People often ignore the externalities we find in life. The fact that your car means less space for others on the road, the ever-escalating volumes at parties, etc. I recently finished reading Enrico Moreetti’s The New Geography In Jobs. In it he notes an oft-ignored externality – that education has not just private benefits but public ones as well. We are all made better off when there are more educated people around us. At a basic level this is obvious. It only makes sense to install street signs if a high enough portion of the population can read. I once read about a late-nineteenth century advertisement for Ivory soap with the caption 99% Pure! Of course, that ad only makes sense if most potential customers have a certain level of mathematical facility. The level of education matters in all sorts of ways that we probably don’t notice. (I suspect the quality of public leadership is an important one from a development perspective.) Wages are just the easiest to measure.
Taken as a whole, this market failure is a strong argument for subsidizing education and one that’s too often ignored or unknown.
The existence of human capital externalities is good news for less educated workers in highly educated cities, because it means that they end up earning more than they would otherwise. But it also implies that well-educated individuals are not fully compensated for the social benefits that their education generates. This is an important example of a market failure. Essentially, education has a private benefit, in the form of higher earnings for the individual who acquires it, and an additional benefit for all other individuals who live in the same city. In fact, the full return on education for society – sometimes called the social return – is larger than its private return. Since college graduates are not compensated for the benefit that they bestow on everyone around them, there are fewer college graduates than we as a society would ideally like. To put it differently, if the salary of college graduates reflected its full social value, more people would go to college. One way to correct for this market failure is to provide public subsidies for college education. Indeed, this is the reason that state and local governments pick up much of the cost of educating their residents. There are certainly other reasons to justify public investment in higher education – political and ethical – but I know of none more powerful than this one. It is in our own interest to subsidize other people’s education, as it ends up indirectly benefitting us.
– Enrico Morretti, The New Geography of Jobs pg 101