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Returns on Investment in Public Higher Education

OAIRP Fall Conference, Columbus, OH October 18, 2002. Returns on Investment in Public Higher Education. Henry Y. Zheng, Ph.D The Graduate School The Ohio State University. Why Study Return on Investment.

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Returns on Investment in Public Higher Education

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  1. OAIRP Fall Conference, Columbus, OH October 18, 2002 Returns on Investment in Public Higher Education Henry Y. Zheng, Ph.D The Graduate School The Ohio State University

  2. Why Study Return on Investment • To demonstrate the value of public funded higher education to key investors / stakeholders: • Parents/Students • State/local government agencies • Elected officials • Justify continuing public support for higher education as a public good • Tools for economic impact analysis

  3. What is Return on Investment • Return on investment (ROI) is a financial calculation that indicates the degree to which benefits exceed the investment (costs) for a given project. • The calculation of ROI is in the form of a ratio where benefits are in the numerator (top) and investment/costs are in the denominator (bottom). By itself, ROI is just a number.

  4. ROI in Higher Education • Based on Human Capital theory • Higher education improves an individual’s economic productive ability through his/her systematic acquisition of knowledge and skills • Students invest money and time to acquire such knowledge and skills • ROI is to measure how much a student’s investment adds value to his human capital post-graduation.

  5. ROI in Higher Education • Based on Public Goods Theory • Assumption: individuals’ consumption of higher education produces positive externalities, including: • increased participation in civil and public affairs • healthier lifestyle and lower health risk • lower probability to commit crime • less reliance on public welfare system • greater inter-generational effects • The positive externalities are so desirable that higher education is should be regarded as a “public good” (meaning government funding)

  6. ROI in Higher Education • Assessment of current research • No consensus on what exactly are private and public returns to investment • Research limited by data availability and conceptual ambiguity • What is a clear-cut analysis in the business environment is not so clear in public environment

  7. Private vs. Public ROI Private Investments Public Investments Financial Aid Tuition and Fees State Subsidies Cost of Producing a College Degree

  8. Private Return on Investment • Assumption: • Student pays full-tuition without receiving any financial aid • Method • Individual costs: • Earnings forgone while attending college • Tuition, fees, school-related expenses • Living expenses such as room and board are not included • Individual Returns: • Marginal earnings when compared to a typical high school graduate who is working.

  9. Private Return on Investment

  10. Private ROI: OSU Study • Wage Data: • from Ohio Bureau of Employment Services -- matched with OSU FY94 undergraduate degree awardees cohort. • Cost Data: • Tuition and Fees -- 6-year average in 94 dollars, varies by TTD quarters. • Books -- assuming $300 per quarter FT and $150 per quarter PT. • Foregone revenue: HS Graduate Wages for age group 18-25 multiply by time to degree (Sum of Quarter / 3).

  11. Private ROI: OSU Study Five Year Rates of ROI: Year to Break Even for Investment:

  12. Example Findings: Private ROI

  13. Implications from findings of Private Return on Investment • From an individual’s perspective, a college degree from a public university is a good investment • Large increases in tuition rates may discount the value of college education unless the labor market matches the pace of increase • Rates of ROI associated with academic major which is mostly decided by the labor market • Different rates of ROI may also reflect differences in cost structures

  14. Public Return on Investment Private Investments Public Investments Financial Aid Tuition and Fees State Subsidies Cost of Producing a College Degree

  15. Public Return on Investment • A very problematic area of research • Public investments come in many forms • Instructional subsidies • Low-interest loans or loan guarantees • Low income assistance grants • Disability assistance grants • Individual level data are hard to access due to privacy protections • Intangible benefits are hard to quantify

  16. Public Return on Investment • My proposal – focus on the tangible and measurable variables: • State Investments: • State instructional subsidy earned by students • State-assisted financial aid for qualified students (average) • State Returns • Marginal tax revenue generated from college graduates

  17. NPV of State Investments • Because intangible social benefits are not measurable, public ROI cannot be accurately captured. Alternatively, we may use the net present value analysis to see if state investments in higher education is a value-added activity. • In business environment, NPV represents the value added to the organization by the investment, which leads to a net increase in the market value of the stockholders’ wealth • An investment that generates positive NPV will make the stockholders better off by the amount of its NPV.

  18. NPV of State Investments • Applying the NPV analysis to public higher education, we assume: • the taxpayers are viewed as the stockholders who ultimately pay for the investment; • the government is the corporation who serves as the agent for the stockholders and make the investment decision; • state universities are the contractors; and interactions between faculty and students represent the production process. • When students start paying taxes to the government after graduation, the investment by the taxpayers begins to generate measurable financial returns.

  19. Net Present Value Analysis Definition: NPV = P - I where: P = the present value of the project’s future cash inflows I = the present value of the project’s cost (usually the initial outlay) NPV IS A MEASURE OF THE PROFITABILITY OF AN INVESTMENT, EXPRESSED IN CURRENT DOLLARS.

  20. Net Present Value Example A project promises to return $10,000 after one year and $20,000 after two years. The project also requires an initial investment of $22,000. Calculate its net present value assuming a 12% discount rate. Discount Present Year Cash Flow Factor Value 0 $(22,000) 1.000 $(22,000) 1 10,000 0.893 8,930 2 20,000 0.797 15,940 $2,870 ===

  21. Decision Criteria for NPV If the NPV >0, this indicates: the present value of future cash flows, discounted by cost of capital, at least equal to the current cost of the investment – it adds value to investors Therefore, the investment should be made

  22. NPV Analysis Applied: • Assumptions: • State instruction support per in-state undergraduate: 1990 – 1994 (estimates) • $3300, $3,800, $4,200, $4,500, $5,000 • Average state grants-in-aid per in-state undergraduate: 1990-1994 (estimates) • $1,100, $1,133, $1,167, $1,202, $1,238

  23. NPV Analysis Applied: • Assumptions: • Marginal revenue of OSU graduates is taxed at 4.8% (Ohio Dept of Taxation) • A lifetime payback period of 30 years • Average Marginal Revenue • Actual wage data from OSU 94 cohort from 1995 to 1999 • 4% annual increase for OSU grads and 3% increase for HS grads

  24. NPV Analysis Applied: (estimates, please do not cite)

  25. NPV Analysis Results: (estimates, please do not cite)

  26. Comments & Questions

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