Indonesia | Economics

Saturday, September 16, 2006

The economics of scholarship allocation (3 of 3)

It's been a while, so let's begin with a recap.

In Part One, I argued that the two principles guiding the allocation of public investments should be used to guide the allocation of publicly-funded scholarships: First, invest in activities with the highest social returns; and second, do not crowd out private investments.

Meanwhile, in Part Two, I described the two rules of thumb used to get around the problem of defining "social returns". These are, first, finding investments with high multiplier effects; and second, bias the allocation towards groups or regions that have the least number of educated people. I then illustrate how, in practice, these rules of thumb had been used to good effect in allocating Inpres elementary schools in Indonesia.

But there is a catch: The second rule-of-thumb, which seems to have worked well in allocating public investments in basic education, may not be good enough in allocating higher education scholarships. Why? Here's a clue: It has something to do with this post.

Before going into why this second rule doesn't work, let's begin by examining why it does.

One can think of education – or “human capital” in economic-speak – as inputs to production processes that generates the aforementioned social returns within a particular “economic unit”. An economic unit is usually defined as firms, but a tightly-knit community where its members’ economic activities are highly interdependent can also be considered as one.

Besides education, physical capital and manpower play equally important roles as inputs to production processes. We can call these three broad types of inputs “factors of production”. Combined together, these factors of production determine an economic unit’s output.

Now, for most goods, one thing that we know about these production factors is that less is more: The scarcest production factor usually is the most valuable. In turn, increasing this production factor usually bring the highest increase in productivity.

This last thing is quite intuitive. Just think of that time when your high priority assignment was stuck in the legal department because it’s overstretched. Didn’t you wish that the firm had added more people in legal so that the office can “work better”? At the same time, it wouldn’t make sense to add an extra department whose outputs highly depend on the legal department without expanding the latter.

This is exactly the reason why this second rule-of-thumb works for allocating basic education investments. If we think of Indonesia’s regions (provinces or districts) as economic units, the strategy of putting basic education investments in regions with lowest levels of per-capita education is optimal.

But I argue that this works less well with allocating higher-education scholarships, particularly the (highly-specialized) doctorate scholarships. I describe a variant of this problem in this post, but here, I’ll try to connect it directly with the problem of scholarship allocation.

As critical readers might notice, while it may be intuitive, the assertion that “the scarcest production factor is the most valuable” only applies for production processes whose productivity depends on the interactions of all three types of factors, i.e., human capital, physical capital, and labour. This describes most manufacturing processes, in which case, investment in the relatively scarce production factor is most optimal.

However, if the output can mostly depend on the interaction within one factor of production only (say, human capital only), than investing in just that one factor (and not the scarcest of them) is most optimal. This phenomenon is known among economists as “increasing returns to scale”.

This explains why the second rule-of-thumb is not a good guide in allocating PhD scholarships. How? Think of the main “outputs” of PhDs. Two that merit publicly-funded scholarships are teaching and research. A critical feature of both of these activities is that the quality of their outputs depends a lot on more human capital in similar study areas.

A PhD graduate in biochemistry working as a teacher-researcher is likely to produce more outputs working around PhDs in biochemistry than around PhDs in political science, and vice versa. Hence, two PhDs in biochemistry generate more social returns than two PhDs, one in biochemistry and another in political science. In other words, there is an increasing return to scale in higher-education investments.

What’s the implication? Abstracting from politically-motivated decisions, the sense that I got from the way (Fulbright) doctorate scholarships are allocated is that the selection committee still utilised the second rule-of-thumb in its allocation decision. That is, not only does it prioritise “backward” regions, it also seems to prioritise subjects that Indonesia has the least number of PhDs in.

I think this is not an optimal strategy. This strategy is only optimal for subjects that have immediate practical relevance (i.e., those that allow linkages with the private sector). For more research-oriented ones, increasing-return plays a significant role and hence, choosing candidates in “scarcest” subjects might give sub-optimal social returns.

Instead, a better strategy might be to choose candidates in subjects where there are quite a number of research-oriented (and teaching-oriented) PhDs already – such as, umm… I don’t know, economics, perhaps?

6 Comments:

  • two points:

    one. behavioral economics, for example, was born due to (finally) sufficient, productive interactions between people with phd in economics and people with phd in psychology. biochemistry, as you pointed out, might be off the track for economists, but psychology, sociology, history, anthropology, and others might not. any comments?

    two. say we follow your suggestion: give scholarships for phd in economics. questions: (a) how many should we give, and until when? (b) when will other fields have their chance to start building their own network of research excellence -- someone has to start as the first phd holder, hasn't she?

