The returns to education in Malaysia, 1995-2004

Abstract

Human capital development is a prerequisite for a knowledge-based economy and for sustaining economic growth. Capability and capacity in the management of new knowledge and technology is determined by the quality of human capital. With globalization, Malaysia faces ever increasing competition in trade and investment. Therefore, the workforce will have to be equipped with a strong base in education and training. Efforts should, therefore, be made to ensure that the education and training system has the capacity to enhance the quality of intellectual capital as well as expanding the human resource base. In mainstream human capital theory, the basic principle is to measure the quality of human capital through some measure of educational achievement, such as years of schooling. It is generally assumed that more years in schooling improves the quality of human capital. Thus it is assumed by policy makers that an increased level of education will impact directly on labour market productivity. Concomitantly, policy makers argue that increasing the level of schooling will give an impact on wages. One of the obvious methods to assess the impact of investment in education is to calculate the rate of return to education. The overall impact of education on wages for society is described as the social rate of return and for the individual as the private rate of return. The major concern of this thesis is to assess the impact of investment in education on individuals. Thus I use a household income survey to estimate the private rate of return to Malaysian education from 1995 to 2004. A recent important strand in human capital literature is concerned with the role of education in emerging economies. This study is not as well established as in developed economies. Malaysia, as one of the High-Performing Asian Economies (HPAEs) over the past two decades, has experienced a steady growth with continuous improvement in the education system. Data and infonnation collected on Malaysian education and earnings serve to provide an important indicator of the benefits from investment in education for this important economy. Previous data and analysis on returns were hampered by relatively few observations and other data inadequacies. This thesis offers estimates based on a consistent set of household income surveys from 1995 to 2004. Thus, the estimation is more consistent compared with previous fmdings. Moreover, this thesis estimates the returns using both a standard and an alternative approach, i.e. Instrumental Variable (IV) that has never been applied to the Malaysian data. This is important because the latter estimation not only reduces the potential bias but also shows the impact of school reform on the returns. Additionally, returns to education using IV estimation are rarely compared between emerging economies and the developed countries. Such an analysis provides an indication of how important the human capital investment and educational reform have been at the current stage of development. Our results also provide new methodology for developing economies in estimating returns to education. The standard approach to estimating returns is based on homogenous returns to education - everyone gets the same return to the same qualification. Our results from this homogenous returns model shows the private rate of return to education in Malaysia is about the world average. However, endogeneity in schooling, omitted variables and other factors, such as ability will produce potential bias in estimation. The heterogeneous returns model allows for varying returns across individuals. This thesis clarifies differences in returns to different individuals. The exogenous impact in the Malaysian education system. i.e. the schooling reform is used as an instrument. The results reveal that the returns from IV estimation were higher than the standard approach. This result adds to literature by showing that OLS may underestimate the returns to education in the context of a developing country. The literature on rates of return paints a complex picture of the theoretical frameworks, methods and even results of such studies. Many of the benefits of education are not easily measured and are often not even recognized by rate of return studies. It is important for rate of return studies to acknowledge the methodological limitations and explain that rates of return are only an imperfect proxy to education benefits, which should ideally be used in conjunction with other measures of educational results.