes increasingly difficult. Valuation from the students’ perspective is a difficult exercise as the students would have different preferences in work-leisure choices, or they may have to borrow from an imperfect capital market, or they may not optimize at all. Long term gains in productivity in terms (p.105) of higher skills are neglected whereby both the students and the nation stand to gain. Measuring the other two forms of output produced by an educational institute is extremely difficult. They are consumption benefits and informational output. Measuring school quality is extended well beyond the school with focus on subsequent attainments, particularly labour market performance. The emergence of the hypothesis in treating education as a screening device as an alternative to human capital approach to the study of schooling-earnings relationships has added uncertainty to the nature and extent of contribution that schooling makes in the transformation of an individual. The screening hypothesis claims that schools identify and rank individuals as more able rather than improving the skills of the students as human capital theorists claim. Bowles and Gintis (1976) argue that differences in earnings are attributable to existing social structures with schools adjusting to and perpetuating the structures. The other interesting argument is that luck and personal characteristics which are unaffected by schooling have the potential to explain differences in earnings (Jencks et al. 1972).9

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Input–Output Analysis Public Benefits

Education contributes towards making better citizens who take well-informed decisions for a more stable society. The issue is how to distinguish between primary, secondary, and higher education while valuing externalities. The distinction between ‘privateness’ and externalities in view of a work-leisure choice is a difficult exercise. Valuing Research

Measuring research output is more problematic than measuring the effectiveness of teaching (Attiyeh 1974). Research consists of the generation of new knowledge and its dissemination in society. Valuing research on the basis of the number of words ignores the content and its impact value. Publications cannot be a surrogate for dissemination either. Many research papers may remain unpublished in the form of working papers. Dissemination would also (p. 106) depend on the circulation of journals and their ratings. If any idea or discovery is patented, valuation becomes easier and at the same time it contributes to the revenue of the government. However, the market is often not the true measure of research output. If the market fails, valuation becomes difficult. It is generally recognized that there is a market failure for fundamental research. In the short run, there may not be any valuation if the import of research is not recognized. If the research output is fundamental in nature, the market cannot value either. The research output would contribute towards development of many marketable products as a part of development of applied research. May be there will be long term gains which will influence applied sciences or technology? If the new knowledge is patented, one can make an attempt to value it but still the valuation will remain incomplete as the impact on societal well-being cannot be quantified with ease. Budgetary allocations cannot capture the extent of public benefits which accrue to society. Further, it is always difficult to ascertain how research output will change in response to a change in resources allocated as there is a high degree of serendipity in any research. This creates problems for the purpose of resource allocation between the two most important components of university output—teaching and research. The problem is further compounded by the fact that teaching and research are conjointly determined in a university as described in the optimization exercise. Teaching helps a teacher as she gets exposed to available knowledge and gains from the participation of students in the class resulting in an improvement in the course content. Attiyeh (1974) argues that the costs of neglecting research through reallocation of budgetary resources from research to teaching may be counterproductive particularly for a university. Massy (2004: 28) draws attention to a similar type of problem where research is increasingly getting prioritized at the expense of teaching. Academic ratchet refers to ‘steady, irreversible shift of faculty allegiance away from the goals of a given institution, toward those of an academic speciality’ (Zemsky and Massy 1990: 22 quoted in Massy 2004). Though there may be an improvement in the quality of Page 13 of 22

Input–Output Analysis output, it may come at the expense of teaching (p.107) and other activities which also constitute the mission of a university as the faculty members are faced with time constraint.10 With regard to educational and informational output, the question is: are they mutually exclusive? Since they are not, weighting each of the components of output becomes difficult. For the production of quality educational output, if the assessment of students is made stringent, there would also be an automatic improvement in informational output11 (Stiglitz 1975). In the ultimate analysis, important question that we need to confront is whether there exists any educational production function. As argued earlier, it is difficult to accept that there exists a well-defined relationship between inputs and outputs largely because of the vagueness or ambiguity in defining output and the ambiguous role played by different inputs. Further, concept of optimum input coefficient is hardly tenable (Majumdar 1983). The problem is that capital and labour as in the conventional production function, Q = f (K, L) are not substitutable in an academic institute the way we conceptualize substitutability along an isoquant representing a production function.12 The price ratio of the inputs remains vague and ill-defined. Even output is not well defined if one insists on quality to be associated with it as discussed earlier. Valuing Inputs

Time spent is an important component of the input vector in an institution. It is in fact the most important input as argued by Becker (1964). There could be two components of time spent—student time and faculty time. For students, it would vary with their IQs and preparation time may vary with respect to discipline. The market wage forgone should also be counted as an item cost as it is done in the rate of return calculation. This is however debatable. As argued by Vaizey et al. (1972: 216) prevailing market wage cannot be used because two assumptions are rarely satisfied: (a) full employment prevails in the labour market, and (b) labour market is unresponsive to major shifts in labour supply. There is one more additional assumption that the net welfare effect is zero. In view (p.108) of rising demand, Vaizey et al. (1972) argue that this assumption is also not tenable. A student’s effort should reflect pain and pleasure for being a student. The problem is that if foregone earnings are considered as costs and the earnings compensate for the disutility for being in school, no consumption benefits arise for the student. This is rather difficult to accept. If more students are given admission, the productivity would tend to fall. The problem is further compounded by teacher absenteeism and students’ dropping out. For effecting desirable pedagogical improvements in teaching methods, better trained teachers, better quality inputs, and favourable student–teacher ratios are all ‘cost-raising’. Relating input to output in a particular year is difficult if Page 14 of 22

Input–Output Analysis improvements in outcome materialize over a period of time. This again makes the estimated coefficients biased because of the ‘imprecise characterisation of the stream of educational inputs…’ (Hanushek 1986: 1156). Faculty time is often proposed to be valued at the prevailing salary level though time spent would vary faculty-wise. Teaching-research choice would vary across individuals, university jobs, and departmental chores. However, salary reflects cumulative past accomplishments, and teaching and research are joint products. A major problem with teachers’ salaries is that in most cases they are administered as decided by the government. Hence, they do not reflect scarcity as a price of a product reflects in a free market. Capital services should also be included as in the case of other firms as a replacement cost, or on the basis of the PV. Prices of other inputs can be subject to similar standard methods as generally applied. If a university has the social objective of equalization of opportunities, there may be some impact on the average performance which may fall if some category of students are given admission with a lower cut-off. The social objective or equity and contributions to the process of social mobility can hardly be valued but these are important social commitments of a university (Béteille 2010). Every type of valuation implies that there exists an objective function for the economic agent (Blaug 1969: 313). Arguably, (p.109) a university has a combination of many objective functions resulting in many types of valuation exercises. Correspondingly, there exist many measures of productivity as well. Measuring Productivity

On the basis of our discussion on the possible problems encountered in the valuation of outputs and inputs, the important issue we need to grapple with is how to measure productivity. This entails valuation of inputs as well as outputs which are difficult to identify, let alone measure. One important indicator that is often measured is the teacher–student ratio.13 Too large a ratio may be a measure of high productivity but possibly indicative of bad quality as classroom interactions may be less and faculty time given to a student on an average may also fall. But such ratios which are often institutionally determined may have no correspondence with the performance of the institution though they can have some impact on it. Generally, in a privately funded institution, the class size would stretch to the maximum permissible. As argued by Winch (2010: 34), regression-based production function models fail to explain variation in the learning outcomes due to limited understanding of what are the actual inputs that contribute to the teaching-learning process. The teaching-learning process which cannot be understood without any reference to pedagogical processes and curricula is crucial in determining outcomes and ascertaining that the outcomes

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Input–Output Analysis are internally related to inputs. This makes the output–input relationship rather vague for an educational institution. Measuring teachers’ productivity is an important agenda for any educational institution. Higher teachers’ productivity contributes towards better ranking of the institution. Can productivity be measured by money cost per student? Effect of price increase has to be eliminated so as to measure the improvement in the quality of input. Higher wage is a return to the student and not to the university. As discussed earlier, an institution is a typical firm which uses a consumer (customer)-input technology (Winston 1999). Technology entails buying important inputs only from customers who actually buy their products. Students, who are the inputs of (p.110) the system, are also decision-makers or the optimizing agents (Majumdar 1983). Students pay for services, or precisely speaking for degrees. But students are not to be confused with consumers. Degrees have to be earned and not purchased as a consumer can in the sphere of the market subject of course to her ability to pay. This has serious implications for quality because if educational institutions depend on fees and look forward to an expansion of the student base, there would develop a tendency to sell degrees at the expense of quality education. So the funding mechanism and the objective function determine the relationship between price and cost of education. Peer quality is important in education which makes the process of teachinglearning different from the process of manufacturing in a factory. The quality of students contributes to the quality of the teaching-learning process as well. Peer quality is an input with no comparable substitutes (Winston 1999). Students try to compete with one another and strive for improvements and even learn from one another. A student as a customer pays a price while a student as a customer is paid a wage rate (scholarship/subsidy) leaving a net tuition payment as the difference (Winston 1999). Selectivity in admissions contributes to the maintenance of the status quo of the university as selectivity is a self-fulfilling prophecy (Massy 2004: 30). Good students opt for better schools and peer effects come into play as good students interact with other good ones, produce better results, and in turn help institutions achieve better results. This attracts better students and the trend continues. This forms an incentive for higher education institutes to choose their students when the number of applicants is far greater than the number of seats. In research institutions the selection process may be stringent for the faculty as the research output would depend on the selection process. In fact, private institutions often strike a balance by extending scholarship to rope in meritorious students and raise the fees to cover costs or even cross-subsidize. This selection process makes the institutions hierarchical and the nature of

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Input–Output Analysis competition assumes a different meaning for the purpose of ensuring quality output. (p.111) Teaching–Learning Process: Concepts of Efficiency and Productivity

For education, inputs, processes, and outcomes are all intertwined in a manner that it is not only difficult to separate them, but it would be misleading as well (Vaizey et al.1972: 214). Since students and teachers are actively involved in the process of exchange in teaching–learning, the process of exchange cannot be described independently of the changes in the nature of inputs and outputs. In standard theory, relative price changes in inputs effect changes in the technology or processes of production. In this sense, for a firm there exists a technological relationship depicting this substitutability. For a school or a college, there can be different ways of carrying out the teaching–learning process. The changes in the processes can be described in ‘pedagogic, psychological, and sociological terms’. What is problematic is attributing the change in the processes to changes in relative prices. Measuring productivity for a non-market institution is based on costs. It leads us to conclude that any measure to improve quality through higher costs would lead to a decline in productivity. There is a need for a distinction between economic and technical efficiency. Economic efficiency refers to the correct choice of inputs given their prices and the production function while technical efficiency means operating on the production frontier. Achieving efficiency is difficult in government funded institutions as educational decision-makers are not guided by the incentive structure to maximize profits or minimize costs. Further decisions are not informed by an understanding of educational processes (Hanushek 1986: 1166). It is possible that an equivalent amount of input may generate variation in output because of the differences in production decisions regarding process choices, organization of materials, and interaction with students which are difficult to identify, measure, and model (Hanushek 1986). The differences cannot be labelled as differences in inefficiencies as the inputs are the same. Efficiency is an optimal combination of inputs or it is, given output, minimum cost. It is measured at a point of time as technology and prices change. But productivity is measured at two points of time, 1 and 2. (p.112) A production possibility frontier (PPF) is usually assumed to be continuous over the factor space. Given relative prices, an optimum is reached. Either it is in terms of minimizing cost given the output or maximizing output given cost. It is difficult to conceive of any optimum student-teacher-booksphysical infrastructure in an educational institute? The coefficients are generated not out of relative price variation. In fact, as argued, such a production function does not exist and hence there is no such optimum-input combination (Majumdar 1983). Virtually there could be many different Page 17 of 22

Input–Output Analysis combinations of teachers and books and computers to produce output but all are not of the same quality. Often, what is desirable or a ‘technological’ consideration is not what the planners would like to achieve. The Unit Cost of Production

Unit costs reflect efficiency. Unit cost can be defined as the ratio of cost to output and it varies inversely with the average productivity of labour.14 In a multi-input case, a weighted average of all inputs is required. There would arise again the need to negotiate with the problem of fixed and variable inputs and their valuations. In fact, how to weigh the various inputs would depend on the importance assigned by a university. The question is whether an optimization principle is applicable for an educational process with quality remaining unchanged. Given the problem of valuation of inputs, measuring the cost of education per student is also a difficult exercise. Quality of output produced is positively related to the cost of production in education and more so in higher education. This strikes at the very root of the presumption that there exists a well-defined technical relationship between input and output. Whether we can maximize output with respect to a given cost is an important question because in the age of reforms, it has serious implications for policymaking. Advocates for achieving efficiency in resource use in a higher education institute clearly tilt in favour of promoting the market mechanism. However, higher education institutions (HEIs) are mostly dependent on government aid and charities with no (p.113) objective function being clearly defined. The problem seems a little more complicated because of the existence of stakeholders with varying interests—students, teachers, administrators, and society at large. Their demands may conflict with each other as each would like to have a larger say in the administration of a university. Outside the university, various political, ethnic, economic, and social groups would like to view a university as an instrument of social policy irrespective of costs and benefits. Even the students and teachers may not always press for higher quality irrespective of costs. Students are required to earn degrees by dint of deligence and perseverance and the teachers may shirk responsibilities to deliver quality education in the absence of monitoring and incentivized pay structures (discussed in Chapter 8). Society and the government would like universities to cut costs with the possibility of quality being given a second priority. The question is how to reconcile these often conflicting demands in a rational way. Attiyeh (1974) argues against the political process but raises the question whether a greater reliance on the market mechanism would take a university closer towards an efficient functioning unit. Maximizing social profit entails that for each output, its value is proxied by the market price which is equated to its cost of production (Attiyeh 1974: 9). The problem with all these conceptualizations remains on paper for all practical purposes as neither the concept of profit nor market prices are tenable for any output produced. Even if there exists a price, the price can be a partial portrayal of benefits which accrue to society. If research is a Page 18 of 22

Input–Output Analysis public good, pricing is simply not feasible. The concept of preferences and their desirability are highly limited in the Indian context. It tends to support the logic of marketization of not only higher education institutions but for the education sector as a whole. It is not really feasible to charge fees for each of the courses in line with respective estimates of MCs.15 The voucher system is argued to be a better instrument to help an educational institute achieve efficiency in the use of resources. All this requires a closer examination in view of the importance of merit and equity in any education system. Though it appears as the advocates lament: ‘The lack of enthusiasm for this reform results in part from a vague (p. 114) but prevalent distrust of the market mechanism as a way of allocating resources for “socially important” services’ (Attiyeh 1974: 12).

Policy Implications This survey of issues involved in conceptualizing an educational production function has implications for policymaking in two ways. One is the contention regarding the existence of an educational production function and governance, and two a hierarchy in the ranking of institutions questions the application of market principles to generate competition among the players for realizing the coveted goals of efficiency and quality. Though, as discussed the application of simple microeconomics to study the functioning of an educational institute with the help of the production function is rather difficult despite many instances of empirical investigations of input– output relationships, this very analysis has something to offer for administrators and policymakers. Governance reforms are being initiated to reduce costs and increase efficiency as different methods of funding are being explored to effect changes. As Marginson (1997: 223) remarked: Using input–output modelling, the complex, heterogeneous work of education institutions could be standardised on a common scale, creating common measures of ‘total’ output. An education institution or educational system could be tracked, monitored, structured, deconstructed, and reconstructed from a fixed central point. To infuse competition, improve performances, and provide the right kind of information to stakeholders, higher education institutions are being ranked both by government nominated agencies and international agencies. Assessment of output and infrastructure facilities is a prerequisite for estimating various indicators required for ranking the institutions. However, there are exceptions. Faculties of very few universities/institutions at the top of the pyramid that exists in India may have an objective function of ‘prestige maximization’. But the owners of a (p.115) majority of the private institutions, depending on the composition of sources of funds, may simply be interested in finding ways to siphon out surplus/profits without officially recording it.16 In a way this is tantamount to abusing the absence of a Page 19 of 22

Input–Output Analysis production function by choosing any combination of inputs as long as it leads to suppression of costs. This is one major factor for the delivery of poor quality education by a majority of the privately funded institutions in India (Chattopadhyay 2009). In a larger context, customer-input technology has implications for market, efficiency, and quality. Since students are decision-making agents and they choose the institutes that they would like to study in, they would of course be concerned with the reputation of the institutes. The better institutes would also be looking for the best of minds, both in their faculties and students as the quality of output depends on the quality of inputs, particularly of students. The best institutes will be well endowed with funds to offer scholarships and higher salaries. The better the faculty, the better would be a university’s contribution in the realm of teaching and research and greater would be the possibility of its attracting contributions from the alumni, corporate, and other organizations. The difference with competition in a typical market is that inputs vary with respect to quality and the inputs selected. The change in quality comes from innovative ideas and R&D rather than the quality of inputs. As discussed in Chapter 3, Romer (1990) also pointed out that knowledge is essentially an idea. However, for a university (or HEI), quality output will be produced with quality inputs and only the best institutions are well placed to attract quality inputs. It is quite natural, therefore, that quality cannot be so easily achieved through competition as the market is likely to maintain hierarchy in the ranking of institutions. Even the concept of efficiency is difficult to conceptualize in the absence of a well-defined input–output relationship as discussed earlier. This problem is further compounded by the fact that quality is a direct function of cost as quality cannot be defined exactly. The best inputs entail greater costs and there is virtually no limit to the quality of inputs and the costs associated with them. (p.116) Some of these observations made in the chapter will be invoked again in later chapters when we discuss policy matters. Though economists’ way of looking at an educational institution as a firm is fraught with dangers, it yields insights and offers policy directions which may be considered with a pinch of salt. Notes:

(1.) Generally, education is largely funded by the government. Even if education is provided by the private sector, in many countries profit making is not permissible. (2.) Human capital can also depreciate beyond a point as embodied in a particular person because of ageing. However valuation is a different issue.

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Input–Output Analysis (3.) Chapter 5 provides detailed discussion on Sen’s approach to the role of education particularly with reference to development. The same may be considered as a critique to the human capital approach. (4.) In India, at the beginning of the Eleventh Five Year Plan, it was discussed whether there exists an optimal size of a university which would be cost efficient. (5.) In contrast, for-profit institutions would equate MC with MR only. (6.) The balancing equation is slightly modified by including g as well on the receipt side of the firms. (7.) It is discussed in Chapter 7, why higher status makes a university financially better off in a competitive scenario. The same factor renders the hierarchy in the ranking of the universities to get consolidated overtime as it becomes easier for the high ranking universities to maintain their status by virtue of their financial health. (8.) There could be outputs which are qualitative in nature like students’ socialization, civic mindedness, and motivation. The question is whether these outputs influence attainments. (9.) Some of these theories are discussed in Chapter 5. (10.) This may result in smaller classes, lower teaching loads, and offering of specialized courses in the faculty’s area of expertise. Though this may be construed as a move towards internal efficiency, stakeholders may remain dissatisfied with such a change as they gain very little in the process (Massy 2004: 28–9). (11.) Stiglitz (1975) makes a similar point (as discussed in Chapter 5). If the quality of knowledge generation improves and the exercise is intense, the quality of information regarding students’ quality will also improve. (12.) An isoquant is defined as various combinations of factors of production, K and L to produce a given a level of output. Given output, say, Q 1 = g (K,L). (13.) Which is even used by NAAC in India. (14.) If w is the wage of labour and L and Q are labour input and output respectively then average variable cost, wL/Q = w/(Q/L)= w/average productivity of labour. (15.) Recently, Indian Institue of Technology (IIT) also raised its fees based on the recommendations of committees to reflect largely the true cost of education.

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Input–Output Analysis (16.) Because of the possible differences in the objectives of the principal and the faculty, the principal-agent problem may crop up which can seriously affect the governance of institutions (Massy 2004: 18–20) as discussed in Chapter 8.

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A Critique of the Human Capital Theory

Education and Economics: Disciplinary Evolution and Policy Discourse Saumen Chattopadhyay

Print publication date: 2012 Print ISBN-13: 9780198082255 Published to Oxford Scholarship Online: January 2013 DOI: 10.1093/acprof:oso/9780198082255.001.0001

A Critique of the Human Capital Theory Various Perspectives Saumen Chattopadhyay

DOI:10.1093/acprof:oso/9780198082255.003.0005

Abstract and Keywords This chapter undertakes a critical review of the human capital approach from different perspectives. Notwithstanding the dominance of neo-classical theory in human capital approach, a journey to the alternatives approaches bring out many facets of education and its linkage with society for a meaningful engagement in the study of education, economy, and society. The chapter begins with a brief account of screening hypothesis, which provides an alternative to the dominant human capital approach. The capability approach in the discourse on development economics adopts a much broader view of education, subsuming the human capital approach. The other two approaches discussed are social choice approach and the Marxian approach. Keywords:   education, screening, social choice, capability approach, functioning and capabilities, dual market, job market, human capital approach, neo-classical theory

As discussed in Chapters 2 and 3, the concept of human capital and the ‘human capital research programme’ to study education has been dominant since its origin in the writings of Schultz, Becker, and Mincer. However, a gradual waning in the importance of studying education and relative sterility in terms of further research as lamented by Blaug (1976a) led to the relegation of economics of education from graduate and masters programmes in economics. Sociologists and educationists would argue that the focus of the human capital research programme has been rather narrow and therefore inadequate to study decisionmaking in education. But within economics, the concept of human capital and its Page 1 of 29

A Critique of the Human Capital Theory use has been critiqued. This chapter takes a closer look at the human capital approach. The objective is to develop a better understanding of education and its relationship with earnings and development through a critical appraisal of this dominant approach. A critique will not only expose its limitations but also bring forth what education is and to what extent it can be subject to an economic analysis. Broadly speaking one can identify four strands in a critique of the human capital approach. We begin with the theory of education as a screening or signalling device which has posed a considerable (p.119) challenge to the human capital approach. In the second approach we deal with the social choice approach as developed by Majumdar (1983). The third approach, Sen’s capability approach, can be considered a competitor of the human capital approach which goes beyond a mere relationship between education and earnings. This approach deals with the broader aspect of education and development. Lastly, we give an overview of the thesis put forward by Bowles and Gintis from a Marxian perspective.

Education as a Screening Device Theory of Signalling and Screening

The theory of signalling or to treat education as a screening device could be considered as an alternative explanation for the empirically observed correspondence between earnings and the level of education. As discussed in Chapter 2, the human capital theory argues that education essentially augments skills through an improvement in cognitive capacity and therefore increased productivity resulting in higher incomes. In contrast, the theory of signalling argues that education raises productivity and incomes but the underlying causal relation is not through an improvement in cognitive capacity but because education helps in screening or segregating more able workers from less able workers. In this case, attainment in levels of education reflects certain characteristics not acquired in the process of being educated but which are necessary for educational attainment such as diligence, sincerity, and motivation. So the educated workers are all qualitatively different as they possess differential innate abilities and educational attainment is a proxy for those innate abilities. Success in education as reflected in marks/grades is not merely an outcome of a random process but it is earned through hard work, good habits, honesty, and many other desirable traits which are considered to be valuable by employers while selecting employees for their firms. Education or a degree or what is often referred to as credentials acts as a screening device because it signals the employers to distinguish between high and low productive workers. Screening is a word used for sorting based on the (p.120) identification of qualities as possessed by employees, and education is the device used for sorting and is called a screening device. In other words, employers who are looking for behavioural traits which they presume are productivity enhancing for the jobs that the employees will be assigned in their firms use education to select the employees with desirable traits from the set of job Page 2 of 29

A Critique of the Human Capital Theory applicants. This becomes necessary because employers, the buyers of labour services, cannot gauge the true quality of the sellers of labour service, or to put it in the language of an economist they suffer from information asymmetry but the sellers, the job applicants, know about their true quality, good mediocre or bad as the case may be. The problem of information asymmetry as one of the causes for market failure was first pointed out by Akerlof (1970) in his famous article, ‘The Market for “Lemons”: …’. Later application of information asymmetry to the study of education in the context of the labour market can be attributed to Arrow (1973), Spence (1973), and Stiglitz (1975) among others. We may recall, Becker (1975) highlighted the relative importance of nature and nurture in the determination of earnings arising out of investment in education. The ability or nature is intrinsic to an individual and it refers to the general level of intelligence. If we control for investment in education, the same level of investment would lead to different levels of earnings which would essentially reflect different levels of abilities. However, in this framework the focus is on the selection of employees by employers and what the role of education is when the employers are also willing to select those with higher productivities. Becker focuses on what happens to the wage profile post-selection. If acquiring a degree is relatively less expensive than the benefits arising out of it in the form of higher wages, it would be rational on the part of the workers to pursue higher levels of education. In general, sorting models or the theory of screening extends the human capital theory by allowing some productivity differences which are correlated with the costs and benefits of schooling but which are not observable to firms. There are some basic similarities between the two approaches in the ways in which the workers and the firms behave. The firms (p.121) are profit maximizing and the workers are utility maximizing in the sense of maximization of net life time expected income, and equalization of marginal return with the cost of schooling. In this context Weiss (1995) makes a pertinent point about the marginal rate of return from one additional year of schooling. The last year of schooling, say from 11th standard to 12th standard does not mean that the extra wage earned reflects an increase in productivity due to one additional year of schooling but the combined effect of the entire school period of 12 years. What makes the sorting models different is because they consider ways how schooling can work as a filter or can act as a signal for the productivity differences that firms cannot compensate directly. Schooling is supposed to be correlated with differences in workers which were the same before schooling choices were made and the firms take decisions based on schooling choices. In response, the students respond to this inference process of recruiters by making their schooling longer (Weiss 1995: 134). Signalling in the Job Market

Employers in the labour market suffer from information asymmetry as they fail to perceive, for example, the level of motivation of the job applicant and its possible impact on productivity at the time of selection. Therefore, hiring a job Page 3 of 29

A Critique of the Human Capital Theory applicant in the job market is similar to investment under uncertainty. Employers form conditional probabilistic beliefs based on past experiences. If it is believed that education/degree can be regarded as an indicator of productivity, wages would be offered as a function of such a proxy or a signal. Job applicants undertake optimization exercises as maximization of net benefit where benefits from education arise out of higher wages and costs of education are expenses incurred to acquire the degrees, or signalling costs. Sorting is based on unobserved attributes. The root cause of the market failure in this case is that the price has to carry out two functions: determining the average quality of the product and ensuring equilibrium between demand and supply (for illustration see, Brown and Sessions 2004: 59–61). Often the buyers may have to resort to third party verification to be sanguine about the quality of the product. (p.122) There have been many attempts to understand how signalling works and the role of education in sorting workers between two groups, one with above average productivity and the other with lower than the average productivity. We prefer to present the model developed by Stiglitz (1975) as it captures many of the important results and their implications in a simple model. A Basic Model

Let job applicants be characterized by a single feature, say θ, which is linked to individual productivity, p: (5.1)

There are just two categories of workers with θ 1 and θ 2. The workers with θ 1 will take θ 2/θ 1 hours to complete a job what the worker with θ 2 will do in an hour. The units are so chosen that m =1. The feature θ can be observed while selecting the prospective one and not p. The proportion of workers with the characteristic θ is h(θ). Let us assume that firms are not in a position to select workers with regard to their productivities and hence all the workers are identical for the firms. However, individual workers are aware of their own abilities. Since the abilities are not known to the firms, they are remunerated at the average of the group in which the workers are deployed in assigned jobs. The average value of θ corresponds to the average productivity in the assembly line of production. So individual workers with abilities higher than the mean value of θ are paid less as they are not identified by employers and therefore, are not paid in accordance with their productivities in the absence of screening (or education). They will naturally have a tendency to be identified by some identifiable feature (that is, education) albeit at a cost.

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A Critique of the Human Capital Theory Let us assume θ 1 〉 θ 2 as workers with θ 1 and θ 2 characteristics are classified as more and less productive respectively. Let there be a perfect screening device (say, education) which comes at a cost ‘c’ per individual. There are two conditions: (5.2)

(p.123) (5.3)

The cost of acquiring education c is less than the increase in pay after being identified with higher productivity with the help of screening. The implication of such a condition will become clearer as we explain the attainment of equilibrium in the absence and presence of education. As we can see that the average wage depends on the proportion of workers in each of the two groups. If the supply of labour is inelastic, the first and the second set of workers receive income θ 1 and θ 2 respectively.1 There can be two equilibria: 1. ‘The no-screening equilibrium’: In this case there is no screening, and therefore, all the workers will receive the same amount which is the average for the entire population of workers. The more productive (able) workers would have a tendency to resort to simple quantification of costs and benefits at the margin as typical optimizing agents to decide whether acquiring education for the purpose of being screened is a right one. With screening, income will go beyond average income but it will come at the expense of c. Additional cost c 〉 MB (θ 1 – θ average), or, the net gain (θ 1 – c) 〈 θ average the pay in absence of screening as per equation 5.1. Therefore, it is not profitable for an individual to resort to screening. 2. The full-screening equilibrium: In this situation, since screening as an option is available, the two groups will now behave differently. For type 1 individuals, the net income will be (θ 1–c) as they decide to educate themselves so that they are classified as ‘able’ whereas type 2 individuals will perforce settle with θ 2 income. As per equation 5.1, since (θ 1–c) 〉 θ 2, the type 1 individuals stand to gain with the screening as otherwise they would be grouped together with group 2 and perforce settle for θ 2 which is less than income. Based on this, Stiglitz (1975) made four propositions which bring to the fore the typical role that education plays in the extreme (p.124) case where it merely sorts individuals rather than augmenting their productivities through development of cognitive capacity. The propositions are: 1. There may be multiple equilibria. Depending on the specific values, there could be many equilibrium points. Page 5 of 29

A Critique of the Human Capital Theory 2. Some of the equilibria are Pareto inferior unambiguously. In the presence of screening, both categories of workers suffer income loss compared to a no-screening equilibrium. Type 1 earns (θ 1–c) which is less than θ average in the absence of screening. Similarly, type 2 earns θ 2 which is less than θ average. Both are, therefore, Pareto inferior unambiguously. 3. In both the cases, either in the case of no-screening or in the case of full-screening, the more productive ones (able) suffer an income loss in the presence of the less productive. Type 1 suffers in both the equilibria due to the presence of type 2. In absence of type 2, they would have earned θ 1. In no screening, they earn the average which is lower than θ 1, and in the case of full-screening they pay c to end up with (θ 1–c). But this is not true for type 2. They gain in the case of no-screening as θ average 〉 θ 2 which is what they deserve. In full-screening, they earn what they deserve, that is, θ 2. 4. Social returns differ from private returns when education plays a narrow role of screening. Since there is a change only in income distribution, gross social return is zero whereas net returns are negative as c is positive. Net national output is lower as in the process there is no change in productivity and hence an output loss. As discussed, both groups 1 and 2 incur a loss in the presence of screening. However, the private rate of return is positive for type 1 in a full-screening equilibrium as the marginal change in income over additional cost is greater than one:

(p.125) Who will provide information? Of course, able workers stand to gain from providing information for the purpose of screening. Therefore, it can be argued that the least able will not be interested in screening. In the process, the able ones are able to capture the returns to general information about their skills themselves and hence they will spend on education.2 Who All Will Invest in Education?

Stiglitz (1975) goes a little further to find out who all will invest in screening or rather education. Of course, here the purpose of education is not about consumption benefits. If some individuals are aware of their potential in selfemployment opportunities these individuals may not like to go for screening and incur a cost when the returns can be appropriated without investment in education. Some individuals are so certain about their abilities that they intend to prove their worth after being selected possibly ‘on-the-job’ and so the individual persuades the employer to give her an opportunity to work at a low wage until she proves her worth for the job assigned. In such cases the skill requirement at the entry point is rather low. Therefore the individual, in the Page 6 of 29

A Critique of the Human Capital Theory process, absorbs the risk associated with hiring and training costs. On the other hand, some individuals are risk averse and would like to be treated as average rather than taking the risk of being screened and labelled as ‘below’ average. However, it all depends on the kind of job that one is looking for. Often certain jobs require minimum qualifications. Individuals, in order to become eligible for being considered for selection, climb on to the ladder of education. The screening hypothesis is applicable in cases where jobs do not require specific skills. What the employers are looking for is the trainability and adaptability of employees as the skills are acquired through on-the-job training and ‘learning by doing’ (Sobel 1982). Completion of a particular level of schooling acts as a surrogate for employees’ potential productivity as the personality attributes become more important for raising productivity rather than any specific skill acquired in school. (p.126) Benefits of Screening

As discussed earlier, in the absence of screening the more able earn less than what they deserve and the less able earn more than what they deserve as both earn the average wage. It is like an ‘information wage tax’ on the ‘able’ and a wage subsidy for the less able. The tax being distortionary, it will have its effects on the work-leisure choice. If screening costs are low, labour is elastic and screening can help everyone gain as long as the taxes are appropriate. There could arise a matching problem if the workers give importance to non-pecuniary benefits and in the process let wage deviate from marginal product. Informational Output Produced by Educational Institutions

As discussed in Chapter 4 in relation to the discussion on educational output, institutions produce informational output as well. Other than educational institutions, employment agencies and entrance examinations at the institutional level as well as at the national or international level also carry out the job of screening. Though there could be possibilities of screening after one joins an organization, or in the sphere of on-the-job training, educational institutions provide primary information to employers. If an institution is low in ranking, the credentials earned by an individual suffer erosion in their credibility in the market and do not help the individual in the selection process in the job market.3 Scarcity of resources is efficiently utilized if institutions are able to identify persons with different abilities as required for the jobs. Teachers also identify students. The better the institutions in imparting quality education and knowledge generation, the greater would be the efficiency of the institutions in screening which is a by-product of knowledge creation (Stiglitz 1975). Therefore, if the quality of education and research is sub-standard, informational output as mentioned in Chapter 4 will also be so and as a result screening will lose its efficacy in the job market. Degrees churned out by low quality professional

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A Critique of the Human Capital Theory institutes in India are not valued in the job market which lead to unemployment or below job expectations for graduates. (p.127) The other assumption that individuals spend on education in order to be screened in the job market needs to be questioned as well. There can be cases where individuals with merit may not have the necessary wherewithal to spend on education for the purpose of screening in the job market. In such cases, the entry of the meritorious in the job market will prove to be difficult due to absence of a degree (or a credential). On the other hand, there will be people with high incomes but low ability who will perceive cost of education to be low and hence go ahead with higher studies. A matching problem could arise in the choice of job if the skills and abilities of individuals do not match with those of the job’s requirements. Within a given occupation where individuals act together there is a need to ensure the right kind of combination otherwise a mix of slow and fast workers will slow down production.

Concluding Remarks on Screening Theory The basic question we need to deal with is whether the screening hypothesis can be considered as a substitute or a complement to the human capital approach. Weiss (1995) wonders why sorting models are viewed with skepticism despite empirical support in their favour and their ability to explain a number of unexplained observations. Classifying sorting models with credentialism is not tenable in which wage differences are independent of productivity differences. Since from the standpoint of economic theory, sorting models are Pareto inefficient and estimation of social rates of return is often not feasible, this adds to the problem of non-acceptability of the sorting models. In fact, Blaug (1976a) went to the extreme saying that since the relative impact of education on earnings has remained unresolved in empirical studies, it is difficult to take a position on the importance of education in the determination of income levels. The debate has remained even to this day as Page (2010: 36) argues in the concluding part of the entry on ‘signalling in the labour market’: ‘More (p.128) than 30 years have passed since the signalling model first gained attention; yet, much is still unknown about the relative importance of signalling versus human capital theories’. The human capital theory assumes a flexible labour market where absorption of the educated workforce is not an issue as long as the wage is flexible downward (Blaug 1976a: 845–6). What additional insights do we gain from the screening hypothesis is the question. Blaug (ibid.) argues that it is not evidently clear in the human capital approach why employers continue to prefer an educated workforce. It can be because of cognitive capacity as emphasized in the human capital approach or desirable personality traits. In any case, an employer may not know exactly to what extent the employees possess the desirable attributes. Page 8 of 29

A Critique of the Human Capital Theory The argument given by Blaug (ibid.) that the human capital research approach is silent on why there is a ‘persistent bias in the preferences of the employers’. This is not tenable as the demand for skills is expected to grow with the advancement of technology. In other areas where the demand for skills is not high, there is also a demand for an educated workforce. The selection problem of how to assess and predict the future performance of job applicants remains for an employer. It is tempting for an employer to assign more importance to educational qualifications to distinguish new workers in terms of personality traits like ‘…ability, achievement motivation, and possibly family origin’ (ibid.: 846) rather than cognitive skills. The argument that cognitive skills are acquired in on-the-job-training and hence employers would fundamentally focus on trainability is a very general remark. As argued earlier, possibly there is a need to distinguish between the kind of skills required in jobs or the distinction between general training or specific training to determine the relative importance of the skill acquired and the trainability of the workforce. The other important aspect of information is what kind of information does education as a screening device provide? Stiglitz (1975) argues that it is general information about the characteristics of an individual worker which would affect productivity in a wide number of jobs rather than any specific information which (p.129) is about the skills required to operate with a particular machine in a particular type of firm. In his words (Stiglitz 1975: 286): ‘The information acquired is “general” information. General information is information about characteristics of an individual which affect his productivity in a specific firm, for example, his ability to operate a particular machine.’ These aspects of information—general and specific—shed light on the debate on the relative importance of education in enhancing earnings as argued in the human capital theory and in the theory under consideration where education acts as a screening device. The debate to a large extent can be resolved by arguing that the firms which are looking for general information about individuals which would contribute to higher productivity based on the general characteristics of individuals rather than any specific skills acquired through education, education would indeed act as a screening device. In cases where specific skills are acquired in the process of training and education, employers would in fact be no more interested in education revealing some general kind of information. It is contended that the screening theory lies in the domain of institutional or organizational behaviour in an environment of uncertainty and imperfect knowledge (Sobel 1982: 261). The estimation of the earnings function which posits a relationship between earnings, education levels, and experiences does not clearly reveal the correlation between schooling and the attributes that characterize trainability. Page 9 of 29

A Critique of the Human Capital Theory However the issue of whether schooling is an effective mechanism for sorting an able workforce from a less able workforce whereby education would lead to growth remains. But a serious objection is that the screening theory can explain only the entry point salary and not the earnings function estimated over a long period. Once selected, an employer can assess the performance of employees without any reference to educational qualifications. In the stronger version of the theory of credentialism, the expansion of education need not lead to a commensurate impact on the earnings differential if college graduates are perfect substitutes for high school students who are substitutes for school students (p.130) and the education system is merely a sorting device. In practice, some of these apprehensions can be negotiated if we assume that there is a continuous demand for skills because of changing technology. At the end, we need to understand why does the demand for schooling go up? If we go by the screening hypothesis, acquiring a degree gives a signal to an employer and hence the probability of getting selected goes up. This is again reflected in the higher rate of return to investment in education. Further, since sorting models argue that schooling decisions are often distorted, these models are silent about the extent of public expenditure required for school education. However, it is difficult to accept that schooling does not lead to an increase in productivity but reflects merely the unobserved differences in ability and contributes to the process of strengthening these differences. Particularly in the context of developing countries where there are variations in the quality of schooling, the steepness in the slope of the wage-education relationship over the primary level of schooling implies that part of the steep relationship is also due to differences in schooling and hence productivity enhancing effects of schooling are captured. The estimated returns to schooling may remain downward biased if skilled labourers are employed in low skill jobs or if high skilled and low skilled jobs are complementary or high skilled jobs create demand for low skilled jobs. Weiss (1995: 151) concludes by saying that students study civics, or arts, or music not ‘solely in order to improve their labour productivity, but rather to enrich their lives and make them better citizens’. As Blaug (1976a) opines, the screening hypothesis is less ambitious than the human capital approach. The other aspects of the human capital approach like migration, job search, and healthcare are not under the purview of the former. The focus is on the demand side of the programme whereas the human capital theory is stronger on the supply side. Individuals investing in education and incurring costs in the process in order to gain in future in terms of higher earnings is common to both the human capital approach and the screening (p.131) approach (Sobel 1982: 261). What is different is the underlying causal mechanism or conceptual framework. Both the theories may actually complement each other in that sense (Blaug 1976a). The Page 10 of 29

A Critique of the Human Capital Theory role of schooling in contributing towards higher future earnings is differently hypothesized. Schools primarily sort students in accordance with those characteristics which are valued by employers when they enter the job market in comparison to the basic tenet of the human capital approach that schools enhance cognitive capacity and, therefore, augment productivity. Whether schools identify pre-existing skills and make them marketable as in the screening theory or schools produce the attributes valued in the labour market can be resolved only by focusing on what happens inside the classrooms as Blaug rightly remarks (1976a: 848). So schooling affects earnings in both the theories but the question is one of unraveling the mechanism. As pointed out by Stiglitz (1975) and Blaug (1976a), screening raises productivity through matching of individuals with a specific skill with that of demand for that particular type of skill. It is a question of disentangling the effects of skill augmenting education as in the human capital theory or career characteristics as per the screening theory on earnings (Sobel 1982). In fact there are two versions of the screening theory, the weak and the strong version. In the weak version, education is just a proxy for personality attributes and screening is restricted to the point of entry to the job market. At subsequent stages, employers develop their own assessment procedures. In the strong version, credentials are surrogates for trainability and adaptability. The internal labour market opens up many avenues for those screened to move up with the help of opportunities for undergoing training and learning by doing. Dual Market Hypothesis

Sobel (1982) presents the segmented or dual labour market hypothesis as a representation of the Kerr-Dunlop approach as it adds a new dimension to the debate. The hypothesis claims that the labour market can be categorized as ‘structured’ and ‘unstructured’ market. In the unstructured market, employers and employees have (p.132) a relationship based only on work and wage which is impersonal in the sense that there is no attachment or bonding between the employer and the employees. Whereas, in the structured labour market, the relationship between the employees and the employers goes beyond the mere exchange, the work performed, and the wage paid. The employees and the employers are bonded in the sense that they feel attached and concerned. In this type of market there are two components, internal and external. The internal market is more of an administrative in nature as it is governed by a set of rules and procedures for wage determination and allocation of labour time. The external market refers to the clusters of job applicants. Those who are seeking jobs from this external market would gain entry merely to the internal labour market at the entry point which therefore connects the two markets. Once selected, their upward movement in the hierarchy, assignment to a particular job, and determination of salaries as reward would be governed by the internal structure which is formed by conventions, customs and traditions, negotiations and unilateral imposition. Since productivity and earnings are job specific, Page 11 of 29

A Critique of the Human Capital Theory demand and supply of employees and their individual efficiency do not really count in the ultimate analysis. Essentially the labour market is segmented or ‘balkanised’ as supported by evidence of differential rates of unemployment and wage differences among the employees who were essentially in the noncompeting groups. So the structured primary labour market offers good jobs with higher pay packages, brighter promotion prospects, and governed by the internal administration. Whereas the secondary labour market (unstructured) is non-unionized and characterized by less attractive jobs, low pay, indecent working conditions, and an unpredictable management.

