Public spending on higher education in developing countries: Too much or too little?

Economics of Education Review, Vol. 15, No. 4, pp. 407~119, 1996

Copyright © 1996 Elsevier Science Ltd Printed in Great Britain. All rights reserved 0272-7757/96 $15.00+0.00

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Public Spending on Higher Education in Developing Countries: Too Much or Too Little? NANCY BIRDSALL Inter-American Development Bank, Washington, DC 20577, U.S.A.

Abstract--This paper discusses problems with the prevalent view that public resources for education in developing countries should be reallocated from higher to lower levels of education. There may be a case for maintaining and even increasing spending on higher education, as long as public funds can be directed to research and other "public good" functions of institutions of higher education. Current measures of social returns to primary, secondary and higher education do not reflect unmeasured social benefits at each level; since we do not know the relative size of these benefits across levels, we do not know the true ranking of social returns across primary, secondary and higher education. The true social rate of return to certain components of higher education, such as research and postgraduate training in science and technology, and creation of other skills where social returns probably exceed private returns (such as public administration) is probably high, and in some settings, may now be as high or higher than the social rate of return to primary and secondary education. Moreover, achieving and sustaining adequate levels of quality to capture these social returns requires minimal stability in public financing, arguing against major reallocations away from higher education. But this does not argue for more public spending on all higher education programs. On the contrary; within the envelope of total public spending on higher education, reallocation away from public spending on undergraduate training makes sense, since such training probably has low social compared to private returns, and can be accomplished by greater reliance on private universities and by increasing tuition and other fees in public universities, while ensuring equitable access through loan and scholarship programs. [JEL I28] Copyright 01996 Elsevier Science Ltd

1. I N T R O D U C T I O N THE VIEW THAT basic education yields higher social rates of return than higher education and tends to benefit the poor more than the rich, and that therefore allocation of scarce government funds should favor the former, is increasingly espoused by international donors. The World Bank in particular, in various policy documents, has emphasized the efficiency and equity costs associated with relatively high public spending on university and other tertiary education compared with primary education/ In a study of policy options in education for developing countries (Psacharopoulos et al., 1986), World Bank staff recommend imposition of selective user charges at the university (and the secondary) level, and reallocation of government spending on education "toward the level with the highest social returns". The World Bank authors state clearly that the level where social 407

returns are highest may vary across countries. However, their work has been widely interpreted as discouraging public spending on higher compared with primary education, because their summary table shows that in fact estimated social returns throughout the developing world are higher at the primary (and secondary) levels. At the same time, education policy makers in developing countries continue to express concern about the poor state of higher education, and in the larger countries, the implications of limited spending on basic and applied research, particularly for science and technology development. Lack of local capacity to carry out research may be one explanation for the failure of many developing countries to exploit fully existing technologies in such fields as agriculture and health2--what scientists in developing countries have referred to as the "knowledge gap" and as "intellectual dependency". 3

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This paper discusses possible problems with the notion that educational resources should be reallocated from higher to lower levels of education. It concludes that there is a case for maintaining levels of public spending on higher education, particularly if public funds can be directed toward research and other "public good" functions of institutions of higher learning, and away from undergraduate training and other functions where private returns relative to social returns are high. First, general issues regarding the measurement and. interpretation of estimated social rates of return to various levels of education are discussed. A critical problem is that conventional rate of return estimates do not take into account non-private (social) benefits of education at any level. Then the specific nature of probable unmeasured social benefits of higher education is reviewed, taking into account not only the training function of higher education institutions, but research and "nation-building" functions. A concluding section summarizes the implications of the discussion for policies regarding the financing of the education sector in developing countries. The purpose of the paper is to provoke further thinking. As will become clear, lack of information on certain points prevents definitive conclusions. 2. S O C I A L RATES O F RETURN TO EDUCATION

2.1. High Social Rates of Return to Higher Education The first point is a simple one, not worth belaboring. Though estimated social rates of return to higher education are below those to lower levels of education, at an average of 13% for all developing countries (Psacharopoulos et al., 1986), they still tend to exceed social rates of return to other investments. Thus, public funds should be reallocated from higher to lower levels of education only assuming a narrow realm of choice for policy makers, i.e. confinement to reallocation within the education sector. Ideally, instead of such reallocation, funds currently invested outside the education sector would be reallocated, first to lower levels of education until those rates of return were driven down to the rates for higher education, and then to any level of education until rates for all levels were driven down to the rates for noneducation investments. Of course, in the face of political barriers that make intersectoral shifts unlikely (over the long run4), real-

location from higher to lower levels of education might be warranted. But the political reality in most developing countries in fact dictates otherwise: support among influential groups is greatest for higher education, and funds reallocated from higher to lower levels might eventually be lost entirely to education)

