Copyright is owned by the Author of the thesis. Permission is given for a copy to be downloaded by an individual for the purpose of research and private study only. The thesis may not be reproduced elsewhere without the permission of the Author. THE APPROACH TO MEASURING THE RETURNS TO SECONDARY AND TERTIARY QUALIFICATIONS IN NEW ZEALAND: AN INVESTIGATION AND UPDATE USING DATA FROM THE 2001 CENSUS A Research Thesis submitted in fulfilment of the requirements for the degree of Master of Applied Economics at Massey University NATHANJ. PENNY DEPARTMENT OF APPLIED AND INTERNATIONAL ECONOMICS COLLEGE OF BUSINESS MASSEY UNIVERSITY, NEW ZEALAND 2004 Acknowledgements I would like to take this opportunity to thank the many Massey University staff who have helped not only with this research, but throughout my studies at the Department of Applied and International Economics. In particular, Stuart Birks, Ha Lien Ton, Dr Jen-Je Su and Dr Vilaphonh Xayavong have made invaluable contributions towards this thesis. I would like to thank Roger Smyth from the Ministry of Education for his encouragement and assistance in making this study possible. Also, I would like to extend my thanks to John Upfold and the team at Stats New Zealand for their assistance in the datalab. In addition, I would like to show my appreciation to my family and thank them for their patience, understanding and support. The final word of thanks goes to all my fellow students at Massey University who have made my time there thoroughly enjoyable. 2 Abstract This study investigates the approaches to measuring the returns to secondary and tertiary qualifications in New Zealand using the latest Census of Population and Dwellings data from 2001. It calculates the returns to qualifications using income function analysis, elaborate analysis and also extends the elaborate analysis by using the quantile regression technique. It reports returns within a narrow band for both methods and at a similar or higher magnitude to previous years. However, the results reported using the net present value (NPV) criteria reveal higher social returns to qualifications than private returns. This contradicts previous literature. In the policy implications section, the study recommends policies focus more on reducing the level of forgone earnings. Also, the study finds that income function analysis is better suited to measuring income inequality and its link with education. Furthermore, the study concludes that elaborate analysis, using the NPV criteria, allows better comparison of the marginal returns to educational investments of varying scale and duration. Finally, the quantile regression estimates show that point estimates of the mean return give a poor indication of the distribution of returns. 3 Table of Contents Acknowledgements ............................................................................. 2 Abstract ............................................................................................. 3 Table of Contents ................................................................................ 4 1 Introduction ................................................................................. 8 1.1 Background ............................................................................ 8 1.1.1 Previous Studies ............................................................... 9 1.2 Research Aims and Objectives .................................................. 9 1.3 Data and Methodology ............................................................ 10 1.3.1 Data and Sample Characteristics ....................................... 10 1.3.2 Income Function Analysis ................................................. 10 1.3.3 Elaborate Analysis ........................................................... 11 1.4 Chapter Outline ..................................................................... 12 2 Literature Review ......................................................................... 13 2.1 Human Capital Theory ............................................................ 13 2.2 Returns to Education .............................................................. 15 2.2.1 Returns to Schooling ........................................................ 15 2.2.2 The Extended Earnings Function ........................................ 15 2.2.3 The Elaborate Method ...................................................... 16 2.3 The Returns to Education Literature ......................................... 17 2.3.1 The New Zealand Returns to Education Literature ................ 17 2.3.2 The Research by Sholeh Maani .......................................... 18 2.4 The Returns to Education Literature Critiques ............................ 20 2.4.1 The Screening Hypothesis ................................................. 20 2.4.2 The Impact of Ability ........................................................ 21 2.5 The Externalities of Higher Education ....................................... 21 2.5.1 Education and Crime ........................................................ 22 2.5.2 Education and Democratic Values ...................................... 23 2.5.3 Education, Health, Poverty and Social Welfare ..................... 