How universities boost economic growth

Anna Valero, John Van Reenen 10 November 2016

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In 1900, only one in 100 young people in the world would go to university. Over the next century, in particular after WWII, this became one in five as recognition of the value of human capital for both economic and social progress became widespread (Goldin and Katz 2008, Schofer and Meyer 2005).

Today, many governments – even in countries with advanced university sectors – see value in further expansion in higher education. In the UK, for example, the Higher Education and Research Bill is being pushed through parliament. This bill includes measures to encourage entry into the sector to foster growth and social mobility. At the same time university maintenance grants have been converted to loans. Evidence suggests this could harm applications from poorer students (Dearden et al. 2014 and Dynarski 2003).

The most obvious channel through which universities create economic growth is as producers of human capital. There is ample evidence that higher education pays off for the individual, as wages of graduates are much higher than those of non-graduates. Empirical macroeconomic research has generally found that human capital (typically measured by years of schooling) is important for a country's development and growth. Proving the link at the country level is difficult though, as there are many factors for which we need to control. At the subnational level – where you can hold unobserved country-specific factors constant – human capital is important for regional GDP per capita in the cross section, and also for growth (Gennaioli et al. 2013, 2014).

Universities may also affect growth by stimulating innovation in their region (Silicon Valley, for example), and there is a lot of evidence that this occurs (Jaffe 1989 and 1993, Belenzon and Schankerman 2013, Hausman 2013, Toivanen and Väänänen 2014). Universities may additionally affect economic growth through their role in the development of institutions, and also because they are purchasers of goods and services from a region.

In recent work, we consider the effect of the growth of universities on regional growth (Valero and Van Reenen 2016). We compiled our data from UNESCO’s World Higher Education Database, which include the location of 15,000 universities in 1,500 subnational regions across 78 countries, and examine the relationship between university entry and regional growth between 1950 and 2010.

It turns out that the expansion of the higher education in this period was not just the product of riches – it has helped fuel economic growth around the world. These findings are consistent with the conclusions of contextual papers that have linked universities, or their spending, to local firm or regional economic outcomes (Cantoni and Yuchtman 2014, Aghion et al. 2009, Kantor and Whalley 2014).

Growth in universities during the last 1,000 years

The term 'university' was first used by the University of Bologna, founded in 1088. As the first modern university, it was distinct from the religion-based institutions that had come before. It was a community with administrative autonomy, courses of study, publicly recognised degrees and research objectives.

Since then, universities have spread worldwide (Figure 1) in broadly the same form. Economic historians have argued that universities were an important force in the commercial revolution through the development of legal institutions (Cantoni and Yuchtman 2014), and also the Industrial Revolution through their role in building and disseminating knowledge (Mokyr 2002).

Figure 1 The global growth of universities, 1088 to present

Note: Dates marked when the number of universities in the world doubled.
Source: World Higher Education Database (WHED).

Today’s global distribution of universities is skewed, with seven countries (US, Brazil, Philippines, Mexico, Japan, Russia and India, in descending order) accounting for more than half the universities in the world (Figure 2). With 13% of the world’s universities according to our data, the US is the country with the largest share.

Figure 2 Location of universities in 2010

Note: Pie chart shows the share of worldwide universities in each country.
Source: WHED

Universities and regional growth

In our analysis, we focus on the period since 1950 when, as Figure 1 shows, university growth was particularly rapid. We look at subnational data at the regional level (US states, for example) and find that increases in university numbers significantly raised future GDP per capita. Our main result is that a 10% increase in the number of universities (roughly, adding one more university in the average region in our data) increases that region’s income by 0.4% (Figure 3). This implies that the effect of adding a university to a region that has ten universities is much larger (0.40%) than adding a university to a region that already has 100 universities (0.04%), reflecting diminishing returns. Our results are robust when controlling for population and geographical factors, and even unobserved regional trends. We rule out reverse causality, so this relationship is not a result of fast-growing regions creating new universities.

Figure 3 Average growth rates, region-year observations

Note: 8,128 region-year observations are grouped equally into 20 bins; variation is within-country.
Source: WHED and Gennaioli et al. (2014) for regional GDP per capita and population.