2.2. Unmeasured Social Benefits in Estimated Social Rates of Return The efficiency argument for reallocation of public funds from higher to lower levels of education is based on differences in the estimated social returns to various levels of education, with estimated social returns being higher to primary than to secondary and higher to secondary than to tertiary education (Psacharopoulos, 1994). These estimated social returns, however, do not actually take into account the social benefits of education at any level. They are generally based on the private returns (measured in terms of additional wages of those with more education), with account also taken of the social costs associated with educating students at the various levels (for example, the opportunity cost of teachers' time and other inputs). These social costs include the private costs to individuals but other costs as well. Measured this way, social costs therefore always exceed private costs. Hence, social returns are always below private returns; they do not take into account the non-private benefits of education arising from what economists call positive externalities. If these externalities are sufficiently greater at higher than at lower levels of education, then the sum of measured returns plus these unmeasured externalities, or social returns to higher education, could in fact exceed the sum of measured and unmeasured returns at other levels. In short, the actual ranking of the true social returns to various levels of education could shift. Table 1 illustrates this point. The first column shows the estimated social returns to investment in education (which are labelled "measured" social returns, to indicate they do not reflect positive externalities) at the three levels of education for various geographic regions, as presented in the World Bank policy study (Psacharopoulos et al., 1986) based on studies in 45 developing countries. The second column shows the difference between the social returns to higher minus primary, and higher minus secondary education. This difference is simply the sum of the differences in private returns plus the differences in social cost. In principle, positive exter-

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Table 1. Measured social returns to investment in education by country type and level Returns by level

Africa (sub-Saharan) Asia Latin America Middle East, North Africa and Europe (developing countries of) Developed countries

Sum of differences in private returns and in social costs

Higher

Primary

Secondary

28 27 26 13

17 15 18 10

13 13 16 8

11

9

Higherminus primary

Higherminus secondary

15 14 10 5

4 2 2 2 2

Source: Psacharopoulos et al. (1986), p. 7.

nalities to higher education (greater than at the other levels) could offset these differences. This is particularly likely in the case of secondary education since the differences in the social returns are relatively small in all regions. The nature of these externalities to higher education is discussed below. Table 2 illustrates an additional point. The second column of Table 2 shows the estimated private returns to investment in education from the World Bank study (Psacharopoulos et al., 1986). The third column shows the difference between the private returns and the measured social returns (from Table l) at the various levels. Except in Africa, the differences between

private returns and these measured social returns are not very different.6 Now note that the imposition of user fees at the secondary and higher education levels would in fact reduce the private returns to education, at these levels, by raising the private costs. These fees would not lower the social costs, but by raising private costs, would reduce the differences between private returns and the measured social returns. Suppose such fees were "optimal", in the sense that they exactly eliminated the difference between private and measured social returns (abstracting from the issue of unmeasured social benefits), as shown by the zeros entered in the last column of Table 2. Then using this

Table 2. Differences between private and measured social returns to education, by country type and level Region

Africa (subSaharan) Asia Latin America Middle East, North Africa and Europe (developing countries of) Developed countries

Measured social returns

Private returns

Private minus measured social return

Primary Secondary Higher

Primary Secondary Higher

Primary Secondary Higher

With "optimal" user charges, higher

28

17

13

45

26

32

17

9

19

0

27 26 13

15 18 10

13 16 8

31 32 17

15 23 13

18 23 13

4 6 4

0 5 3

5 7 5

0 0 0

11

9

12

12

I

3

Source: Psacharopoulos et al. (1986), p. 7

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approach to measure costs and returns, there would be no logic at all in proposing reallocation of government spending away from higher toward lower levels! 7

2.3. Social Rates of Return: General Equilibrium and Dynamic Effects There is nothing immutable about rates of return to various levels of education. Referring back to Table 1, suppose that user fees or other reforms led to improvements in internal efficiency and quality in pub.lic universities, thus raising the social return to higher education. The optimal schedule of user fees would, for example, induce the fight students to enter the right fields and reduce the social losses implied by high drop-out rates. 8 [User fees accompanied by a loan and scholarship program would in addition improve equity, as amply illustrated in the World Bank staff document (Psacharopoulos et al., 1986).] There are no systematic estimates of the potential for raising social returns to higher education in developing countries by improving internal efficiency and raising quality. However, studies of higher education systems in such countries as the Philippines and Brazil indicate that public universities have surprisingly high costs per graduate due to high repetition and drop-out rates; high faculty to student ratios and low teaching loads; and low quality measured in terms of faculty research. The studies attribute these problems to systems of governance and budgeting, including lack of any consumer control, which provide no incentives to individual institutions to cut costs or improve teaching quality. 9 Thus, a number of reforms in addition to user fees have potential to increase internal efficiency and raise quality: prospective budgeting for each institution; autonomy in hiring and firing faculty and in setting salaries; depoliticization of governance and of appointments; and transparent and publicly available evaluation. With higher internal efficiency and quality in public universities, the difference between social returns to higher vs primary education would fall and correspondingly vitiate further the argument for reallocation of education resources. As will be shown below, student fees could also permit an increase in resources within public universities for research and other activities that have particularly high (unmeasured) social benefits, raising still further the true social return to higher education. Obviously, quality could be increased at the primary and secondary levels too; however, improve-

