Chapter 1
Introduction

DALE W. JORGENSON

Frederic Eaton Abbe Professor of Economics

Harvard University

The achievements of American education in the post-World War II period are rarely appreciated. The proportion of American workers who have completed four or more years of college education quadrupled from around 6 percent in 1948 to more than 25 percent in 1990. The proportion of workers with some college tripled from 14 percent to more than 46 percent over the same period. Finally, the proportion of workers who completed high school more than doubled from 37 percent to 85 percent.

The notion of investment in human capital provides a helpful framework for analyzing the economic consequences of the massive upgrading of levels of educational attainment of the American population. Investment may be defined as the commitment of current resources in the expectation of future returns and can take a multiplicity of forms. The most straightforward application of this concept is to investments that create property rights, including rights to transfer the resulting assets and benefit from incomes that accrue to the owner.

Economic research, beginning with the Nobel Prize-winning contributions of Gary S. Becker and Theodore W. Schultz, has successfully quantified the notion of investment in human capital. This concept encompasses investments that do not create property rights. For example, a student enrolled in school or a worker participating in a training program can be viewed as an investor. Although there are no asset markets for human capital, investments in human and nonhuman capital have the common feature that the returns can be appropriated by the investor.

The mechanism for translating investments in human capital into impacts on economic growth is well understood. Although these investments do not create



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--> Chapter 1 Introduction DALE W. JORGENSON Frederic Eaton Abbe Professor of Economics Harvard University The achievements of American education in the post-World War II period are rarely appreciated. The proportion of American workers who have completed four or more years of college education quadrupled from around 6 percent in 1948 to more than 25 percent in 1990. The proportion of workers with some college tripled from 14 percent to more than 46 percent over the same period. Finally, the proportion of workers who completed high school more than doubled from 37 percent to 85 percent. The notion of investment in human capital provides a helpful framework for analyzing the economic consequences of the massive upgrading of levels of educational attainment of the American population. Investment may be defined as the commitment of current resources in the expectation of future returns and can take a multiplicity of forms. The most straightforward application of this concept is to investments that create property rights, including rights to transfer the resulting assets and benefit from incomes that accrue to the owner. Economic research, beginning with the Nobel Prize-winning contributions of Gary S. Becker and Theodore W. Schultz, has successfully quantified the notion of investment in human capital. This concept encompasses investments that do not create property rights. For example, a student enrolled in school or a worker participating in a training program can be viewed as an investor. Although there are no asset markets for human capital, investments in human and nonhuman capital have the common feature that the returns can be appropriated by the investor. The mechanism for translating investments in human capital into impacts on economic growth is well understood. Although these investments do not create

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--> assets that can be bought or sold, the returns to higher educational qualifications or better skills in the workplace take the form of higher incomes. An individual who completes a course of education or training adds to the supply of people with higher qualifications or skills. The resulting income stream can be decomposed into a rise in labor services and the price of these services or wage rate. The increase in labor services contributes to output growth in proportion to the wage rate. Investments in tangible assets were the subject of the STEP board's first report, Investing for Productivity and Prosperity (Board on Science, Technology and Economic Policy, 1994). These investments appear on the balance sheets of firms, industries, and the nation as a whole as buildings, equipment, and inventories. The benefits of these investments appear on the income statements of these same economic units as profits, rents, and royalties. Investments in tangible assets accounted for more than 45 percent of U.S. economic growth over the postwar period.1 Investments in human capital, especially through formal education, are a very significant source of U.S. economic growth. These investments do not appear on the balance sheets of individuals receiving the education or the institutions providing it. However, increases in labor incomes make it possible to measure the investments and assess their contributions to economic growth. Investments in human capital accounted for almost 30 percent of U.S. economic growth over the postwar period. Another way of quantifying the role of investments in human capital is to compare them to investments in tangible assets. Barbara M. Fraumeni and I have shown that investments in human capital in the United States have been more than three times those in tangible assets during the postwar period. We also compared wealth in the form of human capital with wealth in the form of tangible assets. Given the long-lasting character of investments in human capital, affecting the incomes of investors throughout their working lives, it is not surprising that human wealth is more than 10 times nonhuman wealth. (Jorgenson and Fraumeni, 1995) Investment in education has been one of the great, if almost unheralded, achievements of the postwar American economy. This investment program has taken place ''off the books," represented by the U.S. national income and product accounts, the measuring rod of the U.S. economy. However, investment in education has been quantified and compared with other forms of investment. The magnitude of the benefits of higher educational attainments to American society has been truly staggering! The year 1983 was an important milestone in charting the course of educational investments. The proportion of the youngest of the "prime-age" cohorts of workers aged 25–34 years who had not graduated from high school reached a low 1   For further details, see Bureau of Labor Statistics (1994).