Investment in Education: A Social Choice Approach Tapas Majumdar in his book Investments in Education and Social Choice (1983) proposed a new approach to analyse the rationale behind societal investment in education with respect to the social implications and whether the rate of return could be a reliable indicator for (p.133) determining societal investment. While critically examining two of the three propositions of the human capital approach that the outcome of learning is a form of human capital and expenditure on education is in the nature of investment, he provided a comprehensive critique of the use of the estimates of rate of return for the purpose of decision-making in investment. Investment in Education is Different

The human capital approach seeks to study investment in education only from the perspective of an individual, that is, of a student or a household. Mainstream economic theory subscribes to the assumption of ‘methodological individualism’ and homo economicus, and therefore the study of investment behaviour of an individual and in this particular case of a student’s investment in education may appear to be in tune with the overall approach. But investment in education is not akin to investment in the capital market. The crucial point is that the structure of investment in education is heterogeneous in nature which is different from other types of investment and hence it deserves to be treated differently. Domain Distinction Argument

Investment made by an individual student cannot be meaningfully studied unless we take into consideration the other essential and, most importantly, the complementary component of investment in education made by institutions or the government. A decision to invest in a particular stream by an individual may not fructify as long as there is no commensurate investment in that stream by an institution and/or by the government. In fact, the two channels must match lest it results in either empty or overcrowded classrooms. These two domains of decision-making must complement each other because of the underlying interdependencies. This aspect of heterogeneity called the domain-distinction

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A Critique of the Human Capital Theory argument constitutes the first point of departure in Majumdar’s approach from the conventional human capital approach to investment in education. What may contribute to the mismatch are differences in the objectives of the two domains, individuals and institutions, and (p.134) differences in their respective time horizons while deciding on investments. Institutions and the government have a longer time horizon and should keep the interest of the nation in their consideration. The level of uncertainty and the associated issue of short term instability may also vary with respect to the two domains as an individual and an institution will essentially have two different ways of looking at investment in education in terms of their assessment of costs and benefits. The problem of social choice arises because society is not a homogeneous category. It is possible that an investment decision at the institutional level will affect different social categories differently. Arriving at a decision at the societal level entails interpersonal comparisons and making judgments on equity related issues which are problematic. Majumdar (1983) advances a scathing critique of why a study based on decision to undertake investment in education based on the estimates of rate of returns by a homegeneous category like indviduals is faulty. Estimates of rate of returns for different levels of schooling for an individual to decide at a particular point in time are not really any meaningful set of alternatives because levels of education are sequential in nature. One has to follow the sequence to reach the desired level of education. An individual cannot afford to choose a particular level with the highest rate of return ignoring the fact that an individual can neither skip any level nor stay put or choose a level from the past. For investment in physical capital, it is a choice among different sectors of the economy, power, road, transport, or any other sector which are alternatives avenues. Investment in education is a one shot investment in the sense that it is irreversible, which implies that it is more like ‘curing cancer rather than buying groceries’. The second aspect of his criticism pertains to the components of investment. Conventionally, the rate of returns ignores that there could be other meaningful alternatives available to a student at a particular juncture. The student may focus more on lengthening the time period meant for study by withdrawing herself from the job market. A student may purchase other inputs, books, or (p. 135) computers to improve her performance or may opt for any other suitable option like shifting to a better institution or going for tuitions rather than considering only the investment alternatives which are sequential in time. It is therefore difficult to infer, whether the investment made in education over a period of time has been optimum or not, as the student looks for the right combination of various alternatives of investment options at different levels of

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A Critique of the Human Capital Theory education. The rate of return approach suffers from an absence of real comparability among estimates of rate of return for different levels of schooling. Even at the individual level, the problem of optimum decision-making may get further compounded when a family considers investment in education for more than one family member and the amount of investment for different levels of schooling may vary. For example, some parents may choose under resource constraint between: (a) financing all their children up to an identical level of schooling, and (b) financing some of the children further up the ladder at the expense of others. Rate of return from say higher education (HE) is higher than that of primary education and the amount of investment required is also correspondingly higher. It would be difficult to justify if the parents decide to maximize returns after dedicating the budget for one individual for her higher studies at the expense of the other. So in order to study societal investment in education, the distinction between the two domains needs to be considered. Basic arguments for domaindistinctions are that formation of human capital in the aggregate sense takes place in two domains. The total investment depends on two complementary parts and a decision is taken in two domains, individual and institutions. They are complementary in nature and have different purposes/objectives. Students invest time and money in their own education and an institution/society and the government has to invest to make that a meaningful one. Time horizons for investment are different (shorter for a student but much longer for the state/ society, for example, in nano-technology). One cannot bank on short-term stability for long-term planning. (p.136) Micro–Macro Argument

While decisions are taken at an individual level whether to invest based on the expected rate of return, the realization of these expected rates of return depends on the then prevailing macro developments with their influence on demand–supply situations in the labour market. The aggregate impact of institutional decisions is generally substantial enough to influence the demand– supply of labour. Societal judgment should take into account two kinds of quantitative considerations at the macro level. The rate of return expected may not remain constant in the long run because of the possible impact of the investment on the market as a whole. Ruling prices and rates of factor earnings cease to be dependable parameters for decision-making. The total impact on the market will be in terms of the aggregate of all anticipated investment decisions. Suppose individuals consider investing in IT training keeping in mind the prevailing pay packages for software professionals as something which would grow in the future. As individuals decide to join courses in large numbers lured by the prospects, institutions also respond by opening up IT training institutes in large numbers. If the demand for IT skilled professionals does not grow Page 14 of 29

A Critique of the Human Capital Theory commensurately and sufficiently, the pay packages suffer a downfall thereby pulling the rate of return below the expected one, which now on introspection makes the decision regrettable. There arises a mismatch between the micro and macro aspects of investment decision-making. Decisions based on micro considerations may not materialize at the macro level as the parameters for an individual turn out to be variables when many individuals act together at the macro level. Collective Choice Argument

The third line of argument marks the culmination of the social choice approach as a critique of the rate of return approach. The basic purpose, as mentioned earlier, is to offer a new perspective to evaluate and decide on societal investment in education against the backdrop of heterogeneity in the structure of investment and of society. Because of this heterogeneity, there could be two major (p.137) sources of the problems arising out of a breakdown of signalling and an absence of equilibrium. If a particular investment decision affects certain groups of individuals differently, aggregation of choices would be problematic. While there can be no clear cut way to resolve the social choice problem as each paradoxical situation would be different in terms of its contents and form, an analysis of such situations would reveal the dilemmas and the possible areas of conflict of interest. This approach will make the institutions and the state sensitive to the issue of possible emergence of social choice problems rather than glossing over the conflicts and contradictions altogether. Policy design should take into consideration that different groups in society are affected differently, which involves (sub-optimal) use of resources both at the individual level as well as at the macro level. If the framework or the institutional mechanism for the articulation of interests between an individual and an institutional investor is not clear, arriving at a judgment at the social level remains a problem. The objective function of the affected parties might not be clearly revealed to decision-makers to arrive at the best judgment. Making value judgments is always difficult and would get coloured by the ideology of the state. The institution making the decision has to weigh costs and benefits in a situation of discovered conflict. With respect to the domain-distinction argument, a class of equilibrium problems may arise due to the: (i) direct nature of the complementarity between the two domains of investment, individuals and the institutions, indirectly due to differences in time horizons envisaged by the two domains, and (ii) the micro– macro argument. For example, a lucrative rate of return for an individual joining IT training may conflict with the possible emergence of unemployment among IT graduates Page 15 of 29

A Critique of the Human Capital Theory which questions the rationale behind investing at the macro level to ensure increased supply of IT graduates. Suppose it is tempting for science graduates to join a technical programme for one additional year. Employers give a positive signal in the job market that they indeed prefer science graduates with an additional degree in a technical course. At the same time, experts (p.138) believe that the quality of science graduates should be improved and they will turn out to be as good as those with an additional year of schooling in a technical programme. But there exists no way for the government to discern the signal and invest instead in the science programme to improve quality. But the dilemma faced by the government is where to invest: should it trust employers and invest in science education or pay heed to the factor-market pay packages and invest in technical programmes? If societal investment is undertaken on the basis of aggregation of revealed preferences of the employers in the factor market conflicts with the aggregation of value judgments of the same set of agents, that is, the preference revealed by the employers for better quality science graduates, there emerges a typical social choice problem in investment in education. The other instance of a social choice problem which may arise out of the same situation as discussed earlier where the same set of individuals tend to reveal opposite preferences at societal and individual levels. As consumers of education, individuals would prefer the quality of education in the science programmes to improve but when it comes to investment, they go way ahead with investing in a technical course. This is because it is not individuals but institutions that should devote more resources for science teaching programmes. So individual investors collectively behave in a manner which is opposite to what they would like to do as individuals. As Majumdar (1983: 38) summarizes, this dilemma could be seen as ‘… contradictory investment decisions made in the two domains—as a case of the collection of individual choices conflicting with the collective choice of the same individuals’. As Majumdar (1983: 38) argues, this social choice problem arises out of the typical nature of a market where there is limited communication between and within the two domains, the employers and the employees. In the example of IT graduates remaining unemployed, the issue was whether the institution should go ahead and invest knowing well that all the successful graduates will not be employed. Though the social marginal rate of investment as an indicator of social profitability will be positive because it is an average of the (p.139) positive rate of returns of those who will get jobs and zero or negative for those who will not. Here arises a case where interpersonal comparison of utility becomes necessary to justify societal investment. There is another case of the social choice problem regarding funding. If it is funded by tax payers who know that not all of them will be employed, the question is why Page 16 of 29

A Critique of the Human Capital Theory would the tax payers like to fund for all? A similar situation can be argued to find its resonance in the Indian case. The government has raised budgetary allocations for higher education in the Eleventh Five Year Plan. The expansion of government funded institutions is taking place when the quality of education imparted by the existing institutions is poor. The army of graduates remaining unemployed is swelling fast. At the same time there are certain sectors where pay packages have burgeoned. So the labour market is characterized by mismatches. Social valuation of all investments involves interpersonal comparability. The issues which need to be addressed are: What should be counted as the social rate of return? Whose perception would help determine what will count as social returns to education? How are they aggregated?

Concluding Remarks on the Social Choice Approach The social choice approach forces us to rethink policy prescriptions that follow from the human capital approach which emphasizes on the rate of return as a determinant of investment in education both at the individual as well as at the institutional level. The social choice approach brings to the fore the problems associated with a mechanical interpretation of the rate of return to guide social investment, particularly at the macro level. This was partly inevitable as the human capital programme was couched in the neo-classical framework in which decision-making by an individual was at the centre of the analysis and the macro aspects were relegated to the background. The social choice approach sensitizes us to the paradoxes and dilemmas encountered in the context of social reality while policymakers grapple for a solution to make the right choice in determining sector specific or level specific (p.140) investments in education. This approach also provides a glaring example where the very rationale behind micro-based policy prescriptions becomes unsustainable when applied at the macro level in a society with diverse interests and conflicts.

Education and the Capability Approach Amartya Sen has proposed a new approach to development based on the central concept of capability in which education plays an important role. In order to appreciate and evaluate Sen’s understanding of education and its role, it would be appropriate to briefly introduce his concept of ‘development as freedom’. The role of education in development needs to be ideally located within the theoretical framework. Sen’s capability approach to development (Nussbam and Sen 1993, Drèze and Sen 1996, Sen 2000) offers a new perspective for examining the role of education in society, and particularly in economic development. This approach which seeks to focus on giving an opportunity for a fuller life is different from the utility based welfare economics and commodity based growth calculus. The concept of the approach focuses on a vector of essentials like ‘nutrition, health, shelter, water, sanitation, education, and other essentials’ concerned with a number of important capabilities rather than on Page 17 of 29

A Critique of the Human Capital Theory income alone. Though it still operates in a commodity space and its contingent nature is acknowledged but the relationship is many-to-one. Before we proceed further to examine the role of education in development, we define the concepts essential for understanding this new paradigm of development as advocated by Sen and the means for achieving it. Though there are many ways of examining Sen’s approach, possibly as Robeyns (2008: 84) argues, the most faithful interpretation would be to examine the capability approach ‘against the background of the crossroads of normative welfare economics and theories of distributive justice in liberal political philosophy’. Functioning and Capabilities

The concept of development revolves around what people are effectively able to do and to be with their capabilities (Robeyns 2008: 84). A ‘functioning’ is an achievement of a person: what a (p.141) person manages to do or be or the state of that person. Achieving a functioning with a given bundle of commodities depends on a range of personal social factors (conversion). A functioning vector represents a combination of ‘doings and beings’ that constitute a person’s life or lifestyle. Capability reflects a person’s ability to achieve a given functioning of doing and being. The capability set describes the set of attainable ‘functionings’ obtained by applying all feasible utilizations to all attainable commodity bundles. Capabilities are therefore real opportunities to achieve ‘functionings’. Entitlements generate capabilities. They refer to a set of alternative commodity bundles that a person can command in society using the totality of rights and opportunities that he or she faces. Therefore, there is a functional relationship between entitlements and capabilities. Development can also be seen as an expansion of entitlements. The concept of entitlements, broadly speaking, go beyond the narrow realm of the market. This remains inadequate though. For example, if price of education is high, even large entitlements may prove to be insufficient. In contrast, even small entitlements may prove to be adequate if the price of education is subsidized, as it is in a welfare state. One serious limitation of traditional development economics is the failure to see the importance of entitlements against the supply of goods and services. It is argued to be better than focusing on income with concern for distribution. A village with education and health facilities will constitute a part of entitlements and it will be beneficial for the villagers to overcome their income deprivation. There can be three types of conversion factors: social institutions, for example, the educational system, political system, the family, social norms (gender norms, religious norms, and cultural and moral norms), traditions, and behaviour of others in society. Conversion takes into account the possible transformation in the preference function. The preference formation mechanism takes place when people interact with each other, succumb to peer pressure, ensure social conformity, fulfill expectations, and so on. Even at the individual level, mental state of being like Page 18 of 29

A Critique of the Human Capital Theory self-esteem will also matter. Conversion of the characteristics of the commodities into ‘functionings’ will differ from individual to individual depending on the variation in societal structures and the mental (p.142) state of the being. A man and woman with the same performance at a particular level in higher education are differently placed when it comes to success in the job market. Gender discrimination and family responsibilities often pose more challenges for a woman in her endeavor for realizing excellence and freedom. The important issue is understanding the import of this approach and comparing it with the traditional one. Capabilities are not a positive function of commodities because distribution and conversion varies with a number of parameters such as age, sex, health, social relations, class, education, and ideology in view of pervasive human diversity. Personal heterogeneity, variations in social climate, differences in relational perspectives, and distribution within the family would affect the conversion of entitlements to capabilities, the chosen set of ‘functionings’ as the individual desires to attain. For example, the ability to be well-nourished depends not only on food and nutrition, but also on its availability and distribution. In consumer theory, a characteristic is a feature of a good whereas capability is a feature of a person in relation to goods. Capability refers to what a person can do or can be. Capability is achieved through the use of the good as characteristics relate to capabilities. But capabilities are different from characteristics and valuing one has implications for the other but it is not equivalent to valuing the other. Capability to function is closest to freedom and if freedom is valued then capability can serve as an object of value and moral importance. The focus is not on achieving a particular ‘functioning’, say same grade obtained by two different students from starkly different socio-economic backgrounds. The focus has to be on the equalization of capabilities in the positive sense. Take the example of a commodity, a bicycle. The most important characteristic of a bicycle is transportation. This characteristic gives the person the capability of moving in a certain way. That capability will give the person utility or happiness if that person seeks happiness. A sequence may be as follows: a commodity 〉 characteristics 〉 capability to function 〉 utility (pleasure of moving) (p.143) It is capability that comes closest to the standard of living. Ownership is no guarantee. A rich person may be unhappy and a farmer may be happy with a cheerful disposition. It is not ownership, not the properties of the commodity but what one can do rather than the mental reaction to it. For example, ability to be well nourished, to move about freely, or to be adequately sheltered.

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A Critique of the Human Capital Theory The Capability Approach

Following Sen (1985) and based on Lelli (2008: 313) in particular, and Laderchi (2008: 209) the capability approach could be presented as follows. As discussed earlier, ‘functionings’ are the various doings and beings of a person. Essentially the notion reflects the achievement of an individual who has been able to utilize the available goods in a particular way. Let x i be a vector of commodities possessed by a person i and selected from the consumption set X i. Let c be the function converting the vector of commodities into a vector of characteristics of those commodities. As argued earlier, mere possession of commodities do not indicate the extent of benefits derived by an individual from her ownership of the commodities. Therefore, the vector of characteristics of those commodities consumed by the individual i can be given by c(xi) and ui be the utilisation function determined by the individual i in the set Ui. Ui indicates the specific use of the commodities the person is able to make with the purpose of generating a functioning vector out of application of i’s actual abilities to use the characteristics of the commodities. Person i’s functioning bi can be expressed as, bi = ui (c(xi)) where,

xi = xi (yh, ti, to, dh, zh, l) The Ui function can be expressed as follows, Ui = [ui | ui = (ti, to, dh, zh, l)] (p.144) where yh is a measure of household income, ti is a set of individual characteristics, to represents a set of characteristics of other members of household, dh demographic features of a household, zh is a set of public goods available and l captures location specific influences. These are the factors that define the basket of goods and services x. The conversion c extracts the characteristics and then are combined in accordance with the utilization function (u) of individual i.

Capabilities are supposed to reflect one’s freedom to choose the kind of life the person wants to live. Therefore, it indicates the real freedom enjoyed by the person to pursue and achieve those doings and beings the person wants to. It is the autonomy to choose a particular life-style a person enjoys. There are two main factors—the consumption set of the person (i.e., the set Xi) and the ability to convert commodities into achievements (i.e., the set U i). Capabilities can be expressed as, Qi = {bi = ui (c(xi)), for some ui(.) ∈ Ui and some xi ∈ Xi} However, the notion of capability requires possible consideration of hypothetical situations which have to be taken into account at the time of evaluating one’s

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A Critique of the Human Capital Theory living standards. This implies that measurement of one’s capabilities is more difficult than measurement of one’s actual ‘functionings’ (Lelli 2008). Sen (2000: 3) proposed a new concept of economic development which can be seen ‘as a process of expanding the real freedoms that people enjoy’. In a way, therefore, the central feature of the process of economic development would be the expansion of human capability. Essentially, what people can do or can be, whether they can live long, be well nourished, be able to read and write and communicate, take part in literary and scientific pursuits, culminating in a process of emancipation from the enforced necessity to ‘live less or be less’ would constitute, broadly speaking, the new concept of economic development. Capabilities reflect freedom which is necessary to achieve happiness. This entails the command that people have over their lives. Deprivations (exploited landless labourers) (p.145) are not captured in the metric of utilities. Happiness is one of many capabilities but happiness by itself cannot be the sole indicator of all capabilities (one may get good food but would feel constrained at every step). Development is about structural changes and questioning existing inequities and unfair practices. So the focus is neither on commodities, nor characteristics, nor utility, but on a person’s capability, on autonomous actions. It is not merely a compilation of ‘functionings’ to remain actively involved in shaping their own destiny and not the recipients of development programmes. ‘Development as Freedom’: A New Concept of Development

If development as freedom is a challenge to the conventional approach where per capita income is central to development, then the question is to identify the essence of this paradigm and how it compares with the traditional one. In the conventional approach, per capita income is measured and considered as a proxy for development. The underlying idea is that material well-being yields satisfaction. Apart from concern for distribution, one of course, needs to worry about externalities, black economy, destruction of nature, and household work when one relies on income as the sole indicator of well being. When the nation grows, the expectation is that the trickle down will also gather momentum. But focusing on growth is not adequate even if we consider all other aspects related to the structure of the economy. There are issues, like gender discrimination or discrimination based on social categories, poor quality of public utilities, and/or absence of rights and liberties which deter and inhibit an individual to realize the full potential of opportunities and earn income. One needs access to other basic amenities of life and availability of goods and services so as to convert them to achieve a state of being. Mere availability of a consumption basket does not mean much. The question is what does one do with it? Our aim in life goes beyond mere consumption of goods and services. When we aspire to live with dignity and seek to achieve a state of being, the question is how does it relate to Page 21 of 29

A Critique of the Human Capital Theory goods and services and, broadly speaking, entitlement? To probe, a little deeper, (p.146) even entitlements are not sufficient as conversion depends on so many factors as discussed earlier. Therefore, concepts of capabilities and freedom, equity and social justice, and skill formation become critically important. Therefore, this new approach is different from mere expansion of goods and services: growth in the conventional approach is a rise in per capita income and a concomitant rise in consumption and satisfaction. The value of goods and services depends on what they can do for people or what people can do with those goods and services. However, happiness or fulfilling one’s desire is only one aspect of human existence. Traditional welfare economics is narrow and fundamentally inadequate for the study of holistic development and structural change. Deprivations and exploitation which are the defining features of a developing economy are not reflected in this per capita income based approach to development. For example, giving food to somebody in prison or giving a book to somebody illiterate would do little for their sense of freedom and attainment of a state they desire to be in. Role of Education in Development

Education is central to the capability approach and basic to all other capabilities. Absence or lack of opportunities can put an individual in a disadvantageous position irreversibly and forever. Further, this basic capability contributes towards the expansion of all other capabilities including future ones (Terzi 2007: 30). The notion of capability as implied by education has a much larger role to play for an individual and for social development. Not only does it enhance the well-being and freedom of the people and contribute to economic production, but it also also ushers in social change. If development is defined as an expansion of other capabilities and freedom, education occupies a central place. Social context and social relations can enlarge or constrain individual capabilities for education. Equality thus depends on personal responsibility for actions (effort). Material (goods and services) and non-material (effort) aspects shape the opportunities that we have and the choices that we make. Education is viewed as a constitutive aspect of development. In this regard (p.147) there is a critical difference in terms of valuation between the focus of the two approaches, the human capital approach and the human capability approach. This distinction pertains to difference between ends and means. If we accept that development is synonymous with expansion of human freedom, then the role of economic growth would contribute to the expansion of opportunities to enjoy freedom, and be integrated ‘into that more foundational understanding of the process of development’ (Sen 2000: 295) which focuses not merely on augmentation of income but to enjoy culture, participate in activities and affairs, social and political, and to provide each individual a secure sense of her own worth. People are viewed as ends in themselves not as means to achieve.

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A Critique of the Human Capital Theory Individual ‘functionings’ are influenced by a person’s relative advantages in society and enabling public and policy environments (good teachers, productive peer relationships): 1. Intrinsic importance: valuable achievements in themselves. They can affect effective freedom directly (Drèze and Sen 1996: 14–5). 2. Instrumental personal roles: seizing economic opportunities. Getting a job and earning which will affect achievement of other ‘functionings’. After all, purchasing power is important. Education gives skills and it is easier for a person to render labour service in the job market. 3. Instrumental social roles: participation in public discussions on social needs, informed collective demands, and improvement in the public delivery of services and their better utilization. 4. Instrumental process roles: process of schooling can reduce child labour, improve social connectivity, and expand horizon. For example, ‘campus life’. 5. Empowerment and distributive roles: resist exploitation and organize politically to get a fairer deal, both within groups as well as within family. Female education is effective for tackling gender based inequalities. (p.148) As Terzi (2007: 32) argues, empirical research supports the role of education to the flourishing of individuals and their quality of life. Terzi quotes Schuller et al. (2004) that the important function of education is to enable people to have a sense of a future for themselves, for their families, and communities and provides a kind of choice, opens up new vistas of life, and extends the horizons of life hitherto unimagined. Sen along with Freire and Nussbam restore the humanistic view of education as opposed to the dominant modernist theories of education such as the human capital theory, manpower planning, or an idea of knowledge based economies (Flores-Crespo 2007: 48). Human beings are conceived of as being responsible agents who can define their destiny. Human Capital versus Human Development

We need to distinguish between contributions made by human agency in growth over and above the contributions made by the accumulation of capital. The link between public action and economic progress becomes crucial. Education is about quality of human life and not just an instrument for promoting economic growth. There is asymmetry between human capital and physical capital. The former can have importance on its own. Being educated or healthy are valuables on their own even if they do not have any impact on income generation. Per capita income growth can be seen as merely instrumental. What does it do to our lives? Increase in income and a rise in life expectancy can come about through higher public spending and lowering the

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A Critique of the Human Capital Theory number of people below the poverty line. Growth mediated progress can be seen as growth mediation through public services and the removal of poverty. Human Capability and Human Capital

In the context of his new approach to development as freedom, Sen (2000) deliberates on his concept of human capability in contrast to the traditional concept of human capital as discussed in Chapter 2. Though human agency is common to both the approaches, human capital focuses on skill formation and its influence on productivity (p.149) and human earnings, whereas human capability focuses on the ability of the people to live life they have reason to value and to expand the real choices that they face in life. Sen distinguishes between direct and indirect valuation of achievements of human capability: direct and indirect. The former refers to the direct impact on an individual in the form of better nourishment and better health. Indirect refers to the functioning which contributes to further production. Sen lists three roles of human capabilities (Sen 2000: 296) as: (i) the direct role in terms of well-being and freedom of people; (ii) indirect role through influencing social change, and (iii) indirect role through economic production. Human capital concentrates more on indirect effects and it is in this sense that the approach is narrow. Therefore, human capital would imply only point (iii). It is however true that an increasing income would also help a person achieve freedom to the extent possible in other spheres of life. As Sen (2000: 296) puts it: ‘We must go beyond the notion of human capital, after acknowledging its relevance and reach. The broadening that is needed is additional and inclusive, rather than in any sense, an alternative to the “human capital” perspective.’ An increase in female literacy would not only reduce gender disparities in society, it may also reduce fertility, and lead to women’s larger participation in the operation of local rural bodies. Basic education will also improve the functioning of institutions, and lead to informed public debates.

A Critique of Sen’s Capability Approach Unterhalter (2008) critically examines the adequacy of Sen’s approach to education and its role in development and concludes that education is ‘untheorised’ in Sen’s writings. Unterhalter (2008) argues that education cannot be linked to schooling with ease. In other words, widening of educational opportunities need not lead to an expansion of human capabilities. Given that the focus is on inequality and heterogeneity in societal relations, there is a need to distinguish among the form and outcome of education. (p.150) For example, there are gender-wise and caste-wise discriminations within the classroom and in the teaching-learning process. Sen’s work emphasizes on the role of agency achievement where active participation of people is an imperative. Both facilities and processes are important. Schooling may not always contribute to the enhancement of capabilities. Education leads to measurable outcomes as a Page 24 of 29

A Critique of the Human Capital Theory narrow set of performative measures. This is very similar to measuring economic opportunities through income. It has to be recognized that uniformity and homogeneity in education are rare. If education is viewed as its role in empowering an individual, then the same schooling which provides education can also be playing a role in accentuating gender, caste, and other disparities that exist in society. Basically, a simplistic application of the capability approach is best avoided and instead a more nuanced approach should be adopted to understand the educational processes and congenial conditions that prevail within an institution. In addition, education is conceptualized in two different ways which are often confusing as stressed by Unterhalter (2001 as quoted in Flores-Crespo 2007: 48). Education can be seen as a form of functioning or achieving well-being and education as a part of the process of exercising agency using reflection, information, understanding, and recognition of one’s right to exercise these capacities to formulate ‘valued beings and doings’, or, to put it differently, the reason is an unexplored area in Sen’s approach. Robeyns (2008: 86) says that Sen’s capability approach is ‘deliberately an open ended framework or a broad evaluative paradigm, and not a fully fleshed out theory’. However, this freedom based perspective can be of help in understanding and assessing various social phenomena such as poverty, inequality, and well-being. Specific to education, pedagogical practices, and institutional aspects including the conduct of teaching-learning process, and governance in the broader sense can be paid more attention to negate and nullify ‘oppressive cultural manifestations and regressive social mores’. (FloresCrespo 2007: 60). This approach is worth contrasting with the functionalist perspective that considers education as an engine of growth.

(p.151) A Critique of the Human Capital Theory: From a Marxian Perspective Bowles and Gintis (1975) offer a critique of the human capital theory from a Marxian perspective. They argue that there is a need to understand the process of schooling and training from a broader perspective in the context of the capitalist system. In conventional neo-classical economics, labour is treated as a commodity which is traded at a price in the market. Labour, however, is not a typical commodity where exchange is carried out at a mutually agreeable price (wage) particularly in a capitalist economy where capitalists own the means of production and the labourers are pushed to the wall to sell their labour power. In the labour market the exchange price of labour is hardly fair as in the Marxian portrayal of a capitalist economy balance of forces in the process of negotiation of wage is inherently against the workers. The human capital theory treats labour as a means of production which is an extension and continuation of the Ricardian and Marxian notion of labour. Labour ceases to be homogeneous because of the different levels of skills that the labour acquires. Social institutions like family and school are required in the production of labour and they were brought under the purview of the human capital approach. Despite Page 25 of 29

A Critique of the Human Capital Theory these contributions, Bowles and Gintis (1975) argue that the human capital approach ended up with a narrow perspective of schooling. Schooling performs two functions. One, in production of labour, an essential but arguably, an indirect role, and two, in social reproduction which seeks to consolidate and perpetuate economic and social order. The latter entails an understanding of the capitalist system of production, the class structure, and the institutions which sustains the vitality of such a system. The aspect of reproduction does not feature in the human capital approach; only the first aspect is partially captured. In particular, Bowles and Gintis (1976) explained that schooling produces technical and cognitive skills to meet specific job requirements. Second, the educational system helps legitimate economic inequality. Third, the school produces rewards and labels personal characteristics relevant for (p.152) consolidation of the hierarchy. Fourth, the educational system reinforces stratified consciousness which constitutes the basis of fragmentation of economic classes. Bowles and Gintis (1975) are categorical that education is not merely an exercise in labelling in the context of imperfections in the capital market and information asymmetries. What is missing is an analysis of class to juxtapose sharply how labour is reproduced vis-à-vis capital to sustain the system and perpetuate class differences. Here comes the importance of schooling in social reproduction rather than focusing merely on reproduction albeit inadequately in the human capital approach. In sharp contrast, the analysis of production of the means of production is purely technical in the neo-classical model and hence it completely ignores the underlying social processes. To argue that schooling enhances cognitive capacities and helps explain higher productivity and earning is only a part, albeit a major one, of the story. Schooling helps impart education keeping in view the kind of workforce the capitalist system needs, but at the same time it jointly produces a kind of consciousness which nurtures the working class consciousness in the system of schooling as the labour is segmented into different classes which is essential for the sustainability of the system. Determining wages is a more complex affair than what is understood in the context of a demand–supply analysis. Credentials are often used to fragment the workforce to prevent the formation of a coalition within a firm.4 Assignment of jobs and promotions depends on the class structure created by the capitalists and would depend more on the dependability, status, and lifestyle of the workers. Supply of human capital is not merely the sum of individual choices to undertake individual training under their respective constraints. As articulated by Bowles and Gintis (1975: 77–8): ‘… the education system does much more than produce human capital. It segments the workforce, forestalls the development of working class consciousness, and legitimates economic inequality by providing an open, objective and ostensibly meritocratic mechanism for assigning individuals to unequal occupational positions.’

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A Critique of the Human Capital Theory (p.153) Human capital is not only heterogeneous in terms of the levels of education since different schools and families teach different things to different individuals and the resulting labour force is qualitatively different because there are many dimensions of education involved in the process. The objection to the use of the word capital for education is difficult as in a capitalist system, workers hardly have any control over what they own.5 The criticism for the rate of return approach is rather belittling. In view of what schooling does and how wage is determined, the concept of rate of return from investment in education becomes fragile and the foundation of the human capital theory gets weakened. Since the capitalist class is interested in the longterm sustainability of the system, there is also a tendency to guide the education policy with the mediation of the state. Rates of return may often yield contradictory results. The impact of education on growth may simply go beyond the concept of quality as envisaged in the growth theoretic structure. In a capitalist system growth may be propelled by the perpetuation of a class structure in a system which facilitates wage-labour reproduction.6 Explanations for income distribution in terms of demand and supply as discussed in Chapter 2 are inadequate for capturing the complexity of the social reality. These ignore macro, market structure, economic dualism, and technical change among other factors. Where the school system legitimates inequality, the rate of return approach seems to be flawed. However, one thing we need to understand is that the earnings function had a resounding support from empirical studies. The emergence of a middle class, demand for skilled labour, and advancement in technology may lead to the process of dilution of class differences as sharply exposed in the Marxian analysis. Moreover, we need to understand the structure of economic theory and modelling because a lot many factors are considered to be parameters in the short run micro-based modelling. The issues raised by Bowles and Gintis (1975) remain valid but discarding the human capital approach will be tantamount to throwing the baby with the bath water. The explanation that wage is determined on the (p.154) basis of demand and supply as in the human capital approach is at best a superficial analysis, because the process of schooling is not adequately deconstructed in the approach. If it is, schooling would be found to have an impact in a multi-dimensional framework. Neo-classical economics is based on the assumption that preferences do not vary. If schooling legitimates economic inequality then the causal relationship between schooling and inequality is radically different from the determination of wage in the neo-classical framework in which wage is determined in the market influenced by the market structure and the processes of technical changes. The other problem with a costbenefit analysis is a strict separation of economic and non-economic welfare.

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A Critique of the Human Capital Theory Public expenditure assumes exogenous preferences. But it is education which influences preferences. Applying the Marxian notion of capital Fitzsimons and Peters (1994: 253–4) argue that ‘Human capital theory is an impoverished notion of capital’. Capital is much more than a physical quantity. It is a social force which effects transformations in an unequal society where labourers have to struggle for survival as both commodities and capital are concentrated in the hands of the capitalists. And this struggle is mediated through social relations. Fitzsimons and Peters (ibid.) remark ‘… human capital is an abstract form of labour—a commodity—and not capital. Commodities such as human capital are therefore part of the life cycle of capitalism as a form of labour and not able to be exchanged independently of it.’

Concluding Remarks In this chapter our endeavour was to critically examine the human capital theory from four different perspectives. While the theory of signalling remains a part of the neo-classical paradigm in the realm of the economics of education, the other three approaches are not. The signalling theory was developed in response to the problem of information asymmetry in the job market which is considered to be a source of market failure. Though debates continue to draw attention to empirical investigations, the theory can be viewed as an extension of the human capital research programme (p.155) or as a complement to it. It is not surprising that the other three perspectives do not find a place in recent publications related to the economics of education.7 Sen wriggled out of the conventional neo-classical doctrine to offer a different perspective of development and a broader view of education in development which is more humane and holistic located within the socio-cultural set up. Majumdar brought in a new perspective to highlight the importance of social choice in designing investment policy in education. The Marxian approach focussed on labour and labour power and their inability to participate in a free exchange in the labour market given the adverse social relations they find themselves in. The deconstruction of the social process of reproduction of labour deserves attention to comprehend the nature and the functioning of the system. In sum, all these perspectives allow us to evaluate the role of education in a socio-economic setup as the limitations of the human capital theory are realized and overcomed, and therefore enrich our understanding of the economic conceptualization of education. Notes:

(1.) Under competitive conditions, wage equals marginal productivity of labour. These can also be treated as life time income as discounted value of future wages.

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A Critique of the Human Capital Theory (2.) It sounds similar to Becker’s argument that able individuals or their families would like to spend on education as they perceive higher returns from investment in education. (3.) This may well explain why engineering graduates who have passed out of the privately funded poor ranking colleges remain unemployed or settle for low paying jobs where the specific skills acquired will have very little relevance. This is discussed in the Indian context in Chapter 9. (4.) This is also echoed in the theory of dual market hypothesis discussed in the context of theory of screening. If we may recall, after the entry point, promotions and assignment to particular jobs have got to more with the organizational structure and their rules and procedures and less with human capital or skill embodied. (5.) This is the distinction between labour and labour power as discussed. (6.) In a way, the contribution of education to growth may be negative on balance as inequalities may have accentuated. (7.) Even if there are references to these three perspectives in recent publications related to economics of education, the space and importance assigned to these theories can be best considered as inadequate.

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Education as a Public Good

Education and Economics: Disciplinary Evolution and Policy Discourse Saumen Chattopadhyay

Print publication date: 2012 Print ISBN-13: 9780198082255 Published to Oxford Scholarship Online: January 2013 DOI: 10.1093/acprof:oso/9780198082255.001.0001

Education as a Public Good Saumen Chattopadhyay

DOI:10.1093/acprof:oso/9780198082255.003.0006

Abstract and Keywords This chapter argues that if education is subject to economic analysis, it is imperative to classify what type of commodity education is. Different levels of education need to be classified differently. While school education is a merit good, higher education is best described as a quasi-public good. In contrast, knowledge is often classified as a global public good. Policy issues like various forms of private participation in education, extent of subsidization and funding of research, and regulation are linked to this debate on classification. However, water-tight classification is difficult as the privateness and publicness in the delivery of education is a social construct. This chapter sets the stage for an engagement in debate in the subsequent chapters. Keywords:   education, merit good, public good, quasi-public good, global public good, externalities, excludability, non-rivalry, publicness

How to classify education as a good (or a service) from an economic perspective has continued to remain debatable among academicians and policymakers. For concerned citizens, it has been a matter of confusion. Particularly with regard to higher education (HE), classification has remained all the more debatable because classification of HE has important policy implications. In 1995 in India, the debate gained significance and publicity in the wake of the White Paper on Government Subsidies prepared by the Government of India (GoI) which sought to classify primary and higher education for the purpose of revisiting the extent of subsidization that the country could afford at a time when it was implementing the new economic policy. The White Paper sought to classify humanities and social sciences as a ‘non-merit good’ and sciences and applied Page 1 of 25

Education as a Public Good sciences as a ‘merit good’; higher education as a public good or a private good or a blend of the two has been a matter of contention in the policy discourse at the global level as well.1 This chapter endeavours to give a brief account of the literature on public good and merit good with the objective of classifying education and assessing the role of the state in education. Generally there are two divergent approaches for examining the role of the state in the economy. The approach which was founded by Knut Wicksell and later developed by James Buchanan under the rubric of public choice theory could be called individualistic. (p.157) However, Nobel Laureate Paul Samuelson formulated the path breaking analysis of the theory of public expenditure (Samuelson 1954). Samuelson proposed Pareto optimal conditions for the allocation of resources in the presence of public good and private good. While Wicksell argued in favour of a political process for voting mechanism as an alternative to the market mechanism for the sake of preference revelation, in Samuelson’s model, a referee is supposed to know the preferences of the individuals, albeit the fact that the preferences revealed are pseudo ones. Then the referee is, supposed to facilitate the determination of allocation of resources between private and public good based on those preferences. However, selfinterested choice is the common thread running through both the approaches (Bagchi 2005b: 7). The first approach is individualistic and articulated in the public choice theory and the second is communitarian advanced mainly by Richard Musgrave. In the latter approach, community concern is reflected along with self-interest based choice. The concept of a merit good proposed by Musgrave is supposed to settle the doubts between the two. In this chapter we follow the Samuelson’s analysis of public good.

Private Good and Public Good Broadly speaking there are two approaches for understanding the distinction between a public good and a private good. The juridical approach focuses on the nature of ownership of the producer while the neo-classical approach developed by Samuelson (1954) focuses on the nature of the good in the sphere of the market (Marginson 2007). In the first approach, a good produced by a publicly owned unit is a public good and a private good is produced by a private enterprise. This approach is not amenable to an economic analysis as it is the nature of the good in the market and the efficiency conditions required for optimal allocation of resources which matter rather than who is the provider, the private or the public sector. However, the ownership of the manufacturing unit ceases to be relevant as even the government can supply a private good or a private enterprise can also deliver a public good.2 Therefore, in (p.158) the case of education, the earlier approach based on ownership hardly makes any sense as the same education is produced both by government funded schools as well as by private funded schools.

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Education as a Public Good Private Good

In economic theory, production and distribution of goods and services which are left to market forces where buyers and the sellers participate in a voluntary exchange of goods and services at a price mutually agreed upon are actually private goods. Private goods are characterized by rivalry in consumption in the sense that one’s consumption precludes others from partaking consumption benefits. Further, because consumption is a rival, it is feasible to exclude those who would not like to pay but would enjoy the benefits. The exclusion principle works well for a non-rivalrous good due to its inherent technical characteristic that only one can consume and/or due to legal backing where many can consume even if they do not want to pay but it is feasible to exclude them. The ideal market is portrayed to be a perfectly competitive market where all the efficiency conditions are satisfied. A perfectly competitive market, regarded as a benchmark for analysis of other forms of market which are closer to what we obtain in reality is based on certain crucial assumptions. These assumptions are the existence of a large number of buyers and sellers, a private good which is homogeneous (undifferentiated), availability of perfect information to all the participants, and free entry and free exit of firms. Non-fulfillment of one or more assumptions is generally considered to be the source of market failure. So an imperfect market with product differentiation as we encounter more often in the sphere of the market is also an example of market failure.3 Intervention by the government is justified only if one or more of these assumptions fail to satisfy and hence the market is considered to have failed to ensure efficiency in the allocation of resources. One of these assumptions is that the good to be traded in the sphere of the market is a private good in the sense that consumption is a rival as mentioned earlier. This aspect is important in the present context as for the efficient functioning of the market, buyers remain the only beneficiaries of (p.159) the consumption of the goods and services. In such a case, benefits arising out of consumption by one person who pays the price do not accrue to anybody else and therefore only the person paying the price of the good appropriates the benefits. The market functions smoothly and efficiently as exclusion is feasible, if it is so required. A private good is defined as a good characterized by rivalry in consumption and excludability. The conditions are (Samuelson 1954): (6.1)

(6.2)

Since consumption is a rival, the total amount consumed is the sum of the individual level of consumption (equation 6.1). Each and every consumer has to equate her marginal rate of substitution between the two private goods (MRSxy) Page 3 of 25

Education as a Public Good with the given price ratio, p, the efficiency condition as in equation 6.2. So the market demand curve is the horizontal summation of the individual demand curve. Public Good

However, the question of exclusion arises if the consumption of the good is nonrival in the sense that consumption by one person generates benefits for others in the form of (positive) externalities, either directly or indirectly. Further, depending on the nature of the product, it often becomes difficult to exclude those who do not pay but stand to gain from the consumption of others who pay. If exclusion is feasible, the good can be purchased only at a price. Under certain conditions, exclusion is not feasible when there are a large number of such consumers who enjoy the benefits.4 For certain goods, the consumption benefits accruing to all would remain the same and there does not exist any primary beneficiary. There can be cases where one can identify the primary beneficiary and the beneficiaries who would indirectly gain from consumption by the primary beneficiary. Even if the beneficiaries are asked to reveal their valuations of the good so that they can be asked to pay and (p.160) the social demand curve be arrived at, they can under-report and the production of the good will remain sub-optimal.5 In general, externalities present before us a case of missing markets as non-rivalry in partaking the benefits arising out of consumption and the consequent failure to apply the exclusion principle renders the demand curve either non-existent or a pseudo demand curve as preferences are not truthfully revealed. It is therefore rational on the part of the consumers to be the free riders. Even if they are goaded to reveal their preferences, they are unlikely to be truthful as they cannot be excluded from the market if they do not reveal their preferences truthfully. As a result the market becomes a nonworkable mechanism for the determination of equilibrium level of price and quantity of the good. The market in case of non-rivalry in consumption is said to fail to yield a socially optimum outcome as equilibrium is reached without taking any cognizance of the benefits accruing to society as a whole as social demand reflecting social benefits is not considered as individuals are engaged in an optimization exercise to make the economy reach an equilibrium position based on private demand. In the neo-classical approach, Samuelson (1954) provides the definition of a public good which is posited in sharp contrast to the nature of a private good. A public good is defined to be a good with two main characteristics: non-rivalry in consumption and non-excludability in benefits. For a pure public good, the consumption benefit accrues to all and by an equal amount. One commonly given example is defence or even that of a light house. Efficiency conditions of a private and a public good are opposites. A public good is defined as (Samuelson 1954):

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Education as a Public Good (6.3)

(6.4)

In case of a public good, since the same amount is available to all the n number of consumers, all the consumers contribute to the cost recovery as each of them pays a price but the price will be in (p.161) accordance with their respective marginal rate of substitution in consumption. Hence the price of the public good will be the sum of MRS of all the n consumers as all of them collectively contribute to the cost of provision of the public good.6 The market demand curve is the vertical summation of individual demand curves. Due to the free rider problem, individual demand is actually a pseudo-demand curve because unless the exclusion principle is enforced, it is in the interest of an individual not to reveal her true valuation. In the Samuelson model of public good (1954), the demand curve is actually a pseudo-demand curve and the free rider problem remains. The referee has to know the utility possibility frontier and a social welfare function which is indeed a virtually impossible task. However, there are some goods whose benefits are subject to the level of consumption. If the number of users goes beyond a level, what is called congestion, the benefits would decline. The important issue is how to recover the cost of provision if benefits accrue to all and exclusion is not feasible. There would again arise a free rider problem. The beneficiaries may as well escape by saying that they are not the beneficiaries or even if they admit to being beneficiaries, they can grossly underestimate the benefits and therefore they would like to pay a price lower than what is required to achieve a social optimum.7 It is however difficult to categorize all goods into either private or public. Actually, there is a spectrum along which the goods can be placed depending on the extent of excludability. The extent of excludability which arises from the nature of consumption benefits is important for policymaking as it demarcates how and to what extent the government is supposed to intervene and accordingly the extent of private participation. This aspect will become clearer as we take up the case of education in the following section.8 In C in Table 6.1, though the good is non-rivalrous in consumption, exclusion is feasible due to technical reasons. As long as there is no congestion on the road, obstructing entry into a toll (p.162)

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Education as a Public Good

Table 6.1 Classification of Public Good: The Conventional Approach Rival

Non-rival

Excludable A (= private good)

C (=A toll booth) exclusion may cause inefficiency due to limited non-rivalness.

