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«Financing lifelong learning Hessel Oosterbeeka, Harry Anthony Patrinosb,∗ a Universiteit van Amsterdam School of Economics b World Bank Abstract ...»

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Empirical Research in Vocational Education and Training 1 (2009) 25-43

Financing lifelong learning

Hessel Oosterbeeka, Harry Anthony Patrinosb,∗


Universiteit van Amsterdam School of Economics


World Bank


This paper describes and analyzes different financial schemes to promote

lifelong learning. Positive effects of financial incentives to pupils are not restricted to high ability pupils, as low ability students also seem to benefit. The

evidence regarding the effects of subsidy forms is limited. The most prominent knowledge gaps regarding the effects of various financing schemes related to lifelong learning are the effects of vouchers; financial aid schemes for students;

and entitlements and individual learning accounts.

Keywords: lifelong learning, finance, training

1. Introduction Different financial schemes to promote lifelong learning have been put forward (World Bank, 2003). There is a belief that current expenditures are directed to learners and providers in an inefficient way. By giving better incentives more can potentially be achieved with the same amount of resources. There is the notion that spending on education needs to be increased to meet the requirements of the knowledge economy, and that this should be achieved by increasing private expenditures on education, both directly and by creating new sources of finance.

Considered in this review are financial instruments to stimulate lifelong learning.

We apply the standard normative framework of welfare economics and discuss relevant empirical findings. The education finance literature has traditionally paid much attention to financial aid schemes for higher education. A standard economic analysis of capital market failures provides reasons for government intervention. Despite the almost universal enthusiasm about income contingent loans among economists, practical experience with such schemes is very limited.

To stimulate lifelong learning, it is often believed that simply making such activities available below marginal costs provides insufficient incentives. Instruments such as vouchers, entitlements and individual learning accounts give potential learners a very explicit confirmation of their increased purchasing power. This should strengthen people’s awareness of the importance of learning activities. The evidence of the effects of these subsidies is limited.

∗ Corresponding author: hpatrinos@worldbank.org. The views expressed here are those of the authors and should not be attributed to the authors’ organizations. We thank Stefan Wolter for useful comments.

–  –  –

The importance of investments in education is widely documented in terms of earnings and employment. For individuals, education also has other important benefits, such as health (Grossman, 2006). Also, investment in education is regarded as an engine for countries’ prosperity.

Our analysis of financial schemes fits into the normative economics framework in which efficiency and equity serve as guidelines. We outline an analytical framework that serves as a reference point. We also pay attention to empirical studies that inform us about the effectiveness of various financial arrangements. In reviews of financial arrangements in the field of education, the empirical analysis confines itself often to a description of alleged success stories. We will move away from that custom and instead focus on empirical results coming from studies that use credible strategies to identify the causal impact. By emphasizing this, we will also show that much is still unknown. We apply our analytical framework to various financial arrangements, including various loans schemes, human capital contracts and financial incentives for students. Finally, we bring together insights regarding subsidization mechanisms such as scholarships and grants, vouchers and tax deductions.

2. Analytical Framework

According to standard economics, education (formal schooling and training) can be classified as a private good. A good is private rather than public when people can be excluded and when there is rivalry in consumption. Exclusiveness means that it is, at relatively low cost, possible to prohibit a person from using the good. In the case of education, this can be achieved by not allowing someone to enter the school building, the classroom, or the workplace. Rivalry means that the use of the good by one person reduces the opportunities for other persons to use the same good. Again, in the case of education, this condition is satisfied since the attention that a teacher or instructor gives to one student or trainee reduces the amount of time available to others.

Private goods can in principle be provided through the market. Without any form of cooperative action (for example, government intervention) a certain positive quantity of the good is provided. This is not true for pure public goods. If it is impossible to exclude a person from the use of a good and if there is no rivalry in consumption, then provision without some form of cooperation or coordination will be impossible. No single individual will pay for all of the costs, except in the rare case that their private benefits exceed the full costs.

While private provision of education is possible, in almost every country there is some level of government intervention. Intervention takes the form of regulation and/or financing. The amount and form of government intervention in the schooling market differs considerably from country to country. Motives for intervening in the market for education relate to efficiency and equity. The form of intervention is, therefore, typically evaluated in terms of its effects on these criteria.

Financing lifelong learning 27

2.1 Efficiency

Efficiency requires that (social) marginal costs equals (social) marginal benefits. Two main factors are often mentioned as potential sources for inefficiency in education markets: externalities and capital market failures. Here we analyze these factors in some depth. This is important because understanding the precise causes of inefficiencies is helpful in judging the possible effectiveness of suggested solutions.

Externalities occur when the production or consumption of a good has effects on people other than the decision-makers. Externalities can be either positive or negative. Since decision-makers are assumed to take only their own private costs and benefits into account, there will be, from a social point of view, an under-provision of goods that generate positive externalities and an overprovision of goods that cause negative externalities. In the case of schooling, the common view is that it produces positive external effects. Attempts have been made to quantify the external effects of schooling by estimating social and private returns separately, but findings diverge considerably. Acemoglu and Angrist (2000) find that almost all of the returns to education are private, while Moretti’s (2004) findings imply that the macro impact of education is close to four times the private rate of return. Lange and Topel (2006) conclude that there is no evidence that social returns are smaller than private ones, yet neither is there much to suggest that they are larger.