ments in quality at the primary and secondary levels would probably require higher public spending, while many improvements in higher education such as introduction of tuition, though politically difficult, would actually reduce public outlays. In short, measured social returns to various levels of education can easily change over time. Moreover, for several reasons the likely direction of change would be to reduce the measured advantage of primary and secondary over higher education. First, recall that differences in measured social returns to the three levels of education reflect only differences in social costs. An important component of social cost at each level is the opportunity cost of the time of trained teachers. Costs rise by level of education in part because of the higher levels of training and thus higher social opportunity costs of employing teachers at higher levels. Social costs by level of education rise more in the poorer countries of Africa and Asia (Tables 1 and 2) because highly trained people are relatively more scarce. Put another way, the social costs of higher education are especially high in poor countries (relative to returns to primary and secondary education) because there is not enough higher education! As more people are educated, their general skills become less scarce, and the social cost of employing them as teachers falls. [Indeed, see Schultz (1987) for evidence that their relative wages fall too.] Thus, for the poorest countries, all other things equal, we can expect the measured social returns to higher (and secondary) education to rise slightly as measured social costs decline, weakening the argument for reallocation of government spending. Second, the social costs of higher education will also decline, especially in Africa, if there are scale economies. Unit costs may be high in Africa because enrollments are low; this could matter especially in fields such as laboratory sciences, where fixed costs are high. Third, there is evidence that social returns to primary schooling fall over time, probably as a result of the reduction in the scarcity premium of graduates as the numbers of graduates and their proportionate representation in the workforce increase, m Fourth, changes outside education systems such as the recent opening of many developing economies through liberalization of trade policies could increase social returns to education at all levels--but particularly at the higher level, given that technical, entrepreneurial, and managerial skills increase in

Too Much or Too Little Spent on Higher Education in Developing Countries value in open and competitive economies facing global markets. Finally, even assuming the conventional ranking of social rates of return by level of education is correct in the short run (because, for example, the unmeasured social benefits of certain university activities are currently low), caution in reallocating funds away from higher education might be warranted. As suggested above, a reasonable social return to certain university activities may require attainment of a minimum quality. Development of quality (excellence) in university teaching and research probably requires time; short-term reductions in allocations for higher education could contribute to uncertainty about the stability of public support, loss of good faculty and failure to initiate new research. These losses might not easily be recouped. Development of quality in many universities also, of course, requires reform; the poor quality of most public higher education in developing countries suggests that without retbrm, social returns will be lower than their potential, in which case the arguments for sustaining or raising public spending on higher education will be much less defensible.

3. A BROADER VIEW OF HIGHER EDUCATION We return now to the issue of unmeasured social benefits of investments in higher education. Are positive externalities at the level of higher education sufficiently great, at least in some settings, to alter the ranking of levels by social rate of return shown in Table 1? There is no question that investments in the lower levels of education yield positive externalities, including lower fertility and better health and nutrition, and a politically aware and competent citizenry capable of contributing to political and social cohesion. The usual assumption has been that these externalities are greater at the lower level than the higher level. To quote from the World Bank study (Psacharopoulos et al., 1986): "In addition, apart from measurable monetary rewards, investments in the lower levels of education may generate more externalities than would investments in the higher levels." But there is really no solid basis for this assumption. What are the positive externalities at the higher level? Positive externalities of higher education are less likely to arise directly from the existence of more people in a society with higher education than is the

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case with primary education since most of those people capture (i.e. internalize) the full benefits of their additional education in the form of higher wages or personal nonpecuniary returns." However, there may well be externalities associated with other non"training" activities of higher education institutions (where training is used as shorthand for the preparation of undergraduates for productive work), such as research and research-based training of graduate students. Several questions therefore need consideration: • First, is higher education more than training? • Second, are the externalities associated with nontraining education activities high enough, given costs, to alter the ranking of social rates of return by level of education? • Third, can the non-training "public good" components of higher education be produced independently? Or are they part of a bundle of activities that can be produced more effectively or cheaply together than separately? If not produced independently, can they be separately financed?