NonB (= common excludable resources)

D (= pure public goods)

Source: Musgrave and Musgrave (1989). road will be inefficient but feasible because a toll gate can be installed. In D in Table 6.1, the consumption is a rival as the individuals own a common property, for example, but exclusion will be difficult. Mixed Good or Quasi-public Good

A mixed good or a quasi-public good (Musgrave and Musgrave 1989) is essentially a private good which generates externalities, therefore combining the characteristics of both public and private goods. Pure private goods do not generate externalities but a public good on the other hand is available to all which in a way can be argued to be generating an equal amount of externalities for all. In Figure 6.1 the market demand curve is derived from the sum of the private demand curve (MPB) and the social demand curve (MSB) which intersects with the supply curve. The intersection with the market demand curve occurs to the right of the intersection with the private demand curve. This shows that the transaction of a good at the intersection between the private demand curve and the supply curve in the presence of externalities is lower than what it should have been once the externalities are considered as reflected in the social demand curve. Figure 6.1 shows the pricing rule in higher education. Since education is an investment, costs and benefits are spread over time, the two sets of curves—the cost and benefits curves—are in PV terms. There are two MB curves, private (MPB) and social (MSB). The curves are downward sloping because the wages decline with the increase in the number of graduates. The gap between MSB (p. 163)

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Education as a Public Good and MPB is attributable to the value emanating from positive externalities. It is assumed that the externalities remain invariant to the number of students enrolled in higher education as the two curves are drawn parallel to each other.9 The MPC curve slopes upwards as the opportunity costs will keep rising with enrolments.

If externalities are not considered, in the absence of any government intervention the equilibrium enrolment rate will be achieved at E0 which is

Figure 6.1 Private Demand and Social Demand: Accounting for Externalities

at the intersection point between the cost curve (MPC) Source: Musgrave and Musgrave (1989). and the marginal private benefit curve (MPB). However, the aggregate demand curve is the sum of private and social demand which is nothing but a reflection of the valuation of externalities. Ideally, Es is the socially optimum level of enrolment. This equilibrium can be achieved if the cost is lowered to intersect the AD curve at a point which makes the attainment of Es feasible. The MPC curve shifts downward as the government subsidizes education which reduces the cost of education that the students would be required to pay. (p.164) Externalities

Education generates benefits which spill over to society called externalities in economic parlance. Non-rivalry in consumption is nothing but externalities. It is in fact the most important defining characteristic of education from the perspective of economic theory which, to a large extent assumes central place in the many of the debatable issues when education is subject to an economic analysis. Externalities are cases of missing markets and hence valuation is extremely difficult. But that cannot be the reason for keeping externalities out of an economic analysis of education. Externalities are to be distinguished from private non-market benefits beyond earnings such as health and the quality of life. External benefits of education comprise many direct and indirect benefits. These can range from ensuring democratic functioning of institutions, deepening democracy, and human rights to longevity, lower crime and corruption, to happiness and social capital (McMahon 2010). Indirect external benefits of education are over and above these direct benefits. Indirect benefits work through other variables and feedback over time to contribute towards private market and non-market benefits. Indirect benefits set the stage for higher growth in the present and also Page 7 of 25

Education as a Public Good for future generations. This dynamics means that the present growth is also being contributed by past levels of education attainments and present education will also raise the future growth profile. As McMahon (2004 and 2010) explains there is a need to distinguish between external social benefits and non-market benefits. Non-market benefits can contribute to private benefits in the form of better health. Some public benefits will also have a salutary impact on private earnings through political stability. Market benefits are the benefits which are valued in the sphere of the market. Income of an individual which is attributable to education will, in the aggregate raises the national income. Lucas’s (1988) theory of endogenous growth (as discussed in Chapter 3) is augmented to capture the effects of trade, rule of law, and political stability. Further, the externalities lead the economy to achieve overall economic efficiency as the optimal solution. (p.165) Table 6.2 Total Benefits of Education Private Benefits

External Social Benefits

A1. Private monetary benefits: direct

B1. Externality benefits to GDP/capita: indirect

A2. Private non-market benefits: direct

B2. Externality benefits, non-market: indirect

A3. Pure public good externalities: B3. Pure public goods externalities: direct non-rivalrous effects indirect non-rivalrous effects Source: McMahon (2010). Private non-market benefits of education accrue to family members, intra-family, and intra-firm spill-overs. Some of the private non-market benefits are indirect as own health would contribute to child education and child health as given in panel B2 in Table 6.2. The value of external benefits in comparison to total benefits indicates the extent to which the government is required to fund education through taxes to ensure economic efficiency.

Economic efficiency requires attainment of both production efficiency and exchange efficiency, or in other words, internal efficiency and external efficiency respectively. If an institution is driven by a profit motive, it may achieve internal efficiency but possibly not external efficiency. At the other extreme, if a university is funded by the public exchequer external efficiency will be achieved but not internal efficiency (McMahon 2010). However, as discussed in Chapter 4, the concept of internal efficiency is hardly tenable because of the nonapplicability of the concept of the production function for an educational institution. In fact, the divide between public and private participation which is

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Education as a Public Good economically efficient will be determined by the respective valuation and the resulting funding pattern.

Revisiting the Concept of Public Good As discussed earlier, conventional treatment requires a public good to be delivered by the state and private goods by the market. Policy choices are made or norms established to make the goods private (p.166) (exclusive) or public (non-exclusive). Marginson (2007) provides a new perspective for the classification of education. Marginson argues that a strict dichotomy between a public and a private good, state and the market, and the associated question of ownership of government and non-government is difficult to accept and pursue. The definition of what is public and what is private is actually policy sensitive because the extent of excludability is essentially a policy decision apart from the intrinsic characteristics of higher education. Notionally, a private–public mix and the extent of ‘publicness’ can be determined by the ratio of external benefits to private benefits. There have been attempts to revisit the concept of public good (Kaul and Mendoza 2003; Touffut 2006). In the case of public goods the concept of nonexcludability means that it is not only technically infeasible to exclude someone from consuming the goods, it is also politically infeasible and economically nondesirable. However, there can also be cases where exclusion is feasible such as a piece of knowledge or innovation where use may be restricted by patent and, therefore, recovery of the cost of production is feasible. But it is inefficient as per the efficiency condition, as given the cost of production a larger number of users could have been satisfied if there were no patent.10 Kaul and Mendoza (2003) argue for an expansion of the standard definition of public goods at two levels. At the first level, any good characterized by non-rivalry and nonexcludability has the potential for being public and made available to all. At the second level a complementary definition referring to the actual properties of public goods could be, ‘goods are de facto public if they are non-exclusive and available for all to consume’ (Kaul and Mendoza 2003: 88). The distinction is between a good’s potential for being inclusive and it actually being inclusive in the sense that the good has been made non-exclusive by policy design which is actually rival and excludable. Even though the technical feature of a good remains unchanged, inclusiveness and publicness of the good could be changed by technology and policy design. So whether a good should be publicly provided or not will not merely depend on its technical feature but (p.167) should be seen more as a political issue, and after all it is a social construct (Marginson 2007). Strictly speaking, education is a private good if we adhere to the neo-classical definition of public good because it is both rivalrous in consumption and excludable in benefits. However, keeping in mind the immense positive externalities that education generates for society as a whole, at least ‘basic Page 9 of 25

Education as a Public Good education’ is made to be non-excludable which would put education in box 4B in Table 6.3. The implementation of the Right to Education Act in India is supposed to facilitate the process of universalization of education notwithstanding many criticisms being levelled against the proper implementation of the Act.11 The Act is supposed to make denial to admission in a school to all irrespective of their socio-economic backgrounds an offense. However, full-fledged implementation of the Act is still a question, particularly because of the prevalence of qualitative differences among government funded schools. Arguably, the present system of basic education could be put in the box 4A. Table 6.3 Revisiting the Concept of Education as a Public Good: The New Approach Rivalrous Exclusive

1. PRIVATE GOODS • Education

Non-rivalrous 2A. NON-RIVALROUS GOODS MADE EXCLUSIVE • Patented knowledge of the manufacturing process 2B. NON-RIVALROUS GOODS MADE NONEXCLUSIVE • Noncommercial knowledge (such as the Pythagorean theorem)

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Nonexclusive

Education as a Public Good

Rivalrous 4A. RIVALROUS GOODS MADE (PARTIALLY) EXCLUSIVE (possibly the present system of education beyond Class VIII) 4B. RIVALROUS GOODS MADE NON-EXCLUSIVE • Basic education

Non-rivalrous 3. PURE PUBLIC GOODS • Growth and development potential (such as an educated workforce) • Knowledge embodied in pharmaceutical drugs

Source: Kaul (2006). (p.168) Neo-classical economics fails to assign a value to the externalities. Education is a club good as it is non-rivalrous but excludable (places in MIT) (as there exists rivalry as students get degrees as primary beneficiaries). There are, however, two problems: a. Some aspects are more readily rivalrous in consumption and are nonexcludable. b. Production can be configured in both private as well as public ways. Since goods are available not in their original forms but as social constructs being determined by policy choices and collective human actions (Kaul and Mendoza ibid: 81), it is therefore imperative to consider a good as potentially rivalrous or non-rivalrous and potentially excludable and non-excludable. Education can also be subject to a similar analysis as the extent of public benefits or externalities emanating out of education would depend on the policy choices and human action. Hence, Marginson argues (2007) that it is desirable to consider education as potentially rivalrous, or, non-rivalrous and potentially excludable and non-excludable. It is a matter of policy choice. Neo-classical theory tends to downplay the potential for externalities, looking forward to extending market competition but ignoring production of most public goods. It is argued that the purview of public good should be made more specific by adding one more feature, which appears to be obvious but is often not given adequate importance. Public goods are characterized by: (1) non-rivalry and/or non-excludability, and (2) that are made broadly available across populations and

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Education as a Public Good over generations. For example, vocational education whether produced by the private or public sector will have externalities. Knowledge is considered to be a public good par excellence (Romer 1990) because it is non-rivalrous and cost of replication is often so low that it can be construed to be almost zero as discussed in Chapter 3. One may wonder why education is intrinsically in the nature of a private good whereas knowledge is intrinsically a non-rival good. Education is a process of formal learning that one has to go through and hence as long as the number of seats is (p.169) inadequate, access cannot be granted to all. Knowledge is a product of the system of education and once created, it is characterized by non-rivalry. However, when knowledge is created by the private sector and its creation entails investment, it is often the case that the investors and creators of knowledge like to recover the cost through patenting which will make knowledge exclusive at least for a period of time. In 2A (Table 6.3), knowledge is made exclusive through patenting to give the producer of knowledge some breathing time to enjoy monopoly over the product and recover the cost before others can emulate her or come up with new competitive products. There are examples of knowledge which have been made non-exclusive for the benefit of mankind. People have been using that piece of knowledge over the years and all over the world. There are plenty of examples from geometry and laws in Physics and Chemistry. There are examples of knowledge which are technically pure public goods and to make them non-exclusive no policy intervention became necessary. They can be made public advertently or inadvertently. Open access knowledge is a typical example where knowledge will have been entirely exclusive and could belong to 2B (Table 6.3). But because of private initiative and mass support it is a pure public good. The difference with the Pythagorean theorem is that it is technically very difficult to prevent application of basic formulas which are a part of the school level curriculum. It is also nonexclusive because it is morally inappropriate and technically impossible. The open access system, despite being in the non-public domain, has been made accessible to all with the same purpose. Similarly, course material of a university is made downloadable. E-journals may also be put in 2B. In quadrant 3, we have an educated workforce which will contribute to the growth and development of a nation. If public goods are often intermediate in nature, they will contribute to each other’s development. What essentially being argued is that one has to go beyond the mere ‘publicness’ in the consumption of a good and examine two other important features which (p.170)

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Education as a Public Good are essential to have a complete assessment of the benefits, both potential and actual. They are ‘publicness’ in decision-making and publicness in the distribution of net benefits (equity aspect). So a good has to be examined in all three dimensions as shown in Figure 6.2. Higher Education as a Public Good: A Different Notion

Figure 6.2 Triangle of Publicness

Higher education can be Source: Kaul et al. (2003: 24). considered to be a public good altogether from a different perspective. Higher education has a role in the public sphere which provides for non-violent forms of social integration based on a discourse with power or money being relegated from the sphere which seeks equality among all. This idea ‘is the realization of an enhanced form of university autonomy in which the university serves as a site for knowledge production, deliberation and contest beyond the control of the state, private interests or the institution itself’ (Pusser 2008: 117). As Marginson (2007: 191) argues: ‘One way to conceive the public dimension in higher education is to argue that the sector constitutes—or could constitute—an umbrella of ‘public sphere’ that makes the more narrowly defined public goods possible … Potentially it is comprised by ‘flat’ social relations in which status differences are virtually eliminated.’

(p.171) Classifying Education Education can be considered to be a private good as those who attend classes are the ones who are imparted training and get awarded with certificates after the successful completion of their studies. There is indeed rivalry in getting access to an educational institution, the primary benefits are rival. However, education in general generates positive externalities in various forms as discussed earlier in this chapter, which can even spill-over national boundaries to other nations in the form of transmission of knowledge. Hence, the market on its own will fail to generate a socially desirable outcome as externalities create an edge, for example, education and health, a substantial amount of gap between private demand and social demand. There is, therefore, an element of non-rivalry in consumption in the sense that educated individuals generate positive externalities for society. Can we classify education based on this understanding alone? It is difficult. In fact, there is a need to distinguish among all the three layers of education, primary, secondary, and higher, while resorting to an economic classification of education. The debate on education policy, particularly from the narrow (teleological) perspective of government interventions hinges on the classification of education in terms of a private, public or merit good. However, as argued such a classification is difficult in view of the fact that higher education produces multiple outputs like teaching and Page 13 of 25

Education as a Public Good research both by private as well as by public institutions.12 Further, higher education undergoes transformations all the time changing its character and nature. The notion of education as an economic good is deconstructed so as to understand what type of good (or service) education is from the perspective of economic theory. This classification is an imperative before we embark on a policy discourse in education as the nature and quantum of government intervention will derive its rationale from the classification of education, particularly focusing on primary education and higher education. An attempt is also made to provide an overview of the debate in India and abroad. In particular, classification of higher education poses a challenge possibly because (p.172) of the subjectivity involved which makes this task of classification contentious. Concepts of Merit Good, Public Good, and Mixed Good

In order to understand the nature of the market, it is imperative to address what kind of good/service higher education is. Technically speaking, higher education should be considered a mixed good or a quasi-public good (Musgrave and Musgrave 1989; Marginson 2007),13 that is, essentially a private good with positive externalities which accrue to society as a whole.14 However, such a categorization is difficult as the line drawn between public and private goods in case of higher education is thin and shifting depending on the policy stance. It is also argued that one has to go beyond an economist’s obsession of categorizing higher education either as a public good or not. Or, one may sidestep the efficiency conditions and appeal to the importance of citizens’ demand for higher education and, hence it can be classified as a public good (Bridges and Jonathan 2003). Though the task of categorization of higher education as a public good or a quasi-public good is delicate, subjective, and often emotional, it has important policy implications.15 Therefore, as per the neo-classical approach it is difficult to categorize higher education either as a public or a private good. Not only because teaching and research are the two major components of higher education, but both public and private institutions can produce outputs. It does not depend on ownership but the underlying policy framework which governs such production. Therefore, the defining characteristics are not inherent in the product but are often socially endogenous; they are social constructs and sensitive to policy changes. The challenge is to define or classify something that does not depend on the market but which involves general public and political processes. Valuation of externalities is difficult: heterogeneous range of outcomes, both in the sphere of the market and non-market, short and the long term, and individualized and collective. Relying on a single indicator which is (p.173) not so comprehensive will be improper. The nature of production determines the nature of goods and not the other way round. It is open to social and cultural variations and would

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Education as a Public Good therefore vary from region to region and over a period of time as the policy stance changes.

Higher Education: A Public Good, a Mixed Good, or a Merit Good? Based on the analysis given earlier, it follows that the issue we need to address is how to identify higher education as a good (or service) before we deal with the question of mode of financing higher education. Pricing of higher education and the associated question of the extent of subsidization is based on our understanding of this basic question of classification. Is higher education a public good, or a mixed good, or a quasi-public good, or even a merit good? In order for higher education to qualify for a pure public good, two important characteristics need to be satisfied—non-rivalry in consumption and nonexcludability. Strictly speaking, higher education fails to satisfy both these criteria. Often eligibility requirements are needed to be complied with for taking admission to institutes of higher learning and credential certificates are given to successful candidates who pass the examination and comply with the norms of the institutions for being considered successful candidates. Therefore, there is rivalry in admissions and exclusion is easily enforceable for higher education. Higher education, or training for skill development is not exactly akin to a private service either, which can be bought and sold in the market. Paying for the service does not entitle a student to a degree. It has to be earned or acquired (Majumdar 1983).16 The mix of public and private is determined by public policy, institutional leaders, and day to day practices of personnel. In fact, the mix can differentiate institutions and national policies in higher education (Marginson 2007). To the extent that public and private are positive, one can augment the other. Higher education is argued to be an ‘experience (p.174) good’ (Teixeira et al. 2004a: 6) which means that true assessment of its quality by the students is feasible as they consume, that is, they experience and undergo the rigorous process of attending classes and interacting with the faculty and peers and ultimately as they face the job market and society. This is partly responsible for the problem of information asymmetry which is inherent to education (Dill and Soo 2004; Massy 2004: 29–30). Students often lack information to make the right choice of the programme/product and the institution/provider when they seek admission as gathering accurate information regarding relevance and quality of the course, faculty reputation, campus placements, and reputation of the institution in the job market from seniors, or brochures and from the ranking of institutions, in case it is available, is a difficult task. Though it is mainly considered as an ‘investment good’, depending on the objective and interest of a student, it can partly also be a consumption good. Jongbloed (2004) adds a further dimension by arguing that it may also be similar to a trust good. Though trust is essential for any good that we purchase, education and health as services being so fundamental in nature and crucial for our dignified existence, Page 15 of 25

Education as a Public Good trust becomes a critical aspect. Stiglitz (2000) considers education as a publicly provided private good because education is a rival and excludable as seats are limited in educational institutions, particularly in privately funded ones. Therefore, education can be bought and sold in the market just like any other private good. Private Goods Produced in Higher Education

Private goods produced in higher education are individualized status benefits or positional goods and credentials which depend on the brand of the institutions. Scarce spaces are allocated in institutions of higher learning that provide opportunities to secure higher incomes and social standing. Leaders of the institutions are driven by status as they seek to improve and raise the status of their institutions. Thus in the process, they produce status. They compete with others to attract the best students and the faculty by virtue of being prestigious institutions and muster social power in the process. (p.175) Further, credentials play a role in social selection and the distribution of individual benefits as private goods. Values are generated which are subject to both rivalry and excludability even when education is free and state provided. Free universities are associated with broadening of access and flattening of social/status distinctions, enhancing the role of non-rivalry and non-excludability and reducing the role of private goods. Private goods are in scarcity, their production and consumption are subject to competition, and universities compete with one another for best students and best teachers. Public Goods Produced in Higher Education

Higher education produces public goods whether it is marketized or not. Knowledge is a classic example of public good. Say, a mathematical formula is in the nature of a public good. Knowledge is only temporarily excludable in a networked environment. The structure of social opportunity is an example of public good provided by higher education. Equitable access is underprovided by the market because the private providers stratify opportunity by distinguishing between a high cost-high value and low cost-low value institution. Affirmative action, irrespective of number of seats, will generate public good (that is, fairness) and an aspect of private good (that is, access to scarce high ranking institutions). In fact regulation, financing, and provision are meant for providing an equitable structure of opportunity. What is decisive in determining the public/private character of the goods produced is not ownership but purposes of the unit or the institution. Marketization may increase the value of superior status goods by driving up costs and exclusivity which will diminish equal educational opportunity. In sum, higher education is potentially rivalrous and non-rivalrous, excludable and nonPage 16 of 25

Education as a Public Good excludable. They are interdependent and are related in a positive sum fashion. This is precisely the critical difference with the neo-classical definition of public and private good a la Samuelson (1954). What market does is to enhance the role of private goods, augment rivalry and exclusion, and tends to conceal possibility (p.176) and actuality of public goods. Policies are to be so framed so as to enhance the public goods that markets create and to compensate for those public goods that tend to remain suppressed (Marginson 2007). A mix of public and private goods in the national dimension is highly variable and policy sensitive. In some nations, private goods are under-recognized and in some, public goods are under-recognized. Private goods are private benefits that accrue and public goods are benefits which spill over through higher literacy, science and technology, and a better civic life.

Primary Education as a Merit Good Merit goods are in the nature of private goods but the market cannot be relied upon to serve the needs of the community. The distinctive character of merit good is made clearer ‘… it may be noted that provision based on communal concern may involve private as well public in the technical sense of rival versus non-rival consumption, so that the two perspectives should be kept distinct’ (Musgrave as quoted in Bagchi 2005a). For both private and public goods, same individualistic psychology is applied. Wants are experienced individually not to deny the existence of social interaction. However, there are dominant tastes and cultures, and fashion should also not be undermined. In the case of altruism, an individual A is socially minded person who derives satisfaction from others’ consumption. In this case, utilities are interdependent. This is in contrast with a situation where satisfaction is derived individually by A and B and not by A + B. Two major assumptions are being questioned here: information and rationality. How come an outside agency knows better than an individual? Information is available but still individuals do wrong things. Smoking is an example. Individuals can also let the government decide. Market failure cannot deal with situations where the preferences are wrong. Since preferences are endogenous they can arise out of a faulty environment or undesirable childhood experiences, which need not be respected in the conventional value judgment. Citizens must respect the decision-making process. (p.177) Communal wants develop through sustained association among the community members and mutual sympathy evolves out of community interests. In case of merit goods, preferences are imposed cutting across private and public goods like imposition of tax on alcohol and provision of low cost housing,

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Education as a Public Good the provision of which society wishes to encourage. Therefore, interference with individual choice is needed and hence distribution is paternalistic. A merit good is defined as a good preferred by the community as a whole and it is meant for societal benefit without any reference to individual choice (Creedy 1995; Musgrave and Musgrave 1989) and it is more a matter of paternalistic choice implying that the government knows better than the individuals what is good for them. However, a merit good as defined by Srivastava et al. (1997) is a good with positive externalities.17 It is disconcerting to note that higher education was identified as a non-merit good as it defies the entire body of empirical evidence and endogenous growth theoretic literature that higher education generates substantial externalities and influences growth. Primary education is considered to be a merit good where individual choice in the sphere of the market is subjugated in playing its part, and society or the state on behalf of society decides the quantum of its provision (Musgrave and Musgrave 1989). The concept of a merit good occupies a key position in the debate between the two camps led by Buchanan and Musgrave. Merit goods are in the nature of private goods but the market cannot be relied upon to provide adequately to serve the needs of the community. The concept of merit good, paternalistic choices, and the associated issue regarding the role of the state in the provision of basic services advanced by Musgrave has been contested by Buchanan who is a proponent of the public choice approach. Musgrave draws a distinction between self-interested choice and communal concern to argue that a good society cannot be based on a selfinterested choice alone (Bagchi 2005c: 499). Musgrave argues for public intervention to provide social security and merit goods as (p.178) people willingly pay taxes to fund public provision arising out of their community concerns and the need for public good delivery which is a major source of market failure. The redistributive function of the state derives its rationale from the concept of a merit good. A cohesive and thriving society has to be built on social coexistence, distributive justice, and enforcement of rights and obligations to add meaning to the concept of liberty. Buchanan disagrees as state provision of merit good violates individual preferences as individualism and subjectivism (Bagchi 2005c: 499; Olssen et al. 2004: 156). A distinction is made between primary distribution and redistribution. To ensure fairness in a competitive market set up, public provision is needed not because education is a merit good but because education is one great way to ensure equality of opportunity. Further, to justify public provision of a merit good one may note that there is nothing sacrosanct about individual preferences because individuals are myopic. This entails social welfare to be viewed inter-temporally. For a merit good, an individual has to be seen ‘in relation to the individual’s place in the society not Page 18 of 25

Education as a Public Good as an isolated person but as a member of his community’ (Musgrave as quoted in Bagchi 2005c: 499). Buchanan is against majoritarianism as state intervention is warranted if it is in conformity with the unanimity principle.

Global Private Goods When the benefits emanating out of consumption transcend international borders, consumption does not remain confined to the territory marked by the international border of a nation. Degrees obtained by cross-border foreign students and individualized status goods produced by nations are examples of this. Foreign degrees in a way can be classified as global goods as these are degrees obtained by crossing borders and the degree credentials can be used in more than one nation in management, IT, and scientific research (Marginson 2004). In importing nations, commercial education implies an extension of national educational capacity and individual student choice. Since foreign education is expensive, it reduces the (p.179) ‘publicness’ by narrowing the size of the population. Other public goods are cross-cultural exchanges and activities, communications and understanding at the international level are the examples of global public goods other than higher education and research. Stiglitz (1999) argued that knowledge could be treated as a global public good. Global public goods can be defined as being characterized by: (1) Non-rivalry and non-excludability; and (2) Goods that are made broadly available across the population on a global scale. Broadly available within countries, they are intergenerational, with no possible trade-off across generations. At the same time, cross-border pollution is an example of global public ‘bad’. Global externalities in higher education arise from cross-border relationships and flows between nations, as higher education is getting extensively and intensively networked, through research collaborations, e-mails, etc. Cross-border facilitations of research, cross-border recognition of universities, qualifications and individuals are some of the examples of such externalities. Global public ‘bads’ are brain drain and the downside of cultural homogenization. Two way flows of personnel in the global higher education environment may be unequal as it leads to brain circulation; the skilled personnel prefer to circulate among the developed nations moving from one nation to another in search of coveted jobs. It can be global public bads for some nations as it subtracts from the capacity to create as indicated by the prevailing stock of human capital at the national level. In an open global sphere, some nations lose out as they suffer flight of brains; other nations gain precious capital without dedicating resources for its production. The same can be true for networks of universities and research institutions who build up partnerships to foster collaborations in research and the circulation of brains tend to remain confined within these networks at the expense of other universities and institutions. In the global knowledge economy, there seems to be ‘a single mainstream system of English language publication of research knowledge, a system that tends to marginalize work in other languages rather than absorbing it’ (Marginson 2010c: 202). The belief that (p.180) EnglishPage 19 of 25

Education as a Public Good language education and/or Western culture is superior and it continued domination in the global sphere in education and culture is only somewhat dented as China, India a few other nations in the world economy have gained economic power. Developed countries are well placed to retain skills and infrastructure to access knowledge while underdeveloped and developing countries are not (Marginson 2004). As such there is no global policy space unlike a national economy as nations are autarkic and competing. However, global private goods are recognized. The overarching framework of World Trade Organization/General Agreement on Trade in Services (WTO/GATS) provides a negotiating framework for participating nations. In this framework higher education is treated as a tradable good as it is believed that nations will gain from trading of higher education as it is argued to be true for any other tradable good or service. Education, and in particular higher education, is treated as no different from any other tradable good or a service. As per the prevailing practice, there is hardly any consideration for free flow of knowledge across borders and there is no need to align national recognition protocols, no consideration for public bads, and gross unevenness between national educational systems. Commodification of Education in WTO/GATS Framework

GATS is an international agreement which seeks to widen the scope of international trade regulations by including services and intellectual property rights in its mandate with the objective of promoting economic growth of all the trading partners.18 Since GATS consist of both a framework convention and a regulatory treaty, it has a hybrid nature (Devidal 2009: 75). Essentially GATS’ rules seek to eliminate barriers to trade, to regulate the trading system and ensure enforcement of the non-discrimination principle.19 To reassert the moral and legal value of the right to education which was earlier considered as an economic and social right, has been finally codified in the Universal Declaration of Human Rights (Article 26). Education is not only an economic, cultural, (p.181) and social right, it reflects ‘the indivisibility and interdependence’ of human rights (United Nations Committee on Economic, Social and Cultural Rights, 1999, para 1) (Devidal 2009: 79). Right to education is a fundamental right and it is considered to be the best available option for investment because it allows individuals to evolve in society, participate in the political and economic life of their community, fight against exploitation and deprivation, and derive benefits from joys and rewards of human existence (Devidal 2009). What is important for us to note is that the general characteristics of the right to receive education are irrespective of its forms and levels.

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Education as a Public Good In order to understand how GATS will affect the national education system in a varied manner one has to examine the four modes under which the transaction of education services can take place.20 GATS is an international agreement which seeks to widen the scope of international trade regulations by including services and intellectual property rights in its mandate with the objective of promoting economic growth of all the trading partners. Out of the five levels of education, only three are relevant for higher education. The most important question is whether and/or how global public goods are provided determines whether globalization is an opportunity or a threat? It entails that policymaking is crucial for a nation to extract benefits from the circulation of public goods in the global sphere. Governments should assume full responsibility for the cross-border effects that their citizens generate in the inter-governmental global space, (1) where costs and benefits of externalities are taken into account in national decision-making, and (2) collective goods can be negotiated and developed, that is, there is crossborder recognition and a quality assurance system. In addition to governments and international agencies, higher education should also take in civil agents, including autonomous higher education institutions (HEIs) so that they can create public goods along with their production of private goods (Marginson 2004).

(p.182) The Indian Scenario Similar debates exist in India where higher education has generally been classified as a public good or at least a quasi-public good to advocate greater support from the government (Tilak 2004a, 2008). In the context of economic reforms initiated in 1991, the White Paper on Subsidies (GoI 1996)21 questioned subsidization of higher education in general classifying it as a non-merit good while primary education was identified as a merit good as it generates externalities.22 More appropriately, higher education should be classified as a quasi-public good and, therefore, theoretically, the case for government support remains sound because of the externalities it generates and the significance of catering to social demand rather than market demand backed only by purchasing power (Chattopadhyay 2007).23 A Taxonomy of Goods

Economic reforms initiated in 1991 in the aftermath of the balance of payment crisis led to a fall in the budgetary allocation for education as fiscal deficit was sought to be pruned in terms of GDP in the face of stagnation of revenue growth. As argued by Tilak (2008), there has been a gradual change in the way HE has been conceived of. It has become more of a private good rather than a public good as the government has shown an interest in going ahead with structural reforms even in the social sector. Further, the government is virtually at a Page 21 of 25

Education as a Public Good crossroads with regard to the relative role of the market and the state in the provision of higher education (Tilak 2008). The decline in the budget also led to a fall in the real per capita expenditure on students (Tilak 2004a).24 During the second phase of reforms with the gradual emergence of knowledge as a factor of economic growth and a strong urge to realize the full potential of India’s growing pool of aspiring youth to take part in the economy’s supposed march towards prosperity, the government constituted the National Knowledge Commission (NKC) in 2005. Though, the Centre has shown keenness to raise budgetary allocations for higher education in recent (p.183) years buoyed by a higher than anticipated tax collection, a majority of the universities continue to suffer from fund crunch as the states are compelled to comply with the restrictions on borrowing as per the Fiscal Responsibility and Budget Management (FRBM) Act (Chattopadhyay 2010).25 Higher Education Classified as a Non-merit Good

Categorizing different streams of higher education like technical and nontechnical education as merit and non-merit goods respectively (Srivastava and Rao 2004) foments further debate on the essential characteristics of higher education. However, in the Report, ‘Central Government Subsidies in India’ submitted in 2004 by the Ministry of Finance, education other than elementary was described as ‘Merit-II good’, the extent of subsidization for which was advocated to be at a lower level than that of ‘Merit-I good’. This classification is tantamount to the admission that non-technical education has limited positive externalities compared to that of technical education. This is in sharp contradiction with umpteen number of empirical studies that higher education as a whole generates significant positive externalities, albeit with a varying degree as mentioned earlier. It is intriguing that technical education, and in particular scientific research, are classified as merit goods and hence they deserve to be subsidized, whereas humanities and social sciences are identified as non-merit goods and hence, they need not be subsidized. This reflects a lack of social science perspective and a partial understanding of the inter-linkages between science and society, and disregard for art, culture, and society as a whole. This technocratic view has adverse implications for the entire society and eventually for the future of higher education. It will distort choices of courses and will give a wrong signal to society and furthermore, it may foster alienation of individuals from society.26 A national higher education system is not universally public in character. A substantial part of the goods produced are private. The tendencies are not universal and would depend on the context and on an understanding of the public/private divide. It can obscure the role of the private sector and ignore the incidence of private (p.184) goods in the public sphere (for example, IITs and Indian Institutes of Management [IIMs]). Similarly the privately owned institutions would also generate public goods. However, the extent of public Page 22 of 25

Education as a Public Good good production would vary across the institutions and different social and cultural groups. However, valuing of public good components like access and equity would remain difficult. The public good component arising out of initiatives taken by the philanthropic organizations in the form of scholarship and funding of basic research can also be large. Similarly an assessment of private benefits gets rhetorical support and its rate of return are calculated. Collective benefits, externalities, and funding of basic research in the long term tend to be neglected. Notes:

(1.) The World Conference on Higher Education held in Paris in 2009 classified it as a public good. (2.) This can happen under special conditions where the system will take care of the funding problem. (3.) Product differentiation implies that a firm is faced with a negatively sloped demand curve. Under perfect competition, since the product is homogeneous, the firm has to take the price determined at the aggregate level by forces of market demand and supply as given. The efficiency condition that a price equals the MRS of all the consumers is satisfied. (4.) The Coase theorem which argues that it is feasible for the two parties to enter into a mutually agreeable solution to resolve what economists call externalities is based on certain assumptions. Costs and benefits associated with an economic activity, like consumption and investment, spill over to others. Examples are passive smoking as a negative externality or inoculation to prevent the spread of an infectious disease. (5.) In the Samuelson model (1954), the aggregate demand curve is derived in this fashion and since reporting by an individual may not be true and correct, this aggregate demand curve is called a pseudo-demand curve. (6.) Whereas for a private good, total supply is the sum of consumption by all, and price is equal to each and every MRS of the individual consumer. (7.) The conditions for the Coase theorem are not often fulfilled in reality. (8.) Though one can derive the efficiency condition, it is not workable as true demand is never revealed. For private goods, MB 1 = MB 2 = MC: same price for different quantities. For public goods MB 1 + MB 2 = MC: different prices but same quantities. (9.) If the value of externalities falls with the rise in the number of graduates, the gap between the two curves will fall.

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Education as a Public Good (10.) If MC = 0, price should also be zero. But the question remains how to recover the fixed cost. (11.) The Right to Education Act will eliminate rivalry in getting admission to a government school or even a private school as a matter of right for children by arguing that they cannot be excluded from the school system. (12.) As discussed in Chapter 4. (13.) Externalities associated with a public good are different from that of a mixed good. In case of a public good, benefits arising out of consumption accrue in equal measure to all in society. Whereas in the case of a mixed good the benefits are appropriated primarily by a student in terms of higher salaries and externalities accrue to the rest indirectly and need not be by the same amount as the ability to partake benefits differs among members of society. Therefore, higher education is not a public good as there is rivalry in consumption in view of the paucity or limited number of seats in higher education institutions as opposed to non-rivalry in consumption of a public good. Benefits from higher education accrue primarily to students and society gains only indirectly. (14.) Literature identifies a wide range of externalities (positive) associated with higher education. Externalities cause social benefits to exceed private benefits which entails that the government should intervene in the form of public provisioning or subsidization of the cost to take the economy to a socially optimum position. However, theoretically the extent of government intervention or support depends on the exact quantification of externalities which is an extremely difficult job. (15.) The discussion is largely in the context of education in general without distinguishing between the levels, but the spirit of the argument has to be taken note of. If higher education is considered to be more like a public good, and not at par with school education, then higher education would fit the Bill to a large extent in contemporary India. However, it seems that higher education is being treated like a quasi-public good by the Planning Commission and the Ministry of Human Resource Development (MoHRD) as they seek to promote education loans. (16.) However, owing to the universal nature of primary education, it can be treated as a public good or better as a merit good. Because of the enormous benefits that are associated with primary education for any society, developed or developing, and its intrinsic importance for building human capability, there is general agreement the world over that primary education should be made universal and therefore be funded by the government. (17.) It is echoed in the ‘Discussion Paper on Government Subsidies in India’ (1996) brought out by the GoI. Page 24 of 25

Education as a Public Good (18.) GATS came into force in 1995. The first major round of renegotiations took place in 2003. All members are signatories to GATS and they are required to treat all other WTO members equally, promote transparency in trade regulation, and establish legal processes. (19.) Governments can choose to allow unrestricted market access to the students implying that the government will not be practising discriminatory policies. There should also be no discrimination between the national and foreign providers. (20.) Out of five levels of education, only three are relevant for higher education. (21.) Discussion Paper on Government Subsidies in India (1996), GoI. (22.) The Report argued that social sciences need not be subsidized while science education should be (Srivastava et al. 1997). An attempt by the government to set the stage for gradual withdrawal of subsidies from HE met with severe opposition in the academia which led to some modifications in the classification debate which was published in a later report. (23.) Even market demand for HE, private or social, can be radically different from social need. It is needless to say that social need as a concept is more valid for ascertaining the goal for widening access to HE. However, classification of HE is actually policy sensitive (Marginson and van der Wende 2007) and policy trends like greater cost-recovery and creating space for private providers indicate that HE is being treated more as a private good. Advocates of economic reforms have tended to push HE more towards a private good by assigning fewer premiums to the externalities defying virtually the literature on endogenous growth theory and externalities. (24.) Per student expenditure has declined at a rate of 2.4 per cent since 1992–3 (Tilak 2004a). (25.) The Fiscal Responsibility and Budget Management Act which seeks to restrict borrowing by the government so that the fiscal deficit as a percentage of the GDP remains at 3 and revenue deficit is altogether wiped out. (26.) Even in IITs social sciences are taught because after all we are all accountable to society and are expected to behave in a socially responsible manner.

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Concept of Market and Market Failure in Education

Education and Economics: Disciplinary Evolution and Policy Discourse Saumen Chattopadhyay

Print publication date: 2012 Print ISBN-13: 9780198082255 Published to Oxford Scholarship Online: January 2013 DOI: 10.1093/acprof:oso/9780198082255.001.0001

Concept of Market and Market Failure in Education Saumen Chattopadhyay

DOI:10.1093/acprof:oso/9780198082255.003.0007

Abstract and Keywords Education policy world over is increasingly being determined within the framework of the neo-liberal approach, which advocates setting up of a regulated market with a limited but redefined role for the government. This chapter seeks to deconstruct the myth of market mechanism for education. The market for education fails on various counts to guarantee an efficient allocation of resources and deliver quality education through competition. Not only is the market an imperfect one due to the differentiation in the quality of education, but also the social demand for education remains largely unaddressed. Since, the nature of competition in the market for education is characterized by selection-based competition rather than efficiency-based competition, promotion of market accentuates differentiation among institutions and society. Keywords:   education, quasi-market, market failure, efficiency, equity, competition, sovereignty

This chapter initiates a discussion on policy issues based on the discussion on aspects of education and economic theory that we have had in the preceding chapters. In Chapter 6 we discussed how different levels of education, when characterized from an economic perspective, would have implications for the nature and extent of government intervention and private sector participation. However, if we look at the entire gamut of policy reforms the world over in the realm of education, we will observe an unmistakable tendency to infuse market principles both at the economy level to develop a national level education market as well as at the institutional level to resort to governance reforms in line Page 1 of 23

Concept of Market and Market Failure in Education with the functioning of a corporate entity. In this chapter we dwell on the concept of market for education, particularly higher education (HE) to understand the pros and cons of the marketization of education. Policy initiatives are viewed as corrective measures to restore the functioning of the market as it is considered in the West and by the multilateral lending agencies like the World Bank to be the best institution to organize economic activities. However, we need to remind ourselves from time to time about how the market for education is different from the conventional understanding of a market; to be precise; how does such a market differ from the highly lauded perfectly competitive market structure. As discussed (p.188) in Chapter 6, only in a perfectly competitive market are all the efficiency conditions satisfied. If education as a good (truly speaking, a service) is different from a typical commodity and an educational institutional is different from a firm as a manufacturing unit, we need to examine critically the applicability of market principles in educational reforms in view of the fact that policy reforms in education the world over are informed by the logic of market under the overarching framework of neo-liberalism.1 However, it remains an imperative to distinguish among the three levels of education. We commence our discussion with the concept of market and examine the validity of the assumptions underlying a perfectly competitive market for education. We then discuss the sources of market failure and possible cases of government intervention. This is followed by a discussion on the concept of a quasi-market to set the stage for a critical appraisal of the major policy initiatives being mooted and implemented both in India as well in a majority of the developed countries in subsequent chapters.

