(This essay was published in Hong Kong Economic Journal on 9 September 2015.)
From 1981 to 1994 the number of UGC funded undergraduate places increased from 2,500 to 15,000. The change reflected a shift in government policy to increase the number of undergraduate places from around 2.2% of the relevant admissions age cohort to 18%. This targeted percentage has since remained unchanged.
There is a belief in some quarters of Hong Kong and among some government officials that Hong Kong is perhaps already overeducated. They point to numerous reports of recent graduates having difficulty in finding well-paid jobs, growing numbers of graduates in clerical jobs, young graduates whose salaries have failed to increase for years and more, and complaints of few upward mobility opportunities for the young.
These officials worry that if more undergraduates are trained then there will be more frustration among the educated youths who fail to land good jobs. Social unrest may become a worrying issue if upward mobility is negatively impacted. Economically, any overinvestment is a waste of valuable resources that should be avoided.
So is Hong Kong overeducated?
From 1976 to 2011, the total number of university graduates in the working age (20-59) population rose rapidly from 87,000 in 1976 to 1.033 million in 2011. Despite this substantial increase in graduates, the average private rate of return to education has also increased from 8.8% to 14.8% over the same period (see Figure 1).
An average rate of return of 14.8% in real terms over a lifetime would beat the investment performance of the most successful fund managers anywhere in the world. More importantly, the payoff to acquiring more education has risen even as the proportion of the population with university education has risen from 4.1% of the working age population in 1976 to 23.1% in 2011.
Even more revealing is the extremely high marginal rate of return to degree education, which has risen from 16.6% in 1976 to 22.7% in 2011. The marginal rate of return to secondary education is also very high and has risen more modestly from 12.6% to 15.8% over the same period. This is the clearest evidence that education has not hit diminishing returns in Hong Kong.
Harvard economics professor Richard Freeman alleged in his 1976 book The Overeducated American that Americans had overinvested in education. His argument was based on a perceived decline in the rates of return to university education in the years 1969-74. Freeman’s research was challenged and shown to be in error for failing to take into account demographic changes and business cycle effects. But at the very least we can draw from his work this concept that falling rates of return to university education is a sign of overeducation. Hong Kong could hardly be overeducated with our incredibly high rates of return – and ones that are rising, too!
Still, why are young graduates complaining about poor job opportunities, stagnant wages, and lack of upward mobility? The most important clue to what is happening can be surmised from a comparison of the earnings of university and secondary school graduates at the same age (see Figure 2). In 2011, the earnings ratio of university graduates relative to secondary school graduates increased steadily from 1-5 times at age 25 to 5.0 times at age 65. But a very different result was to be found in 1976, when the earnings ratio did not increase at all with age.
This is a very unusual but critical result. What accounts for the difference in the earnings ratio profiles in the years 1976 and 2011?
Since the expansion of higher education occurred only relatively recently in the period 1981-94, the increase of university graduates is concentrated among the younger cohort aged 20-39 (see Figure 3). Their numbers rose from 60,000 in 1976 to 694,000 in 2011. The increase of the older cohort aged 40-59 was much lower, from 26,000 in 1976 to 338,000 in 2011. The percentage share of university graduates among the younger cohort has remained relatively stable at around 70% over this period with some minor fluctuations.
The results from figures 1, 2 and 3 tell us three things. First, Hong Kong has a severe shortage of university graduates and that is why the private rate of return to university education has risen steadily over time. The rapid expansion of the world economy in the period 1980-2005 combined with the rise of the Chinese economy at our doorstep has fuelled the demand for skilled manpower at a time when labor supply in Hong Kong was becoming increasingly tight for demographic reasons.
Second, the supply of university graduates is recent and therefore heavily concentrated among the younger aged cohorts. The fraction of younger cohorts of university graduates has remained largely unchanged at around 70% of all graduates from 1976 to 2011. The percentage share of university graduates among the younger cohort is only beginning to decline now. According to projections, the relative supply of older cohorts of graduates will exceed younger cohorts for the first time in 2030.
Third, as a consequence of the relative scarcity of older university graduates, and therefore more experienced ones, the market pays a huge premium for them. This then is another reason that has lead to the perception, or rather misperception, of the lack of upward mobility of younger graduates. Rapid expansion of university places reduces the relative earnings of younger graduates relative to older graduates, but not the true lifetime earnings of a university education.
The full reward to a university education will only materialize with age and experience in the years and decades ahead.
The rapid expansion of university places in Hong Kong also means older graduates were probably more selective than recent cohorts and therefore would be commanding a higher efficiency wage in the marketplace. This has probably widened the earnings gap between older and younger graduates. But this will come to pass as the older cohort retires from the labor market. Nevertheless the slow growth of the labor force in the future will continue to reward university graduates handsomely.
Recent reports that claim some university graduates have failed to secure middle-class positions – as manager, administrator, professional and associate professional – and that some graduates are working in clerical jobs, should not be construed as a mismatch in the labor market or evidence that the Hong Kong workforce is overeducated.
I find occupational studies largely uninformative of what is happening in the labor market because these categories do not really tell us what jobs are being performed. Figure 1 shows that the marginal rate of return to even secondary school education in Hong Kong was 15.8% in 2011. Does anyone know a fund manager who can deliver such a rate of return over a lifetime?
Hong Kong’s real challenge is that it has a very tight labor market and pays high wages, but the standards of living are not great for many because property prices and rents are even higher. It is not overeducated.