3.1. Question No. 1: Is Higher Education More Than Training? In developing countries, higher education includes at least one and often more than one of four activities: '~ • The first is the most obvious: the training of students, who then are prepared to function in professional, entrepreneurial, managerial, and technical positions. • The second is basic research: basic research ideally contributes to the generation of new knowledge and to the acquisition and adaptation of existing knowledge to local conditions; training in research, normally at the graduate level, helps build and sustain local capacity to extend and adapt new knowledge. • The third is the carrying out of various services for the public and private sectors, including applied research under contract, advisory services, and university-sponsored programs for the local community. In carrying out this third activity, universities and other institutions of higher education ideally provide a perspective on local and national social, political and cultural issues that is independent of dominant political or cultural interests. • The fourth activity is somewhat more difficult to

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characterize; to quote from a (different) World Bank document, referring to the potential contributions of African universities, "Higher education institutions also encourage indigenous selfexpression, conserve and adapt local traditions and values, and constitute important symbols of national prestige and. attainment" (World Bank, 1988). This fourth activity will be referred to here as "nation-building". It is useful to characterize these four activities in terms of the extent to which they are public or quasipublic goods. Training as defined above is largely though not entirely a private good. Most trained individuals capture the full benefits of their training in the form of higher lifetime pay. This is true even though in some countries shortages of certain types of trained personnel exist, as long as people with training in those fields receive pay reflecting their scarcity (the case, for example, with doctors in many developing countries). Because training is largely a private good, user charges will generally contribute to more efficient use of social resources for training. [See Psacharopoulos et al. (1986) for discussion of this point.] Where trained people are scarce, it is critical that training opportunities expand, but most types of training need not and generally should not be financed publicly.~3 That training is a private good is more true for undergraduate than graduate training, and more true for certain types of undergraduate and graduate training. Undergraduate training of primary and secondary teachers may seem an exception, since such training may have social benefits that are not reflected fully in teachers' salaries; still, raising teacher salaries to better reflect their social product would be more efficient than subsidizing undergraduates, many of whom will not enter teaching. A more straightforward example is graduate training in science. Such training is partially a public good, in that successful graduates do tend to enter teaching or research and receive less in salaries than the full value of their marginal social product. Potential students will therefore not be willing to pay the full costs of training in such fields, whether directly or through borrowing. Compounding the problem is that graduate training in science is relatively costly, requiring small classes (e.g. at the graduate level) or large amounts of capital (e.g. laboratory sciences). (Costly medical training is an exception in that it is probably possible to charge the

full costs of medical training in most developing countries, as long as a loan program is available, since doctors can capture in high salaries or fees the full social benefits of their education.) Symptomatic of the high costs and high social benefits to laboratory science programs, institutions that need to minimize costs, including private profit-maximizing institutions, usually avoid these. Instead they tend to concentrate on undergraduate "vocational" training and on low-cost courses such as business, the humanities and the social sciences, and to offer degrees in engineering as a theoretical rather than a laboratory science. The problem will be exacerbated where students believe that employers are satisfied with credentials in "vocational" fields such as business, and are therefore willing to pay the (low) costs of training in business, but not the higher costs of training in the scarce fields.~4 Similarly, public institutions of higher education, faced with the need to cut costs as public funds decline, will tend to cut research and costly training first. The second activity, basic research (i.e. research that produces additions to knowledge that have no known practical use) is generally viewed as a largely public good. In contrast to applied research, the result of which can be appropriated as long as intellectual property rights are secured, for example, via patent legislation, it is difficult to exclude others from use of the additional knowledge gained in basic research, and the use of new knowledge by some does not diminish opportunities for its use by others. Basic research should therefore be publicly subsidized. The market alone will not produce enough basic research from a social point of view. The third activity, applied research, and most advisory services that faculty might provide are largely private goods, the marginal costs of which consumers (including government agencies) are generally willing to pay. However, community services often carried out in university settings (public health clinics, demonstration projects in education) may have a public good component. The nation-building aspect of universities is difficult to define and impossible to measure, t5 To the extent it exists it is a public good. In short, higher education is more than training. Basic research and nation-building are also activities of higher education institutions, and these (as well as some parts of training) have substantial public good components, with positive externalities. There may be other arguments for public involve-

Too Much or Too Little Spent on Higher Education in Developing Countries ment in higher education beyond any "public good" argument: on equity grounds, given poor credit markets, and the difficulties poor students face in borrowing; and on grounds of economies of scale, and thus natural monopolies, in some disciplines.