Market and Market Failure in Higher Education Market as is generally understood in common parlance is an institutional arrangement to facilitate transactions between two sets of economic agents with conflicting objectives, the consumers and the producers. For the market for education, Patnaik (2007) raises a fundamental point about whether the teaching-learning process in higher education can at all be treated as a market. He pleads for an alternative conception of higher education where ‘… higher education as an activity in which students and teachers are jointly engaged on behalf of the people of a society’ (Patnaik 2007: 3–4, emphasis original). According to this view, the delivery of education takes place with concern for and an awareness of the social context with a complete relegation of market obsession in sharp contrast to the narrow view in which higher education is viewed merely as an instrument for earning a livelihood. The convenient and conventional point for examining policy issues is to understand the concept of a market. Market failure arises (p.189) in the wake of the non-conformity of the market to the assumptions for a perfectly competitive market as discussed in Chapter 6. It is generally held that the government should intervene if the market fails. The larger case for public Page 2 of 23

Concept of Market and Market Failure in Education intervention rests on three cases (Musgrave and Musgrave1989): (a) Allocation of resources, (b) Macroeconomic stabilization, and (c) Redistribution of income. For allocation which seeks to ensure that the market serves its role, the task of the government is to correct market failure, or even create a market where it does not exist. There are generally four cases of market failure which entail government intervention: (1) Competition is not perfect, (2) Generation of externalities, (3) Information is not perfect, and (4) Markets are incomplete.2 There can be additional dimensions of market failure for knowledge as compared to education and particularly with respect to higher education in the global economy (see Marginson 2009b). The education market tends to be always imperfect because in a way it violates the assumption that tradable goods and services are homogeneous. Though particular types of degrees are offered by many institutions, the degrees are actually differentiated. The value of the degree depends on the brand value of the institution. This means the quality of institutions will determine the quality of the degrees and quality would vary because of the wide variation in the quality of human capital, students and the teachers, involved in the process and also in the infrastructure facilities provided. Case 2 is a classic case of market failure. Primary education is a merit good and higher education (HE) is argued to be a mixed good, or, a quasi-public good. Case 3 is Information asymmetry which requires the government to intervene and safeguards measures to address grievances which may require setting up of a Tribunal. In Case 4 the education loan market is imperfect in the absence of collaterals. Under restrictive assumptions,3 perfect competition guarantees fulfilment of Pareto efficiency conditions implying the efficient allocation of resources. However, given the inequality in initial distribution of resources, the concern for equitable distribution of resources (p.190) remains unaddressed in a typical market. The concern for equity in terms of effecting an equitable distribution of resources remains largely unaddressed in a typical market. In general, since a market fosters a competitive ambience among the participants, it paves the way for improving the quality of the product to be delivered at a competitive price. Imperfect competition is considered to be a case for market failure as the Pareto efficiency conditions are not satisfied. In case of higher education, the advocates of a market argue for differentiated products to ensure that the consumers (students/parents) can choose from a wide variety of products (Bridges and Jonathan 2003: 135). Hence, the concept of perfect competition loses its relevance in our context. To reconcile the objective function of universities and the nature of competition we may refer to Marginson (2004: 178–87) who argues that the market for higher education is essentially a competition for social status (social advantage, social position) or as he says, a market organized as a ‘status competition’,

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Concept of Market and Market Failure in Education where the institutions play a key role in the production and allocation of social status. Information Asymmetry

As discussed earlier, education is in the nature of a service and often referred to as an experience good. The quality of education can only be judged through participation in the process and its relevance over a period of time. Education is essentially a package of services which involves dedication of time over a long period with uncertain future payoffs. The process involved in imparting education is complicated and the instructional process is built over time which renders schooling hardly comprehensible to students and parents, making comparisons among the institutions difficult (Plank and Davis 2010: 301). At the time of enrolment in an institution, it is difficult for students and parents to ascertain the quality of education and take an appropriate decision though the students and the parents would always try to gather the necessary information from the brochure prepared by an institution, its website, reputation which is formed on the basis of the assessment made by senior students who are still studying there and those who have left, and the ranking of the institution if available. Notwithstanding, experience is personal and the institution may (p. 191) have a tendency to hide information and even mislead students. This tendency depends on the nature of the management of the institution and its objective and character and it can be argued that such a tendency is more prevalent among privately managed institutions. This is a source of market failure in the education market as choice of courses and the institutions get distorted (Teixeira et al. 2004a, etc.). One way to overcome this problem of information asymmetry is to regulate the education system with the purpose of standardization in teacher recruitment, curricula, and equalization of funding across the schools (Brown 1992, as quoted in Plank and Davis 2010). Schools through absorption of risk, provide insurance to students and parents who are uncertain about their children’s abilities and future returns. Government schools occupy a larger space in the delivery of education and take the lead in setting up the curricula for the private schools to adopt. The second option for the state is to make sure that correct information is made available to students and parents through publication of brochures and maintaining websites containing data with regard to schools’ performances and other relevant facts. The Case of Adverse Selection and Moral Hazard

The case of adverse selection may arise when, for example, in response to poor quality education in government schools, students who can afford to pay high fees in private schools leave government schools. Those who are left behind suffer as the quality of education gets adversely affected due to lack of monitoring and reduced involvement of parents in the functioning of schools. Students who continue with government schools feel demoralized and have to remain contended perforce with inferior quality education (Hillman 2009: 604). This is an example of the adverse selection that private schools bring about in Page 4 of 23

Concept of Market and Market Failure in Education the education market with adverse implications for equalization of educational opportunities. The problem of a ‘moral hazard occurs when the presence of insurance affects personal decisions in ways that make personal benefit from insurance more likely’ (Hillman 2009: 627). People would develop a tendency to put in lesser effort for their own (p.192) advantage by exploiting the available insurance scheme. In the absence of proper monitoring of students, teachers can change their behaviour and put in lesser effort at the expense of a good quality teaching-learning process. The borrowers of education loans can also change their behaviour which may affect their success with a possible dent on the prospect of getting a job and remaining solvent.

Knowledge and the Failure of the Market Since knowledge is more like a public good as discussed in Chapters 3 and 6, market fails in the sense that knowledge production will always remain suboptimal in the absence of government intervention. While it is argued that knowledge is best created under the forces of a market and hence it is patented, knowledge becomes a victim of the market as well. The market fails in many respects to deal with knowledge and production. Engagement in creativity is a risky affair with uncertainty continuing to haunt investors. Often the private sector is not capable of taking risks and investing in knowledge creation whereas the public sector can take risks as it is not unduly concerned with return from investment in knowledge generation. So, though the market provides incentives, the issue is what kind of incentives. The possibility remains that market forces will determine a research agenda which is often not in the best interest of society. Market forces are also often not reliable for giving direction to undertake research in a completely uncharted area. In the realm of the market sphere, if profits become paramount, the market fails to capture risks and in the needs of an unequal society, the public sector is often required to bypass market forces and take a lead role in funding science and research. This source of market failure can also be looked at from a different angle. Investment in knowledge takes place in the absence of perfect information particularly about the future (Aranson 1995). Dedication of resources to generate knowledge is tantamount to investment in knowledge. But the relationships between the choices available and profits (outcome) which are expected to (p.193) follow are non-transparent, uncertain, or unknown. Risk aversion may further lead to suboptimal allocation of resources to research as the risk-averse investor will look forward to a higher rate of return. If the scale of investment required is far too high, there will often be a lukewarm response to investing by a government in a particular period.

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Concept of Market and Market Failure in Education Since knowledge defies the economic law of scarcity, the economics of knowledge poses difficulty particularly for economists. It shares many of the features of a global public good. In view of this, the government has a greater role to play in protecting intellectual property rights in the present age as compared to the industrial age. One disturbing feature of the emerging global economy is the growing polarization of the world with respect to income caused largely by the emerging knowledge economy. As per the Solow’s model of growth, if nations are subject to market forces, they will tend to converge which defies the present scenario.4 The countries will achieve two peaks, one at high growth and the other at low growth. Growth of the knowledge economy is attributable to increase in knowledge intensity of economic activities and globalization of economic affairs. The market can be inimical to particular types of knowledge owing to the intrinsic manner in which the market economy functions. As Kenway et al. (2006) explain knowledge is measured according to a common scale in terms of the commodity exchange value. Creativity is defined in terms of scientific and technological innovation. Knowledge is further standardized, codified, or digitalized which can be transmitted through computer technology in the market. The fallout of this is that any kind of knowledge which is not amenable to market processes will remain at the periphery or even be relegated, leading to a diminution in its importance irrespective of the need of society. The use of knowledge under capitalism is in terms of an improvement in economic efficiency and profit enhancement. This process of legitimation is likely to exclude typically cultural and aesthetic economies if they are not instrumental in the advancement of capitalism. Capitalism is primarily driven by knowledge which can be used for advancement of (p.194) capitalism through cheapening of prices and quality. Here lies the danger that the market may assume so much of dominance that it can define the rules, norms, and values of these knowledge economies. If the desire of the consumer has to be incessantly satisfied, a continuous process of innovation has to be sustained to bring new products in the market. As a product is used for a period of time, the satisfaction of the consumer diminishes as the process ceases to be a sought after one, which is described as aesthetic obsolescence (Kenway et al. 2006). It often leads to a rapid turnover of style and fashion. The rise to the dominance of market logic has led to the disappearance of certain arts and disciplinary knowledge.5 There is a world out there in the realm of arts and literature which arises out of our penchant, our desire for creation. Kenway et al. (2006) characterize it as a libidinal economy. Creation in the forms of art and culture responds to what is demanded in the market. A related aspect of the power of destruction of the knowledge economy is located in the interface between a globalizing market and indigenous knowledge. Many traditional economies have also contributed to the process of Page 6 of 23

Concept of Market and Market Failure in Education knowledge generation in the way in which they have managed the survival of their economies without coming into contact with the market economy. The modern concept of knowledge is narrowly defined in the realm of modernization in the West. Bio-prospecting, the patenting nature, and trade related intellectual property rights are the spheres of research activities where the market can be exploitative. The modern economic theory is argued to be incompetent to deal with nature in general. Raising the status of market theoretically and subjugation of policymaking to the market as the ‘highest organizing principle of society’ can mean disaster for nature, in particular for ‘survival economies’. Survival economies use indigenous technology and bank on natural ecological cycles which are outside the realm of the market. Shiva (1991) argues that it is a western concept to equate science and technology with modernity and westernization. Biological resources are transferred from primitive economies located mainly in the third world to the first world which can be construed as a transfer from colonies to the centres of imperial power leading to (p.195) the eventual displacement of local biodiversity in the colonies by monocultures of raw materials. This process is described as bio-imperialism which has assumed a new shape in this age of biology. Life sciences relate to our daily existence in numerous ways starting with food, health products, medicine, and the environment. Biotechnology or biomedical technology is now being touted as the new wave of technology. The survival economy is exposed to the knowledge economy as knowledge is patented and privatized through various related notions of licensing, copyright, and trademarks. Genetic and other material are pirated and patented by certain areas of biotechnology which were earlier used by the people for their day to day use. Patenting allows companies to claim exclusive rights to produce and sell modified plants and animals. It can be considered to be a double theft, as first it allows a theft of creativity and innovation and second it claims exclusive rights established by patents on the stolen knowledge. Over time, these have the potentials to create monopolies and make everyday products highly priced (Kenway et al. 2006 quote Shiva 1991). Knowledge can give rise to increasing returns to scale which are likely to undermine competition for large network externalities and create forms of monopoly capitalism (Olssen and Peters2005). This has the potential to become a threat at the international level as competition is suppressed and monopoly profits are reaped. Microsoft is an example of this. Marginson et al. (2010) add a new dimension to situate knowledge and market failure in the emerging form of the global knowledge economy. Knowledge is essentially a public good, non-rivalrous, and non-excludable because once it is created it is available in the public domain as a public good. This distinction between the creator of knowledge as embodied in a human being as human capital and her creation of knowledge which is non-rival in the form of ideas came out sharply in Chapter 3 in the context of our discussion of how knowledge and human capital are incorporated in the growth models (Romer 1990). Private Page 7 of 23

Concept of Market and Market Failure in Education goods created in elite institutions in the nature of the value of the degree certificate and status acquired because of networking benefits in (p.196) elite institutions are of value owing to the richness and rigour of the knowledge content of learning which contributes to the status of elite institutions and the degrees that they confer. In a way therefore the ‘…acquisition of the private goods depends on the simultaneous production of the public knowledge goods inherent in student learning’ (Marginson 2010b: 142). At a broader level, ‘publicness’ in the provision of knowledge and research training continue to create a sound base for future production of knowledge and innovations. If the market were indeed dominant, the base of knowledge as available for the growth of various sectors would have been weaker and poor. Because of the hierarchical nature that exists in the quality of higher education institutions (HIEs) as both elite and diploma mills continue to produce certificates of value and mere pieces of papers, the economic character of production remains limited. What makes this market distinguishable from other markets where both good and bad products sell, is often the rejection of these pieces of paper by the industry resulting in graduates being unemployed and/or acceptance of a lower than expected job profile by graduates of diploma mills (Marginson 2010b). The rise in the network of open source associations in the production of knowledge and their synchronous functioning defy the neo-liberal imaginary of market based knowledge production (ibid.). The rise in instances of cross-border cooperation in knowledge production has also undermined the idea of a closed national market as the international ranking of universities situate national quality vis-à-vis the international level. The concept of freedom in the neo-liberal construct is one of negative freedom, freedom from constraints whereas the concept of positive freedom which is the capacity for self-determining action is undermined in the market-based theory of choice making.6 Market Failure: Imperfect Capital Market

Potential for market failure is as much in primary education as in higher education. In the former, even the parents who emerge as decision-makers for these school-going students are not always in a (p.197) position to comprehend fully the benefits of education. However, investments in education continue to be risky (Hillman 2009; Lleras 2004) from the perspective of an individual on account of the following factors. Students may not be able to assess the likely benefits of higher education in terms of higher pay packages and other non-monetary benefits. While uncertainty associated with the future stream of earnings is true for any investment, the problem is accentuated for a developing economy with limited job prospects and more for students hailing from economically challenged backgrounds. Drop-outs may also be on the higher side because of the long Page 8 of 23

Concept of Market and Market Failure in Education gestation period and other uncertainties of life. Because of skill obsolescence, need for sustained reinvestment due to changing skill requirements in the job market, and continuous technological development, individuals are required to reinvest in education to remain competitive in the market. The other problem is that of illiquid investment. This problem arises because human capital cannot be construed to be collateral as it is not tradable unlike in the case of housing and car financing since a student cannot dispose off the PV of future incomes. This leads to the problem of absence of collateral in education loans. From the perspective of a lender, asymmetric information and difficulty in collecting payments may be a deterrent. The problem of asymmetric information arises because lenders may know little about the ability of the students seeking loans, their ambitions, and intended career paths. This leads to the associated problem of adverse selection because it discriminates against students from economically challenged sections of society. If premiums are charged, mediocre students may hesitate as some students with confidence and potential take the plunge. As the possibility of getting good jobs declines for mediocre students, failure rates rise forcing lenders to charge a still higher premium. High mobility of students, particularly for those going abroad, poses a difficulty for lenders of tracing defaulters and ensuring recovery. All this put together make a lender wary of giving loans to students irrespective of their socio-economic backgrounds and choice of streams. (p.198) Market for Higher Education is Hierarchical

When we extol the virtues of a competitive market, the pertinent question is whether competition in a market for higher education will usher in quality improvement and some movement towards homogenization through the price mechanism. In higher education, quality depends on the quality of students and teachers and their commitment to excel. Since pricing in the public higher education system is hardly based on cost (as reflected in the supply curve) and demand, the role of price is drastically curbed and whatever role it plays in the private sector its nature is somewhat different compared to the conventional market because of the complications associated with tuition fees, capitation fees, and regulation. However, price is determined based on financial aid or donations and the extent of cost recovery as decided by the management of institutions and quality of education imparted as it depends on the quality of infrastructure and human capital. As Marginson (2009a: 208) argues essentially universities are engaged in status competition characterized by the ‘winner-takes-allmarkets’ or, in other words, the positional market is a zero-sum game. As nonprofit universities pursue maximizing their profits and output (or revenue), an improvement in position is associated with a commensurate improvement in the financial position. Scarcity of seats and the related issue of unequal social opportunity in education render this education market different as universities Page 9 of 23

Concept of Market and Market Failure in Education do not really care to meet the entire demand and let the value plummet along with the status. It is a competition where price does not feature prominently in the scheme of the universities. Reputed institutions attract more funds in a scenario of competitive funding and more endowments from reputed alumni as they come forward to donate and form a network, which enables these institutions to offer more scholarships and lower fees to attract good students. Similarly they attract the best minds to teach and to do research (Winston 1999). As a consequence, the top institutions remain at the top and the mediocre ones are at the middle and the not-so-good ones are at the bottom. In a similar vein, Bok argues (2003: 104): ‘In higher education, the cards are stacked against any institution that lacks (p.199) an established reputation and money.’ In the context of the US, he argues that ‘In all these ways the strongest universities tend to perpetuate themselves almost automatically. Success begets more success, which helps to explain why the list of top-rated universities in 2000 looks remarkably like a similar list in 1950 or even 1900’. This makes the higher education market intrinsically hierarchical to a large extent. So the extent by which competition can be conducive for quality improvement remains limited with no major shuffling of university rankings year after year. Since the ‘lowstatus institutions are condemned to remain in the bargain basement’ (Marginson 2009a: 209) it could be argued that investment in these low-ranking institutions ‘it more like investment in human capital as the economist imagines it, in that the screening and positional functioning are diminished’ (Marginson ibid.). Extending the argument a little further, Bridges and Jonathan (2003: 135) argue: The trouble is, however, that market conditions contain several dynamics which create first differences of quality (and not just of character) and then unequal access to the best. First, it is evident that in market conditions success breeds success and failure just as surely breeds failure. Early achievement encourages custom, which brings additional resources and commitment, which enables further success, and so on: early failure opens the way to a precipitous drop down a less virtuous circle. Thus the very rationale for infusing the market in higher education should be subject to close scrutiny. Market is Inherently an Unequal Sphere

Though market as an institutional arrangement is neutral and provides equal opportunities to all in the normative sense, in practice it accentuates inequality as all the participants are not equally placed in terms of command over resources and what Hogan (1997) argued ‘market capacities’ to participate in the market. ‘Market capacities’ include ‘informational resources’, various elements of social and cultural capital in terms of education and networks among many other factors. Those who are left out of the market become the (p. Page 10 of 23

Concept of Market and Market Failure in Education 200) worst sufferers. For education it is a serious problem as education is akin more to an investment good than a consumption good and therefore denial of good education incapacitates an individual for life to live with dignity, and in the process it hinders social mobility. For this, higher education has gained importance in people’s agenda without there being any diminution in the importance associated with school education as investment in these two levels of education are not competitive but sequential and complementary in nature. Educational markets, as Hogan (1997: 135) argues: … are not just mechanisms that record and aggregate ontologically prior preferences. Rather, markets are structures of power organized around a system of social (specifically, class) relations that ‘structure’ social action in determinate ways in which the possession of certain attributes or ‘market capacities’ advantages some individuals and groups relative to others. Marginson (2004: 186) argues that some students gain in the job market and in society by virtue of being the alumini of top-ranking institutions, at the same time other students from low-ranked institutions incur a loss. So, the ‘positional competition’ renders the job market a zero-sum game. What is more interesting is that both types of status goods, the individualized status of students and the institutional status of the universities are co-produced by students and the university as they, the students and the universities, stand to gain from each other. Market and Social Values

Market, it is argued, fails to respect social ethos and community feeling. The problem becomes serious in case of a social good like education. Individual choices with respect to social goods are not fully rational as the choices may interfere with larger social goals (Bridges and Jonathan 2003: 135–6). In the sphere of the market, individuals take decisions to secure maximum ‘individual positional advantage’, but education bestows positional advantage only at the expense of others in society (Marginson 2004). It is heartening (p.201) to note that it often suits parents to have unequally distributed educational provisions as long as they are better placed in society to extract a good deal for their children. In the process, the non-positional advantages are assigned less priority. Values associated with community living like compassion and benevolence are degraded as competitiveness tends to occupy a larger space in the most crucial sphere of our making of life, education, where we learn, appreciate, and inculcate values so essential for maintaining the fabric of society. But markets are essentially guided by narrow interests as market participants become impersonal and cooperation vacates space for competition (Olssen 1996: 341–2). However, Stephen Ball argues that the advocates of competition regard the Page 11 of 23

Concept of Market and Market Failure in Education market as value-neutral. If not, the market mechanism is more efficient or responsive or effective for the delivery of education ‘…as possessing a set of positive moral values in its own right—effort, thrift, self-reliance, independence and risk-taking, what is called “virtuous self-interest”’. In this latter view, market is ‘… a transformational force that carries and disseminates its own values’ (Ball 2007: 12). Preference, Choice, and Endowments

Hogan (1997) deconstructs the underlying assumptions of the demand curve and the market logic beautifully in the context of education. There are two major strands in the argument: one the assumption that preferences are exogenous to the market. But in practice, the manner in which choices are made by a consumer defy the assumptions. Two, the market is embedded in the economy and the economy is embedded in society, thus the market is primarily a social institution. Endogenous Preference Formation

In neo-classical economic theory, preferences are formed exogenously outside the realm of activity.7 However, in reality this is hardly tenable. Educational aspirations are adapted to existing opportunities; tastes are not exogenous and, accidentally determined but are socially determined and interdependent. Preferences are socially (p.202) constructed and mutually determining. The standard assumptions of the neo-classical theory of preference formation are deficient in the sense that they are unable to establish the link between action and preference function. Economics transcend historical and institutional variations. Choice is socially embedded and there is a need to recognize the prevalence of systematic information asymmetries. In the education market, there exists variability across groups, the kind of information available, and its subsequent processing. Educational aspirations are adapted to existing or anticipated opportunities. Interdependencies in the society, formation of taste, and the intensity of status competition are socially determined. Therefore, as Hogan (1997) argues that preferences are produced endogenously. The assumption that factor endowments are exogenous for consumers in the sphere of the market is highly questionable. Pareto is compatible with any distribution of factor endowments. This apparently benign assumption does not really capture the real world. In fact it can be misleading.8 There are six reasons for this (Hogan 1997): 1. Market capacities other than land, labour, and capital need to be considered. Other than wealth, the narrowly defined exogenous factor endowment, labour market skills, credentials, cultural capital, information, and social capital are derived from families, schools, and the neighbourhood. Family and school transfer capacities to successive generations and help facilitate their ability to accumulate. Page 12 of 23

Concept of Market and Market Failure in Education 2. The actor is rational, consistent, self-interested, and utility maximizing. The actor is also asocial, amoral, classless, raceless, genderless, ageless, transcultural, and transhistorical and therefore, the individual is an abstract individual. Individuals are socially constitutive and embedded within the social economy and the social economy is structured by social relations and market processes. 3. Choices in education are not akin to consumption but investments and they are lumpy, in fact, super lumpy in nature. Choices once made are not easily alterable. (p.203) A choice once made has its own long term multiplier effects with implications for the economic and social well being of adults. Specifically, it can determine schooling, occupation, spouse, and how in turn the next generation will shape up. Educational choices are mere reflections in investments in human capital, social capital, cultural property, and competitive advantage that they will eventually command. 4. An individual is viewed as self interested and engaged in constrained maximization. However, sociability, non-self interested motives, sympathy, trust, commitment, cooperation, loyalty, etc., can be the factors which can influence decision making and choice in sharp contrast to the self-interest motive which is regarded as the sole determining factor in choice making in mainstream economics. This indicates that culture constitutes utility. 5. The market is embedded in the social structure. Information and influence, exercise of power, networks, and choice sets are constituted by opportunity and the nature of resources. Parental choice involves sophistication and understanding to make informed decisions. Social reproduction takes place in a class divided society. 6. Markets are political constructions of distribution of economic, social, and cultural power. Educational choices are affected by resources and capacities and market structured opportunity sets where resources and capacities are determined by social structure, family structure, exercise of state power, and market processes. The market is structured around a system of relations where its capacities and resources are unequally distributed. Thus, it develops an inherent tendency to reproduce the prevailing social order.

Quasi-market for Higher Education There are two concepts of efficiencies, exchange efficiency and productive efficiency, which are allocative and technical in nature. (p.204) Policy initiatives in countries like the United Kingdom and New Zealand have sought to simulate a market like situation in education essentially to uphold consumer sovereignty by giving more discretionary powers to students/parents to choose their providers. This type of market is called a quasimarket as though some of the essential elements of a typical market are injected Page 13 of 23

Concept of Market and Market Failure in Education into the system like elements of competition, user charges, individual responsibilities, and freedom of choice (Teixeira et al. 2004a: 3–4), at the same time education continues to be subsidized and its provision regulated. Competition is generally infused with the purpose of improving the quality of schooling through a mechanism which entails financial empowerment of students/parents to exercise their choice effectively. In addition, this requires competitive funding, or ‘user-pays’ or ‘per capita’ funding9 to put pressure on institutions/universities to design courses and programmes to respond to students’ demands, as funding is encouraged to follow the students (Glennerster 1991) rather than giving directly to the institutions. This generates competition among institutions and also among different disciplines within the institutions to set their fee levels in relation to cost and service. An attempt to promote the use of vouchers in school education is made in the same spirit of giving freedom to students and parents to choose the right school and the right course that they want to pursue. State and the Market Interface

For policymakers, an important question is how authority relations in postsecondary education or higher education in terms of the relation among the state, the market, and the institutional leadership be structured? The relationships among the three are being challenged by stakeholders and are also being transformed to arrive at an ideal relationship. Related with this is the question of the autonomy that an institution should exercise and the important issue of institutional governance. While autonomy is often considered to be a pre-requisite for achieving academic excellence and a turnaround of the system, to what extent we can give autonomy to institutions in practice and how it can be blended with accountability are pertinent questions. If institutions do not have financial autonomy (p.205) and they are supposed to conform to some basic norms for the interests of society as decided by the government, autonomy would get substantially curtailed. Studies on institutional organizations have long been of research interest not only for scholars from the discipline of economics, but also for those from sociology. Smith, Weber, and Veblen have all talked about authority and governance in the context of academic institutions. Constructs such as culture, stratification, habitus, and the role of professionals have also been the areas of research (Pusser 2008). Burton Clark’s work on the ‘triangle of coordination’ with academic oligarchs (faculty or institutional leaders, boards, or ministries), state, and the market could be a useful model to study authority relations (Pusser 2008: 106–9). Essentially the attempt will be to focus on the fusion of the state and the market where at one extreme will be the state controlled one and at the other extreme the system will be based on ‘dependence on exchange’, a system of nongovernmental and non-regulation. A third dimension is added with the Page 14 of 23

Concept of Market and Market Failure in Education emergence of education ministries, boards, or even powerful academics. The US is a market controlled system. Institutional markets are sites for competition among institutions for prestige and resources as mediated by the state and the market. Transformations are taking place as students emerge as consumers, both because of their size and consumption patterns. Allocation of resources and the enforcement of regulatory constraints have been the traditional roles of the state. Teixeira et al. (2004a) provide a different way of looking at the higher education system by characterizing the student-institution interface with the extent of freedom that students and providers enjoy. Institutions are also political where public costs and benefits are allocated as the policies and instruments are to be seen in the broader context of socio-political contests over social reforms and other forms of activism. We can identify three key areas of interaction between the state and higher education: (1) grants and subsidies; (2) regulation of the activities; and (3) promotion of access and opportunity. One way of viewing the state and the HE system as a regime is a series of networks that exist at various levels which are duly legitimated (p.206) and financially supported by state resources. The state and the market are envisaged as fragmented with various disciplines and areas of research and academic functions. The HE system is viewed as a market because of consumers’ role, for-profit institutions, and entrepreneurial universities. Smith, Marshall, Mill, and Friedman have all commented on the role of the state in education. Smith argued that since education for the poor generate social benefits; the government should support it (Smith 1976, Vol. II: 309 as quoted in Stabile 2007: 39). Similarly Marshall recognized the benefit of spending on education for the masses to help them realize their full potential as he puts it brilliantly, “All that is spent during many years in opening the means of higher education to the masses would be well paid for if it called out one more Newton or Darwin, Shakespeare or Beethoven” (Marshall 1890/1920: 180). Mill favoured government regulation for achieving academic excellence (Mill 1969, as quoted in Stabile 2007: 65). Public funded universities should compete with the privately funded universities otherwise the academic standard may witness decline. Friedman (1962) argued in favour of giving choice to the parents to choose schools they desire. Subsidy should be given directly to the individuals to foster competition between the public and private schools.

Features of the Market The features of a market can be characterized in terms of freedom that the two broad sets of economic agents, consumers and providers enjoy, that is, consumer and producer sovereignty. We follow Jongbloed (2004) to specify eight such features of a higher education market which revolve around the hallmark of a freely competitive market, the freedom which is the most valued aspect in a Page 15 of 23

Concept of Market and Market Failure in Education competitive market economy. Consumers-students and providers-institutions have four types of freedoms which are discussed to shed light on their desirability in a market for higher education and the extent of marketization. (p.207) Four Freedoms for Consumers

Freedom which can be enjoyed by students and parents at the time of purchase in the education market can be classified into four categories. Similarly education providers can also be envisaged to have freedom in four crucial areas a la students. An analysis of the freedom will help in characterizing and understanding the nature and the structure of the market and the interface between students and providers. Freedom to Choose the Provider

In the case of the higher education market, should a student have the freedom to choose the institution just as a consumer can choose the seller/producer in a market for consumption goods? The issue is therefore one of desirability of such a feature for a market in higher education. In neo-liberal theory, the notion of choice is derived from consumer demand which should not be confused with social need (Olssen et al. 2004: 179). Since freedom to choose depends primarily on command over resources and ‘market capacities’, any student with adequate resources will gain access to an institution of her choice and not necessarily the most deserving one. Markets do not conform to a model of equality of opportunity as neo-liberals ignore inherent power inequalities due to unequal distribution of purchasing power and ‘market capacities’. Moreover, Majumdar (1983) draws attention to the potential conflict between the equilibrium: at micro and the macro sphere; in short term and the long term. Students form their preferences on the basis of their expected profile of future incomes which may not materialise as on the macro level, as there may be millions of individuals making such choices and thus affecting the demand and supply conditions, which can lead to a totally different outcome compared to the micro level expectations.10 But does the market function? If the producers’ responsiveness to the demands of customers under the profit motive in a competitive situation is desirable, Bok (2003: 162) argues that three conditions are to be fulfilled. One, students know what they really need; (p.208) two, they can evaluate alternatives; and three, their preferences correspond to the needs of society as one important objective of education is to prepare students for contributing effectively to common welfare. In the presence of information asymmetry and education being an ‘experience good’, fulfilment of the first of the two conditions is difficult. Generally institutions are ranked and getting admission to institutions higher in the pecking order becomes increasingly difficult. Since merit should be assigned more importance than money power, freedom to choose providers in the case of higher education should be backed by merit to encourage the pursuit for Page 16 of 23

Concept of Market and Market Failure in Education excellence. Effectively, since education is a ‘positional good’ and both students and universities compete for social status, institutions and students choose each other (Marginson 2004) as social status is jointly produced. However, the quota regime tends to negate this and for a good reason. If freedom is empowered by money, higher education will lose much of its ‘positional value’ and, essentially, the degree becomes available for sale. The process that students engage in to get enrolled in top institutions as top institutions are like ‘brands’ and command prestige in the job market, generates competition as the students bring the best out of themselves. In essence, hierarchy has its merit of keeping competition alive. However, freedom for students to choose providers may lead to delivery of quality education through competition among the providers as they compete to select the best students. Financial empowerment through education loans is not of much help as the very process of sanctioning loans is infused with several forms of discrimination.11 As Olssen et al. (2004: 208) summarize aptly the consequences of using the principle of applying consumer sovereignty on wider scale in various spheres of an education market as follows: they protect privilege; they deny all students equal access to education; they deny all students exposure to alternative perspectives; they limit community’s progress as a democratic community, and they undermine the basis of its integration, socially and politically. (p.209) Freedom to Choose a Product

Freedom to choose a provider and a product are often linked as these depend on a student’s decision as to whether the institution or the stream/discipline should get priority. If a student is driven entirely by market logic, she will consider whether it is the reputation of an institution as a ‘brand’ that matters or is it the course which sells more in the job market. It is also possible that a student may keep aside the question of market demand and would like to opt for a course or opt for an institution of her choice. Either a student chooses her product first and then she looks for the relevant institution or she chooses the institution first and then opts for the course offered by the chosen institution. In both the cases, her merit will restrict her choice set. The option to exercise the freedom to choose a provider arises in the case of top institutions followed by the choice of course or discipline. For professional courses, the freedom to choose a course/ discipline comes first and not the institutions other than the top ranking ones. However, general courses offered even by top institutions are assigned very little value in a market where a particular skill is valued. The dominance of freedom to choose a product over the freedom to choose a provider explains partly the mushrooming of private institutions of little repute offering market-oriented professional courses in view of the high demand for these courses.

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Concept of Market and Market Failure in Education Often a course or a specialization requires a certain aptitude or some specific skill. Ideally every student should be allowed to choose the course/discipline she wants to study, subject of course to merit and aptitude. A student seeking admission in a medical college should have merit as well as aptitude and her parents’ income should not count. If money power counts, society stands to suffer as trust and credibility of a skilled person like a doctor in this case is at stake. In India, though charging of capitation12 fee is banned, it is a widely known secret now. Applying the same logic as before one can argue that if freedom is backed by the power of money, education is degraded to a commodity with serious consequences as merit is devalued and the poor get crowded out from the market. (p.210) Adequate Information on Prices and Quality

One important assumption of a meaningful and efficient market exchange is availability of adequate information to enable a consumer (or a student) to participate in the market (Dill and Soo 2004; Massy 2004; Olssen 1996). Competition need not yield optimal results in higher education because information asymmetry distorts students’ choice as they are unable to weigh and evaluate the programmes offered by institutions. The ranking or the reputation of an institution matters in making informed choices but not always. In India where a majority of the institutions are not even assessed and accredited, lesser known private institutions often take gullible students for a ride particularly in the absence of monitoring by an alert regulatory authority.13 In view of the wide prevalence of an information asymmetry in the private education market, there is therefore a sound case for regulation on entry and monitoring of quality by an independent regulatory authority. Direct and Cost-covering Prices

In a competitive market in the absence of subsidization, prices should be cost recovering. However, for the higher education market, when subsidization of higher education is indisputable, the issue is to what extent should the price be cost recovering, Ideally, the extent of subsidization will depend on the precise measure of positive externalities. Further, provision of higher education should be guided more by social demand rather than by market demand. As discussed earlier, the concept of cost minimization is not tenable as better quality education costs more. For government aided institutions, the price is generally subsidized other than for self-financing courses, and hence price is determined mainly by the institution rather than by cost. For the private sector there is some regulation over price but there are cases where non-resident Indian seats and management quota are sold at a market determined (illegal) capitation fee to a desperate lot. Capitation fee reflects super-normal profit. Education being akin to investment and desired by all, its

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Concept of Market and Market Failure in Education price should (p.211) not be determined by its cost as those who cannot afford to pay will be left out of the market bypassing merit in the process.

Four Freedoms for Providers As pointed out earlier, on similar lines we may also consider the freedom enjoyed by providers to deepen our understanding of the Indian higher education market. Freedom of Entry

Freedom of entry (and exit) for producers is essential to guarantee efficient allocation of resources and to limit the possibility of monopoly profit. Can we apply the same logic to the higher education market and is it desirable? The specific characteristics of higher education as discussed earlier provide us a clue to the answer. If there is no restriction on entry, there is a high possibility of compromising with the quality of education as providers, no matter whether they have expertise or not, will crowd in taking full advantage of the absence of clear specifications about quality and adequate monitoring by a regulatory authority. Freedom to Specify a Product

In a competitive market, a producer should have the full freedom to determine what to produce and what to sell. The valuation of the product is correctly assessed in the sphere of the market. For higher education, the freedom to offer courses should be limited to an extent. Since market-oriented professional courses are in demand owing to job prospects, private providers will have a strong tendency to offer market-oriented courses. Similarly, in research private funding will promote applied research rather than fundamental research because return from such kind of research is uncertain and associated with a long gestation period. Freedom to Use Available Resources

In a competitive market, a producer has the freedom to decide what to do with the surplus as the concept of profit in education is (p.212) not tenable. A firm can either reinvest the surplus or pay dividends to investors. For education the freedom is restricted because education is not a profit making industry. If surplus is generated then it is required to be reinvested to expand the sector or it has to be dedicated to society. Freedom to Determine Prices

Producers should set the price to equate supply with demand and achieve allocational efficiency in the process. For the education market, particularly the higher education market, price should not be left to the discretion of a producer simply because education is not like any other commodity. The issue of having discretion over determining the price is only for the private sector. Generally the number of seats in an institution is given and for reputed institutions the demand far exceeds the number of seats. If price is allowed to vary, only Page 19 of 23

Concept of Market and Market Failure in Education privileged students will gain access to these institutions. Merit will be devalued and social mobility will be curtailed. Government aided institutions are largely autonomous and therefore, there is freedom to determine the fee structure. For the private sector, the price charged should recover the cost of production and allow for reasonable surplus only.

Incompatibility between the Market and Equity In this chapter we sought to address the issue of applicability of market logic to the higher education market. This issue deserves utmost attention because it has important policy implications at this crucial juncture in India. The higher education sector in India seems to be poised for an overhaul while it undergoes the process of marketization. There is ambivalence in the policy approach as the government is grappling with finding out the right mix of public and private participation, a concern for equity while the dominance of the neo-liberal ideology in the realm of policymaking has become more apparent. The promotion of PPPs, inclination to table a bill on Foreign Education Providers, and setting up of a regulatory body while the number of private providers continues to burgeon (p.213) corroborate the propensity to lean towards a greater role of private providers and reliance on market principles in shaping the higher education sector. This chapter examined the desirability of having a market like situation in higher education characterized in terms of consumer-student sovereignty and producer-institution sovereignty. This chapter argued that though higher education is being recognized as a quasi-public good, it has distinct characteristics vis–à-vis a conventional commodity which have serious implications for society and policymaking. Policymakers should recognize these aspects while pursuing an inclusive and sensitive society and a vibrant university system. Penetration of the market, this chapter apprehends will interfere with the government’s objective of attaining inclusive expansion. In a country with widening disparities it is an imperative that higher education be viewed as an instrument for fostering social mobility and the policies be made accordingly. Technically speaking, the market fails in higher education because of its lack of concern for social need and the huge externalities that it generates. While the former needs regulation, the latter calls for public support. Since the market fails to ensure equal distribution of resources, the role of the government has to remain proactive in the provision of social goods like education. Further, the application of market principles questions the very basic objective of education: is it for the market or for society? Marketization is synonymous with commodification and the more we treat education as any other consumption good like chocolates, the more we rob education of its vital role in building a democratic, humane, and inclusive society. Access to higher education may suffer as privatization raises the cost of education and merit is bypassed as a new class of consumers-students emerges with money power which can now choose their product and the providers even across the border. Competition, in the case of the education market, has limited significance as the market tends to Page 20 of 23

Concept of Market and Market Failure in Education remain hierarchical. As we compromise with the true meaning of education, quality suffers and it strikes at the very root of the foundation of our society. Virtual free entry in the absence of a strong and alert regulatory (p.214) authority has led to an abysmally poor quality of education at all levels. The other challenge for policymakers is how to revitalize the public higher education system which is plagued by apathy, indifference, and malpractices. Should we infuse competition among universities and colleges through installation of a competitive funding mechanism and incentivization of the pay structure of the faculty to usher in a new era notwithstanding all the shortcomings of a higher education market? The issue needs a deeper analysis.

Concluding Remarks This chapter sought to examine the specific characteristics of an education market focusing particularly on the market for higher education. In view of the mainstream economists’ proclivity to indulge in market based economic analysis and arrive at policy measures as correctives to market failures, this chapter could be construed as a prelude to the analysis of policy making in education in the following chapters. The education reforms being carried out over the world seek to install a market like situation to reap all the benefits of a market as advocated in mainstream economic theory. As discussed in this chapter, an education market is essentially very different and hence it entails a nuanced treatment of market principles when they are applied to reform the education sector. In reality, the market structure is deeply embedded in society and the unequal distribution of resources and market capacities tends to perpetuate existing inequalities. There are sources of market failure which require the state to intervene and assume a larger role in the provisioning of education. In fact, in order to understand and appreciate the deeper meanings of education, invocation of market logic is best avoided. Notes:

(1.) Discussed in Chapter 8. Briefly, the neo-liberals argue that the state should construct the market to reap the benefits of competition, efficiency, and quality. The precise role of the state would be to steer it from a distance. (2.) These sources are broadly similar to the assumptions of a perfectly competitive market. (3.) The assumptions of a perfectly competitive market are homogeneous goods and services, perfect information with the participants, free entry and free exit of firms to ensure perfect mobility of resources and a large number of buyers and sellers. (4.) In literature, a distinction is made between convergence and conditional convergence.

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Concept of Market and Market Failure in Education (5.) Under the dominance of market pressure as the courses become selffinancing and market oriented, the demand for these courses continues to mount at the expense of traditional disciplines like philosophy and history. Even the course curriculum is revised keeping in mind the demand from students. The dominance of neo-classical macro economics in the course curriculum even in a developing country like India in place of a Keynesian-Kaleckian macro analysis is testimony to the pressure of the market on education and research in a broader sense. There are hardly any takers for an important course like economic history or classical theory of value and distribution in a reputed department of economics in India. (6.) Marginson (2010b: 141) refers to Adam Smith’s argument in ‘The Theory of Moral Sentiments’ about motives for human association as compared to a neoliberal’s imagination of sociability in terms of competition and market exchange. (7.) In neo-classical economic theory, preferences are prior to choices and these two are connected conceptually in a tight manner (Hogan 1997: 123). Empirical evidence based on a large volume of literature shows that there exist social interdependencies of consumption and taste formation as argued by Hogan. (8.) This is merely a reflection of the obsession of neo-classical economists with efficiency as an outcome of choice making without giving adequate attention to the fact that people who make choices are different with regard to their societal and cultural values and may not be well-informed and knowledgeable to make those choices which ensure efficiency in resource use. (9.) Competition is generated by modifying the funding mechanism. At the school level, students are empowered with vouchers in case they lack resources. For higher education this requires adequate amount of scholarships to be given to students while phasing out subsidies being given directly to institutions. The fee structure would therefore rise as the students are now assumed to find payment of fees affordable. (10.) A higher supply of a particular skill may drive the rate of return lower than what was considered while making the choice (an individual decides under the assumption that all others are not doing the same). If all others are virtually doing the same thing, the impact on market demand and supply will be so profound so as to entirely negate each individual’s expectations. (11.) The government has been trying to promote education loans in a big way under the Eleventh Five Year Plan (EFYP). However, it suffers from various types of discrimination like gender, income, and region despite measures adopted by the government to curb these practices. Poor students feel vulnerable to loans more than the rich ones.

