Setting Investment Priorities in Education

International Monetary Fund. External Relations Dept.
Published Date:
January 1995
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In recent years, a global consensus has emerged on the importance of investing in human capital, which is viewed as an essential part of efforts to raise incomes and achieve sustained economic growth. The pace of changing technology, economic reforms, and the rapid increase in knowledge have brought about more frequent job changes in individuals’ lives. This has created two key priorities for education: it must meet economies’ growing demands for adaptable workers who can readily acquire new skills, and it must support the continued expansion of knowledge.

Education is a sound economic investment. For individuals and families, education increases income, improves health, and reduces fertility rates. For society, investing in education raises per capita GNP, reduces poverty, and supports the expansion of knowledge.

For example, in 1960, only 7 percent of Guatemala’s children attended secondary school. Had that share been 50 percent, Guatemala’s per capita income today would have been almost 40 percent higher than the actual outcome. Numerous studies have shown that the monetary returns on investment in education are well above the 10 percent yardstick that is commonly used to indicate the opportunity cost of capital. The returns on investments in primary education are the highest (see chart).

Investing in education complements investment in physical capital, and the benefits derived from both are highest where macroeconomic policy is sound. Investing in education sets off an intergenerational process of poverty reduction, because better-educated persons are more likely to ensure the education of their children. Massive investment in both primary and lower secondary education—complemented by a pattern of growth that channels labor into productive uses—was one key element in the East Asian development “miracle.” Other countries, including India and Mexico, have come to this realization more recently and have started to expand and reform their basic education systems extensively.

Progress and challenges

The economies of low- and middle-income countries have been growing at historically rapid rates. Progress in education—expanded enrollments and longer schooling—has contributed to this growth and so has helped to reduce poverty in developing countries. For the first time in history, most children at least start school. By 1990, 76 percent of the 538 million children between the ages of 6 and 11 in developing countries were in school, up from 48 percent in 1960 and 69 percent in 1980. As a result of these gains, in 1990, an average 6-year-old child in a developing country could expect to complete 8.5 years of school, up from 7.6 years in 1980. In Eastern Europe and Central Asia, the norm is 9 or 10 years of schooling. In East Asia, Latin America, and the Caribbean, primary education is almost universal. Countries in South Asia, the Middle East, and North Africa are also making steady progress in increasing primary school enrollments, though South Asian countries lag considerably behind. The number of expected years of schooling rose in the 1980s in every region except Africa, where the gross enrollment ratio for primary school actually fell and 50 percent of 6-to-ll-year-old children were not in school as of 1990.

Nicholas Burnett, a UK national, is Principal Economist in the Education Group of the World Bank’s Human Development Department.

Kari Marble, a US national, is a Consultant in the Education Group of the World Bank’s Human Development Department.

Harry Anthony Patrinos, a national of both Greece and Canada, is an Economist in the Education Group of the World Bank’s Human Development Department.

The transition economies of Eastern and Central Europe have high primary and secondary enrollment ratios but need to adjust their entire education systems to better meet the needs of a market economy. It is particularly important for these countries to maintain funding levels for basic and upper-secondary education; to shift away from overspecialization at vocational, technical, and higher education institutions; and to reform the governance and financing of higher education.

Despite substantial achievements in the world as a whole, major educational challenges remain: to increase access in some countries; improve equity; improve quality; and, where needed, speed reform.

Finance and management

Public intervention in education can reduce inequality, open opportunities for the poor and disadvantaged, compensate for market failures in lending for education, and make information about the benefits of education more generally available. But public spending on education is often inefficient and inequitable. It is inefficient when it is misallocated among competing uses; it is inequitable when qualified potential students are unable to enroll in institutions because educational opportunities are lacking or because of their inability to pay. Present systems for financing and managing education often fail to meet these challenges. Public financing, moreover, is becoming more difficult to provide as enrollments expand.

Basic education ought to be the priority for public spending on education in countries that have yet to achieve nearly universal enrollment at the primary and lower-sec-ondary levels. Most countries are already allocating the highest share of public spending on education to primary schools. Public spending on primary education generally favors the poor, but public spending on education as a whole often favors the affluent because of heavy subsidization of the upper-secondary and higher education levels, which usually have relatively few students from poor families.

