The value of education in low skill economies: some evidence from Kenyan and Tanzanian Manufacturing

In depth

There is limited empirical evidence on changes in the returns to education in developing countries over long periods of time.
We have documented changes in the returns to education in Kenya and Tanzania during the 1990s and also compared with earlier work by Knight and Sabot (1990).
The long run the pattern across the two countries has been very different. Kenya: large long-run falls in the return to education at the post primary level; Tanzania: not. Indeed we find for Tanzania an increase in the return to education in the 1990s.

The average return has risen in both countries – could this be due to “skill biased technical change”? No - the rate of technological progress in manufacturing has been very low in these countries over the sample period.
Knight and Sabot (1990) argue that the high returns in Kenya in the 1980s relative to Tanzania reflected a willingness to allow market processes to work in Kenya relative to Tanzania. Over the 1990s Tanzanian polices have become much more similar to those of Kenya. By the end of the 1990s the earnings profile was virtually identical for the two countries.

What are the key econometric issues?
Functional form: Is the earnings function linear, concave or convex? Does it matter?
Unobserved ability: Education is a choice variable and so may be correlated with the earnings residual. How test whilst allowing for a flexible functional form?
We find strong evidence that the earnings function is convex, and typically more so in the young age group. In Tanzania there is increasing convexity over the 1990s, for Kenya stability.
The findings are robust to allowing for the possibility that education is endogenous. In fact, there is no evidence that unobserved ability biases the OLS results in the way that is typically presumed in theory (and rarely verified in practice).

Convexity matters for policy – returns are very high at high levels, and low at low levels. The average return (from linear model) masks this completely. Aggregate return to expanding education depends on who gets the additional education. Heterogeneity in education feeds into higher income inequality, ceteris paribus, under convexity than under concavity.
Convexity should matter for theory – concavity (as in David Card’s model) does not appear a good starting point if we want to write down a behavioural model. Clearly allowing the theoretical earnings function to be convex raises analytical issues as to why not everyone gets a PhD – marginal costs could be increasing, there could be binding credit constraints that stop students to proceed to higher levels, etc.

Our results link to one of the micro-macro puzzles in the development literature:
Why, at the macro level, has the expansion of education in Africa during the last two decades has generated so little growth, while at the micro level the average returns to education appear high?
With convexity, these results could be reconciled if the expansion of education has primarily occurred on relatively flat segments of the earnings function.