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Concept of Market and Market Failure in Education (12.) In 1993, in J.P. Unnikrishnan and Others vs State of AP and Others the Supreme Court of India held that education being a fundamental right, commercialization of education was not permissible and it was opposed to public policy and Indian tradition and the charging of capitation fees was illegal. (13.) Where information asymmetry in the higher education market assumes importance is when education providers, mainly private ones, suppress relevant information in their brochures or mislead students regarding infrastructure, faculty, and placement services. Only 57 per cent of the colleges covered under the University Grants Commission (UGC) grants and 24 per cent of the total colleges were accredited by NAAC in 2008. Only one-third of the universities were assessed by the NAAC (Thorat 2008).

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Economics of Education Policy

Education and Economics: Disciplinary Evolution and Policy Discourse Saumen Chattopadhyay

Print publication date: 2012 Print ISBN-13: 9780198082255 Published to Oxford Scholarship Online: January 2013 DOI: 10.1093/acprof:oso/9780198082255.001.0001

Economics of Education Policy Saumen Chattopadhyay

DOI:10.1093/acprof:oso/9780198082255.003.0008

Abstract and Keywords Based on the economic analysis of education, this chapter embarks on unraveling the rationale behind policymaking in education. Commodification of education (particularly in case of higher education) has led policymakers to repose faith on private-sector provisioning and the market to achieve efficiency and quality through competition both at the institutional level and the economy level. The chapter begins with a discussion on various modes of funding of education followed by a discussion on various forms of private sector participation, public–private partnership (PPP), governance reform, regulation, choice making, and quality assurance mechanism. It discusses why profit making in education has adverse implications for access and quality mainly because of an absence of a well-defined production function. Keywords:   education, privatization, public–private partnership, governance, new public management theory, principal-agent theory, regulation, quality assurance mechanism, neo-liberalism

Presumably, the rationale behind any policy measure to effect a transformation in the prevailing situation primarily to usher in improvement should be based on the diagnosis of the prevailing situation within a theoretical construct. In accordance with this, policy instruments have to be designed to achieve desired goals. A theoretical understanding will help unravel the complexities and interconnections among the variables pertaining to the prevailing reality in terms of an identification of the causal mechanism underlying the forces that establish relationships amongst the variables. Of course, there could be different theoretical perspectives to approach the entire issue of policymaking. A theoretical paradigm is often ideological and loaded with value judgments. Page 1 of 40

Economics of Education Policy Accordingly, there could be a different set of policy instruments to realize the varied objectives. However, there are commonalities in the identification of the problems and challenges facing the nation. After negotiating with the challenges of economic classification of education, particularly higher education (HE) in Chapter 6, we discussed how the market for education would be different in Chapter 7 to set the stage for an analysis of the education policy. This is because the efficacy of policy measures will depend largely on the economic conceptualization of education and nature of the education market. In this chapter we seek to examine the rationale behind the series of policy initiatives mooted, some of (p.218) which are in the process of being implemented, and discuss their implications for the education sector, focusing particularly on the higher education sector. Though justification for government intervention in the provision of school education is not contestable as it is classified as a merit good, but in the present context of an increasing role of the private it focus on choice and efficiency, there is considerable scope for policy analysis for school-level education. We begin with a discussion on the main drivers of policymaking in the national and international context and the issues associated with it. There are three major issues with regard to government intervention: how is it funded, how is it provided, and how is it regulated. We discuss policy issues with regard to financing of education. We follow it up with a discussion on the different forms of privatization. In subsequent sections we begin with a discussion on low cost private schools, followed by PPPs, choice of school, regulation, and the quality assurance mechanism or accreditation.

Policy Discourse In the realm of policy discourse, neo-liberalism seems to be dominant in the aftermath of the decline of the welfare state. However, when it comes to policymaking, neo-liberalism needs to be contrasted with the earlier school of classical economic liberalism. The presuppositions that the two schools share include that an individual is homo-economicus, the market is the best institution to allocate resources, and commitment to laissez-fairism and the invisible hand theory to argue in favour of circumscribing the role of the state in the economy. Competitiveness was believed to ensure efficiency and quality, and pursuit of self-interest by individuals to be in harmony with the overall benefit of the entire society. However, neo-liberalism differed in its visualization of the state in its role as one of positive construction of the market and steering the market from a distance. This entails creation of an individual as a ‘manipulatable man’ and perpetually responsive to policies so as to build up a competitive economy (Olssen et al. 2004: 160).1 (p.219) It is through the state’s initiative in its positive role that the end goals of freedom, choice, sovereignty, and competition are to be achieved with the enforcement of auditing, accounting, and management in the conduct of economic activity (Olssen and Peters 2005: 315).

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Economics of Education Policy The public choice approach gives a strong critique of the state becoming an oppressive institution and the role of politics and politicians involved in it. The theory is premised on methodological individualism but mounted an attack on the use of the social welfare function to arrive at the point of maximum social welfare. In Chapter 6 we briefly presented two different perspectives to assess and prescribe the role of the state in the economy, particularly with respect to the provision of services and the issue of redistribution. Public choice theory along with the agency theory and transaction cost economics provides a theoretical basis for understanding the role of the state in the economy from the neo-liberal perspective. With regard to governance reforms, the rationale behind the kind of institutional restructuring that the neo-liberals suggest could be located in the Agency Theory (AT) and transaction cost economics. Work relations are viewed as hierarchical with a principal and agents at all levels of the management hierarchy. Work relations are like contracts where the principal gives a command to the agents based on incentives rather than relying on professionalism based on autonomy and trust. Individuals are rational utility maximizers but there exists a possibility where the interests of the principal and the agents diverge as the agents remain engaged in rent seeking activities. The prevalence of information asymmetry gives rise to the problem. AT advocates monitoring, eliciting of information, and the performance appraisal technique to overcome the said problems. The focus is on finding the best way to motivate agents, encouraging performances, and finding the best ways to monitor and frame contracts to ward off opportunism (Olssen and Peters 2005: 320). Olssen et al. (2004: 169) agree that economic criteria are inducted into spheres which are not economic and the ambit of market exchange relations replaces all areas of voluntary exchange among individuals. (p.220) Neo-liberals portray rational individuals to be competitive, entrepreneurial, and manipulatable as mentioned earlier. The market is a place which fosters competition instead of cooperation to structure the community. The inherent tendency of the market to create inequalities needs to be monitored by the state. Education gets imbued with instrumentalist values where the person is essentially self-serving, competitive, and likely to be amoral and dishonest.2 As discussed in Chapter 6 school education being a merit good is considered largely to be a public responsibility. Higher education being classified as a quasipublic good, the extent of public support for it would depend, theoretically speaking, on the extent of externalities that it generates and concern for equity. The mode of subsidization remains unaddressed in this framework. However, various developments are ushering in rapid transformations in the manner in which education, in particular higher education, is being funded, provided, and governed. Almost all the nations face fiscal constraints and more so when it Page 3 of 40

Economics of Education Policy comes to allocation of budgets among the various layers and sectors in higher education. At the same time, government funded institutions are arguably inefficient in resource use and less productive. Delivery of public services suffers due to the inherent problem of poor governance. As a result it is argued that reform measures should include promoting private sector participation in various ways. The demand for education has continued to soar. Delivery of education and conducting research have become costlier. Fiscal constraints and poor governance emphasize value for money, relevance, and accountability in public funding of higher education. The private sector is expected to infuse a competitive spirit to compete in the global knowledge economy as universities compete for students and funding at the global level. Measures are also mooted to tone up governance of government funded institutions as they are made to behave more like business firms. So, an important issue is the emerging public– private divide in higher education when the boundary is being redefined and rearticulated. What needs closer examination is the nature of the divide as the application of market principles promotes (p.221) ‘privateness’ and subdues ‘publicness’ of higher education which are likely to conflict with the broader goals of education like social mobility, deepening of democracy, and nation building. Theorization of education in economics has had a profound influence on policymaking (Marginson 1997) and the main purpose of this book is to bring to the fore how theorization of education from an economic perspective has informed policymaking and trace its impact on the economy and society. It can also be argued that a dominant paradigm in economics such as neo-classical economics which essentially constitutes the basis of the neo-liberal approach has been applied to education as if education is no different from any other sector. Education policy, the world over shows allegiance to a policy framework based on a neo-liberal paradigm. We discuss below some of the policy measures being mooted, discussed, and debated; some of the measures are also in the process of being implemented in India. The apparent dominance of mainline economics among policymakers and thinkers means that the reform measures tend to be guided also by market logic. This chapter purports to give a theoretical underpinning of the policy measures which are not necessarily applicable to India but relevant for the education sector in general. Rizvi and Lingard (2010: 71–2) argue that education inevitably involves consideration of a range of values such as equality, excellence, autonomy, accountability, and efficiency as education implies that something worthwhile is being deliberately imparted with the purpose of developing individuals to be knowledgeable and responsible as well as the creation of a sustainable community. Policymaking in education is essentially a political process which involves trade-offs between values as different values are renegotiated and rearticulated in the process. As the emerging policy paradigm within the overarching framework of neo-liberalism indicates that the dominant concern for Page 4 of 40

Economics of Education Policy market values and efficiency has led to reconceptualization of social equality and emphasis on accountability has redefined autonomy. This renegotiation takes place against the background of an emerging global economy with a growing role of transnational corporations. (p.222) Differences lie in the differences in trade-offs which reflect the manner in which conflicting objectives and values associated with education are negotiated. The series of policy measures mooted and in the process of being implemented seem to be largely based on the dominant neo-liberal ideology which has been guiding worldwide reforms as well as the initiation of the new economic policy in India. In fact, the reform measures reflect the way policymakers view the world as some values are privileged and subsequently faith is reposed in the efficacy of the instruments to steer the economy towards the envisioned state. Within the neo-liberal framework of policymaking, the role of the government is redefined to be primarily limited to regulation and provision of public goods, thus assigning a greater role to the private sector.3 Setting up of new institutions which specialize in different disciplines and subject areas through PPPs and private funding are some examples. Globalization poses new challenges for the government as the education sector gets connected with the global world in myriad ways with varying ramifications. Reforms in the higher education sector are being given high priority as evidence shows how higher education can contribute to economic and social development. On top of this aspirations of the youth in a relatively young and populous country like India to participate in the growing economy need to be addressed on an urgent basis. Globalization has led to a process where educational values seem to be converging as the diagnosis and solutions offered by policymakers to confront the problems are very similar notwithstanding differences in social, political, and economic contexts (Rizvi and Lingard 2010: 72). The new theory of human capital tends to emphasize on the creation of knowledge workers so as to participate in knowledge industries and the global knowledge economy while social values of equality and autonomy are made subservient to dominant economic concerns. Individuals, corporations, and nations are envisaged to be made competitive within a transnational context. This requires a new form of governance which will create creative workers who are flexible, mobile, (p.223) globally minded, inter-culturally confident, and life-long learners redefining educational values in the process (Rizvi and Lingard 2010: 80–1).

State–Education Relationship: The Emerging Structure Education systems in a majority of the nations are witnessing far-reaching changes from one of a state controlled regime to market based decentralized systems with growing participation of the private sector. The state is now subject to what is called ‘hollowing out’ (Jessop as quoted in Dale 1997). Some state Page 5 of 40

Economics of Education Policy activities are given upwards to supranational bodies and at the same time some activities are delegated to sub-national and non-state bodies. The role of the state in the process is being redefined. Whether the state will continue to be in the driving seat as a major funder and regulator depends on how it views the extent of private participation vis-à-vis the public sector. Three forms of government intervention can be contemplated: how it is funded, how it is provided (or delivered), and how it is regulated (or controlled) as discussed earlier. Three major institutions of social coordination are the state, the market, and the community. It has never been fully state controlled as the market and the community have also played their parts. As shown in Dale (1997), there exists a complex set of interactions among the three coordinating institutions with regard to three governance activities of funding, provision, and regulation. It shows the potential complexity of education reforms where either a fully state-controlled or at the other extreme, a fully non-state controlled coordinating mechanism cannot be envisaged (see Table 8.1). Public Funding for Higher Education

For primary education and even secondary education, the government should provide financial support since school education as a whole is best classified as a merit good. The financing of compulsory education is not therefore debatable though private providers occupy substantial spaces in the school education sector in many nations. The financing of post-compulsory education is (p.224) Table 8.1 Coordinating Institutions and Their Activities Coordinating Institutions Governance Activities

State

Market

Community

Funding Regulation Provision Source: Dale (1997). however debatable. We would therefore like to devote more space for financing of higher education in the following sections.

Economic theory indicates that under normal circumstances the market is likely to fail to attain a socially optimum equilibrium outcome and, therefore, investment in higher education is likely to be suboptimal. Market failure can also arise out of a long gestation period, risk and uncertainty, and information asymmetry. Markets may be ‘missing’, failing thereby to assign true value to higher education more often than not as education brings about transformation in human life. Olssen (1996) discusses some of the inherent problems with the Page 6 of 40

Economics of Education Policy market solution for social sector activity like education (discussed in Chapter 7). All these call for public support to higher education.4 While the world over higher education is supported largely by the government, the issue is one of ascertaining the extent of subsidization. The imperfect nature of the credit market for education loans provides another reason why the burden of financing higher education cannot be entirely imposed on the household sector (Lleras 2004). The chief reason behind imperfections in the market for educational loans is that future income cannot be treated as a collateral in case a student defaults in repaying loans in a world of non-slavery. If education is an investment, there should be no reason why future income would be conditioned by the household income. Since there are disparities in distribution of household income, an ideal loan market will alleviate the inequity in the lifetime income of individuals. (p.225) Funding Policies for Public Higher Education Institutions

Policies to reform government funded institutions will constitute two major areas —reform measures related to funding and functioning or what may be called governance. While the rationale for government support for education in general is derived from the generation of externalities and concern for equity, two main questions which need to be addressed in determining the funding mechanism are what is funded and how is it funded (Jongbloed 2007). In traditional models of funding, the policy approach was to arrive at the quantum of funding based on negotiations of budgetary items such as salaries, maintenance, and students’ enrolment. This is what is called input-based funding. A major drawback with this kind of funding mechanism is that it fosters inefficiency as the process and outcome are not considered. It is argued that there will be very little incentive for employees of the public sector to economize on the use of resources as gains in efficiency will not be the guiding principle for them because the concept of efficiency in education is rather nebulous and not understandable by stakeholders in absence of a profit-maximising objective. As discussed earlier, this is not necessarily true for the private sector. Inefficiency in the use of resources gets in-built in the functioning of institutions over the years and the process of perpetuation continues. The issue is how to change the mode of funding so as to overcome the inherent inefficiency in the functioning of the HEIs. Therefore, to ensure accountability to society and to incentivize the actors to deliver, the tendency has been to shift towards performance-based budgeting whereby the release of funds is made contingent upon performances of the stakeholders as reflected in the outcome of institutions. With regard to the second question, one can envisage two types of funding mechanisms. One is based on a centralized agency where the funds are sanctioned by the top most agency. In the other extreme case, the funding is through students as it happens in a typical market where the source of revenue is the expenditure incurred by the customers. Advocates of the market model will naturally press for moving towards student based funding through the voucher scheme. It is argued that to generate (p.226) Page 7 of 40

Economics of Education Policy competition in the market students should be financially empowered and in the process, HEIs will have very little scope to rest on their laurels and instead will have to compete with one another for a larger share in the market as a typical firm would do. There has been a tendency to move from Q1 to Q2 and Q3 to Q4.

Figure 8.1 Funding Systems

Source: Jongbloed (2007). In Figure 8.1, the horizontal axis shows the degree to which the governments are paying for outcomes instead of inputs and the vertical axis depicts the extent of decentralization. All the four quadrants (Q1, Q2, Q3, and Q4) show how differently funding arrangements can be conceptualized. Public Support for Higher Education: Evidence

Though theoretically there is a strong case for public support to higher education and this is indeed corroborated by statistics from the developed world,5 the issue of the extent of subsidization has become debatable as it is an important policy question in view of a policy trade-off between enhancing enrolment and ensuring equity and equal access in the context of fiscal constraints. Some of the options that are being explored the world over are deregulation of fees, education vouchers, education loans, income contingent loans (ICLs), graduate tax (GT), and own resource generation (Greenaway and Haynes 2004; Tilak 2004a).

Exploring Options for Financing Higher Education The world over, universities are being goaded to explore alternative ways of supplementing government support as the fiscal burden on (p.227) the government keeps mounting and demand for higher education continues to surge. However, the pros and cons of alternative sources of financing higher education need to be assessed keeping in mind the socio-economic context and the fiscal compulsions that the state is confronted with at a particular point of time. Deregulation of Fees

There is an emerging trend to practise a differential fee structure for different courses as new market-oriented courses are being offered at a higher fees to overcome financial crunch and attain financial viability in the long run. This tends to aggravate inequity in society as only students from the privileged section of society can afford these courses, which presumably promise a higher stream of future income to the students. To safeguard equal access to higher education and the role it plays in equalizing opportunities for students coming from different strata in society, there is indeed a need for more scholarships and financial aid to the students. There was once a proposal mooted by the ex-Vice Page 8 of 40

Economics of Education Policy Chancellor of University of Delhi that the last fee paid by students in the previous class should be treated as a benchmark for determining the college and the university fee to be paid by the students. While this resolves the problem of finding out the affordability of a student, albeit partially,6 the problem with this approach is that it distorts parents’ choice at the school level as government schools charge lower fees than privately funded schools. Overcoming this problem entails mitigating differential quality at the school level between government and private schools. There is, in fact, a scope for raising the fees only to a limited extent as even a semblance of cost recovery will lead to an astronomical jump in the fee structure.7 The fee structure of the IITs and IIMs is set at a much higher level, which is, relatively speaking, closer to the cost of provision. There is little protest over this as these courses are job-oriented. The safeguard that exists for students coming from the underprivileged section of society is not an issue because one, there are few takers from that section of society, and two, these courses are (p. 228) job-oriented and, therefore, even commercial banks come forward to provide loans to needy students. Direct subsidies can have a valuable redistributive role. But this notion is challenged because students who pursue higher education and succeed are mostly from well-off sections. A cut in tuition fee across the board is tantamount to giving subsidy to students who may not deserve it at the taxpayers’ expense. This may actually lead to a redistribution from the poor to the rich given that there exists a strong correlation between the income earning ability and the ability to benefit from higher education (Creedy 1995). However, there is a case for an increase in the fee structure while taking adequate measures to ensure equal access through provision of scholarships irrespective of discipline. The scholarship amount matters as it determines a student’s choice on whether to pursue higher studies, or to opt for the job market. In order to attract the best talent, the scholarship amount should be as close as possible to the entry level salary of teaching at the graduate and post-graduate levels. The absorptive capacity of the market varies for research students. The recent initiative by the government to give scholarship to rank holders and MPhil/PhD students in central universities is laudable. But a majority of the student community from other universities not covered under this scheme should also be brought under its purview over time. Education Loans

Since students are argued to be the primary beneficiaries of higher education, they are encouraged to opt for loans to finance their education. The capital market for such loans is inherently imperfect (Hillman 2009; Lleras 2004). The imperfections may arise out of information asymmetry and adverse selection among other factors. As mentioned earlier, human capital is not collaterisable. A change has been mooted to allow deductions of interest payments on loans taken Page 9 of 40

Economics of Education Policy for higher education for assessing taxable income. Notwithstanding recent policy initiatives by banks to overcome imperfections in the education loans market, cases of discrimination with regard to courses to be pursued (p.229) (with market-oriented courses being given a favourable treatment) and in-built discrimination with regard to socio-economic background and region are coming to the fore. Assessing a student’s financial status in a large country like India with a substantial informal economy would be difficult as Srivastava (2007) points out. On account of the inherent imperfections of the market and discrimination practised by banks, overtly or covertly, education loans cannot be a solution for students willing to pursue higher education across the board. Uncertain nature of the job market adds complications by subjecting both the students as well as the lenders to uncertainty. Human Capital Contract

Human capital contracts (HCCs) entail students to commit a part of their future income for a pre-determined period of time in lieu of capital for financing their education (Lleras 2004).8 It was originally Friedman’s proposal (Friedman 1962) to create a financial instrument that would enable an investor to claim a stake in part of a student’s future income. Investment in professional, or vocational schooling is a form of investment analogous to investment in physical capital. However, it came to be effected in a manner where it became akin to loans rather than buying equities or what was referred to as income contingent repayment schemes (ICRS). HCCs are argued to have advantages over ICRS. The pricing of HCCs when they are traded will indicate stream-wise valuation of education, and market expectation from the investment. In the process, information with regard to the rankings of universities and courses will become transparent. This may lead to competition among universities, which may encourage the adoption of quality improvement measures. It is also argued that some of the courses in arts and philosophy need to be subsidized as the market may fail to assign true value to these disciplines (Lleras 2004). There is also a possibility of redistribution of incomes as successful candidates end up paying more than the less successful ones who will make smaller payments. The other advantage is circumvention (p. 230) of the illiquidity problem as students are allowed to sell a part of their investment. An investor is argued to have a sustained interest in investing in continuous retraining so that the value of human capital does not depreciate. In the absence of debt, students may also have an inclination to undertake entrepreneurial risks and use their knowledge. The argument that HCCs offer equal access to education irrespective of the background may sound encouraging but in a developing country with the prevailing uncertainty of getting a job is associated with acute disparity, social acceptability of such a scheme is highly unlikely. Since the market comes to play a prominent role in Page 10 of 40

Economics of Education Policy influencing a student’s decision to pursue a career in a university of her choice, certain important streams (or courses), which are not valued highly in the market, would face extinction. This might lead to the social choice problem (Majumdar 1983) where micro and macro aspects will not be in consonance with one another. Individual preference for a particular career path will, at the macro level, make it unattractive if supply exceeds demand in the job market. Financial market development and all the disadvantages of education loans are equally valid for this scheme. The countries where this scheme has been successful are very different from the Indian system. Income Contingent Loans

ICLs as an alternative to educational loan have turned out to be successful in some of the developed countries (Greenaway and Haynes 2004) since job market uncertainty, the major deterrent for opting for loans, is substantially reduced as loans are required to be paid only if income exceeds a certain threshold limit. However, this requires the government, instead of commercial banks, to play a proactive role. The other advantage is that this scheme does not require any upfront payment. Designing ICLs poses several tricky issues such as (i) the income level on which contingent payments will be based and the percentage to be paid out of it, (ii) the period over which repayment has to be made, (iii) interest rate, and (iv) collection method and ‘buyout’ features. Barr and Crawford (1998) (p. 231) have discussed how this can be implemented without hurting access and avoiding revenue leakages. Tax Financing

The imposition of an additional cess in the Union Budget of Government of India may ensure substantial increase in allocations for secondary and higher education. Asking taxpayers to foot the bill for higher education to a large extent may be a good idea keeping in mind that the government has to continue its support for primary education and compliance with the FRBM Act. However, it can be argued that tinkering with the tax rate is not a good idea as it raises the distortionary effect of a higher tax rate. Imposing a cess is what the government can possibly think of under the compelling circumstance. A majority of the universities are funded to a large extent by state governments and the resource crunch at the state level will hinder the overall increase in the budget for higher education. However, there is enough scope for raising budgetary allocations out of increased tax collections which is a distinct possibility if tax concessions are withdrawn and tax evasion is curbed (Kumar et al. 2012).9 Graduate Tax

GT is a tax in addition to the general income tax which is imposed on graduates. Like any other tax it needs to be paid only if the income exceeds a certain threshold limit; it achieves the same objective of delinking loans from job prospects. However, it has many demerits. It distorts the tax structure and may add to the costs of the tax administration and tax compliance mitigating the Page 11 of 40

Economics of Education Policy benefits of tax reforms. This scheme is not flexible and does not encourage competition. The payment to be made by a student remains independent of the costs of education (Greenaway and Haynes 2004). In a model which recognizes the budget constraints of the government, Creedy (1995) shows that an unconditional grant to all may entail a rise in the tax rate in the future. Grants are argued to be just like deferred fees. This however may not be tenable if we dispense with the notion of honouring the budget (p.232) constraints of the government in an inter-temporal framework. As GDP grows, budget allocation can also grow even in real terms. It is, after all, a question of prioritization. In case the graduates obtained their degrees from privately aided institutions with little or no financial support from the government, justification of imposing such a tax on these graduates will be weaker. Fees, Loans, and Graduate Tax: An Examination of the Pros and Cons

Theoretically, the level of fee should be determined on the basis of private benefits which accrue to individuals. Should fee be the same for all individuals in a particular programme of study? Should it be conditioned by parental income to take cognizance of the wide variations in income levels? Should individuals who cannot fund their education, ideally opt for loans instead of being provided with scholarships? However, the subsidization of higher education is different from the subsidization of any other sector. The benefits of subsidization of higher education accrue to the diminished pool of those who are enrolled in higher education. If the average income of the tax payers is less than that of the average income of the graduates, it is often argued that there is a possibility of reverse redistribution. As the tax payers who are required to pay taxes to fund government welfare expenditure including subsidies10 in order to restore a semblance of parity in the distribution of income, in reality, end up contributing to the higher income of the graduates, who are the beneficiaries of subsidies. This argument is widely used against non-targeted subsidization of higher education. However, public support to higher education is possibly the most dignified way to achieve socio-economic equity as higher education promotes social mobility by making acquisition of skill and training accessible to the economically challenged section of society. This is, however, contested because students from the well-off sections also stand to gain possibly more than the poor ones which would strengthen the prevailing association between lifetime economic opportunities and the socio-economic profile of the parents. If low income families face severe credit constraints, it (p.233) seems rational on grounds of efficiency to provide subsidies based on parental incomes. Liquidity constraints alone cannot explain the strong correlation between parental incomes and educational attainment. A significant part of the correlation can be explained by genetic factors, a less congenial environment for study in low income families, inability to provide moral support, and an absence of role models. As shown by Dur et al. (2004) education subsidy constitutes an optimal redistribution policy. Page 12 of 40

Economics of Education Policy Their argument is crucially dependent on the non-substitutability between low skilled and high skilled workers. If the supply of skilled workers goes up along with the rise in mean level of education, then the pre-tax wage inequality would fall. This may happen because returns to schooling falls as people acquire more human capital and as a result increases the supply of skilled individuals relative to demand. Since this has the potential to reduce disparity in income distribution and therefore there would be lesser reliance on distortionary progressive income taxes. To achieve post-tax wage equality, progressivity required in the tax structure will be less. But subsidization and a progressive tax policy distort labour market equilibrium as subsidization may lead to over-education. The problem with this kind of analysis is that the demand for skilled and unskilled remains the same which is not really tenable in the wake of technological changes. Moreover, education is viewed from a very narrow perspective of only contributing towards skill formation. However, there is a counteracting effect. Since students with higher ability constitute a larger segment of those who are enrolled in higher education, subsidization turns out to be the most beneficial for them. While giving subsidies to students from low income families to equalize opportunities for all is a must, subsidies to the meritorious should continue to reduce the opportunity cost of pursuing higher studies, particularly for the abler students. The distinction between subsidies and loans gets diluted if loans are offered by the government at a rate lower than the rate that the commercial banks charge. In addition, if the government absorbs the shock of those who default in the repayment of loans, it is tantamount (p.234) to giving subsidies, albeit indirectly, to students. One source of imperfection is a kind of information asymmetry which prevails between the students who apply for loans and the banks. Students with a heterogeneous solvency risk profile will have a better idea about their solvency risks than the banks. High risk students will like to pay a higher interest rate thereby pushing the interest rate up. In the process low risk students will be crowded out by high risk ones as it happens in the market for medical insurance. If the banks ration loans rather than raising interest rates to bring about equilibrium, underinvestment in human capital will be an inevitable outcome. If the loan scheme is run by the government, high risk students will get attracted to it. If the purpose is to improve access to education, as it would be an imperative in a developing country, there will be a redistributive effect from the taxpayers to low income families. The vulnerability to loans and therefore getting exposed to the risk profile may require low income families be treated with care. If repayments are made contingent upon a threshold level of income, the government assumes the risk of investment in education like the creation of an insurance market. Further, low income parents may also fail to assess what their wards could do in higher studies and how much they will earn on account Page 13 of 40

Economics of Education Policy of their own low levels of education. ICLs will be equivalent to an income tax. This ICL causes distortions in labour supply, as future returns become less attractive because of higher tax, and in the choice of the course opted for (Dur et al. 2004).11 In case of ICL, repayment of loans is made contingent upon the income above a threshold limit. ICLs ensure two types of insurances. First, it reduces the possibility of default as loans need not be repaid if income earned is below the threshold limit and therefore, inadequate. Secondly, it ensures consumption smoothing, as minimum consumption level could be maintained despite the income falling below the threshold limit, as loans need not have to be repaid out of inadequate income. This helps in maintaining the consumption level even if the income remains low or falls below the threshold limit of an indebted person. (p.235) But how is GT different from ICL? Both share some of the characteristics of risk sharing and risk pooling. Revenue collected from GT is unrelated in many ways like it can be excessive and unrelated to the benefits accruing from higher education. It is not a cost recovery mechanism. There does not exist any resource allocation mechanism as some pay more than others. But GT can ensure progressivity in taxation. Education Vouchers

It is argued that the objective of popularizing education vouchers by giving entitlements directly to students instead of to institutions fosters competition among institutions to achieve efficiency (or X-efficiency) as students exercise a greater freedom of choice (Glennerster 1991). The value of the entitlements may be allowed to vary with respect to the cost of the course, socio-economic background, and to encourage participation in particular courses. This is expected to encourage competition not only within publicly funded education but between public and privately funded education as well. This scheme ensures targeting of students who deserve to be subsidized and transparency in the provision and its use. Students are allowed to top up their entitlements if needed and this is the only way to generate more revenue out of this system (Greenaway and Haynes 2004). In the presence of differences in quality between government funded and private funded institutions, the one with inferior quality will gradually be eliminated from the market. This is generally true for school level education but may not work well for the higher education as costs of higher education are generally much higher than that of school education. In addition, there are possibilities of leakages and rise in administration costs as administering education vouchers at the level of higher education may be expensive. Such vouchers may be misappropriated and misused owing to overeducation and drop-outs, thus leading to leakages as higher education is not compulsory like school education. In addition, because of the diversity in the

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Economics of Education Policy courses offered and the higher education institutions, administration cost may also be substantial. (p.236) Offering Self-financing Market-determined Courses

It has already been noted that there has been an explicit attempt to encourage colleges and universities to offer courses which are largely self-financing thereby opening up the possibility of cross-subsidization. This can be implemented if the courses are in high demand in the market. Own resource generation through commercial funding of research projects by universities may lead to the market dominating over the research agenda. However, this can be overcome through government funding of basic research facilities. Improving Governance: Reducing Cost per Student

It is indisputable that colleges and universities should function in a cost-efficient manner notwithstanding the fact that both a profit maximizing objective and a well-defined input–output relationship are absent. However, given budgetary allocations, there remain many avenues to curtail costs without compromising quality and for eliminating wastage of various kinds. In fact, in a service sector as costs measure income in the absence of market valuation, a lack of commitment and competence would be tantamount to corruption albeit of a different kind. It is argued that cost can be brought down substantially if the salary structure for teachers is delinked from that for civil service employees. Class size may be increased wherever possible or the number of shifts for the staff may be increased. It is maintained that these steps will release resources for primary education. As discussed earlier, applying the efficiency principle may ultimately be achieved at the expense of quality and equity, sooner or later. What is, however, undeniable is the need to improve governance, better utilization of funds, democratic decision-making, and ensuring compliance with the norms through participation of stakeholders like students. Only this will ensure delivery of quality services and better utilization of existing facilities. Therefore, a change in management and leadership can bring about major improvements. This is important keeping in mind the fact that education is, after all, a service with a difference. Private colleges with the objective (p.237) of generating reasonable surplus, hire teachers on a contract basis with substantially lower salaries. As a result, quality suffers. One major focus of fiscal reforms is on governance. Institutions of higher education in the public sector are afflicted with governance-related problems similar to those of the government sector. To ensure better delivery of services, reforming the management of public sector institutions has become very crucial. A majority of the institutions which can compete at the international level also Page 15 of 40

Economics of Education Policy happen to be government-ones. The issue is how to carry out reforms without compromising on the values and ethos that education signifies. Patenting Knowledge

In Chapters 2 and 6 we discussed knowledge and the related issue of patenting. Often top-class universities with reputed faculties emphasize on earning revenue by patenting the knowledge created. The issue is that if knowledge creation is funded by the government, can a university sell knowledge through patenting? Patenting may provide incentives and recognition for the faculty to pursue research with more seriousness. New ways of university-industry linkages are being explored. The other problem is the possibility that a university may show a tendency to gradually move away from fundamental research to a market determined research agenda, though often it is difficult to make such distinctions.

Financing of Higher Education: A Critique of the Neo-liberal Ideology In the dominant neo-liberal ideology, higher education is essentially viewed as a private, individualized commodity, which is in sync with the World Bank approach as well (Jones 1997). The ‘Bank’ as a promoter of an integrated world economy outlines the approach as (ibid.): To recover public cost of higher education and reallocating government expenditure towards primary level with higher social returns: i. Promote education loans through development of a credit market with selective scholarships, especially in higher education. (p.238) ii. To decentralize the management of public education and encouraging the expansion of non-government and community supported schools. The overall thrust is therefore on recovering the public cost of higher education through exploration of alternative sources of financing, including development of a credit market for education and increased emphasis on better governance of institutions of higher learning. This is expected to release resources for the purpose of reallocation towards the lower levels with higher social returns and at the same time explore alternative sources of financing higher education. To support their arguments, the economists from the World Bank emphasize upon the regressive nature of public support to higher education as benefits are argued to be appropriated mainly by the privileged section of the society, inequitable participation patterns, unrealistic curriculum orientation and elitist functions (Jones 1997). The Bank’s economist, George Psacharopoulos (1973, 1981) showed that return to primary education is more than that in higher education, arguing in favour of reducing the extent of subsidization as one climbs up the education ladder. This provided critical input to the design of Bank’s policy of subsidization of education as argued by Jones (1997). But in a knowledge driven society, it is increasingly being realized that higher education is crucial for determining the Page 16 of 40

Economics of Education Policy competitive edge of an economy in the global market as it fosters innovation, development, and dissemination of technology. In the process, it sets the stage for building a knowledge society. With the increase in the demand for skill, access to higher education has become a necessity to participate in the job market meaningfully and productively. In the first wave of human capital theory the focus was on productivity gains. However, the role of higher education in raising productivity has gained even more importance with the emergence of knowledge as a critical input in spurring growth. Moreover, counter-posing primary education with higher education is fallacious (Kumar 2004; Majumdar 1997). Higher education (p.239) provides inputs to primary and secondary education in terms of teachers and administrators. On the other hand, with the fall in drop-out rates and rise in the enrolment ratio, entry to higher education is expected to go up. Further, one should not ignore the adverse implications that the funding of higher education will have on employment prospects in the education sector (Khadria 2004). Therefore, investment in different stages of education is sequential in nature and need not be viewed in isolation. Using the rate of return for determining investment decisions in education has been extensively critiqued by Majumdar (1983) from a social choice perspective as discussed in Chapter 5. Further, the theory of human capital ignores any understanding of educational processes and the historical and socio-economic features of a country. Therefore, the methodology which is applied to education to assess the future stream of costs and benefits can also be applied to any other sector, denying thereby the specific characteristics that education as a whole signifies (Fine and Rose 2001). Efficiency–Equity Trade-off

Typically, in the context of public sector intervention it is argued that there exists a trade-off between efficiency and equity, the two most desirable objectives of the government. However, the distinction loses its significance in the context of higher education. If equality of opportunity remains the major goal, both the objectives are realized in the process of equalizing opportunities. It is efficient as talent does not go waste as students from underprivileged sections get opportunities to showcase their talent. Through social mobility, it gives an opportunity to underprivileged students to climb up the social ladder and restore a semblance of an equal and fair society. Application of Becker’s Model

In the context of the DD-SS model developed by Becker as discussed in Chapter 2 shows that inequity in the distribution of earnings could be traced mainly to two factors, the cost of financing human capital or nurture as reflected in the supply curve and the ability or nature of the individual to benefit from investment as reflected in (p.240) rate of return. Since nature or some proxy for intelligence can be considered to be exogenous to an individual, one way to mitigate inequity in the distribution of earnings is to lower the cost of financing Page 17 of 40

Economics of Education Policy or to make the SS curve as flat as possible and ideally equal for all. Basically, individuals’ decisions to invest in their education should not be deterred by the differential and high cost of financing which would in a way minimize the distortions in decision-making and the resultant inefficiency.12 The traditional efficiency–equity trade-off needs to be revisited in this case (Becker 1975: 128– 9). The greater the variation in the cost of financing, the larger will be inefficiency. At the same time, it is a right step towards equalization of educational opportunities to achieve equity in the distribution of earnings. Offering admission to highly subsidized reputed institutions through an objective selection process may appear to be leading to inequity but at the same time, scarce resources are allocated to the deserving few. This is one way of taking recourse to the ‘second best’ policy when segmentation in the capital market cannot be lessened but subsidization of the abler students can be effectively enforced. Though this objective selection may lead to inequity in earnings and investment, efficiency in investment in human capital improves. One source of variation in income distribution which arises out of financing can therefore be eliminated by designing a suitable policy and the advocacy for this subsidization of education comes from a neo-classical economist in a framework where efficiency gets more importance. Therefore, the pursuit of equity and efficiency get reinforced within a neo-classical paradigm.

Mode of Delivery: Various Forms of Private Participation The major objective of education reforms is to infuse market principles and install relations of competition to ensure efficiency in resource use and increase productivity, accountability, and control. Olssen and Peters (2005: 326) quote Marginson (1997: 5) to capture the essence of reform as: Increased competition is meant to increase responsiveness, flexibility and rates of innovation … increase diversity of what (p.241) is produced and can be chosen … enhance productive and allocative efficiency … improve the quality and volume of production … as well as strengthen accountability to students, employers and government. This entails encouraging a growing share of the private sector in education delivery as this will ensure satisfaction of both internal and external efficiency through a larger increase in competitive elements, a superior ownership and management structure within the enterprise, and an enhanced accountability and incentive system (Belfield and Levin 2002: 41). However, privatization is not the only form of private participation that is sweeping across the world. Private participation is also on the rise in the new initiatives being taken up by the government, in new ventures, or in restructuring of the existing public sector provisioning. There can be various ways in which public–private participation in education can be discussed. As shown in Table 8.2 there are four different levels associated Page 18 of 40

Economics of Education Policy with the delivery of education—the investor, who hires the teachers, the main input in this service sector, who produces in the sense of having control over its delivery in terms of curriculum and pedagogy and who buys education. It could be consumers who pay for education or it could be the government. The government can channelize subsidies either directly to the institution engaged in delivering education or directly to the students. The first row (Case A) is an example of delivery of full government command over-education, funding and provision. There is no role for the private sector. In Case B, the government runs the school in a private set up as it is the funder, employer, and producer while the land and the building are owned by a private party. In Case C, the government owns the building and funds the provision, but the school is managed by the private sector. In this case, the government will retain control over the recruitment process and the overall functioning. In Case D, the government appears in the chain of operations only at the end through funding. It is a case of full scholarship or outsourcing. And the (p.242)

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Economics of Education Policy

Table 8.2 Options for Public–Private Partnership Type

Asset (Building) Owner

Labour (Teacher) Employer

Producer of Education

Purchaser (Who Pays Producer)

A. Pure public provision

Government

Government

Government

Government

B. Public–private partnership. The government runs the school in a private/ community building.

Private

Government

Government

Government

C. Private school (the government may regulate), but it provides the building.

Government

Private

Private

Government

Private

Private

Government

Private

Private

Private

Consumer, directly

Public–Private

Public–Private

Public–Private

Public–Private

D. Case of full scholarship Private or outsourcing (but the government may regulate). E. Pure private provision (but the government may regulate). Memo: F. Public–private cooperation

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Economics of Education Policy

Type

Asset (Building) Owner

G. Application of Public corporate practices in the public sector

Labour (Teacher) Employer

Producer of Education

Purchaser (Who Pays Producer)

Public

Public

Public

Source: Grout and Stevens 2003 (also mentioned in Das-Gupta 2011).

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Economics of Education Policy last option is of pure private provisioning but the government will like to retain control through regulation. Cases F and G have been added.

The other important way in which privatization can take place is by changing the way the public sector institutions function. Elements of market logic like typical corporate managerial practices can be infused in the governance structure of publicly funded institutions. There are cases where the state is withdrawing and (p.243) vacating the space for the private sector to occupy. Some examples are outsourcing of non-core and even core activities like teaching and research. Privatization can be classified into two categories (Ball 2007): ‘Endogenous’ privatization or privatization in public education which involves application of ideas, techniques, and practices borrowed from the private sector in order to ensure that the public sector behaves more like a business enterprise (as in case G in Table 8.2). ‘Exogenous’ privatization or privatization of public education involves policy measures to allow for private sector participation in public education services on a for-profit basis (Cases B, C, and D in Table 8.2). The private sector will help design, manage, or deliver specific areas of public sector delivery. This is relatively new and growing in importance. However, these forms have overlapping areas and are inter-related. It is possible that endogenous privatization sets the stage for exogenous privatization. An evaluation of the different forms of privatization will depend on the objective functions of the institutions involved. However, in case of such collaborations for government funded institutions with non-profit universities abroad, the objective is to gain through academic collaboration. Formation of networks among specialized groups both within and outside the country is growing as knowledge generation is increasingly being considered to be facilitated by cooperation. An open source of knowledge does not fall under the purview of conventional economic theory based on scarcity. We now discuss one emerging debatable issue in relation to funding of school education in India which has policy relevance even in other countries. Ball (2007, 2009) has brought to the fore diverse forms of privatization in their various hues as multi-layered and multi-levels of policymaking in different realms of decision-making—institutional, national and international. It is multifaceted and inter-related. Ball (2009: 83–84) distinguishes among three forms: (1) Organizational changes in public sector institutions. This includes selling of professional development services, consultancy, training support, and programme service delivery directly to institutions. It is like selling a policy as a retail commodity. (2) New state (p.244) forms and modalities (governance, network, and performance management), and (3) Privatization of the state itself and the interests of capital where public service is viewed more as a profit opportunity and effective public service provision.