3.2. Question No. 2: How High are Actual Social Rates of Return to These Activities? Recall that the estimated social rates of return to higher education are generally based on calculation of private rates of return (in turn based on income of graduates of various levels of education), with account taken of the social costs of education. These estimated rates do not, therefore, take into account the non-private or social returns to basic research; training in science, public administration and other fields where social returns may exceed private returns; any service activities that have social returns; and nation-building activities. This author knows of no estimates of the social rate of return to basic research. Mansfield (1980) and Griliches (1986) report high private returns to basic research undertaken by firms in the United States. In cross-section estimations of firm-level production functions, Griliches reports coefficients of basic research on log value-added production that vary depending on the year between 0.27 and 0.5176 His results suggest somewhere between a 3 to 1 and 7 to 1 ratio in favor of basic compared to applied research. Griliches notes that the observed private returns may underestimate the social returns because firms are unlikely to appropriate all the returns in a competitive industry.~7 Studies of growth across developing countries show no systematic effect of public spending on research on growth; data are limited, however? s The estimates of returns to basic research, moreover, provide little information on social rates of return to basic research in the humanities and social sciences, since private industries doing some basic research are likely to be investing in the natural, physical and engineering sciences. The social contribution of research in the former fields (both basic research and some so-called applied research, as the term is used in the social sciences ~9) is likely to be through contributions to "nation-building" rather than through strictly economic gains. Research which enhances understanding of local language, culture and history is the obvious example. It can be argued that high social returns to basic research do not warrant investments by developing countries in local basic research, since results of such

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research can, by definition, be appropriated; and because developing countries are unlikely to succeed in "replicating Oxfords", i.e. centers of excellence in the conduct of basic research. 2° As is true of the great majority of universities in rich countries, most universities in developing countries will fail to contribute to new insights through basic research. However, successful applied researchers (and even effective undergraduate teachers) may require continuous exposure to basic research; applied research may itself be more effective if carried out in close proximity to basic research? ~ (The need for applied research to be carried out at the local level is generally unquestioned.) Thus, public funding of some basic research (through funding of graduate training) may be critical to success in applied research and to success in establishing credible undergraduate faculties. As noted in the Introduction, lack of local capacity to carry out research may help explain the failure of many developing countries to exploit fully existing technologies in agriculture, health and other fields. (Spending is low on research in developing count r i e s - s e e Table 3--there are no data on the breakdown between basic and applied research.) The notable exceptions, such as India (which was able to rapidly exploit the availability of new high-yielding variety seeds, assuring the Green Revolution), tend to be those with somewhat greater spending on research? 2 Similarly, there are no available estimates of the social returns to training in such areas as high-cost laboratory sciences and public administration in developing countries. The high growth rate of Japan and other East Asian economies in the postwar period is often attributed to their heavy emphasis in public spending on the engineering sciences, including via scholarships for overseas training, and to their highly selective approach to high quality training in public administration. But other factors, including macroeconomic stability and heavy public spending on basic education, obviously also contributed, 2~ and it would be foolhardy to attribute growth substantially to the approach on higher education alone. Unfortunately, in most developing countries today, the problems of quality, low internal efficiency and poor incentives in public higher education mentioned above conspire to limit the quantity and quality of undergraduate and graduate training in critical fields where social returns would be high. It is even more difficult to measure the social return to universities' contributions via services and "nation-

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Table 3. Public expenditure on education and total (private and public) expenditure for research and experimental development, selected countries, as a percentage of GNP Country

Year

Nigeria Brazil India Philippines Mexico Costa Rica Korea Germany France U.S.A. U.K.

1987 1988 1988 1988 1989 1986 1988 1987 1988 1988 1988

Public Total expenditures on expenditures on education (% R&D (% GNP) GNP)* 1.1 (1986) 3.9t 3.2 (1987) 2.0 2.5 4.3 2.8 4.0 5.1 4,7 4.6

0.1 0.4 (1985) 0.9 0. ! ( ! 984) 0.2 0.3 1.9 2.9 2.3 2.9 2.3 (1989)

Summary statistics for research and development expenditures as percent of GNP Africa Developed countries 1980:0.28 1980:2.22 1990:0.25 1990:2.92 Latin America Developing countries 1980:0.44 1980:0.52 1990:0.40 1990:0.64 Notes: R&D expenditure comprises current expenditure, including overhead, and capital expenditure; current expenditure on education includes administration, cost of teachers and supporting teaching staff, books and teaching materials, scholarships, welfare services and maintenance of buildings. It does not include capital expenditure (expenditure on land, buildings, construction, loan transactions). Total expenditure is current + capital. *Based on current expenditure. tCurrent expenditure figures unavailable, computed per total expenditure. Source: UNESCO (1992, Tables 4.1, 5.2, and 5.19).