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--> of 10 percent. Only one year later the proportion of this group with four or more years of college peaked at more than 29 percent. Since 1983 the distribution of this age group by educational attainment has been essentially stationary. As the individuals who made up this group in 1983 progress through the age distribution and eventually retire, increases in educational attainment will disappear as a source of U.S. economic growth. The year 1983 also marked the publication of the federal government's report on the state of America's schools, A Nation at Risk (National Commission on Excellence in Education, 1983). This report initiated a vigorous debate over education policy that has produced more than 50 additional reports. This debate led President Bush to convene an educational summit in Charlottesville, Virginia, in 1989. This meeting assembled the governors of all 50 states; it was only the third presidential summit in American history. In March 1994 the U.S. Congress passed and President Clinton signed into law legislation embodying the eight National Education Goals for the year 2000 established in 1990 by then-President Bush and the governors, chaired by then-Governor Clinton: All children would start school ready to learn. The high school graduation rate would be raised to at least 90 percent. Students would leave grades 4, 8, and 12 having demonstrated competency in several specific subjects. U.S. students would be first in the world in mathematics and science achievement. Every American adult would be literate. Every U.S. school would be free of drugs and violence. The nation's teaching force would have access to programs for the continued improvement of their professional skills and the opportunity to acquire the knowledge and skills needed to instruct and prepare all American students for the next century. Every school would promote partnerships that would increase parental involvement and participation in promoting the social, emotional, and academic growth of children. The Goals 2000 legislation included a grant program aimed at supporting state-level reform driven by education standards. Goals 2000 also provided the framework for the five-year $60 billion Elementary and Secondary Education Act (ESEA) reauthorization enacted by the Congress and signed into law by President Clinton in October 1994. The principal architect of this legislation in the U.S. Senate, the senior senator from Massachusetts, Edward M. Kennedy, characterized the Senate vote as "the culmination of two years of impressive bipartisan cooperation and accomplishment in all aspects of education." (The Boston Globe , 1994) The reaction to the National Education Goals was not one of unalloyed

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--> enthusiasm. The senior senator from New York, Daniel Patrick Moynihan, a former professor of education at Harvard University, summarized his reaction in a book jacket endorsement of Eric Hanushek's PEER group report: In 1991, the International Assessment of Education Progress (IAEP) measured achievement levels in science and mathematics for a number of participating countries. Thirteen-year-old U.S. students scored at the bottom of both examinations. In 1994, Congress proclaimed that by the year 2000 American students would be first in the world in mathematics and science. Some would call this fantasy. Others denial. Either way, it is a formula for social calamity. The only remedy at hand is the rigor of economic analysis which Eric Hanushek and his associates have brought together in Making Schools Work. A magnificent achievement. Senator Kennedy's characterization of the ESEA establishes the fundamental point that the main directions of federal education policy were not subject to partisan political disagreements in 1994. In this respect education policy is totally different from health policy, which was also debated in the Congress throughout much of 1994. However, Senator Moynihan's observations underline a second point, namely, that there remains a serious intellectual disagreement over the role of economic considerations in improving performance and controlling costs, the subtitle of the PEER report. It is important to emphasize that the debate over the role of economic considerations in education policy reflects intellectual more than political disagreements. There has been a bipartisan consensus on the importance of clear objectives for national education policy, embodied in Goals 2000 and the ESEA legislation, if not for assigning the federal government partial responsibility for achieving the goals.2 The first contribution to the present volume is by Under Secretary of Education Marshall S. Smith, former dean of education at Stanford University, and two of his associates at the Department of Education—Brett W. Scoll and Jeffrey Link. This is an edited version of Smith's keynote address at the conference on "Improving the Performance of America's Schools." Smith's address provided a detailed summary of the recent accomplishments of the Congress and the Clinton Administration, including Goals 2000 and the ESEA legislation. Smith and his colleagues describe federal education policy in terms of systemic school reform. The first element in systemic reform is to support the development of academic standards by the states, as specified in Goals 2000. The second element is to target the resources of ESEA at helping educationally disadvantaged students and other children with special needs to reach the standards. 2   In the aftermath of the 1994 elections there have been efforts by members of the new Republican majority to repeal the Goals 2000 legislation or eliminate funding for it. This reflects a fundamental disagreement about the federal role in education but not about the need for school reform and thus does not detract from the relevance of the debate about how to improve school performance.