Social rates of return to investments in education1

Source. George Psacharopoulos. ‘Returns to Investment in Education: A Global Update.” World Development. Vol 22 (1994). pp. 1325-43.

1 Private rates of return are even higher than social rates of return because of the public subsidization of education. Per capita income levels of country groups, in US dollars per year, are defined as follows: low-income ($610 or less), lower-middle-incomo ($611 - $2,449). upper-middle-mcome ($2.450~$7.619). and high-income (S7.620 or more)

2 Not applicable.

There is no theoretically appropriate proportion of national income or public spending that should be devoted to education. Some countries that spend very little on education could, of course, dramatically improve results simply by increasing public spending. In many countries, however, education could be improved with the same—or even smaller—amounts of public spending by focusing on the lower levels of education and increasing internal efficiency, as has been done in East Asia.

Finding additional money

The inefficiencies and inequities described above, along with expanding enrollments in public schools at all levels, have helped to increase the share of GNP devoted to public- spending on education. The result has been increasing pressure on public funds at a time when many countries, especially in Eastern Europe and Africa, are experiencing general fiscal difficulties. As enrollments increase, resources per student will decline, as will the quality of schooling unless public spending becomes more efficient.

Although measures to increase the efficiency of public spending on education can make existing funds more productive, such measures alone may not be enough. Some countries have chosen to reallocate public spending to education from other publicly funded activities, such as inefficient public enterprises that can be run better by the private sector. Other countries have found ways, within macroeconomic policy constraints, to increase government revenues and thereby to spend more on education. For example, several Indian states increased their spending on education from about 2.5 percent of state domestic product in the mid-1970s to more than 4 percent in 1990. Still other countries have sought to supplement public funds for education with private funds. In Asia, the more that higher education costs have been financed through student fees, the broader the overall coverage of the education system has been.

Private financing can be encouraged either to fund private institutions or to supplement the income of publicly funded institutions. Although private schools and universities tend to draw their students from more advantaged socioeconomic backgrounds, they nevertheless promote diversity and provide useful competition for public institutions, especially at the higher levels of education.

Reorganizing education

Most education systems are directly managed by central or state governments, which put a great deal of effort into dealing with such issues as teacher salary negotiations, school construction programs, and curriculum reform. This central management, which often extends even to instructional inputs and the classroom environment, allows little room for the flexibility that leads to effective learning.

The main ways governments can help improve the quality of education are by setting clear and high performance standards in core subjects, supporting inputs known to improve achievement, adopting flexible strategies for the acquisition and use of inputs, and monitoring performance. Generally, however, these steps are not taken because they go against the grain of existing education spending and management practices and are opposed by groups with vested interests.

Priorities for reform

Six key reforms in education finance and management, with priorities among them depending on individual country circumstances, will go a long way toward enabling countries to meet the challenges of improving access, equity, and quality, and will also accelerate the pace of reform.

Giving education a higher priority. Because of its important role in enabling countries to achieve both economic development and poverty reduction, education deserves higher priority on governments’ agendas—not just those of their ministries of education. This has long been recognized in East Asia and is coming to be increasingly understood elsewhere, particularly in Latin America. Education alone, however, will not reduce poverty; complementary macroeconomic policies and physical investments are also needed.

Paying greater attention to outcomes. Educational priorities should be set with reference to outcomes, using economic analysis, standard setting, and the measurement of achievement through learning assessments. Governments need to look at the whole educational sector before setting priorities. Countries that have yet to achieve universal basic education will need to pay attention to all levels of education, using economic analysis to guide their decisions about which investments will have the greatest effect. Focusing on outcomes also entails the establishment of performance standards, particularly for primary and general secondary schools, and development of a system of assessments to monitor what students are learning. Standards, curricula, and monitoring are most effective when they are directly linked through appropriate incentives.