We find that universities also increased output in neighbouring areas within the same country, with stronger effects for geographically closer regions.

Policymakers are not only interested in the potential benefits of universities, but also in the costs of building and maintaining them. In the UK we estimate that if one university were added to each of the country’s ten regions, this would increase national income by 0.7% (£11 billion based on 2010 figures). This was higher than the likely annual cost which, based on average university expenditure, would be approximately £1.6 billion. The large difference between benefits and costs suggests university expansion, in this case, would be beneficial.

Mechanisms

A cynic might claim that universities affect growth in a mechanical way, in that more people move to the region, and consume more ‘essentials’ there – housing, beer and nightclub services spring to mind. But our results remain when we control for population growth. It could also be that, where universities are financed by transfers into a region (funded by national government, for example) there is a mechanical impact on GDP per capita. We show that, even under generous assumptions on the size and spending of a new university, this is unlikely to explain a large fraction of our result.

We find that this 'university effect' seems to be related to an increase in the supply of skilled graduates who raise productivity in the firms in which they work. We also find that universities boost innovation, as measured by an increase in patents.

Over a longer time, we find that a higher university presence in a region is also associated with pro-democracy views among individuals. This result persists even when we control for the individual’s education, suggesting there could be some kind of externality generated by the diffusion of ideas into surrounding areas.

The strength of this research is the comprehensiveness of the dataset in terms of the coverage of subnational regions and time periods. But we cannot rule out that effects were in part driven by unobservable factors that vary over time, for example strong regional governments that implemented growth-enhancing policies which included the creation of new universities. Moreover, counting only the number of universities does not take into account differences in size and quality of those institutions. Future work, focused on the UK with more granular data, aims to address these issues and shed more light on the mechanisms at work.

British universities and Brexit       

International data since the 1950s show that universities matter for growth, and using the UK as an example, we estimate that the benefits outweigh the costs. Assuming that any new universities have the same qualities as those we already have, our analysis suggests that policies to encourage entry to the sector would be good for growth. In the UK however, the Brexit vote poses significant risks. British universities have thrived in recent decades in a climate of openness to international students, academics and collaboration, all of which will have contributed to the economy through skilled employees and innovations. It is important that any Brexit deal preserves these key strengths.

References

Aghion, P, L Boustan, C Hoxby, and J Vandenbussche (2009), ‘‘The Causal Impact of Education on Economic Growth: Evidence from U.S.’,’ Harvard University working paper

Cantoni, D and N Yuchtman (2014) “Medieval universities, legal institutions, and the Commercial Revolution,” The Quarterly Journal of Economics, 823–887.

Dearden, L, E Fitsimons and G Wyness (2014), “Money for nothing, estimating the impact of student aid on participation in higher education", The Economics of Education Review 43, 66-78.

Dynarski, S, (2003), "Does Aid Matter? Measuring the Effect of Student Aid on College Attendance and Completion." American Economic Review 93(1).

Gennaioli, N, R La Porta, F Lopez de Silanes and A Shleifer (2013)“ Human Capital and Regional Development,” Quarterly Journal of Economics 128(1), 105-164

Gennaioli, Nicola, La Porta, Rafael, Lopez de Silanes, Florencio, Shleifer, Andrei (2014) “Growth in Regions,” Journal of Economic Growth 19, 259-309

Goldin, C and L Katz (2008), The Race between Education and Technology, Harvard University Press

Kantor, S and A Whalley (2014), “Knowledge spillovers from research universities: evidence from endowment value shocks,” Review of Economics and Statistics 96(1), 171–188.

Mokyr, J (2002), The Gifts of Athena: Historical Origins of the Knowledge Economy, Princeton University Press

Schofer, E and J W Meyer (2005), “The Worldwide Expansion of Higher Education in the Twentieth Century,” American Sociological Review 70(6), 898-920

Valero, A and J Van Reenen (2016), “The Economic Impact of Universities: Evidence from Across the Globe”, CEP Discussion Paper No 1444, August.

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Topics:  Education

Tags:  Universities, growth, higher education, returns to education

Research Economist, CEP; Economics PhD candidate, London School of Economics

Professor MIT Economics Department and Sloan School of Management

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