Aspects that qualify as positive externalities of schooling include: quality of children, health, social cohesion, technological development, income distribution, higher economic growth, less crime, more democracy, philanthropy and political participation (Haveman and Wolfe, 1984). The common view is that externalities of schooling tend to diminish with the level of schooling. If that is the case, the externalities argument cannot explain why in many countries the public subsidy to higher education exceeds that to elementary education. In addition, there is a large body of empirical literature demonstrating that the private returns to education are high enough to pay for its costs (Ashenfelter et al., 1999).

Another form of externality is exclusively connected to investment in firm-specific training. Firm-specific training is defined as training that is only useful in the current firm; it has no value in other firms. By contrast, the definition of general training is that it enhances worker’s productivity not only in the current firm but also to the same extent in all firms. Investments in specific training are predicted to be below their efficient level due to holdup. Since the return to specific investments depends on the two parties staying together, one party can always try to get some of the return to the other party’s investment by threatening to end the relationship. The investing party will anticipate such opportunistic behavior and will invest below the optimum level. Holdup can only occur when the investment is non-contractible but verifiable.

This is likely to be the case for training. Acemoglu and Pischke (1999) have shown that training that is general in a technical sense can still be specific in an economic sense in situations with labor market frictions. This insight enhances the potential relevance of the holdup problem.

28 H. Oosterbeek and H. A. Patrinos Unless they come from wealthy families, students will typically not have the funds to finance their tuition fees and the cost of living while studying. They will, therefore, have to borrow. Because human capital is stored in persons and is not readily transferable, there is no collateral in case of default. Therefore, private banks will be unwilling to provide student loans without any compensation for the default risk.

More fundamentally, capital market failures can be attributed to adverse selection and moral hazard. Adverse selection refers to the mechanism that a default premium will prevent the lowest risk students from taking up a loan. As a result, the average risk for the remaining cases will be higher and the default premium needs to increase.

Moral hazard refers to the fact that after graduation people may be inclined to take no job or a low paying job in order to avoid/evade repayment of the loan.

On average, investments in schooling are beneficial, but earnings prospects are uncertain. Even students with an accurate idea of their own capabilities cannot be certain of their future earnings level. Risk-averse individuals attach heavier weights to bad outcomes than to good outcomes, and may, therefore, underinvest in education.

A concept that only recently attracted the attention of economists, and which is relevant from the perspective of education investments, is debt aversion. This refers to the fact that people dislike carrying debt over and above the consequences of debt on consumption patterns.

2.2 Equity

Probably the most important reason for intervening in education markets is the widely supported view that participation in learning activities should depend only on characteristics that are relevant to education, such as motivation, effort and ability, and not on other factors such as social background, gender or race. Much effort is put into realizing equal opportunities.

With regard to equity, it is important to distinguish between static and dynamic measures. In the static case, it is only current income positions that matter, whereas in the dynamic case it is the lifetime perspective. Put differently, with the static equity concept, it matters that students with poorer social backgrounds have equal access to post-compulsory schooling. Whereas from a dynamic point of view, it matters that those who have attained the highest levels of schooling are among the richest of their cohort. Thus, for the evaluation of subsidies to students, it matters not only whether these students come from poor families, but also whether the subsidies take the lifetime position of the recipients into account.

Related to equity is the fact that individuals may underestimate the value that schooling has for them. If a government thinks it knows better what is good for a person than the person himself, then this is a case of paternalism. The general belief is that paternalism plays a role in education at the elementary and secondary level, but not at the post-secondary level. The reason for this is that there is a contradiction Financing lifelong learning 29 in thinking that people who are qualified to enroll in post-secondary schooling are so ignorant that they do not know what value education has for them. The notion of dynamic spillovers reinforces the case for paternalism. This is especially a concern for children with less-educated parents.

2.3 Evidence-Based Policies

Financial arrangements are a form of policy intervention. In recent years, the evaluation of policy interventions has gained much attention in scholarly papers. To identify the impact of an intervention one has to know what would have happened to persons who were exposed to the intervention in its absence. The construction of a credible counterfactual is a difficult task. Just comparing outcomes of those who were treated by the intervention with the outcomes of those who were not treated is likely to be misleading. The reason is that in most cases treatment is not provided randomly, but is based on (self-) selection.

An experimental setup with randomized assignment to treatment and control groups is regarded by many as the gold standard to estimate the impact of an intervention. While this is probably true in many relevant applications, it is important to realize that even such a setup can give biased results. This is, for instance, the case when there are spillover effects in which outcomes of untreated people are also affected by the policy. An example is that the provision of training for some unemployed persons can reduce the employment prospects of unemployed people who did not receive the training. Another potential problem with the experimental setup is that untreated persons may attempt to obtain substitute treatment. Experimental designs should be set up in a way that such potential problems are addressed.

In addition to the randomized design, other methods operate in the same spirit.

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