Emphasizing investment in basic education. A more efficient, equitable, and sustainable allocation of new public investment in education would do much to meet the challenges that education systems face today. Efficiency is achieved by making public investments where they will yield the highest returns- usually in basic education. Working to improve equity. Equity in education has two principal aspects: (1) everyone’s right to a basic education—that is, to acquire the basic knowledge and skills necessary to function effectively in society, and (2) the government’s obligation to ensure that qualified potential students are not denied education because they are poor or female, are from disadvantaged ethnic (including linguistic) minorities or geographically remote regions, or have special educational needs. At the lowest and compulsory levels of education, equity simply means ensuring that schools are available. Beyond that, it means having fair and valid ways of determining potential students’ qualifications for entry.

Achieving equity requires both financial and administrative measures. Financial measures, such as scholarships, are important at all levels to enable the poor to acquire an education. Scholarships can cover fees and other direct costs, such as transportation, books, and uniforms and, when appropriate, can compensate families for the indirect costs of sending children to school—for example, loss of labor services for the household. Administrative measures can increase enrollment of the poor, females, linguistic minorities, and students with special educational needs. Programs designed to demonstrate the importance of educating children can increase the demand for schooling among the poor. For linguistic minorities, bilingual programs and schools offering a choice of language of instruction are important, especially in primary education.

Increasing household involvement by providing real choices. Around the world, parents and communities are becoming more involved in the governance of their children’s schools. Effective involvement in school governance does not come about easily, however, and training is generally advisable. Several countries have a long tradition of parental choice, and increased experimentation with school choice is now a worldwide phenomenon.

For choice to be effective, students must be able to choose from two or more possible schools. Each of these should have some distinguishing characteristics—for example, in regard to what aspects of the curriculum are emphasized: what teaching styles are used; and, al higher levels, what courses are offered. Finally, teachers need to enjoy considerable autonomy concerning what and how they teach, within limits set by a broad national curriculum. The availability of real choices gives educational institutions an incentive to adapt to demand.

Expanding schools’ autonomy. The quality of education can benefit when schools have the autonomy to use instructional inputs according to local school and community conditions and are accountable to parents and communities. Fully autonomous institutions have the authority to allocate their resources (not necessarily to raise them), and they are able to create an educational environment adapted to local conditions inside and outside the school (see box).

Reliance on local funding must be tempered with adjustments by higher levels of government to compensate for differing resource levels among localities. Local control of resources need not imply local raising of revenues. The goal of local financing of schools should be to improve learning, not to reduce overall resources.

Implementing change

In all countries, entrenched ways of operating and vested interests will make change difficult. Education is intensely political: it affects the majority of citizens, involves all levels of government, almost always makes up the single largest component of public spending in developing countries, and involves public sub- sidies that are biased in favor of the elite. Prevailing systems of education spending and management often protect the interests of teachers’ unions, university students, elites, and the central government rather than those of parents, communities, and the poor. There are, however, strategies that can ease change.

Encouraging schools to be autonomous and accountable

Financial measures to encourage school and institutional autonomy and accountability can include the following:

  • using local and central government taxation;

  • sharing costs with local communities;

  • allocating block grants to communities and schools without putting restrictions on allocation of funds;

  • charging fees at higher levels of education;

  • encouraging revenue diversification;

  • using financing mechanisms in which money follows students, such as capitation grants, vouchers, and student loans; and

  • providing funding to schools and universities based on output and quality.

Financing and management reforms are best introduced in parallel with the expansion of educational opportunities. Sometimes the reforms themselves make for expansion—for example, when prohibitions on the private sector are lifted. Increased cost sharing in public higher education is politically most feasible when it is linked to expansion of opportunities for higher education. Building a national consensus requires stakeholders in the education system to participate in a national consultation mechanism, such as those developed in Bolivia and the Dominican Republic, where reforms recommended by national commissions (composed of stakeholders and all political parties) persisted through changes of government. Increasing the involvement of parents and communities by making schools autonomous and accountable can offset the power of vested interests; it is also critical for increasing flexibility and improving instructional quality. Careful design of reform measures is necessary to avoid disrupting the vital links among education subsectors. An essential, although often neglected, step is the provision of appropriate resources and mechanisms to accompany policy changes.

This article is based on Priorities and Strategies for Education: A World Bank Review, Development Practice Series. 1995, World Bank

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