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--> The resources will be made available to local school districts rather than retained at the state level. The third element is to align the education system to support reform through curriculum development, teacher training, and student assessment consistent with the content standards. The detailed rationale for systemic school reform, as summarized by Smith and his colleagues, is based on eight major research findings: All students can learn to far higher levels than we ever imagined in the past. What you are taught matters. The quality of teaching matters. Teachers are more likely to teach well things that they understand well and that they have been taught to teach. Schools, and the teaching and learning within them, are more likely to change when the school staff has ownership and some control over the nature of the change. Teachers and the public, in general, do not have a common conception of what is meant by high international competitive academic standards. Individual school reform has a long, complex, and unhappy history in the United States. The education system often does little to support change or to sustain schools that appear to be effective. These research findings support the proposition that the performance of the education system can be improved if its major elements are aligned to help all students meet more demanding content and performance standards. Since teachers and the general public do not have a clear conception of the goals of education, the role of federal and state governments is to articulate the goals through standards developed by the individual states. Achievement of these goals will require higher-quality teaching and better teacher training. With the addition of resources provided by the federal government through Goals 2000 and ESEA, schools will improve through systemic reform. While previous school reforms have not been notably successful, the diagnosis given by Smith and his colleagues is that teacher training and educational assessments have not been properly aligned to support reform. This will be remedied under systemic school reform by inculcating content standards through teacher training and aligning assessments with performance standards. However, optimism about the effectiveness of the new approach to reform must be tempered by the fact that the education system does little to support change or even to sustain individual schools that appear to be effective. Persistence and time will be required for success. The research findings that undergird systemic school reform have been produced by psychologists, sociologists, and political scientists. School performance research by economists has not been used in designing a new approach to

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--> reform. Smith and his colleagues emphasize the limitations of economic research rather than its potential contribution to the design of education policy. Although they can conceive of research on school performance that could support the systemic approach, this has not been carried out because of the unavailability of appropriate measures of school performance or "output" and because of deficiencies in existing measures of school resources or "inputs." Smith and his colleagues conclude that school performance research revised along the lines they suggest would support systemic school reform. A properly aligned system would provide a clear focus through state education standards. These standards would increase accountability by making it easier to assess the performance of students, teachers, and schools. Alignment would also promote efficiency by providing incentives for greater achievement and coordinating the actions and decisions of educators and policymakers at all levels. However, systemic school reform does not include specific policies for providing incentives beyond monitoring performance more effectively. In short, the rationale for Goals 2000 and the ESEA legislation builds on 25 years of research on the performance of students, teachers, and schools. The systemic approach to education reform has evolved out of the political debate of the past decade, initiated by A Nation at Risk, and culminating in the impressive legislative achievements documented so persuasively by Smith and his colleagues. The second contribution to this volume is a summary of the PEER report by Eric Hanushek, "Outcomes, Costs, and Incentives in Schools." Hanushek characterizes A Nation at Risk and more than 50 subsequent reports as almost totally devoid of economic content. In particular, efficient use of education resources, the central focus of the PEER report, is missing from earlier reports. The economic issues in education are twofold: Are we investing the right amount? Are the resources devoted to schooling used in the best way? In order to answer these questions, benefits must be compared with costs. The results of investment in education summarized above are based on benefits that are internalized by individual students through higher lifetime incomes. Hanushek also suggests that some of the benefits may be external, consisting, for example, of the contributions of education to better citizenship. With respect to using resources more efficiently, the PEER report advocates introducing performance incentives and basing changes on systematic evaluations of school performance while holding spending constant. The issue of efficiency in the use of education resources is the nub of the disagreement between Hanushek and Smith and his colleagues. One source of skyrocketing education expenditures per pupil during the 1970s and 1980s was a substantial decrease in average class size. Although this is an important goal of teachers, especially in collective bargaining efforts, it has had little or no payoff over time in enhancing the average performance of students. School performance research or, in economic jargon, education "production function" studies show that cross-section variations in performance are uncorrelated with pupil-teacher