building". There is probably some social return, as argued eloquently by Soedjatmoko (1988) and lrele (1988), but as is the case with training, low overall quality, the politicization and elitism of public universities in some regions, and poor incentives to be accountable to the larger society have greatly limited the potential contributions of public universities.24 Though potential social benefits of public universities are high, with a few exceptions actual social benefits are relatively low. In short, we do not know how high the social returns are to basic research, certain types of training and public services, and nation-building activities of institutions of higher learning in developing coun-

tries. We suspect they are relatively low reflecting the actual situation but not the potential situation, were there reform of current practices and incentives. There is no way to establish whether they do or could exceed the (also unmeasured) non-private benefits of primary (and secondary) education. There is more room for uncertainty regarding the overall ranking of actual current and future potential social rates of return to the various levels than is commonly understood.

3.3. Question No. 3: Can the "Public Good" Activities be Produced Independently? Can They be Financed Independently? Of these activities, those that are primarily private goods can and are often produced independently of the others. Low-cost training in such fields as business and law is provided by the private sector in many developing countries as well as in developed; in the Philippines and Brazil, for example, more students attend private sector institutions at the higher level than public sector institutionsY Similarly, the advisory and applied research functions are often produced independently, as testified to by the existence of various private applied research centers and consulting groups (e.g. the Development Research Institute in Thailand), and the prevalence of individual private consulting among qualified persons in most developing countries, particularly in such fields as engineering and management. Though in some countries persons providing such private services may be associated with universities (and this is equally true in the U.S. and Europe), they are generally able to charge the marginal costs of their services (in terms of the opportunity cost of their time) when they provide advisory or applied research services. The situation is different for high-cost graduate training and for the largely public goods of basic research and nation-building activities. These are generally produced in conjunction with undergraduate training in university settings. Regarding basic research, in Germany and some countries of Eastern Europe, basic research in some fields (generally the natural sciences) is carried out independent of undergraduate training in separate research institutes fully supported by government. This set-up is rare in developing countries, however. In the (few) developing countries able to provide public funding for basic research (in the social sciences and humanities as well as in the natural sciences), such research is usually carried out by faculty in uni-

Too Much or Too Little Spent on Higher Education in Developing Countries versity settings. The relative scarcity of highly trained researchers and the need for some critical mass of people to make research productive would seem to make the combination of training and basic research necessary as well as more efficient. (Critical mass is also crucial to developing the "intellectual marketplace" which provides skilled researchers with the prestige and status among peers that helps compensate for their relatively low pay. 26) The inability of small and poor countries to retain highly trained people is often attributed to the lack of critical mass and associated peer support] 7 In addition, a critical input to basic research, i.e. the postgraduate training of future researchers, is virtually everywhere carded out in university settings in combination with undergraduate training. Indeed, there is evidence from the U.S. that in universities, undergraduate education is now a profitable "production" activity, often used to subsidize "consumption" by university faculty of loss-making graduate education and research (James, 1978). 28 On average, universities in the U.S. have a higher ratio of tuition to costs for undergraduates than for graduates. In university settings, undergraduates are less expensive to train because classes are larger, and more teaching assistants are used. (Consistent with this, and contrary to conventional wisdom, the training component of undergraduate education is cheaper to society if provided in universities along with graduate education and research than if provided in community colleges.) Lower costs of undergraduate education when combined with graduate education and research could of course indicate that undergraduate education is simply of lower quality in university settings, rather than indicating the likelihood of efficiency gains due to joint production. But other evidence 29 indicates that small class size does not contribute to academic achievement at the undergraduate level. In developing countries, the likelihood that joint production of undergraduate training with graduate training and research has lower social costs (for given benefits) than separate production would seem if anything more likely. Joint production would presumably improve the possibility of achieving whatever critical mass is necessary to retain faculty both within and across fields (the latter critical to new research insights). Critical mass, and the combination of undergraduate training with graduate training and research, also seem necessary (though not necessarily sufficient) for higher education institutions to truly contribute to

