1 Introduction

The private rate of return to tertiary education is a widely used measure of expected net earnings from undertaking higher education. This measure, as projected over the life cycle, reflects the expectations that influence current student decisions to participate in higher education. In addition, this measure is an indicator of the link between educational qualifications and earnings. Therefore, the private rate of return measure is important as it reflects both potential demand for higher education and the contribution of higher degrees to the distribution of earnings.

International comparisons of private returns to education as commonly produced by the OECD[1] reflect added information on how comparable skills are rewarded by the labour market across countries. However, these measures are necessarily standardised across countries with a wide range of classifications.

In the latest OECD measures, the private rate of return to tertiary education for New Zealand is 8.9%, compared to an OECD average of 12.4%, placing New Zealand toward the bottom of the OECD ranking.The aim of this study is to better understand the reasons for that gap.[2]

We identify a number of measurement issues with the OECD standardisation, and develop a series of decompositions of the New Zealand-OECD gap due to omitted or compositional issues (eg, old tax rates; New Zealand's higher employment rates; and compositional issues, which have not been controlled for in the OECD analysis, such as the mix of degrees, and the mix of degrees and graduates in New Zealand). Once these adjustments are made, around half of the measured gap in New Zealand's private returns to tertiary education can be explained by the way returns are measured rather than a “real” gap.

However, once those are taken into account a gap remains between New Zealand and the OECD average. Explaining the low wage premium relative to the OECD average is a complex issue intimately connected to New Zealand's overall comparative economic performance. In addition, we identify a number of endowment, policy, and decision-related contributing factors (eg, earnings returns to skill for the relatively high proportion of high-skilled immigrants in New Zealand, and factors related to innovation and productivity). We evaluate our findings in light of the existing literature and evaluate their potential contribution, and recommend directions for future research.

It is important to note that the aim of the paper is mainly to understand the key reasons for the measured difference in private returns between New Zealand and the OECD average. We do not compare tertiary education to other investments in New Zealand, nor do we consider non-financial elements of the returns to education. Consequently, while this paper provides information on interpreting and making corrections to the OECD's findings, it is not designed for drawing broad policy conclusions.

In Section 2 we introduce the OECD's findings that form the basis of the paper, and explain the various components of the OECD's measured returns. We identify the wage premium from tertiary education as the major factor in New Zealand's low comparative rank.

Section 3 provides a framework for understanding how the wage premium is determined. It is implicitly based on a human capital framework for understanding investments in tertiary education.

Section 4 surveys the empirical literature on the importance of each identified influence on the wage premium. In this section we produce decompositions of the OECD measures of private returns to education for New Zealand relative to the OECD average. This technique allows us to identify the contribution of omitted and compositional factors to the New Zealand measure.

In Section 5 we draw conclusions and point to future research priorities.