23 2.5.4 Education and Fertility ...................................................... 23 2.6 Productivity, Economic Growth and the Investment in Education .. 24 2.6.1 Growth Theory and Endogenous Growth Theory .................. 24 2.6.2 Productivity and the Investment in Education ...................... 25 2. 7 Quantile Regression Analysis ................................................... 26 2.7.1 Quantile Regression ......................................................... 26 2. 7 .2 Quantile Regression Framework ......................................... 26 2.7.3 Quantile Regression and the Returns to Education ............... 27 3 The New Zealand Tertiary Education Sector - An Overview ............... 29 3.1 Background ........................................................................... 29 3.2 The New Zealand Education System ......................................... 30 3.2.1 Primary School and Intermediate ....................................... 30 3.2.2 Secondary School ............................................................ 30 3.2.3 Tertiary Institutions ......................................................... 30 3.3 Trends in Tertiary Education Enrolments ................................... 31 3.3.1 Overall Enrolments .......................................................... 31 3.3.2 Enrolments by Type of Tertiary Institution .......................... 32 3.3.3 The Breakdown of Enrolments by Gender ............................ 32 3.3.4 The Age Structure of Enrolments ....................................... 34 4 3.3.5 Full-Time and Part-Time Enrolments .................................. 34 3.3.6 Enrolments by Ethnicity .................................................... 35 3.4 Tertiary Education Funding ..................................................... 36 3.4.1 Government Education Expenditure ................................... 36 3.4.2 Tertiary Education Tuition Subsidies ................................... 37 3.4.3 Tertiary Education Tuition Fees .......................................... 39 3.4.4 Student Loans ................................................................. 39 3.4.5 Student Allowances .......................................................... 41 3.5 Summary .............................................................................. 42 4 Data and Characteristics of the Sample ......................................... .43 4.1 The New Zealand Census of Population and Dwellings Sample .... .43 4.1.1 The 2001 Sample ............................................................ 43 4.1.2 Sample Size .................................................................... 44 4.2 Sample Age-Income Profiles .................................................... 44 4.2.1 Female Age-Income Profiles ............................................. .45 4.2.2 Male Age-Income Profiles ................................................ .45 4.3 Labour Force Status by Highest Qualification ............................ .48 4.4 Other Sample Characteristics .................................................. 51 4.4.1 Income Levels and Ethnicity .............................................. 51 4.4.2 Age Profiles ..................................................................... 52 4.4.3 Educational Attainment Levels ........................................... 52 4.4.4 Labour Force Status and Ethnicity ...................................... 53 4.5 Chapter 4 - Appendices .......................................................... 54 5 Income Function Analysis - Methodology ........................................ 60 5.1 Income Function Analysis ....................................................... 60 5.1.1 The "Extended" Income Function ....................................... 60 5.1.2 The Income Effects of Secondary and Tertiary Qualifications .61 5.1.3 The Marginal Income Effects of Secondary and Tertiary Qualifications .............................................................................. 62 5.1.4 Expanded Chow Test ........................................................ 63 5.2 Model Specification ................................................................ 63 5.2.1 Sample Specification ........................................................ 63 5.2.2 The Independent Variable ................................................. 64 5.2.3 The Dependent Variables .................................................. 64 5.2.4 Investigating the Diploma Qualification ............................... 65 6 Income Function Analysis - Results and Discussion .......................... 66 6.1 2001 Census Results .............................................................. 67 6.1.1 Income Effect of Qualifications vs. the No Qualification Group 67 6.1.2 Expanded Chow Test ........................................................ 69 6.1.3 The Marginal Income Effects of Qualifications ...................... 70 6.1.4 Increased Relative Incomes for Skilled Workers ................... 73 6.1.5 Increased Income Effect of the Bursary Qualification ............ 74 6.2 Model Specification ................................................................ 75 6.2.1 Labour Force Experience Specification ................................ 