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"nation-building". As Soedjatmoko, the former rector of United Nations University, wrote: It is the nation's graduate schools which necessarily have to be of international quality...and may develop in depth international competence that will ensure the nation's competitiveness and autonomy...Political controL.has in many countries led to the reduction of the university into an institute of higher vocational training of narrowgauged technicians...incapable...of independently defining and analyzing the problems of their nation (Soedjatmoko, 1988). In countries where undergraduate training is closely associated with social mobility, graduate training and research become the sole source for development of an autonomous tradition of scientific research adapted to local needs and conditions. The loss of this tradition at the University of Ibadan in Nigeria, as resources were increasingly deployed in Nigeria to creation of new centers of undergraduate training, is eloquently described and decried in a paper by Professor lrele of that University (Irele, 1988). In short, the largely private good of undergraduate training may actually be produced at lower cost in combination with graduate training and research; and public spending for the largely public goods of graduate training and research may be easier to sustain politically in combination with undergraduate training. Given that the public good activities of higher education are generally carded out in university settings along with training, the question arises whether it would be possible to better target public funds to the public good activities within institutions of higher learning. There are at least two mechanisms: • tuition and other user charges imposed on students who are going to capture the full benefits of their training in future earnings; this would include most undergraduate students, and graduate students in such fields as business, medicine and law. The more the costs of these "private" services are recovered, the larger the portion of public funds that can go to the public good activities. Loan programs can ensure access to higher education for students unable to pay tuition; and loan repayments can be reduced or forgiven for students who after graduation enter teaching, public service or other professions (where their earnings are likely to be below their marginal social product); and • public support tied to faculty research through research grants awarded directly to faculty members or departments.

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Economics of Education Review 4. CONCLUSIONS

Government spending on education would ideally be directed to those levels where the gap between social and private returns is highest. Though estimated returns suggest this gap is greatest at the primary level, estimated returns do not take into account unmeasured social benefits of education. These social benefits could be substantial in certain components of higher education. Moreover, the social benefits to primary and secondary education may be declining in developing countries as more students complete these levels; and the social benefits to higher education could be increasing, for example, with the opening of many developing economies to global markets and competition. If unmeasured social benefits to higher education are (or could become) high enough, the ranking of social returns as currently measured could change. Thus, it is not obvious that reallocation of public resources for education from higher to the primary (and secondary) levels is warranted. Moreover, even if the social benefits of higher education in most developing countries are not high today, there is ample scope for reforms of financing and governance that would raise quality and improve internal efficiency, thus greatly raising social benefits. For example, were tuition and other charges introduced, such internal efficiencies as reduced repetition and more responsive teaching faculty would probably follow. User charges would also help ensure that a higher proportion of public funds in the higher education field could go to the public goods of basic research and graduate training. Since these public good activities are rarely produced outside university settings, they actually tend to be the first to suffer if public and political demands lead to higher than optimal spending on undergraduate training.

Once the possibility of high social returns to greater investments in research and related graduate training is taken into account, the question arises whether revenues raised by way of user charges to undergraduate students should not be retained within higher education. Given current fiscal constraints in most developing countries (outside East Asia), new funding for local research and for building the capacity to do local research by training graduate students seems unlikely. At the same time, bilateral and international donors are not enthusiastic about supporting research and graduate work, at least not to the extent these activities were supported in the 1950s and 1960s. In university settings, revenues could be realiocated within the individual institution rather than reverting to the larger bureaucracy which runs other levels of education. Retention at the university itself would improve the incentive for collecting tuition charges, and would improve the political likelihood that tuition charges would be imposed and their real value maintained over time. The reduction of subsidies for the direct "training" of students at the undergraduate level (an expensive and heavily subsidized activity, absorbing in some countries up to 50% of all education resources for a tiny number of privileged students3°) in favor of support for graduate training and research would constitute itself a major reordering of priorities in the education or knowledge-building sector in developing countries.

Acknowledgements--The author is grateful to Emmanuel Jimrnez, Ramrn Mayorga, Peter Moock, Donald Winkler, Maureen Woodhall, T. Paul Schultz, participants in the International Symposium on the Economics of Education, Manchester, England, May 1993 and an anonymous referee for comments on an earlier draft. The views and interpretations in this paper are the author's and do not necessarily represent those of the Inter-AmericanDevelopment Bank or the World Bank.

NOTES 1. See, for example, Psacharopoulos et al. (1986), especially pp. 9-10. 2. The perception that developing countries are not exploiting even existing technologies led the Rockefeller Foundation in the late 1980s to redefine the goals of its science-based development program to include assuring the "equitable and effective use of the results of science in the development process" (see Rockefeller Foundation, undated). 3. See, for example, the interview with Salam in The Scientist, as well as Irele (1988) and Soedjatmoko (1988). 4. A long-run view is required, as discussed below, if uncertainty regarding the stability of public support for higher education itself reduces returns to public investment in higher education. 5. For discussion of the political economy of social spending in developing countries, including how attempts to reduce subsidies by non-elites can be undermined, see Birdsall and James (1993). 6. For a number of reasons, estimated rates of return to all levels of education are biased. Such factors