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--> ratios. This finding has been reinforced by the results of a substantial education experiment conducted by the state of Tennessee and summarized by Hanushek. Another important trend during the 1970s and 1980s was a rise in the level of teacher training, as measured by the percentage of staff with master's degrees. In addition, the average level of experience for teachers has risen with the decline in enrollments. Both contribute to higher teacher salaries and add to the costs of education. Again, studies of school performance show no effect of additional teacher training and experience on student performance. While Hanushek agrees with Smith and his colleagues that past education reforms have not been successful, the PEER report diagnosis is that the nation's school system has failed to provide appropriate incentives for teachers and students. Hanushek, like Smith and his colleagues, emphasizes the importance of explicit goals and of developing measures of performance that relate to these goals. However, Hanushek also emphasizes the creation of specific incentives directed at improving student performance, a matter Smith would leave to state and local officials. Examples of performance-based incentives include merit pay and hiring, promotion, and retention of teachers on the basis of classroom performance. The core of this approach would be performance-based contracting between school districts and teachers. This would be phased in through a two-tiered contracting system, leaving the existing seniority-based contracts in place for teachers already in the system. Given anticipated rates of retirement, this could produce a rapid transition to the new system. Some of the incentives would be for schools rather than individual teachers. For example, merit school programs could key school budgets to student performance. School choice could provide incentives for better student performance by engaging the interest of parents and students in good schools. Mechanisms that permit choice, possibly including private as well as public schools, could align better student performance with the allocation of school resources. Hanushek emphasizes that incentives for performance are largely untested, since they have been introduced so infrequently. One attractive approach is to experiment with different incentive systems, coupled with evaluation of the resulting impact on school performance. A final point of disagreement between Hanushek and Smith is the measurement of school performance. Hanushek and Smith agree that better assessments are essential. Hanushek observes that schools resist evaluation; this is echoed in Smith's negative evaluation of existing education assessments. Smith and his colleagues propose to align these assessments with education standards established at the state level. Hanushek propounds a "value-added" approach, based on differences in performance between students entering the school system and those leaving the system. Under Goals 2000, federal education policy charges states with standard setting. Hanushek would have states promote incentive schemes for performance as well as establish standards and set overall education policy. Education policy

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--> would be implemented through incentives rather than regulations. Both authors would have states deregulate choices among education inputs and teacher certification, providing much enhanced discretion for local school administrators in selecting the best mix of education resources for achieving higher performance. The economic perspective provided by the PEER report provides an important new dimension for deliberations about future education reform. This dimension was omitted from the lengthy debate that led to Goals 2000 and the ESEA legislation. Costs and benefits have not been compared in determining levels of support for education at the federal level. Evidence of substantial inefficiencies in the allocation of education resources has been ignored. Incentive schemes are notable by their absence from the resulting program for school reform. The conclusions of economic research on education summarized by Hanushek and the conclusions of education research summarized by Smith and his colleagues represent different ways of abstracting from the same reality about American education. Education research focuses on the goals of education; economic research concentrates on the means of achieving those goals. Viewed from this perspective, the two points of view produce a more complete framework for future education reform. Nevertheless, the policy recommendations of the PEER report go well beyond the education policies described by Smith and his colleagues. A budget crisis arising from rapidly growing enrollments is already enveloping school systems around the country. The new challenges facing America's schools will require balancing the costs and benefits of education and enhancing performance while realizing efficiencies in operation. In meeting these challenges it will be critical to make effective use of economic research in improving America's schools. References Board on Science, Technology and Economic Policy. 1994. Investing for Productivity and Prosperity. National Academy Press, Washington, D.C. Bureau of Labor Statistics, July 11, 1994, "Multifactor Productivity Measures, 1991 and 1992," News Release USDL 94-327, and Dale W. Jorgenson, 1995, Postwar U.S. Economic Growth, The MIT Press, Cambridge, Mass. Jorgenson, Dale W., and Barbara M. Fraumeni. 1995. "The Accumulation of Human and Nonhuman Capital 1948–84," reprinted in Dale W. Jorgenson, Postwar U.S. Economic Growth, The MIT Press, Cambridge, Mass., pp. 273–332. National Commission on Excellence in Education. 1983. A Nation at Risk. U.S. Department of Education, Washington, D.C. The Boston Globe, October 6, 1994, p. 10.