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Economics of Education Policy Education businesses are exploring possibilities of diversifying and internationalizing in order to expand and seize market opportunities (Ball 2009: 93). This leads to ‘policy entrepreneurship’ and simultaneously policy transfer which may culminate in policy convergence. Through this, the private sector becomes an instrument for facilitating recolonization as the profit seeking behaviour influences policymaking in developing societies and imposes western models of organization, leadership, and employment. From the very beginning, private involvement is built into the system. The discourse on privatization includes key terms such as ‘entrepreneurism’, partnerships, companies, innovation, business, private, and the knowledge economy which represent new ways of thinking about education and new ways for the conduct of education workers. Institutions, schools, and universities are looking for opportunities to market their knowledge base and generate surpluses, disseminate creativity, and transfer technology. There is a judicious mix of networks, markets, and competition and collaborations (Ball 2007: 31). Pure Private Provision: Low Cost Private Schools

There is now a debate that low cost private schools present a very good option for alleviating two problems: fiscal constraint and poor governance. Encouraging expansion of primary education facilities means little burden on the exchequer as the teachers in the low cost private schools will not only cost substantially less but will also be responsive, efficient, and productive. Teachers’ salaries will be less because the salaries will be fixed at a much lower level reflecting excess supply of teachers in the job market. Since teachers will be on contract basis, they will be on their toes to perform and deliver in classrooms as they face the possibility of being fired and their contracts annulled in case they fail to deliver. So it is (p.245) argued that the government and students gain on both counts, resource saving as well as quality improvement. Whether quality genuinely would witness an improvement or not will remain a debatable issue. Here, it is an imperative to deconstruct the notion of quality and identify the possible contributory factors (Kumar 2010; Sarangapani 2010). An important question we need to address is whether the lowly paid teachers will be trained and adequately qualified to deliver quality education. Imparting good quality education depends not only on the implicit threat given to the teachers but their sense of commitment, compassion, and care. These attributes are not necessarily measurable and the focus on ‘performativity’ would fail to do justice in delivering quality education. Teaching-learning is a process which is very different from a typical assembly line in a firm. Reducing absenteeism will ensure that teachers will spend more time in the classroom. But to consider it as a factor for improving quality will be bordering on utter ignorance of how quality education is manufactured in the classroom. To pursue this policy objective of encouraging low cost private schools is tantamount to phasing out government schools and ushering in low quality privatization of the school education. This Page 23 of 40

Economics of Education Policy has serious implications for the school education system, and in particular for the government funded school system.

Public–Private Partnership in Education Partnering with the private sector in the provision of education is considered to be the ‘third way out’ for the public sector. While it is felt that the government should own institutions and fund the delivery of education, the quality of service is often sub-optimal due to inefficiency in its operations. Further, it is also argued that the government is perennially faced with a fiscal crunch. One way to retain the ownership of the government and the service being delivered by the private sector is to explore options of blending the functioning of the two radically different entities. PPPs involve the use of private sector providers to design, build, operate, and manage state education facilities on a lease-back basis. Capital costs and (p.246) some risk are transferred to the private sector while the government or local authorities are committed to long-term lease repayments. This mode of privatization is prescribed by the World Bank (Ball and Youdell 2007: 19). There can be many models of PPPs in education as envisaged by the Planning Commission. But the argument that PPPs will alleviate the resource crunch faced by the government is hardly tenable unless the private sector can deliver the same quality education with lesser resources either through an improvement in the organizational set up and governance and/ or through curbing corruption. In government funded institutions there is no concept of profit making. However, if they are managed by the private sector, there is a need to accommodate at least a reasonable amount of surplus or what is plain and simple, profit. In practice, the choice of a possible model among the various alternatives will depend on many factors. As Das-Gupta (2011: 301–2) suggests an important guiding factor is the organizational and ownership form that is best suited to provide public service at the lowest social cost. The notion of service quality should be broadened to include the notion of quality and timeliness. An assessment of the true cost should also take into account the element of risk and the rate of time discount. Further, ‘if resource constraints are binding for, say, direct government provision then use of PPPs may be second best efficient’ (Das-Gupta 2011: 302). PPP: Implications for Cost of Education

If private providers do not intend to make profit and they are as cost efficient as public providers, it may appear that the cost of education provision will remain the same. However, if we allow for profit making and possible differences in the cost of provisioning by the private sector, some interesting observations can be made. While the private sector may look forward to earning a return on invested capital, support from the government will be in the nature of explicit subsidies as reflected in the budgetary outgo without taking into account the opportunity cost of capital. Let us ignore the cost associated with investment in assets or buildings and instead focus on maintenance costs.

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Economics of Education Policy (p.247) Let us invoke the accounting balance for a ‘not-for-profit’ entity to understand how the financial balance can be achieved. We use the financial balance as suggested by Winston (1999) and discussed in Chapter 4, which is: (8.1)

On the right hand side we have the cost of running an institute all inclusive (c) and profit (v) which can be interpreted as reasonable surplus allowed to be made by the private party. On the left, the private party will recover the cost of education from the students in the form of tuition fee (p), and the grants to be received from the government (g). The possibility of donative revenue (dr) being an additional source of receipts can be ruled out here for the present discussion. In order to know whether the government spends less on education due to private participation per institution, we need to categorize government support into capital support and maintenance support (similar to capital and revenue expenditure respectively). Because of private participation, let us focus on maintenance support, g, assuming that the budgetary allocation for expansion of the education sector will remain the same while the private party makes investments as well. A major distinguishing feature of private participation is that unlike the government the private party will be interested in earning a return in the form of profit otherwise it is difficult to sustain the argument that private investment will be forthcoming on a scale which will support the government’s expansion plan meaningfully. We have, therefore, g equals: (8.2)

Case 1: Assume that there is no gain in the form of cost efficiency and consequent reduction in cost due to a supposedly improved management of the organization by the private party. If tuition fee is kept at the same level (p remains the same) government support has to go up to accommodate for ‘reasonable surplus’ so as to ensure minimum return on the capital invested in education by the private sector. (p.248) Case 2: Government expenditure will eventually come down if c can be reduced and/or p can be raised. The fall in c has to be substantial to compensate for the rise in v for g to come down given p. Two points should be mentioned here. One, a reduction in c is desirable as long as inefficiency in resource use is eliminated and the wastage curbed. Otherwise cutting costs may lead to a fall in quality as well since good infrastructure; good quality education requires higher costs as discussed in Chapter 4. Given c, raising p may affect access adversely if adequate safeguards are not taken to help students who are in need of financial help.

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Economics of Education Policy Case 3: Suppose in a PPP model, the government has provided the land and the financial affair is entirely managed by a private party with no grants received from the government. The private party is allowed to make only reasonable amount of surplus, v. Further, suppose that the private party has the inclination to resort to unfair practices to make additional profit, albeit illegally. One way would be to artificially escalate cost and siphon out the amount. This may be accompanied by compression of some expenditures which may affect quality of service. Say the new compressed level of cost is c′. Therefore, the earlier level of cost c equals the sum of c′ and cb. In absence of g, from Equation 8.2, we can write, (8.3)

(8.4)

where v′ is the new level of profit comprising what is permissible v and what is unfair (cb) and unwarranted compression (c – c′), the amount of expenditure which accrues to the owners themselves in the form of amenities including car, directors’ salaries where the directors are often the family members. So, (8.5)

The other way would be to recover more from the students or charge more for non-core services and through imposition of fines. So the actual amount of surplus fair and unfair will go up further by p′. This extra amount extracted from the students may remain unaudited (p.249) or would accrue to a third party related to the management. If unethical practices creep in, the very foundation for arguing in favour of increased private participation is shaken. (8.6)

where (8.7)

There are two unfair sources of surplus now, cb and p′, along with a fall in quality due to undesirable curtailment of cost. Even if v is zero, the private party can make profit, albeit illegally. While one type of corruption is curbed like absenteeism of the teachers with the roping in of the private party, other forms of corruption may resurface which could contribute to illegal profit making by the private providers. In fact, the teachers are burdened with so much teaching load that research and qualiy of teaching Page 26 of 40

Economics of Education Policy suffer. The ability of the private providers to achieve efficiency in resource use has to be accepted with a pinch of salt because it would have all the ingredients bordering on indulgences in unfair practices associated with a compromise with quality.

New Public Management: Governance Reforms This has reference to G in Table 8.2 where governance reforms of the public sector will be carried out in line with corporate managerial practices. Often noncore activities of publicly funded universities will be privatized. This can be also construed as one form of partnership with the private sector albeit of a different type. As Ball and Youdell (2007: 14) put it: NPM has been the primary means through which the structure and culture of public services are recast in order to introduce and entrench the mechanisms of the market form and forms of privatisation. In doing so it affects how and where social policy choices are made and systematically sidelines and disempowers educational practitioners. It also increasingly subjects them to new forms of control through performance management techniques. (p.250) Delivery of higher education and conducting research have become more complex along with mounting pressure from the global economy to conform to international standards and to compete. Political interventions in institutional functioning need to be reined in to avoid compromise with autonomy. It is also argued that costs are getting increasingly disassociated from the benefits that these institutions generate. The fact that these institutions are complex entities with no well-defined input and output relation and no optimum input coefficients compound the problem of monitoring and assessment of performance (as discussed in Chapter 4). Concomitantly, the importance of networks and their spread across borders and over a wide variety of actors—the faculty, students, and administration—have gained significance. Universities are also linking up with industry, government, and civil society (Enders and Jongbloed 2007: 15–6). The governance structure affects university functioning in a big way, so it is necessary to study governance in view of the challenges that higher education institutions (HEIs) in the public sector are confronted with. There have been some attempts to invoke the Principal-Agent Theory (PAT) or the Agency Theory in the study of governance of the higher education institutions (see, Lane and Kivisto 2008; Dill and Soo 2004). A theoretical approach is helpful in identifying the root of the problems and designing suitable policy measures accordingly. PAT helps explain how individuals and/or organizations are motivated to carry out designated tasks when they are placed at different levels of the hierarchy and are bound by contractual relations. The principal is the commissioning party who delegates work to an agent to carry out a task as per his directives where Page 27 of 40

Economics of Education Policy agents are driven by self-interest in the presence of information asymmetry. Generally, institutions are held responsible by the sponsoring agency like the government while institutions (the agents) are established to fulfill a certain agenda and social needs. It is a classic example of a dilemma that an agent is empowered (university as the agents and the ministry as the principal, or vicechancellors as the principal, and teachers as agents) and at the same time, agents need to be constrained from (p.251) deviating from the desired path. Agents, as they are assumed to be driven by self-interest, develop a proclivity to shirk their responsibilities, behave opportunistically, and form collusions as they see greater rewards in pursuing their own agenda. The principal provides incentives to the agents and monitors and imposes punitive measures to preempt deviation by the agents as they suffer from information asymmetry. They negotiate with an uneasy feeling of conflict of interests. An outcome based approach and a merit based salary structure are some of the controversial measures which will arguably reduce conflict and tension. The argument that ‘prestige maximization’ will motivate the faculty and students to strive for excellence may not work in all institutions, particularly in the low ranking ones.13 Neo-managerial Reforms

The restructuring of the educational systems can be understood as a new policy framework which derives its rationale from the public choice theory and new institutional economics, in particular, the agency theory (or PAT) and a transaction cost analysis on the one hand and on the model of corporate managerialism on the other (Marshall and Peters 1999: xxv). Among the countries where educational systems have been restructured in line with such an approach are the United Kingdom, Australia, Canada, and New Zealand. In essence, concern for productive efficiency and choice have made educational services contestable and achieving allocative efficiency has led to the marketization and privatization of the state systems.14 Central to the problem of neo-managerial reforms is how to get an ‘agent’ to act in accordance with the interest of the ‘principal’ within the context of maximization of self-interest, bounded rationality, risk aversion, goal conflict among members, and asymmetrical information (Olssen and Peters 2005: 321– 2).15 Examples are an employer-employee relationship in educational institutions (for example, the principal and teachers), the government and institutions (for example, the UGC and a private deemed university).16 (p.252) In the absence of different objective functions for different levels, interests in a hierarchical organization are often conflicting. Information is difficult to obtain. Agents may exploit the situation to their advantage. Contracting out of services and performance agreements are the preferred measures. There is a greater reliance on short-term employment contracts with greater emphasis on economic rewards/sanctions. Some of the major objectives Page 28 of 40

Economics of Education Policy of governance reforms are increasing competition among units, separating all potentially conflicting responsibilities, accountability and monitoring techniques to overcome corruption and bias arising from the pursuit of self-interest. Input-based funding to performance (outcome) based funding institutions and transition from centrally regulated to de-regulated funding with stakeholders (for example, students) being empowered to decide are all examples of governance reforms based on PAT. Agency Theory (AT) specifies a range of monitoring, information eliciting, and performance appraisal techniques: best form of contract, best way to motivate agents, best way to spur performance, best way to monitor to guard against opportunism on the part of the agents, and deception, cheating, and collusion. Despite a wide array of reform measures and variations in terms of focus and policy design in higher education reforms, certain key features under the rubric of neo-managerial reform or New Public Management can be summarized as (Marshall and Peters 1999: xxvii; Toonen 2007): 1. Adoption of a business-like approach and orientation of practices similar to what corporate entities practise. 2. An extensive use of written contracts and performance agreements. 3. Economic rewards and sanctions to effect improvement in public service delivery. 4. Institutional separation between different categories of functions: advisory, delivery, and regulatory. 5. Contracting out services, mainly non-core services and emphasis on contestable provisions. (p.253) 6. A larger space created in favour of commercial enterprises, deregulation of market, and privatization, etc. In order to capture this wide range of changes in the manner in which the government functions and delivers, Toonen (2007: 51) has coined a new term, ‘decentration’. It refers to the entire gamut of transfer of non-core businesses in the public sector. Decentralization refers to involvement of other public partners at a lower level, contracting out and ‘agencyfication’ which involve private partners and privatization which involves promotion of private ownership associated with or without diminution in public ownership. Decentration leads to a dispersion of tasks from the central government to many entities in many directions involving the local government, special and functional agencies, firms, and civil society. The role of the government is redefined in the process to essentially construct an enabling framework. Institutional reforms are crucial for countering the problem of poor governance as a majority of the higher education institutions are afflicted with it. It is argued that it is only natural that government funded higher education Page 29 of 40

Economics of Education Policy institutions will be inefficient in the absence of a profit maximization objective. Employees are not incentivized enough to deliver their best under the assumption that all individuals are self-interest driven. Therefore, it is argued that higher education institutions should be reformed in line with corporate managerial practices.17 The idea is to measure the performance, incentivize the remuneration structure, and hold agents accountable. And the approach is to let public funded higher education institutions collaborate with private parties: (a) to tide over resource constraints, and (b) to ensure efficiency and quality. With the promotion of the market, government funded institutions are also required to be reformed to ensure their meaningful participation in the market to achieve efficiency and to deliver quality education. The challenge is how is to implement corporate managerial practices in government funded institutions so that these institutions function more like privately funded institutions and (p. 254) reap efficiency gains (Marginson 2009b). Further, it is argued that a government funded institution is likely to suffer from all the typical sources of inefficiencies which lead to government failure. In a world envisaged by mainstream economists, individuals are mainly driven by self-interest and are tutored to respond to economic incentives often called ‘manipulatable man’. Prevalence of what is called the principal–agent problem becomes crucial as those who deliver education, the teachers, may not like to deliver in the absence of proper monitoring, often within a demotivating academic ambience. Once there is a compromise with the teaching–learning process, the quality of education is sure to plummet. Governance reforms are based on the public choice theory which is based on the assumption that an individual, irrespective of the socio-cultural context, is homo-economicus. One has to realize that teaching and research are professions which require commitment, passion, and self-esteem to feel proud of being associated with an institution. New Public Management (NPM) seeks to de-professionalize teaching as both autonomy and trust are undermined and accountability, performance, and control gain prominence as guiding factors for the governance mechanism (Olssen et al. 2004). It is often argued that the reason behind delivery of quality education and research is the notion of prestige maximization, which will drive individuals like faculty and students to strive for the best in the absence of pecuniary incentives as available in the profit maximizing efficiency driven corporate sector. Incentivization of the pay structure and renewed focus on performance will have some impact on the teaching community as it is now required to produce measurable outputs in the form of papers published and engagement with other activities which fetch points for the faculty, but the question is at what price. In other words, measuring academic performance, which is a pre-requisite for incentivization of the pay structure, is argued to be a sure way to improve governance and ensure attainment of excellence. There are enough indications that participation in seminars could go up with very little commensurate improvement in the quality of teaching and research as the Page 30 of 40

Economics of Education Policy stakeholders may (p.255) develop a tendency to subvert the new system. Deprofessionalizing teachers and making students behave more like customers have their own adverse repercussions on the academic ambience that prevails and on building a citizenry with social values and societal sensitivities. Treatment of education at par with other sectors in the neo-liberal approach to governance reforms leads to devaluation of education and the teaching-learning process in the name of efficiency.

Regulation Ideally, advocacy for a freely competitive market is based on the invisible hand theory that a competitive market achieves allocational efficiency in resource use as participants, driven by self-interest, ensure best outcomes for society through the guiding force of the ‘invisible hand’ by equating demand and supply. As discussed in Chapter 7, the market fails when one or more of the assumptions for a perfectly competitive market are not satisfied in the market sphere. This requires the government to intervene to correct the market failure. In addition to this, education being a social good, its provision has larger implications for society. The government has to intervene to achieve wider social goals such as rectifying an unequal bargaining power arising out of unequal distribution of wealth, safeguarding the interests of future generations, prevent socially, morally, and politically unethical economic behaviour, for example, discrimination, and to take special interest in endangered species which are undervalued in the market but which are important for the sustenance of the social and cultural point of view (Jongbloed 2004). The process of achieving efficiency in the sphere of market is rendered unequal when individuals of equal calibre to pursue education have differences in their endowments to access education. Facilitating innovation and technological advancement will make future generations better-off if prevailing problems in society, the economy, and the environment are addressed through this. This is what is referred to as the concept of dynamic efficiency. Innovation requires that the existing technologies are phased out to (p.256) usher in new ones. This may be difficult in a competitive market set up as firms do not have any leverage over price to experiment with the new and embrace risks and uncertainties. Often cooperation is a better idea for a smooth transition. There may exist social category-wise and gender-wise discrimination which may amount to exploitation. The concept of dynamic efficiency is of significance as a good deal of value judgments are involved in education. The problem with the market is its failure to value all good things like moral values and indigenous knowledge which may remain undervalued or certain courses or programmes which are important to society, its past, present, and future. For example, a subject like philosophy is essential to appreciate the growth of knowledge and to understand science and society but job prospects for successful candidates may be dim. Some of these will require the government to frame policies for the global economy with active

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Economics of Education Policy participation from willing nations. The GATS is an example where the global higher education market will be monitored and regulated by a watchdog. The education market is not akin to a typical market where students can switch their products, courses and institutions, with ease as the ‘exit’ option can be exercised at high costs. As argued earlier, education being in the category of a service, quality is not well defined.18 Since producers may have an interest in cheating students through undesirable cuts in the cost of delivery, consumers will repose more trust in a non-profit organization. Lack of knowledge about the qualitative differences among education providers can be overcome through certification and accreditation.19 The important questions are, where, when, and how should the government allow the market to cure? Regulation and Efficiency

A market on its own, as long as all the assumptions of a perfectly competitive market are satisfied, will achieve an efficient outcome. Regulation is an instrument for achieving efficiency as far as possible when the market is far from being perfect as that is what we encounter in reality. Regulation means that the government (p.257) imposes restrictions to control and affect an individual’s and an organization’s behaviour, their freedom to decide, and their rights and liberties (Jongbloed 2004: 91). Regulating the Education Market: The Task of a Regulatory Authority

Essentially, the advocates of neo-liberalism view regulation as a policy measure to introduce competitive pro-market policies. Regulation is not only to curb and restrain competitive elements but also to foster competitive elements as and when policymakers so decide. The state education relationship under the overarching framework of regulation can be categorized into three different types of relationships (King 2007), command-and-control, self-regulation, and market regulation. Jongbloed (2004) has classified regulation into three types— state-imposed regulation, self-regulation, and enforced self-regulation. In a way, the third category will converge under conditions. These three can be taken as the three vertices of a triangle of coordination introduced in Chapter 7. Under command-and-control, the state devises rules and regulations and enforces them strictly. Criticisms leveled against this kind of intervention constitute the very basis of the argument in favour of state retreat and framing of pro-market policies. As discussed earlier, the inflexibility and rigidity to deal with rapid changes, freedom, and autonomy should be bestowed on the academia which will require loosening up the control of the state on institutions. However, this approach may set a minimum standard for social services such as health, education, and environment protection though it may prove to be burdensome. Self-regulation implies professionalization of the workplace where specialized knowledge of products and commodities requires expert interventions, particularly in terms of controls over training, entry, completion, and discipline Page 32 of 40

Economics of Education Policy (King 2007: 71). This mode has also come under criticism for being self-serving and inefficient. Professional disputes and scandals covered in the media have raised serious doubts about the credibility of this approach often from a larger perspective of social democracy. It does not go well with the overall thrust of policymakers who recommend a retreat of (p.258) the state. Self-regulatory spaces can suffer from lack of transparency and vested interests of the leadership. In the wake of marketization and maintaining of ‘self’ in a university, ‘self-regulation’ may come under stress and may, lead to anomalies and confusion due to overlapping jurisdictions of many self-regulatory bodies. Market regulation has emerged as the most preferred form of intervention. Its key elements are encouragement of competition, and informed consumer decision-making. As discussed earlier, creation of a quasi-market through competitive funding, user-fee models for consumption services, and in a way regulation of various realms of the market are often the policy instruments. For a market to function effectively, two more institutional initiatives are necessary. For informed choice making, production and dissemination of information about the quality of the product in the sense of performance evaluation of the courses and the institutions will become necessary. This will require a quality assurance mechanism and the ranking of the institutions to be made mandatory. The other support is to set up tribunals (ombudsmen) for appeals arbitrations primarily for redressal of grievances by stakeholders, mainly students. The possibilities of injustice or cheating are more in the case of social services like education and health because consumers cannot switch from one to the other with ease and quality cannot be readily assessed. Students are increasingly being objectified as consumers with rights rather than as simply welfare recipients (King 2007: 73). When regulation is tied to the market structure or to the conduct of the market, it is similar to market regulation. In a broader sense, regulation of the market structure requires financial and legal requirements, infrastructure requirements, and requirements related to staff and programmes. In conduct regulation, the intervention will be in the form of restrictions on decisions with respect to price and quantity. It may seek to encourage cooperative arrangements between the providers in the form of sharing of infrastructure, recruitment strategies for staff and students, output markets, and innovation and research strategies. Basically, it seeks to regulate the extent of competition. Therefore, there can be three different areas where regulation could (p.259) Table 8.3 Structure of Regulation in Education Market: Structure–Conduct–Performance Model

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Economics of Education Policy

Regulation of Structure

Regulation of Conduct

Administrative Regulation

Regulation of entry/exit

Regulation of price

Tax/fiscal rules

Regulation of competition

Regulation of quantity

Accountability requirements

Protection of intellectual property rights

Regulation of capacity

Funding and recognition of providers

Regulation of quality Regulation of inputs

Source: Jongbloed (2004: 100). be enforced. They are related to academic personnel and governance, and financial matters (see Table 8.3).

As we can see, regulation involves walking a tightrope. While the advocates for a market will try to restrict the scope of regulation so as to maximize gains from competition, the anti-market lobby will favour restrictions to fulfil various objectives. How to balance these two by reconciling the role of competition vis-àvis regulation is a big challenge for any government. Even in terms of objectives, there are possibilities of conflict between efficiency and social goals. Social goals can be so designed to equalize opportunities so that the efficacy and usefulness of competition can be enhanced. In a country with wide disparities of various kinds, short-term conflicts and tensions will arise for sure, which have to be negotiated mainly by the profit driven private providers.

Choice of School, Efficiency, and Quality In the case of reforms of school education, there can be one different type of policy intervention which seeks to simulate market-like competition by fostering choice-making of a school by parents. Advocates of a market will argue that creating a market-like situation in education to foster competition is an effective way to (p.260) realize the benefits of efficiency and delivery of quality education. As it happens in a typical market for consumption good that it is possible for the consumers to switch from one firm’s product to another firm’s product as the consumers are free to exercise their sovereignty, the firms face the competition to retain or to raise the market share. Expectedly, the firms strive to minimize costs and improve quality to remain competitive in the market. Effective choice making in the education market by students is difficult because once admitted it is difficult to switch from one institution to the other (Winston 1999 and others). Choice making in practice is also highly restricted because the ability to afford varies when there are wide differences in quality among schools, and also due to political and social reasons (Olssen et al. 2004: 202). In practice the freedom of choice is highly restricted because the ability to Page 34 of 40

Economics of Education Policy afford varies as there are wide differences in costs and quality among schools, and also due to political and social reasons (ibid.). To infuse competition a change is required in the mode of funding from a system of giving grants or subsidies directly to schools to a system of extending financial help directly to the students with the help of the voucher system. As discussed in Chapter 4, in education the inputs are decision-making agents and hence they select their schools. If the choice is determined by socio-economic and cultural factors, diversity in the classroom is likely to be compromised. In higher education since quality depends on the quality of minds, the best students and faculty will choose the best of the institutions. This will create and crystalize the hierarchical structure as schools which are better-off financially will attract the best students and faculty. Any policy which makes an attempt to foster competition to improve quality and ensure efficiency in resource use is unlikely to achieve the desired result. This is a major drawback of the neo-liberal approach to education reforms.

Quality Assurance Mechanism: Accreditation of HEIs In an increasingly globalized world, institutions now cater to a diverse clientele and greater diversity in the institutions is appreciated. (p.261) At the same time, as generation and dissemination of knowledge assume importance in facilitating growth and overcoming spatial inequalities, expectations from higher education institutions have also gone up. As higher education has become a global public good, and the market for higher education is hierarchical (as discussed in Chapters 4 and 7), there is a tendency towards vertical stratification rather than horizontal stratification (van der Wende 2008). Accreditation is a pre-requisite for ranking institutions. The accreditation of the HEIs serves two main purposes. In view of the fact that there exists information asymmetry and education being an ‘experience good’, accreditation assures clients that the quality of education to be imparted conforms to the standard set by the accreditation body or regulatory authority. Further, it helps students to choose the courses they intend to apply for and higher education institutions to study from as ranking reflects, as it is supposed to, the relative quality of HEIs. Education being in the nature of a service, its true quality can be meaningfully assessed only over time, so students should be informed about the quality of the institutions they intend to choose. From the perspective of the institutions, in absence of any measurement of output, it is important that higher education institutions are intimated about how they fare in comparison to others so that they can identify gaps in their delivery mechanism. It encourages institutions to put in extra effort and improve their ranking. On the down side, ranking based on certain criteria may not be in conformity with the mission of the institution. It, therefore, has the potential to interfere with the specific objectives of higher education institutions for which they were set up.

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Economics of Education Policy Since there exists a wide variety of institutions with different mandates located in different socio-political and cultural contexts both within countries and across the borders, ranking is sensible and meaningful within a defined groups of comparable institutions (van der Wende 2008: 55). From a methodological point of view, ranking has been subject to some valid criticisms. Assessing the quality of a university based on some pre-determined indicators will never be an easy job given the multiple products a university (p.262) produces which are often not measurable as discussed in Chapter 4. Each institution is unique and has been created to serve a purpose which is well-articulated in its mission. The ranking will, therefore, inevitably involve identifying commonalities and focusing on basic purposes such as teaching and research. Research output can somehow be quantified in terms of publications and quality can also be assessed in terms of the ‘citation index’ and impact factor, but the problem lies with social sciences and humanities. In the presence of different paradigms in social sciences, it is difficult to measure research quality and compare it across borders. The dominance of English language tilts the balance in favour of English speaking countries and after all English is the language of research (Marginson 2007). Assessing the quality of teaching has been difficult though it is a major task of a university. Teaching and research cannot be seen separately as they feed each other (discussed in Chapter 4). But there does not exist any indicator to measure teaching quality.20 As Patnaik (2007) emphasizes on the nation building mission of the university, he feels that it is a futile exercise to resort to ranking to assess the performance of a university as addressing the mission is of paramount importance rather than fulfilling certain criteria decided by an agency to assess output of a university. Each ranking method is different as each one is founded on different notions of what constitutes quality education.21 There is neither any commonly accepted notion of quality nor any accepted method consisting of a set of indicators to measure quality. Weighting of indicators is subjective and it is most unlikely to do justice to the mission of a university. Holistic university ranking becomes a fallacy (van der Wende 2008: 57). What is a matter of concern is the possibility of undesirable practices that institutions can clandestinely indulge in. As explained in Chapter 4, the quality of a university depends on the quality of its students and faculty. It has been observed in the US that universities in order to rank higher in the ladder compromised with their student selection policies and preferred merit-based aid rather than need-based aid. One genuine way for a university will be to identify the gaps and flaws in (p.263) its performance and take steps to improve it without much of a compromise with its mission.

Concluding Remarks While economic logic is invoked to rationalize neo-liberal policies, the issue is one of desirability of treating education at par with any other sector. This chapter dealt with major areas of policymaking, financing, mode of delivery, and regulation. Mode of financing is crucial because it determines access to Page 36 of 40

Economics of Education Policy education and the quality of education. With respect to delivery, growing participation of the private sector deserves a deeper analysis. Various forms of privatization were discussed focussing mainly on PPPs. It was argued that profit making in education has adverse implications for access and the quality of education. In view of the discussion on market failure, it was discussed why the market for education has to be regulated. Aspects of governance reforms in line with neo-liberalism sweeping the world have profound implications not only for the functioning of institutions but also teachers and students. Value for money, accountability, autonomy, and performance appraisal are the key words in public sector governance reforms. Neo-liberal governance reforms which seek to establish hierarchical relations, focus on the principle of ‘performativity’ which transforms the teachers to perform more like workers and may deprofessionalize teachers and academics. It erodes the basis of trust in a relationship which is so fundamental to an educational institution. Regulation of the education market is a tight rope walk for the government as it cuts both ways. The challenge is therefore to ensure a balance between efficiency gains arising out of marketization and gains from the ‘publicness’ of higher education arising out of relegation of the market, given the large share of the private sector. Ideally, school education should remain the primary responsibility of the government but this has led to a huge loss of credibility of government funded schools. The debatable issue is whether marketization and increase in the share of the private sector are the right kind of medicines for government failure. Notes:

(1.) Whereas the classical liberalism portrays a negative concept of state power in which individuals need to be liberated from the interventions of the state (Olssen and Peters 2005: 315). The individual is autonomous and can practice freedom. (2.) Even tax evasion is treated in an optimization framework as a taxpayer weighs the costs and benefits of tax evasion and decides how much to evade. The very fact that a taxpayer considers something which is illegal to maximize her income indicates that she is essentially a dishonest person. (3.) The overall framework of policymaking is often informed by two major sets of policies, the stabilization policy advocated by the International Monetary Fund (IMF) and the Structural Adjustment Policy (SAP) generally recommended by the World Bank. The stabilization policy seeks to curtail fiscal deficit as a percentage of GDP mainly by pruning government expenditure and tax rationalization. The SAP argues for a larger role of the private sector and a greater role of the market. These require that the role of the government is redefined and its size is reduced. Both these approaches complement each other to redefine the role of the government in the economy.

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Economics of Education Policy (4.) Often it is stressed that the government will also fail and this is referred to as government failure. (5.) OECD statistics cited in Gradstein et al. (2005). (6.) Parental income may come down as students climb up the ladder of higher education. (7.) The norm is to recover to the tune of 20 per cent of the of expenditure. The VC conference (Prakash 2011) took a softer approach towards fee hike. This is mentioned in Chapter 9. (8.) Human capital option (HCO) is a variant of HCC. An HCO is an option in which “the underlying asset is the value of the earnings that an individual receives as a result of his productive efforts during a given period of time” (Lleras 2004: 85). HCOs provide one way of managing the risk of investments in additional to education which is complementary to HCC. This financing option provides the student certainty on a minimum level of income. The owner has the right to buy or sell an asset at a predetermined price on or before a predetermined rate. (9.) Revenue foregone due to tax concessions given to taxpayers, both direct and indirect, or what is called tax expenditure, amounts to nearly 80 per cent of the tax collected. If a significant part of the tax concessions are withdrawn, investment and growth may suffer but the increased tax collection may help the government to dedicate larger budgetary allocations for the social sector and pursue a balanced growth strategy. (10.) In practice it is difficult to distinguish whether expenditure on a particular sector is tax financed or debt financed as the total expenditure incurred by the government is financed by the consolidated receipts comprising both the revenue (tax and non-tax) and the borrowing. The government continues to borrow while taxes keep accruing to the exchequer. However, for expenditure funded out of collection from education cess, the source of finance is clearly identified as the cess imposed clearly states the purpose for which it is imposed. (11.) Dur et al. (2004) argue that courses with high returns, will become less attractive as higher income will require students to pay the loans back. However, it is to be seen as the post tax (or post repayment) income from course rather than arguing that the students will now be tempted to choose less lucrative courses as argued by Dur et al. (12.) As Becker (1975: 129) explains it, efficiency in allocation in human capital investment requires that the marginal social rate of return be equal for everybody. If the ratio of social to private rates is equal for all, efficiency entails

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Economics of Education Policy that all marginal private rates are also equal. The extent of inequality in the rates will indicate the degree of inefficiency in allocation of investible resources. (13.) There has also been an attempt to explain inefficient bureaucracy by the utility maximizing behaviour of the bureaucrats. Niskanen (1968) argued that the bureaucrats maximize their utility functions which contain all P’s—power, prestige, pay, and promotion (Cullis and Jones 2009). (14.) Basically there are two major elements in the public choice theory developed by James Buchanan and Gordon Tullock. One is the catallactics approach to economics which stresses on a study of institutions as exchange and spontaneous order and the classical postulate of homo-economicus to explain human behaviour (Marshall and Peters 1999). (15.) Bounded rationality challenged the conventional notion of rationality by arguing that maximization is a daunting exercise for the maximiser as it is difficult for her to go beyond the boundary circumscribed by her psychological processes. The maximiser instead is a satisficer rather than a maximiser. In the context of market, bounded rationality is the absence of perfect information or to the asymmetrical nature of relationship between two parties in any exchange relation. Market transaction requires both the parties to possess full information regarding the transaction. Bounded rationality therefore has the potential to render the market unstable, infuse uncertainty, and lead to the agents to behave opportunistically. So the contract between the principal and the agent is formalized to reduce these costs and possible distortions (Olssen and Peters 2005: 321–2). (16.) The PAT as discussed in this chapter is widely used to explain misgovernance in a hierarchical institution. (17.) The UGC has proposed to the universities to adopt a performance based appraisal system based on Academic Performance Indicator (API) where the principle of performativity and the resultant incentivization are key aspects of university governance reform in India. (18.) For health the problem is less severe as curing a disease and restoring good health can be easily assessed by a patient from a practical point of view. In contrast, students may not realize the quality of education that is being imparted even during the period of their study. (19.) This was discussed in Chapter 5 in the context of education being a screening device. (20.) The use of student–staff ratio as a proxy for teaching quality is superfluous. Wide differences across universities and nations in teaching and learning

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Economics of Education Policy practices and identifying a non-controversial indicator for teaching and learning quality which will be internationally comparable is neither desirable nor feasible. (21.) The Shanghai Jiao Tong group focuses on research output as data related to research is more reliable for the purpose of ranking the universities in an objective manner. The approach adopted by the Times Higher Education is argued to be more holistic but results obtained from the survey questionnaires may cast doubt about the coverage and the representativeness of the sample considered because of a poor response rate. Composite approaches for the purpose of comprehensive assessments may not be a good idea as they may end up revealing a convoluted picture altogether.

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Challenges Facing Indian Education and Policy Initiatives

Education and Economics: Disciplinary Evolution and Policy Discourse Saumen Chattopadhyay

Print publication date: 2012 Print ISBN-13: 9780198082255 Published to Oxford Scholarship Online: January 2013 DOI: 10.1093/acprof:oso/9780198082255.001.0001

Challenges Facing Indian Education and Policy Initiatives Saumen Chattopadhyay

DOI:10.1093/acprof:oso/9780198082255.003.0009

Abstract and Keywords This chapter deals with the emerging scenario in the Indian education sector which forms the basis of an account of the recent policy initiatives being mooted or being implemented. It is argued that a growing private-sector provisioning, particularly in higher education, has led to a compromise with inclusiveness and excellence. The basic rationale behind majority of the policy initiatives is one of establishing a quasi-market for higher education which is to be regulated by a regulatory authority, and facilitated by a grievance redressal mechanism, encouraging participation of foreign education providers, quality assurance mechanism, public–private partnership (PPP) in new ventures, and governance reform in the universities in line with new public management. The chapter ends with a discussion on various aspects of globalization of higher education. Keywords:   education, privatization, public–private partnership, governance reform, globalization, quality assurance, regulation

In this chapter we draw on our earlier discussions to evaluate critically the justification behind policy directions being contemplated by the government to meet the challenges that the education sector is facing in India. The Indian higher education sector is at a critical juncture as the challenges assume larger dimensions in view of the growing participation of the private sector in the context of global competition.

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Challenges Facing Indian Education and Policy Initiatives We begin with a discussion on the challenges faced by the Indian education system. However, the focus is mainly on higher education. In the last chapter we deliberated on the economic theory which informs policymaking in general. Since the policy thrust, though not explicitly stated, is on developing a national level market, albeit a regulated one, we undertake an exercise in the concluding part of this chapter to characterize the emerging market for higher education in terms of the freedom enjoyed by consumers and producers. The idea is that such an exercise will help us to critically examine the policy initiatives mooted by the government.

Challenges Facing the Indian Education System As discussed by Govinda and Bandyopadhyay (2011), the two major challenges in elementary education lie in ensuring universal (p.268) access and equity. Although the government has introduced the Right to Education Act and increased expenditure for the overall education sector in the EFYP (2007–12), several problems such as unequal enrolment and retention of children in schools across different social groups and different regions, shortage of well-trained teachers, and poor infrastructure are yet to be solved. High teacher–student ratios and inadequate infrastructure often give rise to dissatisfaction among teachers and their inherent bias against certain social or gender groups prevents them from developing a healthy learning atmosphere in schools (Ramachandran 2005). Due to a huge shortage of motivated teachers, the government had introduced para-teachers to save resources and solve the problems related to teacher management (Tilak 2004b). There are still a number of children outside schools who have either not enrolled in primary education, or have dropped out from school, or got excluded from schools, or completed primary education but not enrolled at the upper primary level. According to Census 2001, out of 209 million children in the 5–14 years age group, only 50 per cent (104 million) attend schools, while Selected Educational Statistics 2003–04 (Government of India 2006) shows that out of 100 children enrolled in Class 1, almost 53 per cent drop out by the time they attain the Class 8 level of education. The main challenge in policymaking in getting all out-of-school children back in schools is that this group is not homogeneous and their problems are not similar (Govinda and Bandyopadhyay 2011). Understanding the dynamics of socio-economic-political and psychological hindrances is a major prerequisite for initiating reforms in school education in India. The Indian higher education sector is faced with unprecedented challenges today. Identifying, confronting, and overcoming these challenges deserve top priority to ensure that India attains inclusive growth and sharpens her competitive edge in the emerging global knowledge economy. The three key words which are enshrined in the objectives for the government in the EFYP to achieve this are expansion, inclusion, and excellence.1 We briefly discuss some (p.269) of these challenges so as to understand the context and rationale behind the policies. However, there is a considerable degree of overlapping Page 2 of 33

Challenges Facing Indian Education and Policy Initiatives among the set of identified challenges and the problems need to be studied in a holistic manner.

The Context in Indian Higher Education High levels of poverty and worsening income inequality, as reflected in the poor ranking in terms of the Human Development Index (HDI),2 and corruption leading to large scale policy failures at all levels are some of the disturbing signs of the underlying problems in the education sector. These impede the realization of India’s potential in human resource development. India’s educational inequality as measured by the Gini coefficient is one of the worst in the world (Bardhan 2007).3 However, a sustained growth rate of around 8 to 9 per cent per annum during the last decade, despite a dip in recent years,

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Challenges Facing Indian Education and Policy Initiatives

Table 9.1 Human Development Index and Educational Attainment: A Comparative Perspective HDI 2010 Rank

GNI per Capita (PPP 2008 Mean Years of Schooling US$) 2010 2010

Expected Years of Schooling 2010

Norway

0.938 (1)

58,810

12.6

17.3

Russia

0.719 (65)

15,258

8.8

14.1

Brazil

0.699 (73)

10,607

7.2

13.8

China

0.663 (89)

7,258

7.5

11.4

Sri Lanka

0.658 (91)

4,486

8.2

12.0

South Africa

0.597 (110)

9,812

8.2

13.4

India

0.519 (119)

3,337

4.4

10.3

Pakistan

0.490 (125)

2,678

4.9

6.8

Bangladesh

0.469 (129)

1,587

4.8

8.1

World

0.624

10,631

7.4

12.3

Source: Human Development Report 2010 (as given in the Economic Survey 2010–11, Gol).

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Challenges Facing Indian Education and Policy Initiatives (p.270) has catapulted India to one of the fastest growing nations. What is misleading and disturbing is that the distribution of benefits of such a growth process has not accrued to a majority of the underprivileged.4 There is a growing realization in one section of the government that the growth process has not been inclusive. This is evident from the fact that the Planning Commission made ‘inclusive growth’ the major objective to be achieved during the EFYP.

The conditions that prevails in primary education and secondary education indicates that school education is the weakest area in India’s socio-economic achievement with high drop-out rates and a pathetic quality of education. Poor infrastructure and teacher absenteeism leading to dismal educational attainments constitute a very fragile base for the Indian higher education system (see Govinda 2011).

Mode of Provisioning: Public and Private Large Size with Failures Galore

The emerging contours of the higher education sector suggest that the ground reality is undergoing rapid transformation. The higher education system since independence has been witnessing phenomenal growth in terms of size. Poor quality of education and a semblance of demoralization among the teachers pervade the university system culminating in a situation where universities can be argued to have ceased to fulfil their basic objective (Balakrishnan 2006; Kapur and Mehta 2004). Only a few universities are able to maintain a semblance of some standard as the structure is pyramidical in nature with very few good quality institutions at the top of the pyramid. The failures are on many counts. The universities have failed to provide a signalling effect to the job market and encourage research in sciences (Kapur and Mehta 2004). Further, the industry claims that the quality of graduates is poor and a majority of them are unemployable. Growth in privately funded institutions has largely been in response to the demand for professional courses like engineering, medical science, and management as the surge in demand for these (p.271) market-oriented courses could not be adequately met by state funded universities. It has happened because a majority of such universities remain immune to changes in demand largely because of internal resistance, bureaucratic hurdles, and poor incentive structures. Notwithstanding the fact that almost half of the HE system is now private, it seems that only a part of it is known and that too superficially. There have been many attempts to study the nature of functioning of private sector institutions on a selective basis (Agarwal 2009; Bhushan 2009; Tilak 2009; Vaidyanathan 2007). An attempt was made to understand and assess the functioning of various kinds of the privately funded higher education institutions (HEIs), their fee structures, how they deliver or impart education, and how they recover the cost of education from students to fathom what the reality is (Chattopadhyay 2009).