Too Much or Too Little Spent on Higher Education in Developing Countries as lack of controls for ability, unmeasured differences in the cost of living, and cohort effects all suggest the bias is positive. [See Behrman and Birdsall (1987) for a summary and citations to specific studies.] Many of these factors are likely to be more important at lower levels of education; thus, the actual differences in rates of return between levels may also be exaggerated. 7. Of course, it is possible that such fees would reduce substantially the need for public financing at the higher levels of education, permitting some reallocation of government spending to other parts of the education system with high social returns--including parts of the higher education system itself, as discussed below. 8. This assumes that student loans assure the qualified poor have access and that fees within higher education vary by subject studied. 9. See James (1991) on the Philippines, and Paul and Wolff (1994) on Brazil. 10. For example, see Knight et al. (1992). The cross-section figures in Table 1 and Table 2 may reflect these effects, in that they demonstrate a pattern of lower returns by region associated with higher per capita incomes; this is especially true of the private return to primary education. The overall pattern of declining returns to all levels of education with higher per capita income probably reflects in part the gradual elimination of scarcity rents as a higher proportion of the population acquires more education. The persistence of relatively high returns in an absolute sense at all levels probably reflects persistently high marginal productivity effects of education due to constant increases in demand for human skills with technological change. 11. There may be social benefits associated with widespread access to higher education--such as a broader understanding of government and the possible range of public policies. Unfortunately, however, there is no association of more stable governments or more just societies with more higher education; consider the 20th century experiences of Nazi Germany and the Soviet Union, both societies with relatively high levels of higher education. 12. These activities are outlined, in somewhat different language, in World Bank (1988) in the context of potential ways that universities can contribute to economic development in Africa. 13. Given poor capital markets, it is usually necessary for governments to make loans available to qualified students. Most governments also subsidize at least some part of undergraduate training in public institutions (including, for example, the U.S.); this makes sense if the costs of administering loan programs are high, if many trained personnel become public servants and are paid less than their marginal social value, or if subsidies are necessary to assure equal access of the poor. 14. James (1988) reports for the Philippines that in proprietary institutions only 1% of all students are in "math and natural sciences" and 76% are in teacher training, engineering, or business, fields for which an undergraduate degree provides, apparently, a useful credential for employment (see her Table 5). 15. The function is captured succinctly by Soedjatmoko (1988): "The universities must play a role in the self-renewal and re-interpretation of their own culture...if developing countries want to retain their cultural authenticity" (p. 8). 16. He reports similar results when he attempts to eliminate possible simultaneity effects (that successful firms spend more on the luxury of basic research) by focusing on firm-growth rates. 17. How do we explain the willingness of private firms to do any basic research at all? Two possible reasons are that they can exploit more fully and rapidly findings of basic research than other firms in the industry; and that the presence of basic research work makes applied research more effective. 18. See Birdsall and Rhee (1993). They report that high spending on research at the country level is a consequence of economic growth but not a cause. They conclude that fast growing countries such as those in East Asia more likely grew by appropriating research results from elsewhere than by generating research internally. 19. In fields such as history and the humanities, much "applied" research holds no potential for profit and would not be undertaken if not supported publicly. 20. See Rottenberg (1988) and also Birdsall and Rhee (1993). Thus, Rottenberg (1988) and others would discourage public funding of any basic research in developing countries. There have been major contributions at developing country universities, including, for example, the Ibadan History series (published by Longmans under the editorship of Kenneth Dike), which in the 1960s made critical contributions to African history; and work in optical physics at the University of Campinas in Sao Paulo State, Brazil. 21. This would explain the willingness of private firms to invest in basic research. See Note 12 and Mansfield (1980). 22. See Table 3 and Evenson (1986). Among developing countries, with the possible exceptions of Korea and India, expenditures (public and private) for research and experimental development are well below 1% of gross national product (Table 3), and much lower compared with public expenditures on education than are such expenditures in developed countries. 23. See World Bank (1993a). 24. On this point, see World Bank (1993b).

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Economics o f Education Review 25. See James (1988) for discussion of the origins and nature of private institutions of higher education in the Philippines. 26. Rottenberg (1981) maintains that the intellectual marketplace obviates in part the need for public funding of basic research in the United States. 27. See, for example, the background note to an interview with the Nobel prize winning Pakistani physicist Salam (1988) in The Scientist. Salam taught at Punjab University early in his career, but without access to journals and with the nearest fellow physicist in Bombay, he was "(f)aced with the agonizing choice of Pakistan or physics" and eventually left to teach and live in England, where he did his prize winning work in theoretical physics. 28. James' study is based on data regarding use of faculty time, mostly reported in earlier studies, and on data on average costs at different types of institutions (two-year, four-year, university, public and private) from a large intertemporal study published in 1971 by the Carnegie Commission on Higher Education. 29. James cites a "controversial" study by Astin (1968), who found no correlation between quality as measured by academic achievement and faculty/student ratios, once incoming student characteristics are controlled. 30. As convincingly shown in Psacharopoulos et al. (1986).

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