    By Anonymous tirta, at 9/17/2006 04:15:00 pm  

  • ‘Ry,

    If I understand the O-ring theory you mentioned correctly, it’s not necessarily a matter of bringing the same good parts to work together, but to bring different good parts to work together. Within the same logic, it’s not enough to have one part (i.e. economics) that function well when other parts (fields) are mediocre. This relates with Tirta’s first point, as well as your own argument in the previous posting on the O-ring theory that good research institute require excellent interdisciplinary supports.

    But, like Tirta pointed out, some fields (economics, sociology, psychology, and other social sciences), at least for the present, are better correlated than others (hard sciences like chemistry, biochemistry, etc.). The social sciences may develop better in Indonesia than hard sciences simply because Indonesia has plenty of social cases to develop the former fields, while latter fields require tools, equipments, and most importantly technology that may not yet available in Indonesia. This explains why many Indonesian Ph.D. graduates in the latter fields choose to stay in the U.S.

    So I diagree with allocating scholarships to Ph.D. candidates in one field (especially economics :) ), but I think extending this thinking to include social sciences may be the most efficient strategy at present, with a note that meanwhile infrastructure for the hard sciences be upgraded to enable growth in these other fields.

    And you know that if you insist that the one field should be economics, then you’ll have to wage stronger arguments than can pass beyond a personal bias! :)

    By Anonymous Dewi, at 9/17/2006 10:36:00 pm  

  • he..he...tirta and dewi, you caught arya off-guard...

    btw, that group of economists known as Berkeley Mafia was funded by Ford Foundation scholarship. I could not recall social scientists (some at CSIS insist that economics is not part of social science..he..he) who studied overseas (funded by any scholarship) at about the same time with them. If any, i am certain, it's a lot fewer in number than those who studied economics.

    It seems to me that Ford Foundation was following the same logic, allocating more phd scholarships in economics. Arya, are you longing for that sort of mafia?...:-)

    By Anonymous philips vermonte, at 9/18/2006 03:04:00 pm  

  • Tirta,

    I'll start with the second. Economists generally believe that increasing returns can't last forever.

    The hypothesis is that as we have more-and-more of a particular "factor", the "extra output" out of the interaction effects will eventually diminish, and eventually disappear.

    In the case of PhDs, the increasing return was the result of knowledge spillovers from discussions. This will disappear once interactions no longer produce knowledge spillovers that eventually feed into the economy.

    Taking my ironic suggestion seriously, let's say we invest public money in economics PhDs (and, taking a very strong assumption, suppose there is knowledge spillovers there ;-)). When do we stop?

    We must go back to the first principle of public investment: Finding the public investment with the highest return. So, we stop when the knowledge spillovers in investing in economics PhD is lower than investments in other fields.

    Thing is, the scholarship committee do not know the size of the knowledge spillovers before the fact. To manage risk, it should invest in more than one subjects.

    The committee maximimises social returns by investing in subjects which will generate knowledge spillovers. The point of this post is that such a committee has a greater chance of doing this by investing in subjects where Indonesia already has more (rather than less) PhDs.

    Dewi,
    Yes, you're right. Per above, essentially my argument is that the choice should focus on maximising knowledge generation through maximising spillovers.

    And of course, I was being vain about suggesting more scholarships in, umm... economics. ;-)

    Philips,
    Berkeley mafia was a brilliant idea, no? ;-)

    Your observation of my longing of a "new mafia" is not far off. But perhaps, not consisting mainly of economists, but all serious scientists. Think Rand or Santa Fe.

    By Blogger Arya, at 9/19/2006 01:49:00 am  

  • Good discussion guys.
    Dewi, apa kabar?
    Arya,

    If your analysis is true, then why don't such scholarships be allocated to U.S. (or other Northern country) students, since in their country there is already a good amount of (assuming not too many) Ph.Ds from whatever field to gain "increasing returns" from?

    I think you're also a fan of the "incentives" principle, right? Then what do you think is the U.S.' incentive to give out scholarships to Indonesians? Is this incentive in line with your economic analysis of scholarship allocation? :)

    Cheers

    By Blogger Muli, at 9/19/2006 08:20:00 am  

  • Muli,
    The analysis starts at that point when a decision has been made (and money available) to finance scholarships using public money. The hows and whys behind the decision is beyond the scope of the analysis. ;-)

    On scholarships to US or Northern country students, I think the amount of public money given to them are already multiples of that given to developing countries' students.

    And this is a lot considering the fact that there are already many "private investors" within universities and without willing to finance many of them already.

    By Blogger Arya, at 9/20/2006 03:00:00 am  

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