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Challenges Facing Indian Education and Policy Initiatives During 2000–1 to 2005–6, government and aided institutions grew at 2 per cent and private unaided at 19 per cent per year (Agarwal 2009: 90–1). Since 1980, there has been a surge in for-profit private institutions in professional areas with government approval.5 As a consequence, presently one-third of the total number of colleges (15,500) are self-financing; most of them have been set up in the last two decades. Nevertheless, the spread of self-financing institutions in India has been skewed.6 Apparently, a majority of the private HEIs are legally ‘non-profit’ but in reality they function more like profit-making enterprises. There are enough cases of frictions and conflicts which arise when concerned government departments enforce norms and rules much to the consternation of private parties. As a result, regulation issue gets impinged by political elements and aspirations. Many private institutions prefer to stay free of regulations, including from the UGC and the All India Council for Technical Education (AICTE) by not getting affiliated and instead prefer to enjoy their autonomous flexibility. It is argued that the process of de facto privatization of the Indian higher education has become an ongoing process, overtly or covertly, and it reflects the failure of the resource starved state sponsored institutions to deliver quality education (Kapur and Mehta 2004) (p.272) as state-sponsored institutions have turned into degree awarding institutions which are considered to be minimum qualifications in the job market. While students look forward to pursuing professional courses to get into the job market, enrolling in coaching centres to ensure success in entrance examinations is a prerequisite. Kapur and Mehta (2004: 15) further argue that higher education suffers from ‘circle of statism’. The privatization process is caught between half-baked capitalism and socialism. They claim that the state’s ‘ideological whims’ manifest in unwarranted state intervention ‘through a web of regulations’. While the examples cited by Kapur and Mehta (2004) deserve merit, given the nature of education where quality assessment remains subjective and difficult, some forms of government control in a service sector like education is desirable. The arguments can be pitched at two different levels. One, leaving everything to the market need not solve the problem as even under the best of the conditions, there is indeed a role for a regulatory authority. Two, it is more pertinent for education, and in particular for HE, that it is supposed to meet social goals and that will be possible when the government intervenes through a slew of regulatory measures in the wake of growing share of private participants. Ownership and Objective of Private Higher Education

Private institutions have been set up with various motivations. They are driven by profit, religious intent, and cultural self-preservation (Kapur and Mehta 2004). But largely in the area of professional education, they are often driven by ‘entrepreneurial activities of politicians’. Increasingly it is also becoming evident Page 6 of 33

Challenges Facing Indian Education and Policy Initiatives that they are driven by profit and that they are owned and managed by people who lack credibility in academic circles. A majority of the institutions are mediocre and they end up as degree producing factories as they place commercial interests above all other objectives. Though they are not supposed to be ‘for-profit’ institutions as profit making is not allowed by the Indian Constitution, but the surplus generated is siphoned out through various means which are essentially on malpractices and illegalities of various kinds. (p.273)

Resource Constraint After the initiation of the new economic policy, budgetary allocations for social sectors suffered a setback both in terms of GDP as well as in the form of real per capita expenditure (Bhushan 2009; Kumar et al. 2005; Tilak 2008). However, the budgetary allocation by the centre towards higher education increased by almost nine times—an unprecedented rise in the recent years during the EFYP.7 But there are areas of concern regarding the absorption of funds at the disposal of the UGC. Only 30 per cent of the colleges under the state universities are financially supported by the UGC. Only 5,808 out of the 17,625 colleges in India, recognized under Section 2(f) and 12(B) of the UGC Act, became eligible for UGC assistance (Bhushan 2010: 31–2). Moreover, state universities and colleges hardly receive any non-plan assistance. Since non-plan grants are meant for maintenance and plan grants are meant for expansion and development, it may appear that UGC’s disbursal of non plan grants as a larger share in total disbursal than plan grants may weaken the role of UGC. (Bhushan 2010).8 However, the centre and states put together spend around 0.8 per cent of GDP which is nearly half of what is desirable, that is, 1.5 per cent as reiterated by the National Knowledge Commission (GoI 2007). The government has so far not been able to raise its budgetary share in education to 6 per cent of GNP as recommended by the Kothari Commission in 1966. It is around 4 per cent now. Since the states spend around 70 per cent of the total budgetary allocations for the higher education sector and they are perennially under a fiscal crunch, the Indian higher education sector will continue to reel under fiscal pressure as almost all the states are under the purview of the FRBM Act. The decision to raise the recovery rate to 20 per cent of the cost of higher education and sustained pursuit for alternative sources of revenue reflect this. The government’s concern to meet the growing demand for higher education is evident from the setting up of the NKC and the recent announcement made by the government to set up a central university in each state. The recent buoyancy in tax collection, political pressure, and expediency have all have led the government to (p.274) dedicate higher allocations for education. The government is keen to create centres of excellence and expand the number of centrally funded institutions as suggested by the NKC and some of the measures were implemented during the EFYP. A large share (around 80 to 90 per cent) of the expenditure is exhausted by emoluments to the staff members, teaching and non-teaching, and maintenance expenditure, leaving little for spending on Page 7 of 33

Challenges Facing Indian Education and Policy Initiatives development related items. With the implementation of the recommendations of the Sixth Pay Commission, the pressure will be on the states to defray the additional expenditure sooner or later which will impose a heavy burden on state governments to fund even the salary bills of staff members of colleges and universities. However, in view of this need for expansion of higher education, the government has to explore perforce the feasibility of trying different sources of financing higher education. Various aspects of some of the alternative sources that are discussed in Chapter 8 remain valid in the Indian context. Issues in Financing

Since the cost of higher education is on the higher side, deregulation of fees or raising it to cover 20 per cent of the total cost as once mooted by the Planning Commission will prove to be of limited efficacy. Arguments that the government is not in a position to spend more on higher education because of a fiscal constraint and there is a greater need for spending more on elementary education are not tenable. The robust growth of the economy, a rise in the tax base as a share in GDP, and growing income inequity indicates that the government could do better on tax reforms.9 Recent measures notwithstanding, the size of the black economy is around 40 per cent of GDP (Kumar 1999). However, in the presence of numerous inter-linkages between efficiency and equity in the Indian education system, it is likely that the education system may suffer on both counts (Majumdar 2005). While the suggestion mooted by the NKC to utilize land resources of universities may be able to garner sufficient resources for setting up new universities, it may vitiate the sanctity of the academic ambience of institutions (p.275) of higher learning. The other suggestion to explore the possibility of philanthropic contributions might also prove to be inadequate. Whatever be efficacy of the means of funding higher education that the government seeks to explore in the context of historical and socio-economic specificity, budgetary support for higher education has to go up. Otherwise, achieving equity and providing quality education will be seriously compromised. The UGC is contemplating different models of financing colleges and universities for implementation in the Twelfth Five Year Plan. The move will ensure equitable distribution of resources among higher education (HE) institutions and efficiency in resource use. In major parts of the world, there has been a gradual shift away from negotiated based funding to performance based and unit cost funding. Access and Equity

In a country like India with a large majority of the population being categorized as underprivileged, access to HE remains the key to climbing up the ladder of the social spectrum and for ensuring social mobility. Since independence, there has been narrowing down of caste-wise, region-wise, and gender-wise discrimination. Béteille (2006/2010: 13) argues that though well into the Page 8 of 33

Challenges Facing Indian Education and Policy Initiatives twentieth century, universities were islands in a country with low level of even elementary education, ‘University education became socially significant not because it reached into every corner of the country but because, as open and secular institutions, the universities served as exemplars and models of a new kind of social existence’. Béteille argued that social inclusiveness should not come at the expense of academic excellence of the institutions. Making a university democratic and inclusive will effect very little change in the social composition as individuals in society are unequally endowed in terms of social, cultural, and intellectual capital. Chattopadhyay (2010b) provides an overall picture of disparities in higher education in terms of enrolment, per capita income, and the number of institutions. The correlation coefficients of expenditure on education (as percentage of NSDP) and (p.276) gross enrolment ratio (GER) in percentage for all categories of states are positive and thus show a positive association between the two. The correlation between GER and number of total institutions per lakh (10 lakh = 1 million) of the relevant age cohort is positive and quite high for high income states whereas it is negative for low income states. This finding throws light on the fact that in low income states, the number of higher education institutes (other than universities, institutes of national importance, and research institutes) is less compared to high income states. The coefficients of correlations for per capita income (in rupees) and GER (in percentage) are positive and high for all the three categories of states (high, middle, and low income). Notably, the positive association with per capita income and GER is the highest for low income states. Thus, GER is a positive function of expenditure on education and per capita NSDP of the state. This suggests that expenditure on education as well as average income of the people have positive influences on GER (Chattopadhyay 2010b). Government institutions are still catering to the highest number of students across areas and gender. The percentage of rural females is higher in diploma courses than rural males. However, the share of urban males is greater in diploma courses than urban females. The shares of rural and urban males are more in private unaided institutions than by rural and urban females except for diploma/certificate courses below the degree level. Dearth of Teachers

As higher education is set to expand, one of the major hurdles in the expansion of the sector is shortage of good quality dedicated teachers. The growing economy and the associated high demand for professional degrees have rendered pursuance of professional degrees highly lucrative. Not many talented students are, therefore, aspiring to pursue higher studies and research and opt for the teaching profession. What aggravates the problem further is that only a handful of universities produce good quality doctoral dissertations. As discussed Page 9 of 33

Challenges Facing Indian Education and Policy Initiatives earlier, low morale and poor governance have contributed to poor quality education in a majority of the universities.10 (p.277) Budgetary allocations for higher education by the states have not grown commensurately with the growth in demand. The states, instead of filling up the posts lying vacant, have shown a distinct preference for running the show with contract and guest faculties.11 Sub-standard Quality and Poor Governance

Notwithstanding the substantial rise in the number of institutions since independence, the greatest concern is the delivery of sub-standard quality education. Poor quality education being delivered by the majority of the public as well as private institutions can be attributed to two different sets of reasons. For the public sector, it is poor governance whereas for the private sector, it is profit motive. As discussed in Chapter 8, the PA theory can throw some light on the present state of affairs. The fact is that the academic community in public sector institutions seems to be self-interest driven and demoralized (Kumar 2004). Commitment to teaching and research as the faculty pursues ‘prestige maximization’ is a pre-requisite for a vibrant academic ambience and is also a part of the larger problem where the agents are keen to pursue their own interests at the expense of those of the institutions that they are associated with. The hypothesis of prestige maximization is tenable only for a few high quality institutions. This process is further aggravated in view of the conflict of interests with regard to consultancy and teaching in coaching classes rather than devoting time for the departments. This is merely a reflection of a much larger malaise of growing individualization of society. Barring a few institutions, the quality of education in a majority of the private institutes is questionable as the pursuit of commercialization is not in sync with the delivery of good quality education. However, on account of improved management and accountability, private institutions can deliver good quality education. But due to wide differences, generalizations should be avoided.12 A majority of the reputed institutions are state funded like IITs, IIMs, and Jawaharlal Nehru University. In a study by Sinha (2007) on the state of two universities in Bihar, he found that meagre resources and widespread malpractices led to a deterioration in the overall academic ambience. (p.278) The apathy of society, teachers, and students are evident in absenteeism, lack of professionalism, and lethargy in regular updation of course material and guiding research with the students producing poor quality dissertations and thesis, which are also sometimes plagiarized. Networking is prevalent not only among academicians but also between academicians and politicians. Political interference can be observed in the appointment of vice chancellors, particularly in state universities. Thus, most of the universities have turned into breeding grounds for self-interested rent seeking academicians. As a result, excellence has remained confined to a few institutions. In terms of international rankings, at best some departments of a couple of universities and professional institutions like IITs are generally in the reckoning down the list. Page 10 of 33

Challenges Facing Indian Education and Policy Initiatives Poor quality is the outcome of a very complex process where lack of resources and the government’s apathy, low morale, and poor functioning plagued by corruption all contribute to the delivery of sub-standard education (Balakrishnan 2006). Of course, it remains a moot point whether we should at all be concerned with international rankings and instead should be concerned with accreditation. Quality improvement entails radical changes in the academic environment which cannot be achieved by increased funding alone. A major problem which remains is the lack of good quality motivated teachers and researchers. The salaries of teachers in government funded institutions have not been able to attract the best talent, both teachers and students, who like to be engaged in higher education. Despite increased pay scales, the situation is unlikely to change much. It seems that the choice of a career in higher education in nonprofessional courses is increasingly being determined residually after the students first opt for engineering, IT, medical, and management. Excellence: Questionable Credibility of Private Institutions

How do we account for the poor quality of education imparted by a large majority of private sector institutions? It was argued in Chapter 4 and 8, that a well-defined production function does not exist for a university or, in general, for an educational institute (Majumdar 1983; Chattopadhyay 2009). This is because (p.279) neither the inputs nor output can be identified and measured for an educational institute. Further, the inputs can be combined in various ways so as to keep costs to a bare minimum to deliver education which is often degraded to a level of production of certificates. The institutes feel tempted to take recourse to cost cutting measures to siphon out surplus which can affect quality adversely as explicit profit making is not permissible in education. Therefore, the private sector tries to take advantage of the absence of a production function and cut costs in an unfair manner. To put it differently, in a general equilibrium model, one of the assumptions is the stability of the technical coefficients (Hogan 1997). In case of education and even health, this assumption becomes untenable. Neither the inputs nor the output can be identified and measured. The institutes feel tempted to take recourse to cost cutting measures to maximize profits which can affect quality adversely. Therefore, the private sector tries to take advantage of the absence of a production function and cut costs in an unfair manner. One has to assess whether the expansion of the private sector can meet the objectives of higher education—expansion, inclusion, and excellence. For private sector based expansion, expansion cannot be inclusive because of the rising cost of education. In India, since the expansion is being mainly driven by the growth of the private sector, access will suffer. Therefore, expansion will be of little relevance for a majority of the population.

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Challenges Facing Indian Education and Policy Initiatives As discussed earlier, the structure of the private higher education sector is highly pyramidical with very few top quality institutions at the top of the heap. Hapless students are taken for a ride with regard to the fees and quality of training that they receive. Higher Education and the Mismatch in the Job Market

An important question that we need to address is whether the present GER of around 14 per cent is in sync with the occupational structure of the Indian labour market. On the one hand, graduates to the extent of 75 per cent are unemployable by the industry, and there are cases of over-education and undereducation in terms of skills and training that the workforce has been imparted with. At the (p.280) same time, with large enrolments in arts and humanities, it is also argued that there is a mismatch between demand for specific skills and discipline-wise supply of skilled manpower. As per some recent estimates,13 almost 84 per cent of the Indian workforce is employed in the unorganized sector and only 16 per cent is in the organized sector. The Indian job market is characterized by both over and under-education. Poor quality education, absence of revision of the course curricula, and lack of responsiveness of publicly funded universities to market demand for skills are some of the major factors which explain high unemployment among educated youth. Education as a screening device acts as a signal to employers about the potential productivity of their prospective employees. As explained by Stiglitz (1975) and discussed in Chapter 5, if the quality of the institutions is poor in terms of knowledge generation the informational output generated will also be substandard. Education imparted will cease to be a screening device as the certificates will lose credibility in the job market. Poor quality education is partly responsible for widespread unemployment or underemployment among graduates in India.

Characterizing the Indian Higher Education Market Four Freedoms for Consumers

As discussed in the last chapter based on Jongbloed (2004) we can undertake an exercise in understanding the features of the market in terms of the freedom that students and providers enjoy. In the process we seek to understand the nature of the quasi-market in higher education. Freedom to Choose the Provider

Getting admission to the top institutions is highly competitive as only 2 to 4 per cent of the candidates who appear in entrance tests qualify for getting into the IITs and IIMs. Freedom to choose reputed institutions as well as schools exist only in a limited sense. Institution specific reasons like fees, infrastructure, and quality influence the decision. Neo-liberals argue that freedom to choose (p. 281) the provider is a necessary condition for developing a quasi-market like situation. A majority of the institutions follow certain criteria to offer admissions Page 12 of 33

Challenges Facing Indian Education and Policy Initiatives to ensure uniformity and to avoid discrimination. The recent controversy about capitation fees in Tamil Nadu is a case that drives home the point how exercise of this freedom may degrade education.14 Transfer of credit among the universities being considered by the UGC will enable students to exercise more freedom in their choice of both courses and institutions.15 Generally students who give more weightage to ‘positional value’ prefer high-ranking institutions ahead of choice of courses as they believe the job market is characterized by status competition. Freedom to Choose Product

In view of the limited number of seats in the best institutions and high demand, the freedom to choose a course or a discipline to pursue studies at the higher level are highly limited. When students appear in examinations, if it is so required they express their willingness to study a particular course or stream. But since appearing in a particular examination requires fulfilling certain eligibility criteria, the freedom to choose is limited. Freedom to choose a product and the freedom to choose a provider may interfere with one another. If institutions have high brand value, students may choose the institution first and then the subjects. If students rely more on skills acquired, or broadly speaking human capital, to compete in the job market, they settle perforce for low-ranking institutions. However, in India the low-ranking institutes impart poor quality education, which make the graduates from these institutions unemployable. It can also happen the other way round if the subject or stream is in high demand in the job market. Counselling is often carried out by a council or a board to advise candidates to choose the product and the provider. There is often parental pressure to choose subjects and streams irrespective of the interest and ability of their wards. Adequate Information on Prices and Quality

As explained earlier, students often do not have adequate information about the institutions and the courses to choose from before (p.282) they take admission. One, education is such a commodity, whose quality can only be judged with experience over a period of time. There is also a tendency, particularly among private providers, to mislead applicants primarily by hiding information on the quality of infrastructure and education. The concerned ministry has made it compulsory for privately funded colleges and universities to upload relevant information on their websites. Once selected or admitted there will always be some amount of cheating either by raising the fees arbitrarily or by cutting costs. Qualifications of the faculty and lab facilities are hardly revealed to the candidates. Because of the heavy rush during admissions and limited options to choose from it is difficult to know the quality of education that an institute delivers. Other than the websites students gather information from the senior students, both from those who have passed out and those who are still enrolled.

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Challenges Facing Indian Education and Policy Initiatives Direct and Cost-covering Prices

There has been a substantial cost recovery by the universities, which is indicated by a rising fee structure, a greater reliance on alternative sources of revenue mobilization, an increasing tendency to introduce self-financing courses, and increased popularity of educational loans. This is tantamount to financial privatization of public institutions of higher education. According to Patnaik (2007: 7), if education ceases to be supported by the government, it becomes incapable of serving the larger interests of the people. As per the Planning Commission and the recommendation of the NKC, universities should gradually move towards higer cost recovery. However, determining the extent of subsidization in education is a delicate and sensitive matter. Particularly in higher education, the cost and quality are positively related as good quality education requires better infrastructure and efficiency gains in terms of cost minimization cannot be reaped in the absence of a wellspecified production function as discussed in Chapter 4. Any attempt to provide good quality education will imply passing on the burden to students which makes a mockery of the system as cheap education becomes synonymous with poor quality and (p.283) vice versa. This means that the worth of degrees and certificates will depend on how much a student paid towards the cost of her education. Strict adherence to cost recovery to a certain extent may face stiff resistance but it will raise a relevant question: how much does good quality education cost?16 Given the salient role of education in ensuring social mobility and social cohesiveness, letting the market determine the price of education will, therefore, pave the way for a social disaster. Four Freedoms for Providers Freedom of Entry

For a perfectly competitive market, free entry and free exit are necessary to generate competition. For a sector like education, the credibility of the investors will matter a great deal and that is why the freedom of entry should ideally be restricted. Producers will in fact be distributing degrees/diplomas and ‘create an illusion of learning (Pathak 2009: 153).17 Unfortunately, this is true for a majority of private operators today (Altbach 2009; Jayaram 2006; Vaiydanathan 2007). This is what appears to be believed by the MoHRD as is evident from its decision to set up an overarching regulatory body subsuming the UGC, AICTE, and other bodies obliquely referring to the failure of the UGC and the AICTE to maintain academic standards while granting affiliations to operate. However, even if there is a regulatory authority, compliance with requirements does not guarantee good quality education. It is often easy for private providers to circumvent the compliance requirements in an unfair manner. So the regulatory authority being contemplated by MoHRD has to be cautious. Though there are not yet too many private universities, but private sector participation has witnessed a very high Page 14 of 33

Challenges Facing Indian Education and Policy Initiatives growth in the market for professional courses (Tilak 2008). Universities can be established under state legislations but they are required to get permission from the UGC which has become almost automatic.18 Therefore, this freedom will pave the way for an unregulated market where quality will be the biggest casualty in the process. Regulated entry is what is desirable for both domestic and foreign players in the higher education market. (p.284) Freedom to Specify and Offer Products

In the government aided segment of the market, there is autonomy in offering courses, subject of course to the approval of state governments or UGC. This is particularly so as additional funding is often required to start a new course unless it is a self-financing one. As is to be expected, there is freedom in the private sector to decide courses and their content subject to approval by the relevant regulatory authority, UGC or AICTE, or as the case may be. To facilitate offering specialized courses, the UGC has been proactive for research institutions with established reputation and credibility by granting them the status of deemed-to-be universities so that they can offer degrees. However, there are some restrictions on them to diversify into other areas, as it is doubtful as to whether quality education can be delivered in the new areas by the specialized institution. Inevitably, there is a tendency among private providers to offer courses which are in high demand in the job market. As argued by Pathak (2009: 155–6) marketization could blight the quest for fundamental knowledge as market-oriented courses assume prominence at the expense of fundamental disciplines like Physics, History, and Economics. It can even lead to a sort of hierarchy of knowledge as what does not sell in the market place becomes irrelevant for students looking for courses in higher education. In India the market for professional courses is increasingly being dominated by the private institutes and there is evidence that the competition among them is also getting stiffer. There is an increasing trend of private institutions also tying up with foreign universities to develop brand value and offer courses which have relevance and acceptability in the global job market. Foreign counterparts, though mostly mediocre ones in their countries of origin, continue to evoke respect and hope among aspiring Indian students.19 Freedom to Use Available Resources

For the private sector we need to distinguish among those institutions which receive grants-in-aid and those who do not. In case of support from the UGC, the freedom to use resources as per the discretion of the institutions is rather limited as release of grants is (p.285) made with a purpose and it is subject to submission of utilization certificates. Within a particular ‘head’, there is autonomy with regard to the use of resources subject to audit. Maintenance costs, inclusive of salary costs, as a percentage of the total cost has been large resulting in a reduction in the discretionary part of the expenditure. This has Page 15 of 33

Challenges Facing Indian Education and Policy Initiatives hampered development related expenditure. However, departments can compete for funds under UGC’s several assistance schemes or apply for project/plan based assistance. Possibly there is a need for freedom to use resources by institutions as financial autonomy is a precursor to autonomy in the broader sense. Though privately owned institutions are not supposed to make profits, they are allowed to make ‘reasonable surplus’ which can be reinvested to further the growth of the institutions.20 In reality, privately owned institutions siphon out a part of the expenditure as surplus through artificial escalation of costs. At the same time, essential expenditure to deliver education is curtailed which leads to a dilution in the quality of education. Arbitrary reduction in expenditure and choice of any input combination to minimize cost is feasible as there does not exist any well defined production function for an educational institution.21 For government institutions it is often debated that the lack of freedom is stifling functioning and innovative practices. The argument is tenable if we can ensure that there was no corruption. Since the system suffers from poor governance and malpractices, financial autonomy requires the institutions to behave responsibly and also to exercise autonomy. Striking a balance is often difficult as the institutions prefer compliance with the rules. Freedom to Determine Prices

As discussed, the fee structure can be so designed so as to recover a part of its cost or even to ensure full cost recovery. As argued earlier, it is difficult to set prices as a fixed percentage of cost in the case of education. For self-financing courses, there is virtual freedom to determine the fee structure. But for the private sector, there is a greater degree of autonomy. Fees are periodically revised upwards and the overall fee structure is loaded with hidden and (p.286) unjustified demands. The brazen practice of charging the illicit capitation fee suggests that the private institutions have the zeal to break away from whatever regulations there are and in the process their true character and intentions are revealed. This has rendered education as a commercially exploitable commodity. High fee has a detrimental effect on access despite the quota regime. It is not, therefore, desirable that the unaided private providers should have the discretion over the fee structure even in higher education in the interest of a larger section of society. Freedom over prices means quiet acceptance of profit making in higher education and that will be the beginning of a decline of the higher education system against the backdrop of India’s sustained effort for building up of an inclusive society. Raising fees in the name of easy availability of loans does not help as there are many shortcomings of even interest free education loans for a country like India. Bhushan (2010: 185) argues that it is generally expected that owing to competition in a market set up there should be convergence towards a uniform fee structure. However, as the market is imperfectly competitive in view of the variation in the quality of the product across the institutions, convergence towards a single price is not expected.

Initiatives in Higher Education Policymaking Page 16 of 33

Challenges Facing Indian Education and Policy Initiatives Though the government intends to pursue neo-liberal policies in higher education, as has been the case for other sectors since 1991,22 policymakers continue to grope for solutions to strike a balance between conflicting objectives and interests. It is evident from the recommendations of the NKC and the Yashpal Committee Report (YPCR) that an independent regulatory authority has to be set up replacing UGC, AICTE, and other bodies23. While on the surface, expansion, inclusion, and excellence are the objectives envisaged by both NKC and the EFYP, there are fundamental differences in their approaches (Joseph 2007). This has serious implications for future developments in the HE sector. There is an unmistakable trend towards creating more space for private providers, both domestic and foreign players, advertently (p.287) or inadvertently. The HE sector is poised for a substantial expansion primarily to meet the growing demand for HE and the emerging need of the economy if we go by the recommendations of NKC, YPCR, and recent policy pronouncements of the government as outlined in the EFYP. However, the expansion plan of the government to attain the desired gross enrolment rate (GER) depends crucially on its ability to raise public support for HE and the ability of the system to absorb such an increased allocation.24 India is getting integrated into the world economy under various modes of the GATS regime and the role of the market; hence, private providers, particularly foreign players, assume greater importance in the internationalization of higher education under GATS. Rationale behind Private Participation

It is believed that government-funded expansion is neither feasible nor desirable. This argument is based on two assumptions. One, resource constraint is argued to be insurmountable as governments, both the centre and a majority of the states, are supposed to comply with the FRBM Act. This is bolstered by the faith reposed in the assumption that government funded HEIs are inherently inefficient and are incapable of delivering quality education. This ignores the fact that there are indeed some good quality HEIs which are funded by the government. Two, the private sector driven by profit is argued to be efficient (internally) in a competitive market. So, infusion of the market principle to foster competition, and as discussed earlier to conjure up a quasi-market in education is a major element of policymaking. The market confers sovereignty to buyers (students) and sellers (providers). The focus is on competition to achieve efficiency and eventually quality by toning up the internal functioning of HEIs to gain mileage from competition. The centre has mooted steps to develop a national level market by insisting on a national level admission test, removal of barriers, encouraging mobility among students across institutions, and replacing existing councils/commissions by one body (for example, the NCHER in place of UGC, AICTE, etc.). Once faith is reposed on the market as the best form of social institution for guiding economic activity (p.288) subject to interventions to address social concerns, it follows that the growth and functioning of the private

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Challenges Facing Indian Education and Policy Initiatives sector will need to be regulated and monitored and that is what is sought to be achieved through the regulatory authority (the NCHER Bill 2010).25 The functioning of various existing regulatory bodies overlaps creating confusions and contradictions. It affects the mobility of students across institutions as well as across courses. NKC suggested setting up a regulatory authority in the form of the Independant Regulatory Authority for Higer Education. YPCR also recommended a regulatory body, the NCHER, but for a different set of reasons. YPCR argued that knowledge fragmentation is detrimental to both knowledge generation and its dissemination. Knowledge is inherently and essentially inter-disciplinary. There have been attempts by the government in the past to usher in changes in the higher education system where the government’s role is substantially curbed and space is created for the private sector to operate. The NDA Government tried to revive the Private Universities (Establishment and Regulation) Bill, which was introduced in the Rajya Sabha in August 1995. The Bill made it explicit that private universities will be self-financing without being dependent on the government for financial support. To facilitate this, universities will offer courses in the emerging areas of science and technology. The Bill is still pending in Parliament because some of its clauses might have made it unpalatable to the private sector (Sharma 2005) like a permanent endowment of Rs 10 crore (1 crore = 10 million), 30 per cent full fee waiver, and government control and monitoring. UGC issued a concept paper in October 2003 with one of its major objectives being mobilization of financial resources to become self-sufficient. The paper also advocated nurturing commercial and corporate culture for better and efficient governance of universities.

Policy Measures under Consideration: The Bills Decision-making by students both with regard to discipline as well as the institutions from where they would like to study will ideally be based on adequate information to facilitate choice making (p.289) and mobility. Regarding informed choice making, institutions on their own should divulge necessary information through brochures and websites. This is, in a way, as an economist would argue, a step towards rectifying market failure (the problem with information asymmetry in particular and limited mobility). The process will be facilitated to a large extent by the accreditation of HEIs as envisaged in The National Accreditation Regulatory Authority for HEIs Bill 2010. In addition, this Bill will also provide an impetus for quality improvement. Accreditation will not only help students in decision-making but will also indicate where an institution stands vis-à-vis other institutions in a competitive scenario. Given the nature of education as a service, and more importantly in the absence of a well-defined production function, there is an increasing tendency among education providers to undermine the delivery of quality of education. Since mobility of students is limited, they are often taken for a ride by private institutions as they cannot Page 18 of 33

Challenges Facing Indian Education and Policy Initiatives switch institutions. In the absence of a proper grievance redressal mechanism, the centre contemplated The Prohibition of Unfair Practices in Technical and Medical Institutions and University Bill 2010. Education policy in a globalizing economy has to reflect other global concerns in some way. Every year, around 120,000 students go abroad for higher studie from India. To improve the quality of education, it is argued that the entry of foreign education providers is an imperative. To improve quality, to cater to those who leave India for higher studies, and to create a hub in the global market for higher education, the centre has proposed the Foreign Educational Institutions Bill (Regulation of Entry and Operations Bill 2010). However, the UGC has proposed to encourage collaboration among the Indian and the world’s top 500 institutions of higer education. Universities for Innovation Bill 2010: ostensibly to achieve excellence in research and to compete with the very best globally, bypassing the existing set up assuming that it is beyond repair. Restructuring of education systems in the west is being carried out with an emphasis on management, called ‘new managerialism’ which is a blend of corporate managerialism and neo-liberal theories of institutional restructuring based on the PAT and agency theory. (p. 290) The approach needs to be viewed in the context of an advocacy for the market to foster competition and, therefore, improvement in quality and achieving efficiency in resource use. This is merely an extension of market rules and principles to organizational restructuring. The public sector lacks a comparable mechanism of economic efficiency. Profit making ideally should not be an objective for privately funded institutions. Governance Reforms

Institutional reforms are crucial for countering the problem of poor governance that a majority of the institutions are afflicted with. It is argued that it is only natural that government funded HEIs will be inefficient in the absence of a profit maximization objective. Employees are not incentivized enough to deliver their best under the assumption that all individuals are self-interest driven. It is argued, therefore, that the institutions should be reformed in line with corporate managerial practices. To reform government funded institutions, UGC has suggested that promotions should be based on points to be earned by the faculty (API system, similar to NPM). The idea is to measure the performance and incentivize the remuneration structure and hold the agents accountable. And let public funded HEIs collaborate with private parties to: (a) tide over resource constraints, and (b) ensure efficiency and quality (PPPs, ‘a third way out’). It is now being felt why the private sector should be interested in investing in education unless it is allowed to make profits. Education vouchers are being advocated by a certain section because they give freedom to students and parents to choose the school and the courses. For primary education parents Page 19 of 33

Challenges Facing Indian Education and Policy Initiatives with limited ability to pay will now not be constrained to send their wards to low cost, low quality government schools.26 Moreover, education vouchers will enable the government to achieve better targeting of subsidies. Low cost schooling is also being advocated invoking the argument for economizing resources under the assumption that the quality of education will remain unchanged. Setting up of a tribunal in higher education seeks to address the grievances of students studying (p.291) primarily in privately funded institutions. This need arises because the education market lacks mobility of students and education is an ‘experience good’ which makes students suffer from information asymmetry at the time of choice of course and institutions. Students often fail to anticipate the quality of education and they are often duped by arbitrary hiking of fees and other unscrupulous measures which lead to a compromise with the quality of education. The setting up of the NCHER is a major decision by the government which seeks to replace UGC and AICTE.27 NCHER will act more like a regulatory body for the higher education market. If we look at the entire gamut of bills being considered by the government, it is quite clear that it is veering towards the third model of regulation, that is, ‘market regulation’. It is possible that market elements will gain strength which may deter imparting of value based inclusive education. Institutions are now to be ranked even within the country to facilitate informed choice making which is central to sovereignty and competition. In effect, a highly differentiated market for education is being created which will create a differentiated and hierarchical society. Cohesion in society is likely to become weaker and more fragile. Even in India, now teachers’ output or contribution is being subject to scrutiny. A university is likely to be subject to a performance audit by Comptroller and Auditor General of India (CAG) to assess its role and contribution in terms of its mandate. Procedural reforms are being initiated as the budget for education is curtailed in the name of fiscal crunch.

Privatization and the PPP Mode In the EFYP, the government proposed a major plan for expanding the Indian higher education sector. According to an estimate done by the Planning Commission, 88 per cent of the funds required for the approved expansions were to be generated through PPPs, whereas the remaining 12 per cent will be met by Planning Commission. The government emphatically reiterated the importance and significance of different PPP modes in different policy statements and realized the need for initiating necessary (p.292) legislations to facilitate private sector participation in the higher education sector. The approach paper of Twelfth Five Year Plan makes it clear that private initiatives in higher education will be actively promoted by mobilizing resources from government and private sources (Tilak 2011b). Apart from promoting private sector growth and innovative PPP models in higher education, the approach paper argues for re-examining the tag ‘non-for-profit’ in the higher education sector, creating

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Challenges Facing Indian Education and Policy Initiatives access through restructuring financial aid and loans for students and competitive research funding. Four PPP models in higher education considered by UGC/Planning Commission are: 1. Basic Infrastructure Model: Under this model, private sector invests in infrastructure and gets annualized payments from the government, which runs the operations and management of institutions (Case B in Table 8.2 in Chapter 8). 2. Outsourcing Model: Under this model, private sector invests in infrastructure and runs operations and management and receives payment from the government for specified services (Case D in Table 8.2 in Chapter 8). 3. Equity/Hybrid Model: Here the government and the private sector share the investments in infrastructure but the private sector runs the operations and management. 4. Reverse Outsourcing Model: The government invests in infrastructure but the private sector is responsible for running operations and managing the institutions (Case C in Table 8.2 in Chapter 8).

The Question of Autonomy It is argued that academic excellence is a pre-requisite for claiming autonomy and financial autonomy is crucial in this regard. Government support in the form of grants comes with strings attached. Like IITs and IIMs enjoy more autonomy because of (p.293) their lesser dependence on the government for grants. Their dependence on the government is less because of other sources of revenue including greater manoeuvrability over fees. Colleges and universities do not enjoy such financial autonomy as fees are on the lower side or moderate as the basket of courses offered is mixed, professional and non-professional, and the practice of fee discrimination is difficult. The IITs and IIMs can rebut the argument that access will suffer because the students who cannot afford to pay the fees, can take recourse to education loans. This argument cannot be invoked by government supported HEIs. To wriggle out of financial dependency on government support, HEIs have also shown a distinct inclination to offer marketoriented or self-financing courses at higher fees. However, admission to both IITs and the IIMs has to follow the government policy for the purpose of equalization of access and opportunities. There have been some attempts to give greater autonomy to IITs and IIMs as they have hiked the fees in the recent past. Autonomy has also been bestowed on them to bypass government rules and recruit foreign faculty at a higher pay package. Since autonomy comes with the question of accountability, the objective of an institution and the character of its management are important. Privately funded HEIs with a greater dependence on fees can exploit students’ vulnerability to Page 21 of 33

Challenges Facing Indian Education and Policy Initiatives information asymmetry and craze for degrees. This abuse of autonomy which is rampant in a major part of the HE private sector can be tackled or restricted only through regulation. Regulation becomes necessary to strike a balance between autonomy and accountability in a broader sense of the terms.

Globalization of the Indian Higher Education Market The role of education, in particular higher education, in economic development assumes a new dimension in the context of the emerging global economy. Though internationalization of Indian higher education has been an ongoing process as it has been in the world, globalization under the WTO-GATS policy framework (p.294) deserves careful attention. Government policies to permit foreign investment in India and to consider education as a tradable service under the overarching GATS framework have added a new dimension to the challenges that the Indian higher education system is faced with.28 Increased connectivity with the rest of the world through a variety of channels under the four modes as recognized by GATS requires careful negotiation by the government. Before we proceed we need to define globalization and distinguish it from internationalization in the context of education. Nayyar (2006, 2007: 30) defines globalization ‘…as a process associated with increasing economic openness, growing economic interdependence and deepening economic integration in the world economy’. Globalization is expected to lead to the unification of world economic development whereas internationalization can be viewed as a response in a proactive manner with respect to quality and excellence, and, broadly speaking, treating education as a public good. Globalization relies more on competition than on cooperation with an underlying threat to the concept of education as a public good (Tilak 2011a: 21–2). Khadria (2011: 27) distinguishes between geo-political and geo-economic aspects in the context of globalization. He argues: ‘…whereas a geo-political definition will satisfy globalization of knowledge workers in the sense of their physical translocation across sovereign states and change of citizenship only, a geo-economic definition in the international trade framework will have a more qualified requirement.’ In order to understand the implications of GATS for the Indian education system, we now discuss the four modes recognized by it. These modes have varying implications for the realization of the objectives envisaged for higher education and its expansion, inclusion, and excellence. Though India has not made any formal commitment to GATS but interactions with the rest of the world under all four modes have gathered momentum. The legislative initiatives being mooted by the government and rapid growth in private participation have set the stage for embarking on formal trade in higher education (Tilak 2011a: 93–5).29

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Challenges Facing Indian Education and Policy Initiatives (p.295) The implications for Indian higher education can be best studied within the framework of a global market for higher education. It is felt that opening up of Indian higher education to global competition will pose a threat for the Indian higher education as India is not favourably placed in the global map for higher education. There is a need to address the following questions. Will globalization help India: (i) raise its gross enrolment ratio, (ii) enhance its capacity in the world of knowledge production, (iii) effect improvements in the quality of education, (iv) enhance access keeping in mind its socio-economic profile, and (v) meet the demand for skills forthcoming from the growing Indian market? Various Modes

In order to understand how GATS will affect the national education system in a variety of ways one has to examine the four modes under which transaction of education services can take place. Mode 1: Cross-border supply of education which facilitates programme mobility. Examples are distance education and e-learning or virtual education programmes and use of ICT and internet facilities including supply of materials through the internet and DVDs. In this mode, a nation with poor infrastructure can gain in the process of international cooperation for the realization of right to education, but access to adequate technology is a necessary prerequisite to reap full benefits. Mode 2: Consumption of education abroad or student mobility as students go abroad to pursue higher studies. Almost two-third of the students including top ranking students from best institutions pursuing professional courses and PhD degrees, prefer to stay back, leading to brain drain in developing world. Education fairs are being regularly organized in India where representatives from foreign universities seek to disseminate information about their programmes and costs. Foreign universities evince interest because it is business for them, whereby the countries encourage this as the migration of foreign students would help in neutralizing the aging population abroad (Khadria 2011). (p.296) Mode 3: Commercial presence or institution mobility. Examples include opening up of local branches, or satellite campuses and partnerships with local institutions. Foreign direct investment (FDI) in the sector is expected to bring about improvements in infrastructure and expand facilities for providing quality education. The most debatable area is liberalization of access to national education markets by foreign institutions either through cross-border supply or through commercial presence. This mode is central to transnational education which has the potential to facilitate transactions in all the other three modes (Khadria 2011). Foreign investors can either invest on their own or through joint ventures and establish partnerships through twining arrangements. Already foreign universities are in collaboration with their Indian counterparts and run Page 23 of 33

Challenges Facing Indian Education and Policy Initiatives joint programmes and a majority of them lack credibility even in their own countries. However, they cannot offer degrees in the absence of a regulatory framework. Mode 4: Movement of natural persons: Mobility of professionals has registered a phenomenal increase which began with brain drain and was facilitated by immigration laws. Apart from this, scientists, doctors, engineers, and now professionals such as lawyers, architects, accountants, and managers in transnational corporations (TNCs) have become transnational employers of people. Investment in human capital is made by home countries and returns accrue to host countries. Therefore, for home countries, there is externalization of benefits and internationalization of costs. Professors, teachers, researchers, professionals, and trainers participate in this mode which may lead to a shortage of skilled professionals including teachers in India. Universities enter into MoUs to facilitate cross-border research. However, this mode has the potential to foster cooperation in the realm of research as well. Modes 1 and 4 can signify ‘embodied internationalization’ of education whereas Modes 2 and 3 will lead to ‘disembodied internationalization’ of education (Khadria 2011: 208). (p.297) Impact

International trade in educational services is more commercialized and less regulated in comparison to the prevailing national system. Spread of markets in the context of globalization has led to the emergence of higher education as a business. Technology has brought about a dramatic transformation in distance education and in the mode of its delivery. In the process, standardization or homogenization at the global level will interfere with free inquiry and university autonomy. Public institutions may feel threatened if national governments are committed to national treatment leaving no scope for discrimination between national and foreign providers in the issue of subsidization. Gradual marketization of education in the global arena has generally been viewed with suspicion and concern (for example, Tilak 2011a and many others). The fundamental question is whether higher education can be treated as a commodity at par with other tradable commodities and particularly so in the context of India’s concerns and needs. Therefore, the question is: should we shy away from global competition since arguably in the realm of knowledge lies India’s strength? In effect what globalization will do is to usher in a market with domestic and foreign players participating together. Barring a few, a majority of the Indian universities are not on the same level to compete with foreign ones as competition will not only be among the unequals, the very nature of competition to achieve quality is problematic (Chattopadhyay 2010a).