75 6.2.2 Before-Tax Versus After-Tax Earnings ................................ 78 6.2.3 All-Employed Versus Employed-Fulltime Samples ................ 78 6.2.4 Allowing for the Increase in Immigration ............................ 79 6.3 Diploma Breakdown ............................................................... 80 6.3.1 Stability Testing on the Diploma Breakdown ........................ 82 6.4 Chapter 6 - Appendices .......................................................... 83 7 Elaborate Analysis - Methodology .................................................. 99 5 7.1 Elaborate Analysis ................................................................. 99 7.1.1 Age-Income Profiles ......................................................... 99 7.1.2 Private Rates of Return Analysis ........................................ 99 7.1.3 The Net Discounted Sum of the Private Returns ................. 101 7.2 Social Rates of Return Analysis .............................................. 101 7 .2.1 The Discounted Sum of the Social Returns ........................ 102 7.2.2 Sensitivity Analysis ........................................................ 102 7.3 Quantile Regression Estimates of Returns ............................... 103 7.3.1 Analytical Framework ..................................................... 104 7.3.2 Utilising the Quantile Estimates of Returns ........................ 105 8 Elaborate Analysis - Results and Discussion .................................. 106 8.1 Age-Income Profiles ............................................................. 107 8.1.1 Diploma Breakdown ....................................................... 107 8.2 Private Returns to Secondary and Tertiary Education ............... 110 8.2.1 The Private Returns - The Internal Rate of Return Method .. 110 8.2.2 The Private Returns - 1996 to 2001 ................................. 111 8.2. 3 The Private Returns - Net Present Values ......................... 111 8.2.4 Diminishing Returns ....................................................... 113 8.2.5 Breakdown of Returns to the Diploma Qualification ............ 113 8.2.6 Sensitivity Analysis ........................................................ 114 8.3 Social Returns to Secondary and Tertiary Education ................. 115 8.3.1 Internal Rates of Return ................................................. 115 8.3.2 Net Present Values ......................................................... 115 8.3.3 Sensitivity Analysis ........................................................ 117 8.4 Quantile Regression Estimates ............................................... 118 8.4.1 Private Returns to Education - Quantile Estimates ............. 118 8.4.2 The Spread of Returns and the Magnitude of Investment .... 118 8.4.3 Male and Female Returns - 1996 and 2001 Returns ........... 119 8.4.4 The Spread of Returns and the Mean Return ..................... 119 8.4.5 Social Returns to Education - Quantile Estimates ............... 122 8.5 Chapter 8 - Appendices ........................................................ 123 9 Tertiary Sector Policy Implications ............................................... 143 9.1 The Importance of Forgone Earnings ...................................... 144 9.1.1 Full-Time Study and Part-Time Work Focused Policies ........ 145 9.1.2 Full-Time Work and Part-Time Study Focused Policies ........ 146 9.1.3 The Death of the Summer Holiday ................................... 147 9.2 Tuition Fee Levels and the Government Funding of Tertiary Education .................................................................................... 149 9.2.1 The Tuition Fees Paradox ................................................ 149 9.3 The Performance of Diploma Qualifications .............................. 150 9.3.1 The Timing of Diploma Studies ........................................ 150 9.3.2 Replacing the Advanced Vocational Diploma Qualification ... 151 9.3.3 Apprenticeship Schemes ................................................. 152 9.4 Measuring the Returns to Education ....................................... 152 9.4.1 Social Returns to Secondary and Tertiary Education ........... 153 9.4.2 Labour Force Experience and the Income Effects of Education 153 10 Conclusions and Suggestions for Further Research ......................... 154 10.1 Approaches to Measuring the Returns to Education in New Zealand 154 10.1.1 Results from the Income Function Analysis ....................... 154 10.1.2 Results from the Elaborate Method Analysis ...................... 155 6 10.1.3 Results from the Quantile Estimates ................................. 155 10.2 Results from the 2001 Census Data ....................................... 156 10.2.1 Overall Returns to Education ........................................... 156 10.2.2 Diploma Breakdown ....................................................... 157 10.2.3 The Bursary Qualification ................................................ 157 10.2.4 Sensitivity Analysis ........................................................ 157 10.3 Suggestions for Further Research .......................................... 158 REFERENCES ................................................................................... 159 7