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Challenges Facing Indian Education and Policy Initiatives Apparently it seems that globalization promotes right to education which is debatable. But at the same time, it creates ‘dual market structures’ (Devidal 2009: 82; Marginson 2004) as it categorizes between good and bad, rich and poor. If foreign degrees are valued at the expense of national degrees and foreign degrees symbolize status, it turns out to be a zero-sum game as those who studied abroad gain at the expense of those who did not when it comes to selection in the national job market. As Marginson (2004) argues, social competition or ‘status’ competition for higher education being a ‘positional good’, is broader and more pervasive than market competition. But since globalization is being led by the neo-liberal (p.298) agenda, market competition gains salience, which will lead to further accentuation of social differentiation and hierarchy. The Question of Expansion

Mode 1 will contribute to expansion but it is not necessary unless there are critical gaps in education and skill areas. Mode 2 opens up a new avenue for students who have the merit and ability to pay. Mobility of students and universities is in response to unmet demand in one country or the other. Under Mode 3 foreign universities may set up their branches in India. Though foreign presence will apparently lead to an expansion of the higher education system, the Indian system may suffer from irreparable damage with the migration of students and faculty and with the creation of an unhealthy and undemocratic academic ambience with two parallel systems running. Under Mode 4, expansion of education and research avenues may take place with the spirit of cooperation being the guiding factor but may create shortage of skilled personnel in India. Education and Society: Inclusiveness

With inclusion being a major objective, the question is whether the government’s recent initiatives to ensure inclusive expansion of higher education will be diluted. Globalizing forces will aggravate the present situation where the battle seems to be almost lost because privatization cannot lead to inclusion by the sheer force of the rationale behind its growth. Profit making or not, it is inevitable that the cost of education will be higher comparatively speaking. Apart from being expensive, if the admission process to foreign institutions does not conform to the process followed in publicly funded institutions, access will inevitably suffer in the broader context. One way to mitigate this will be that the government gives financial support to students and/or to the institutions directly when they are managed by the private sector or are based on the PPP model. Globalization has, therefore, the potential to exacerbate social inequalities by limiting the scope for social mobility. Marketization (p.299) at the global level bestows freedom to consumers and providers about the choice of courses, fee structure, and the choice of institutions in two different sides of the market. The question is what will be on offer, that is, courses and their content and their relevance for India. The most serious and possibly the most damaging Page 25 of 33

Challenges Facing Indian Education and Policy Initiatives implication is that education will now be provided at a higher price despite increased participation of private players in a market-dominated system. The prevalence of capitation fees and availability of seats in the management quota in colleges exhibit the dominance of the pricing principle which prescribes price based on the utility of a product which is roughly a mark-up over the unit cost of education. Courses fetching lucrative jobs are costlier, generally speaking. Accreditation of course helps in differentiating the fee structure and fosters competition among the providers of education. The questions of access and equity become critical issues in the context of globalization of higher education in which there are very few quality institutions, both public and private (Carpentier et al. 2011). Given India’s population and need, it cannot abdicate its responsibility to the poor and middle classes, Scheduled Castes (SCs), Scheduled Tribes(STs), and the other backward classes (OBCs) of providing them quality education. This will probably have two serious fallouts. Given India’s situation, globalization may turn out to be a one-way process if competition gains in strength compared to cooperation. It is also possible that two parallel systems of education will emerge. One is the existing system largely funded by the government catering mostly to traditional courses and general streams at a subsidized price to the masses, particularly to the economically challenged section of society, and the other is the mostly privately owned domestic and foreign players catering to market-oriented professional courses largely to the privileged class. This will widen the gap and erode cohesion in the fragile societal structure in India. Quality

Concept and meaning of the quality of education cannot be studied in isolation from society and its relevance for equity and culture. (p.300) Now there emerges a corporate dimension to the understanding of the concept of quality. Since the concept of quality education is contestable as it can be conceptualized as a marketable skill or value education, the implications of the globalization of India’s higher education under different modes will also remain contentious and debatable. Under Mode 1, it depends on what kind of courses are on offer and their relevance. Under Mode 2, given the fact that foreign universities are of superior quality, access to quality education will now, generally speaking, be available. Under Mode 3, the impact on quality is likely to be salutary but there is considerable uncertainty both because of course content and the reputation of foreign providers. Under Mode 4, cooperation achieved through mobility or for any other channel may contribute both positively or negatively towards an improvement in teaching and research capacity. The way to tackle the threats posed by globalization is to seize the opportunities it brings with it and exploit them to the hilt as the ongoing process is irreversible and inevitable.

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Challenges Facing Indian Education and Policy Initiatives If we adopt a broader vision of education and the associated concept of quality, commodification of education is to be resisted as education is argued to be a public good, and so provision of quality education cannot be a commercial activity (Sobrinho 2009). It must be an instrument that reinforces democratic values, strengthens national sovereignty and national identity, and should perform a critical role as a guardian in open societies (Nayyar 2007: 33) and not merely contribute to the process of economic development. The global public good nature of higher education may severe the link that education has with its historical roots and from an institution’s specific physical environment, and construction of national identity. Comprehensive human development and critical and reflexive capacities in citizens are of immense value to realize the externalities that education generates. It is time that higher education is also elevated to the status of a right and a duty of the state. Curriculum

The question of quality education and curriculum are in a way linked. In a competitive set up with rising dominance of the market, (p.301) universities offer courses which are market determined. Market forces are determining research agenda and resources for science resulting in lack of resources for humanities. Public funded universities are often resistant to changes, and are somewhat inefficient. The range on offer is less likely to meet the perceived social and developmental needs of the nation. Markets at the global level will have influence over the course curriculum. Globalization of the curriculum will decontextualize the curriculum from the local context and thus make it less relevant. Implicit social values of exporting countries will inform curriculum design. Since WTO treats education as a commercial, tradable commodity with substantial diminution in its role in nation building, an indigenous store house of knowledge, in transmission of culture and language. Curriculum design will come under the influence of global commercial forces which effect convergence possibly at the expense of national interests and culture. Governance Reforms

The pros and cons of governance reforms under the neo-liberal framework have been discussed in Chapter 8. Independence of the faculty and an institutional mechanism for checks and balances in society deserve immediate attention. Organizational cultures of universities in terms of administrative and performance measures are being designed in line with the NPM reform (Marginson 2010b: 139). However, the measures are locally nuanced and there are variations within common university imaginings. Social sciences and humanities contribute to the differences. The political economy of funding with its effect on the extent of cost recovery is another source of diversity. Rizvi and Lingard (2010) and Olssen et al. (2004) have expressed reservations about the desirability of NPM in universities. Globalization has become a powerful medium for the spread of NPM practices world over since 1990s, and in the process,

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Challenges Facing Indian Education and Policy Initiatives NPM has been contributing to the reshaping of the knowledge economy as a striking example of policy synchrony. (Marginson 2010b: 139). Strategy making has to consider all three dimensions of space—global, national, and local—and achieve synergies among them. (p.302) This setting is characterized by ‘glonacal’ which is the sum of global, national, and local. The challenge lies in combining all these three when they are heterogeneous in their agents, relationships, behaviours, and resources (Marginson 2004, 2010c: 210). Education and Knowledge

The indigenous knowledge base will be threatened in the wake of widespread marketization of knowledge coupled with the pressure of the market on redesigning the curricula to cater to the global demand for skills. As knowledge is not a homogeneous commodity, it is an imperative for every nation to nurture and nourish its intellectual capital. It is the responsibility of the intellectual capital to lead the country in policy matters and to change social conditions of production and distribution for the benefit of the majority (Patnaik 2007). Poor quality education provided by a majority of the private sector complicates the situation. The problem lies with the credibility of lesser known players and the craze for foreign institutes in the absence of a regulatory regime. When India embraces the global market, it is important to take cognizance of the possibility of subversion of market principles and market ethics by the private sector in its pursuit of profits. Education as a Human Right

Associated with GATS is the risk of transforming human rights into services under the dominant forces of the market. Civil society and a large majority of teachers and students have denounced the trade oriented definition of education. Though the commitments are voluntary in nature, often there is little space for the states to decide as the bargaining process creates pressure on the economically weaker states. GATS may facilitate privatization of education where economic interests will dominate over social interests. Internationalization devoid of a profit motive which banks on cooperation is possibly a better way to embrace the global world of knowledge without being pushed to the corner in the competitive global market. (p.303) Globalization is argued to promote international cooperation and cultural diversity. At present there exists huge asymmetry in the spread of globalization across the border in terms of direction of people movement, distribution of resources, status, and research activity. The openness varies across the countries. American universities do not have to reach out to the world but offer their own national self as the global template (Marginson 2004: 230). Students from the developed nations visit the top universities of the developing nations only as a part of exchange programme. Page 28 of 33

Challenges Facing Indian Education and Policy Initiatives Higher education is a social public good so: (a) states have the fundamental duty to guarantee this right to provide education which is pertinent and of quality, and (b) fostering access to quality HE through appropriate strategies and actions.

Meeting the Three Objectives of Higher Education: Expansion, Excellence, and Inclusion While it is true that privatization of the higher education system has helped in bridging the gap between growing demand and stagnating supply mainly for professional courses delivered by government institutions, aided and non-aided (owned), one has to assess the growing role of the private sector from a larger perspective of meeting the three objectives of the higher education system. Though there are indeed quite a few quality private institutions, a majority of them impart education of questionable quality. Regional disparities are accentuated by market-oriented education reforms and privatization as the institutions are set up in high income states. Expansion of the higher education sector and raising GER to make it comparable to major nations of the world is one of the three key objectives of the government along with inclusion and excellence. Growth in demand for higher education has been faster than the growth in population since independence. Enrolment has been growing at 5 per cent per annum during the last two decades, which is two and half times more than the population growth (Kapur and Mehta 2004). As higher education replaces land to provide economic security, rise in demand for knowledge (p.304) in the economy, and with higher enrolments at the school level, the demand for HE will only rise (Hashim 2008). At present, GER in higher education which is around 15 per cent needs to be raised to 20 per cent by 2015 as per the recommendation of the NKC.30 In comparison, developed countries have a very high GER in higher education.31 Achieving expansion in GER entails a lowering of drop-out rates leading to an improvement in enrolment in secondary schooling, and major improvements in the quality of education is a prerequisite for this. The sheer size of the population and resource crunch that the government, the centre and the states claim to be facing,32 complicate the task of the government against the backdrop of globalizing higher education irrespective of India’s pending commitment to GATS. But the crucial question which remains is how to ensure equity with excellence and what will be the relative role of the government and the private sector to meet this challenge. The biggest challenge for the government is pursuing all the three objectives simultaneously. NKC will like to believe that there exists trade-offs between any two of the three objectives. If expansion is funded by the government, expansion will be inclusive but excellence is not guaranteed as testified by past experiences. If expansion is driven by the private sector,

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Challenges Facing Indian Education and Policy Initiatives inclusiveness will be at stake. Further inclusiveness and excellence may conflict with one another.

Concluding Remarks: Looking Beyond Commodification The pessimism with the economics of education has to do with a narrow focus of ‘mainline’ economic theory. With a changing society, the ever changing process of knowledge creation, and in view of the ongoing pursuit for building a just society where human beings realize their potential, policymakers have a daunting task ahead. In a world which is being increasingly dominated by economic logic, it is a challenge to design policies in a highly differentiated society and yet not compromise with what education signifies and its role in building a just society. This is because economic theory has always informed policymaking. And it ought to be so. But when (p.305) the theory makes errors to conceptualize education, what Majumdar (1997) referred to as ‘category mistakes’, policies will have grave consequences for the education sector, and therefore, for economic development and society. The application of neo-liberal thinking will make teachers as workers, students as investors, and a university a factory. Achieving efficiency, so coveted by economists will turn out to be costly for society and will impede the process of inclusive growth. There is a need to explore the interface between the economics of education and other social science disciplines to contribute towards making a humane and context specific education policy rather than following a one policy suits all kind of approach. Economists have a challenge: how to infuse societal concerns in economic policymaking and begin the process of de-commodification of education. If education is for nation building and if education is for building capabilities for democracy, we need to construct a different framework for policymaking. Notes:

(1.) The fourth one which is often added is relevance of education. (2.) As per rankings in terms of the UN-HDI index (2011), India’s rank is 134. (3.) The distribution of adult schooling years in the population as measured by the Gini coefficient was 0.56 in 1998–2000, whereas China had a Gini coefficient of 0.37 in 2000. (4.) Alternative Economic Survey, 2006–07. (5.) Though profit making in education is not permissible in India, the nature and objectives of private providers are often commercial in nature as evident from their operations. (6.) In Southern States like Andhra Pradesh, Tamil Nadu, and Karnataka as well as in Maharashtra, private colleges outnumber public ones. The growth pattern in Andhra Pradesh is illustrative as in 2000–1, 64.81 per cent of the total number

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Challenges Facing Indian Education and Policy Initiatives of colleges were private while the share of government and the aided colleges together was just 35 per cent (Gnanam 2008). (7.) Possibly the budgeted amount as per the approved plan will not be spent by the end of the EFYP as the system will not absorb the extra resources. (8.) This is however difficult to accept as non-plan grants meant primarily for functioning are no less important for an institution to deliver quality service. Plan grants create assets but once created, assets have to be maintained. (9.) Recently, the Professor Tapas Majumdar Committee has also referred to this. (10.) The shortage of faculty in engineering is the severest. The Indian Institute of Technology (Mumbai) offers Rs 3 lakh for those who join as faculty. Nearly one-fourth of the faculty posts are lying vacant. The main reason cited is the regulated salary structure of government institutions. Run-of-the-mill software experts with five years of experience earn what is equivalent to the peak salary of a senior faculty. In the seven IITs put together, there are 900 vacant positions. India faces an acute shortage of doctors, nurses and paramedics. As per a Planning Commission study, India is facing a shortage of 0.6 million doctors, 1 million nurses, and 0.2 million dental surgeons. (http:// articles.timesofindia.indiatimes.com/2010-08-07), last accessed on 16 May 2012. (11.) The low success rate in UGC conducted eligibility examinations like NET has further contributed to the shortage as many bright research scholars enrolled in PhDs cannot apply for the posts. (12.) There is often illegal exchange of money in the transaction of higher education, which renders the institutions as shops offering degrees for sale. It is known that supervisors accept money from their research students for registration and further for writing their dissertations. The dissertations are also sent to the examiners who are known to the supervisor and there is a likelihood of reciprocity. (13.) Statistics published by the National Commission for Enterprises in the Unorganised Sector (NCEUS) Report 2007, submitted in April 2009, under the Chairmanship of Dr. Arjun Sengupta. (14.) The Times of India, Delhi edition, 4 and 5 June 2009. (15.) Mobility of students across universities between two Indian universities as well as between Indian and foreign universities (Prakash 2011). (16.) This is not to deny that there is no scope for reorganization of an institution to raise efficiency and better use of resources. Corruption often leads to gross

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Challenges Facing Indian Education and Policy Initiatives misutilization of resources. Before we seek to raise cost recovery, achieving good governance is essential. (17.) Since education is a concurrent subject under the Constitution, some states like Chhattisgarh have enacted Private University Acts on their own, and this has led to the mushrooming of private universities in the state. (18.) The proliferation of deemed universities has become a contentious issue after a change in the leadership in MoHRD. (19.) India does not yet have a legislation in place to regulate foreign collaborations. Varying jurisdictions between the central and the state governments and varying policy perspectives are the major hurdles (Altbach 2009: 44). (20.) In 2002, in the case of T M A Pai Foundation vs State of Karnataka, the Court ruled, ‘…the government can provide regulations that will ensure excellence while forbidding capitation fees, …there can be however, be reasonable revenue surplus which may be generated…’ It was further clarified in another judgment in 2003 (Islamic Academy of Education vs State of Karnataka) that fee should correspond to cost, surplus to be used for investment, and no profiteering be allowed. (21.) Majumdar (1983). Inputs and outputs are not only well-defined, there exist many combinations of inputs to produce outputs as the concept of quality remains vague and arbitrary. (22.) The year 1991 marks the beginning of economic reforms in response to the balance of payments crisis. (24.) The unprecedented rise in financial support for the higher education sector could not be utilized by the end of the EFYP. There are many systemic reasons behind this underutilization. One of them is delay in identification of land and setting up of universities. (25.) The National Commission for Higher Education and Research Bill, 2010. The Bill as per the draft is ‘An act to provide for the determination, coordination, maintenance of standards in and promotion of higher education and research including university education, technical, professional other than agricultural [and medical] education’ (http://www.ebookbrowse.com), last accessed on 16 May 2012. (26.) All government schools are not of poor quality. It is generally believed that private schools impart good quality education albeit at a higher cost. (27.) It is yet to be implemented.

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Challenges Facing Indian Education and Policy Initiatives (28.) In 1995, 12 tradable sectors with education being one of them led to the formation of GATS. (29.) Tilak (2011a) provides a detailed survey of trade in education under all four modes. The top 10 universities in India receive foreign students to the tune of 10,000 which is two-third of the total number of foreign students (Tilak 2011a: 96). Whereby, nearly, 1,70,000 students went abroad to study (Tilak 2011a: 101). (30.) Due to different sources of estimating the GER, it is difficult to cite the current GER exactly. However, Human Resource Development Minister Mr. Kapil Sibal stated the GER roughly at 15 per cent which has to be doubled by end of 2020. (Source: http://www.indiaeducationreview.com, dated 03 January 2011, last accessed on 16 May 2012). The GER may have exceeded 17 per cent by end of the EFYP (UGC 2011). (31.) It was 72 per cent in Australia, 60 per cent in the UK, 83 per cent in the US, and 20 per cent in China in 2005 (Agarwal 2009: 28) (32.) An obsession with reducing fiscal deficit will always give an impression of resource crunch. It is a question of priority and political willingness to curb tax evasion. Though tax collections have witnessed considerable improvement in the last three years, it is argued that the government could still do better.

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Education and Economics: Disciplinary Evolution and Policy Discourse Saumen Chattopadhyay

Print publication date: 2012 Print ISBN-13: 9780198082255 Published to Oxford Scholarship Online: January 2013 DOI: 10.1093/acprof:oso/9780198082255.001.0001

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Index

Education and Economics: Disciplinary Evolution and Policy Discourse Saumen Chattopadhyay

Print publication date: 2012 Print ISBN-13: 9780198082255 Published to Oxford Scholarship Online: January 2013 DOI: 10.1093/acprof:oso/9780198082255.001.0001

(p.325) Index Academic Performance Indicator (API) 265 accountability 204, 220–1, 225, 240–1, 252, 254, 263, 277, 293 accreditation 13–14, 218, 256, 261, 278, 289, 299 of higher education institutions 260–3 agency theory 219, 250–2, 289. See also agents agents 12, 18, 54, 73, 138, 219, 250–3, 265, 277, 290, 302 Akerlof, George A. 120 All India Council for Technical Education (AICTE) 271, 283–4, 286–7, 291 Arrow, Kenneth J. 73, 76, 82–3, 120 model of 74, 79 Attiyeh, Richard 91, 101, 104, 106, 113 basic education 149, 167. See also schooling Becker, Gary 3, 19, 22, 24, 30, 32, 34–8, 41–7, 49, 53, 92, 99, 107, 120, 239 model of 53, 92, 239 Blaug, Mark 3, 21, 23, 26, 30, 35–6, 49, 53, 118, 127–8, 130–1 Bowles, Samuel 105, 119, 151–3 brain drain 179, 295–6 Buchanan, James 156, 177–8, 265 business capital 34–5 capabilities 7, 48, 140–6, 150 capability approach 6–7, 22, 54, 140, 143, 146, 150 capital market 25, 32, 44–5, 133, 152, 228, 240 capitalism 151–4, 193–5, 272 capitalist economy balance 151 choice of school 259–60 citation index 262 Cobb-Douglas type 60, 75 collective choice approach 8. See also choice of school college education 34–6, 86, 90, 111, 214, 227, 236, 271, 273–4, 293, 299 commodification of education 4, 8, 11, 180–4, 300 Page 1 of 13

Index of knowledge 64 commodities 11, 54, 63–4, 95, 140–5, 151, 154, 188, 209, 212–13, 257, 282, 297 (p.326) competition 10–11, 13–14, 81–4, 96, 114–15, 189–90, 195, 198–9, 204–6, 208, 215n9, 219–20, 235, 258–60, 283–4, 286–7 market-like 259 competitive market 28, 81, 158, 188–9, 198, 206, 210–11, 255–6, 283, 287 constant returns to scale 58, 70, 77, 80 consumers-students 206, 213 consumption 17, 19, 42, 64, 145–6, 158–61, 164, 167, 169, 171, 173–6, 178, 200, 202, 213 benefits 31, 64, 102, 105, 108, 125, 160–1 non-rivalry in 64, 160, 164, 171, 173 rivalry in 64, 69 corruption 24, 164, 236, 249, 252, 269, 278, 285 cost of education 33, 38, 44, 97, 110, 112, 121, 127, 163, 213, 231, 246–7, 271, 279, 298–9 production 112–13, 166, 212 creative destruction 82 creative economy 85 creativity, theft of 195. See also patenting cross-border recognition 179, 181 cross-subsidization 110, 236 curriculum 103, 169, 238, 241, 300–1 decontextualizing 301 customer-input technology 103, 115 decision-making agents 54, 115, 260 deemed-to-be universities 284. See also universities demand for education 45–8, 15n6 demand–supply approach 15n4 Denison, E.F. 3, 19, 57–9 de-professionalizing teachers 255 development 145–7, 155 education in 140, 155 and entitlements 141 discrimination 145, 208, 228–9, 255, 281, 297 economic growth knowledge as factor of 182 sources of 57 economic(s) development 80, 140, 144, 222, 293–4, 300, 305 of education 1–6, 19, 21, 25, 52, 90, 118, 154–5, 221, 225, 233, 253, 257, 304–5 efficiency 111, 164–5, 193, 290 of knowledge 63, 80, 87–8, 193 liberalism 218 theory 1–4, 6, 9–11, 13, 18, 20–2, 55, 63–4, 67, 81, 83, 90–1, 94, 127, 304 education 98, 146, 150, 152, 171, 181, 190, 240, 295 analysis of 1–2, 4, 164 capabilities for 146 as capital good 23 Page 2 of 13

Index classification of 8, 156, 166, 171–3, 217 delivery of 11, 17–18, 55, 91, 94–5, 101, 188, 191, 201, 220, 241, 245 as economic good 171, 173, 188 as investment 224 levels of 4, 9, 27, 35–6, 39, 49, 56, 91, 119–20, 134–5, 153, 164, 181, 187–8, 200 loans 44, 192, 197, 208, 224, 226, 228–30, 237, 293 marketization of 297 objective of 208, 213, 240 policy 9, 153, 171, 217, 221, 289, 305 policymaking in 1 as private good 167–8 (p.327) public–private participation in 241 quality of 12, 113, 245, 248, 253, 271, 277, 282–3 quasi-market in 287 role of 146, 155 reforms 2, 51, 214, 223, 240, 252, 260, 303 as screening device 119–27, 280 sector 18, 36, 113, 214, 218, 221–2, 239, 247, 267–9, 305 as service 174, 261 and society 4, 298–9 system 18, 113, 130, 152, 169, 191, 223, 274, 289 technical 183 theorization of 221 and training 5, 24, 30, 32, 58–9, 66, 79–80 education market 9, 13, 189, 191, 198, 202, 207–8, 212–14, 217, 256–7, 260, 291 regulation of 263 educational production function (EPF) 91, 94, 99–102, 107, 114 educational institutions 5–7, 9, 11, 18, 85, 90–1, 94–6, 98, 103–5, 109–10, 112–14, 116, 126, 165, 278–9 opportunities 149, 191, 240 output 99–102, 104, 107, 126 processes 90–1, 111–12, 150, 239 systems 114, 141, 151–2, 251 efficiency 5–6, 10–12, 14, 90, 94–6, 111–15, 218, 221, 225, 239–40, 253, 255–6, 259–60, 265, 274–5 egalitarian approach 45–6, 48–9 elite institutions 195–6 elite approach 46–7, 48–9 emotional quotient (EQ) 20 endogenous growth theory 5, 22, 62, 70, 78, 83, 85, 87, 164 entitlements 141–2, 145, 235 entrepreneurship 82, 85, 244 equalization 95, 121, 142, 191, 293 of marginal social rate of return 49 of opportunities 97, 108 exchange 11, 13, 18, 103, 111, 132, 151, 265 expected rate of return 8, 31, 136 expenditure on education 3, 20, 51–2, 133, 275–6 Page 3 of 13

Index as investment 25. See also investment ‘experience good’ 13, 98, 208, 261, 291 external efficiency 165, 241 externalities 164–5, 185n13–14 faculty 97–8, 110, 114–15, 174, 205, 214, 237, 250–1, 254, 260, 262, 277, 282, 290, 298 fees 19, 39, 96–7, 110, 113, 191, 198, 209, 226–7, 231–2, 274, 279–82, 285–6, 291, 293 deregulation of 227–8 in government schools 227 structure of 212, 227–8, 271, 282, 285–6, 299 female literacy 149 financing education 41–2, 44, 228 higher education 226–7, 237–40 Fitzsimons, Patrick 52–3, 154 foreign direct investment (FDI) 296 foreign education providers 14, 212, 289 Foreign Educational Institutions Bill 289 foreign universities 284, 295–6, 298, 300 for-profit institutions 90, 206, 272 FRBM Act 231, 273, 287 freedom to choose 142, 144, 207–9, 280–1 of entry 283 for providers 211–12 Friedman, Milton 22, 206 (p.328) functioning(s) 18, 94, 114, 140–5, 147, 149–50, 155, 164, 187, 191, 199, 225, 241, 271, 288 funded institutions 12–13, 96–7, 109, 111, 115, 139, 220, 225, 242–3, 246, 253–4, 270, 274, 278, 290–1 funding education 47, 96 (See also financing education) capital market for 44 gender discrimination 142, 145, 256, 275 General Agreement on Trade in Services (GATS) 14, 180–1, 185–6n18, 256, 287, 294–5, 302, 304 Gintis, Herbert 105, 119, 151–3 global knowledge economy 179, 195, 220, 222 global private goods 178–80 global public good 179, 181 globalization 14, 181, 193–4, 222, 293–4, 297–301, 303 government aided institutions 97, 210, 212, 271 funded schools 158, 167, 191, 245, 263, 307n26 ‘government failure’ 12, 254, 263–4 graduate tax (GT) 226, 231–2, 235 growth mechanism 61, 70, 87 growth models 5, 22, 57, 59, 63, 70, 79, 86, 193, 195 Hanushek, E.A. 21, 86–7, 94, 98 happiness 142, 144–6, 164. See also capabilities health 17, 24, 36, 79, 140, 142, 164–5, 171, 174, 257–8, 266 Page 4 of 13

Index economics of 15n1 higher education 9–14, 170–6, 179–83, 186n23, 187–90, 196–200, 203–8, 210–14, 220– 9, 231–3, 237–9, 260–1, 266–80, 288–95, 297–300, 303–4 (See also Indian higher education) categorization of 172 characteristics of 211, 213 classification of 171–2 financing 173, 224, 226–7, 238, 274 as global commodity 14 globalizing of 304 internationalization of 287, 293 market failure in 188–92 as non-merit good 183–4 policymaking in 9 as public good 170–3, 185n15 public support for 226 quasi-market in 280 system of 14, 205, 270, 286, 288, 294, 298, 303 higher education institutions 112–15, 181, 196, 225–6, 235, 237, 250, 253, 260–1, 271, 287, 289, 293 privately funded 293 quality of 287 higher education sector 13–14, 212–13, 218, 222, 267–8, 270, 273, 291–2, 303 higher productivities 24–5, 101, 120, 123, 129, 152 homogenization 198, 297 human agents 24 human capability 144, 148–9 human capital (HC) 2–6, 19–25, 31–2, 36–43, 45–53, 65–6, 68–73, 76, 78–81, 85–8, 91–4, 102–4, 148–9, 152–4, 197–9 accumulation of 72 Becker’s approach to income distribution and 41–5 formation of 19, 23–4, 43, 80, 92, 104 in growth theoretic model 70–3 and knowledge 57, 59, 66, 80, 87 measurement of 86 pricing of 92 quality of 86–7 and rate of return 25–35, 47 (p.329) Romer’s concept of 66 stock of 40, 71, 86–7, 104 valuation of 50–1 human capital approach 2, 6, 8, 17, 19, 21–2, 25, 27, 29, 52–5, 118–19, 127–8, 130–1, 133, 151–4 human capital contracts (HCCs) 229–30, 264 Human capital option (HCO) 264n8 human capital research programme 21, 118, 139, 154 human capital theory 4, 6, 19–24, 49, 51–3, 55, 90, 119–20, 128–31, 148, 151, 153–5, 238–9 evolution in 51–2 Page 5 of 13

Index Marxian perspective on 151–4 labour in 151 incentivization 67, 214, 254, 265 and education system 18 income contingent loans (ICLs) 226, 230–1, 234–5 income contingent repayment schemes (ICRS) 229 income distribution 1, 3, 19–20, 38, 41, 45, 56, 124, 153, 232–3, 240 income growth 7, 20, 56–8, 59, 62, 84, 87 Indian education system 267–9, 274, 294 Indian higher education 269–70 access to 175–6 autonomy in 292–3 financing in 274–7 globalization and 293–303 governance in 277–8 and job market 279–80 and market 280–6 objectives of 303–4 and policymaking 286–91 private higher education 272 private institutions 278–9 privatization and 291–2 resource constraint 273–4 teachers shortage in 276–7, 306n10 Indian Institute of Technology 227, 277–8, 280, 292–3 Indian Institute of Management 184, 227, 277, 280, 292–3 indigenous knowledge base 302 inequality 41, 45, 47, 149–50, 154, 189, 214, 220, 265 inequities 38, 47–8, 145, 224, 227, 239–40 information 174, 176, 203, 229, 252 asymmetry 7, 13, 98, 120–1, 152, 154, 174, 189–91, 208, 210, 219, 224, 228, 234, 250–1 wage tax 126 informational output 101, 105, 107, 126, 280 infrastructure 180, 198, 258, 280, 292, 296 quality of 282 innovation 5, 62, 65, 67, 70–1, 80–4, 86, 93, 166, 193–6, 238, 240, 244, 255, 258, 289 over-investment in 84 input-based funding 225, 252 Institutional reforms 253, 290 intelligence quotient (IQ) 20, 46, 50 internal efficiency 91, 96, 165 internal labour market 131–2 internationalization 287, 293–4, 296, 302 investment criteria for 27–8 decisions 26–7, 36, 44, 134, 239 in education 3–4, 42, 62, 32, 34–9, 42, 44, 47, 52, 80, 120, 125, 130, 132–6, 138–40 expenditure 20, 22, 27 Page 6 of 13

Index in human capital 5, 23, 38, 45–7, 49, 51–3, 79, 199, 203, 240, 296 in knowledge creation 63, 192 in physical capital 55n2 strategy for 36 in technology 79 (p.330) investors 13, 25, 29, 45–6, 48, 68, 169, 212, 229–30, 241, 283, 305 job(s) 152 applicants for 120–2, 128, 132 market 26, 30, 38, 50, 54, 103, 121, 126–7, 131, 174, 200, 208–9, 228–30, 272, 279– 81 Jongbloed, B. 174, 206, 257, 280 Kerr-Dunlop approach 131 Keynes, General Theory of 20 knowledge 83, 169, 175, 195 accumulation 58, 73–4 advancement in 34, 58 classification of 68–9, 88 as commodity 63–5, 169 creation of 56–7, 63, 67–8, 81–2, 126, 157, 179, 192–5, 220, 222, 195, 237, 244, 268, 301, 304 definition of 81 dissemination of 51, 58, 261 economy 14, 82, 85, 179, 193–5 and failure of market 192–6 free flow of 180 growth of 59, 73, 256 and human capital 65–6 institutions 85 in the new growth theory 77–81 non-rivalry of 65 producing sector 74–7 production function of 14, 62, 65, 67, 75, 82, 88, 170, 192, 196, 295 production of 14, 62, 75, 82, 196 as public good 168, 192 stock of 69, 75–6, 102 use of 67, 193 workers 84,169, 222, 294 Kuznets, Simon 22, 314 labour 2, 4–5, 20, 24, 30, 54, 57–61, 67, 71–7, 79–80, 84, 86–7, 92–3, 107, 151–5 and capital 5, 57, 59, 76–7 economics 21 market 107, 120–1, 131–2, 136, 139, 151, 155 mobility of 74 productivity 58, 73, 79, 130 production of 151 services 120, 147 laissez-fairism 218 ‘learning by doing’ 23, 73–4, 76, 79, 125 loan scheme 234. See also income contingent loans Page 7 of 13

Index low-cost schooling 13, 290 Lucas, Robert E. Jr. 70, 78–9, 85, 164 Majumdar, Tapas 6–7, 25, 55, 92, 119, 132, 134, 138, 155, 207, 239, 305 ‘manipulatable man’ 254 marginal benefit 18, 20, 26, 42–4, 123 marginal cost 20, 43–4, 48, 68, 95 marginal productivity of capital 60, 77 marginal rate of return 34, 42, 47–8, 121 Marginson, Simon 2, 9, 51, 81, 96, 114, 166, 168, 170, 190, 195, 198, 200, 240, 297 market capacities 199–200, 202, 207, 214 competition and knowledge 81–5 economy 64, 81, 88, 194 and equity 212–14 failure 9–10, 13, 106, 120–1, 154, 158, 176, 178, 188–92, 195–6, 214, 224, 255, 263 features of 206–11 forces 84, 95, 158, 192–3, 301 incentives 63, 65, 78, 82 logic 10, 188, 194, 201, 209, 212, 214, 221, 242 mechanism 112–14, 157, 201 principles 114, 188, 213–14, 220, 287, 302 regulation 257–8, 291 (p.331) and social values 200–1 structure 67, 81, 153–4, 214, 258 valuation 6, 236 marketization 113, 175, 187, 206, 212–13, 251, 258, 263, 284, 298, 302 market-oriented courses 209, 211, 227, 271, 284, 299 Marshall, Alfred 3, 20–1, 206, 251–2 Marxian perspective 6, 54, 119, 151 Mehta, Pratap Bhanu 270, 272, 303 merit good 156–7, 171–3, 176–8, 182–3, 189, 218, 220, 223 concept of 177 methodological individualism 52, 133, 219 Mill, John Stuart 20, 206 Mincer, Jacob 3, 19–20, 36, 38–9, 86, 118 equation of 40, 52, 86 model of 84 mixed good 9, 65, 68, 162–3, 172–3, 189 Musgrave 9, 157, 162–3, 172, 176–8, 189 National Commission for Higher Education and Research Bill (2010) 307n25 National Commission for Higher Education and Research (NCHER) 13, 287–8, 291 national higher education system 183. See also Indian higher education national income 4, 23, 34, 58–9, 164 growth in 4, 23 shares of capital and labour income 59 National Knowledge Commission 182, 273–4, 282, 286–8, 304 neo-classical theory 3, 6, 12, 15n4, 21, 24, 47, 53, 55, 79, 139, 151–2, 154, 157, 160, 168 neo-liberal governance reforms 263 neo-liberalism 2, 11, 188, 207, 212, 218–19, 221–2, 237, 257, 263, 280, 301 Page 8 of 13

Index neo-managerial reforms 251–2, 255 net discounted present value 28–9 New Public Management 249–55, 290, 301 non-economic welfare 154 non-market benefits 164 non-merit goods 156, 183 non-profit organization(s) 95, 98, 256 non-profit universities 96, 198, 243 non-technical education 183 Olssen, Mark 178, 208, 219, 224, 301 on-the-job training 23, 38, 126, 128 over-education 235, 279 Pareto efficiency conditions 189–90 patenting 65, 67–8, 169, 195, 237 Patnaik, Prabhat 188, 262 peer quality 110 performativity 245, 263, 265. See also human capability Peters, Michael A. 52–3, 154, 252 PhD degrees 26, 33, 295 physical capital 4, 23–4, 31–2, 35, 42, 50, 52, 60, 74, 76, 78–9, 91–4, 134, 148, 229 investment in 4, 42, 52, 134, 229 policy instruments 217, 258 positive externalities 4, 8–10, 15n7, 31, 73–4, 163, 167, 171–2, 177, 183, 210 prestige maximization 114, 251, 254, 277 pricing of education 19, 141, 283 of knowledge 67–8, 88 primary education 9, 85, 135, 171, 176–8, 182, 185n16, 189, 196, 223, 231, 236, 238, 268, 270 Principal-Agent Theory (PAT) 250–2, 265, 289 (p.332) private benefits 164, 166, 176, 184, 232 private goods 8–9, 63–4, 156–60, 162, 165–8, 171–2, 174–8, 180–2, 195–6 role of 175 private institutions 110, 115, 172, 209–10, 271–2, 277–8, 284, 286, 289, 303 private investment 52, 247 private providers 211–13, 223, 246, 249, 259, 282–4, 286–7 private rate of return 4, 33–5, 49, 52, 124 private sector 11, 54, 169, 183, 192, 212, 222–3, 241, 243–7, 263–4, 279, 284–5, 287–8, 292–3, 302–4 participation of 263 private universities 283, 288 private colleges 305n6 professional colleges 97 privately aided institutions 232 private funding 12–13, 97, 109, 115, 174, 206, 227, 235, 253, 270–1, 282, 290–1. See also privately aided institutions privateness 105, 221 privatization 213, 218, 241–4, 246, 251, 253, 263, 291, 298, 303 Page 9 of 13

Index classification of 243 production function 5–7, 24, 58–61, 67, 70–3, 75–7, 88, 90, 92–5, 98, 103, 107, 111–12, 114–15, 279 production possibility frontier (PPF) 112 production, factors of 2, 4, 23, 57–8, 77, 95 productivity 1, 6–7, 23–5, 29, 31, 50, 54, 63, 73–6, 90, 108–9, 111, 119–22, 124, 128–32 growth 31 professional institutions 278. See also private professional colleges profit making in education 305–n5 profit maximization 253, 290 profit-making enterprises 271 Prohibition of Unfair Practices in Technical and Medical Institutions and University Bill, The (2010) 289 pro-market policies 257 providers 11, 17–18, 98, 157, 204–9, 211, 213, 258, 280–1, 283, 287, 299 provision of education 5, 10, 33, 90, 245–6 public benefits 105–6, 164, 168 public funding for higher education 223–4 policies for 225–6 public good 8–10, 63–4, 69, 74, 89n8, 156–7, 159–62, 165–70, 172–3, 175–9, 181–2, 184, 192–3, 195, 294, 300 and freedom 144 public higher education system 198, 214 public knowledge goods 80–1, 196 public services 148, 220, 244, 246, 249 publicness 9, 65, 68, 166, 169–70, 179, 196, 221, 263 public–private partnerships (PPPs) 11, 212, 218, 222, 245–6, 248, 263, 290–2, 298 in education 245–9 quality of education 10, 12–13, 87–8, 126, 138–9, 190–1, 210–11, 245–6, 253–4, 260–3, 270–1, 275–8, 280–5, 289–91, 299–300 of schooling 130, 204 of students 104, 110, 198 quasi-market for higher education 203–6 quasi-public good 9–10, 162–3, 172–3, 182, 189, 213, 220 (p.333) rate of return approach to education 8, 26, 31, 35, 52, 107, 135–6, 153–6, 19, 25–6, 29–36, 38–40, 42, 44–8, 52–3, 61, 86, 92, 132–3, 135–6, 139, 239–40 average 34, 37, 46 estimates of 36, 133–5 internal 26–7, 29 social 4, 31–5, 49, 51–2, 139, 265 reasonable surplus 247, 285 regional disparities 303 regulated market 9, 13 regulation and efficiency 13–14, 180, 205, 210–14, 252, 255–9, 261, 272, 283–4, 286, 288, 291, 296, 302 regulatory authority 13, 211, 213–14, 257, 261, 272, 283–4, 288 rent seeking academicians 278 Page 10 of 13

Index research institutions 110, 179, 284 residual growth 4, 34, 57 resources allocation 3, 18, 32, 35, 47, 91, 106, 157–8, 189, 205 Right to Education Act 167, 185n11, 268 risk aversion 193, 251 Rizvi, Fazal 221, 301 Romer, D. 63, 66, 69–71, 73–4, 76, 78, 80–1, 93, 115 model 68–70, 168 Samuelson, Paul 157, 160, 175 model of 9, 157, 184n5 and public good 161 scholarship(s) 48, 55n6, 110, 115, 184, 198, 215, 227–8, 232, 237, 241–2 school education 13, 36, 91, 130, 200, 204, 218, 223, 235, 243, 245, 259, 263, 268, 270 investments in 32 schooling 121, 154, 190, 203 choices in 121 cost functions of 94 and earnings 131 and economic inequality 154 and education 152 functions of 151 investment in 38 and rate of return approach 153 and training 24, 151 Schultz, T.W. 3, 19, 22–3, 118 Schumpeter, Joseph A. 82 theory of 82 screening 6–7, 49, 55, 105, 118–231, 199, 266, 280 as by-product of knowledge creation 126 in job market 127 theory of 6, 49, 120, 127, 129, 131 self-financing 236, 271, 284, 288 self-regulation 257–8 Sen, Amartya 22, 54, 93, 140, 143–4, 148–9, 155 Capability Approach of 119, 140, 149–50 signalling theory 119, 154 and job market 121–5 Sixth Pay Commission recommendations 274 skill formation 2, 7, 80, 146, 148, 233 Smith, Adam 3, 20 social capital 78, 164, 202–3 social choice approach 6–8, 119, 132, 136–49 social costs 32–3 social development 146, 222 social institutions 54, 141, 151, 201, 287 social justice 146 social opportunity 175 social profit 113 social reproduction 151, 203 Page 11 of 13

Index schooling in 152 social returns of investment 34 social welfare 178, 219 societal investment 8, 132–3, 135–6, 138–9 (p.334) society, role of education in 140 Solow, Robert M. 59–60, 83 growth model and technology of 57, 59–62, 73, 76–8, 193 sorting models 120–1, 127, 129–30 state–education relationship 223 state-sponsored institutions 272 status competition 96, 190, 198, 202, 281, 297 steady state growth 60–1, 77, 89 Stiglitz, Joseph E. 120, 122–3, 125, 128, 131, 174, 179, 280 Structural Adjustment Policy (SAP) 264 student community 228 students 6, 197 and access to higher education 197 educational attainment of 103 student–staff ratio 266n20 subsidization 32–4, 36, 48, 96, 156, 173, 183, 210, 220, 224, 226, 232–3, 238, 240, 282 supply conditions 44–8, 207 survival economics 194–5 teachers 10, 13, 92, 98, 106, 108, 111–13, 126, 188–9, 236–7, 244–5, 249–51, 263, 278, 296 employment of 17 management problems of 268 productivity of 109 teacher–student ratios 268 teaching and learning process 13, 91, 109–12, 150, 188, 192, 245, 254–5 and research 3, 96, 101, 103, 106, 108, 115, 171–2, 243, 254, 262, 277, 300 technological advancement 77, 128m 153 change 63–4, 78 progress 58, 61–2, 73, 79 total factor productivity (TFP) 58–9, 74 training and education 129 investing in IT 136 underemployment 30, 280 unemployment 30, 103, 126, 132, 137, 280 universalization of education 167 universities 96, 98, 100, 103, 199, 229, 236–7, 275, 278 cost functions of 94 cross-border recognition of 179 for Innovation Bill 2010 289 for knowledge production 170 mission of 107 networks of 179 Page 12 of 13

Index as not-for-profit organization 95–8 top-class 237 University Grants Commission (UGC) 251, 265, 271, 273, 275, 281, 283–5, 287–92 Vaizey, John 28–9, 104, 107–8 voucher system 113, 260 wage 20, 30–1, 50, 52, 67, 92, 121, 126, 128, 132, 151–4, 162 and rate of return, Mincerian approach to 38–41 wage-labour reproduction 153 winner-takes-all-markets 198 World Bank 187, 237–8, 246, 264 World Trade Organization/General Agreement on Trade in Services 180 WTO-GATS policy framework 29 Yashpal Committee Report (YPCR) 286–8 zero-sum game 198, 200, 297

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