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Investments in Human Capital


Human capital includes accumulated investments in education, job training etc. ... Investment in On-the-Job Training over the Life Cycle ... – PowerPoint PPT presentation

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Title: Investments in Human Capital

Investments in Human Capital
  • Three major labor market investments -
  • (1) education and training (2) migration and (3)
    search for new jobs
  • Investments in human capital - rented out to
  • Initial outlay which will pay-off in the long run

Investments in Human Capital
  • Human capital includes accumulated investments in
    education, job training etc.
  • Total wealth in U.S around 421,000/person in
    1990 of which 59 or 248,000 was in the form of
    human capital
  • Canada 155,000
  • Germany 315,000
  • Japan 458,000

Investments in Human Capital
  • Investments in human capital takes place in three
  • Childhood - parental decisions
  • Teenagers and young adults decide themselves
  • Finally on the job training after entering labor

Investments in Human Capital
  • In this chapter we focus on the second of the
    three stages. The third is dealt in Chap. 10
  • Example 9.1 (page 288)
  • People faces with the same set of options make
    widely different choices
  • Cognitive skills, parental wealth etc. impact
    attitudes towards learning and work

Investments in Human Capital
  • Three types of costs
  • Out of pocket or direct expenses
  • Opportunity costs
  • Psychic costs
  • Present value of a stream of yearly benefits (B1,
    B2,) over time (T) can be calculated as
  • NPVB1/(1r) B2/(1r)2 B3/(1r)3...

Investments in Human Capital
  • Where r is the interest rate (discount rate)
  • As long as r is positive benefits into the future
    will be discounted
  • for instance if r0.06, benefits payable in 30
    years will receive a weight which is 17 of the
    weight placed on immediate benefits
  • 1/(10.06)30 1/(1.06)301/5.74 and

Investments in Human Capital
  • If the net present value of the investment
    exceeds the cost of the investment then the
    investment is undertaken
  • B1/(1r) B2/(1r)2BT/(1r)TgtC

  • Suppose cost of project is 12000
  • Benefits accrue over three years, 3000 in year
    1, 7000 in year 2 and 10,000 in year 3
  • interest rate 3
  • Undertake project?

  • NPV of project is
  • 3000/(10.03) 7000/(10.03)2
    10000/(10.03)3 18662.20
  • So undertake project since NPV exceeds Cost

Optimum acquisition of HC
  • Figure 9.1 (page 291)

Demand for College Education
  • For males enrollment went from 55.2 in 1970 to
    46.7 in 1980 and back up to 59.7 in 1993
  • For women enrollment started lower at 48.5 in
    1970, rose continuously to a high of 65.3 by
  • as measured by the percentage of graduating high
    school seniors who enroll in college

Demand for College Education
  • Figure 9.2 (page 293)
  • Choice between two income streams - going into
    workforce after high school - stream A or going
    to college and then joining the workforce -
    stream B

Alternative Earnings Streams
Figure 9.2
Demand for College Education
  • Four predictions
  • 1. Present oriented people are less likely to go
    to college than forward looking people (all else
  • 2. Most college students will be young
  • 3. Attendance decreases with costs of college
  • 4. Attendance increases with an increasing premium

Demand for College Education
  • 1. Present oriented people would discount future
    incomes very heavily would need very high returns
    on investment
  • 2. Future benefits are higher for younger people
  • 3. Law of demand
  • 4. Table 9.1 (page 297)

Demand for College Education
  • However the problem is quite complicated
  • Increased college attendance may lower future
    earnings if job growth does not keep pace -
    excess supply
  • See Example 9.2 (page 299)

Post-schooling Investments in Human Capital
  • Decision to acquire training later in life
  • Figures 9.3 and 9.4 (pages 301-303)
  • Four notable features (1) average incomes rise
    with the level of education (2) most rapid
    increases occur early in ones life (3)
    Age/earnings profile fan out - so that
    differences are sharper in later years than early
    on (4) age/earnings profile for men fan out more

Figure 9.3
Money Earnings (Mean), for Full-Time,
Year-Round Male Workers, 1997
Money Earnings (Mean), for Full-Time, Year-Round
Female Workers, 1997
Figure 9.4
Post-schooling Investments in Human Capital
  • The increase in earnings with age can be
    attributed to on-the-job training
  • learning by doing
  • specific training - during training workers MP
    is less than wage while after training workers
    MP is greater than wage - so costs shared by
    employer and employee
  • general training - costs borne by employee by
    accepting trading off current earnings for future

Post-schooling Investments in Human Capital
  • Figure 9.5 (page 304)
  • As a result of investing in training initially
    earnings may be lower but over time they become
    larger and increase rapidly
  • Why do age/earnings fan out?
  • Investments in human capital tend to be greater
    (1) when the expected earnings are greater (2)
    when the initial investment costs are lower and
    (3) when the investor has longer time to recoup
    the investment

Investment in On-the-Job Training over the Life
Figure 9.5
Post-schooling Investments in Human Capital
  • People with the ability to learn quickly are more
    likely to seek out and be presented by employers
    with learning opportunities
  • But who are these fast learners?
  • They are usually people who because of their
    abilities were best able to reap the benefits of
    formal schooling. So those who invested more in
    schooling are likely to invest more in
    post-school training
  • This explains why their earnings profile start
    low but rise quickly and keep rising while that
    of their less-educated counterparts have leveled

Women and the acquisition of human capital
  • Earnings of women who work full-time year around
    are lower than that for men of equivalent age
    (See Figures 9.3 and 9.4)
  • What does human capital theory have to say about
    this? We will discuss other factors in Chapter 12
  • Major difference - the length of work-life over
    which the investment can be recouped
  • Table 9.2 (page 307) shows that overall women can
    expect to work fewer years and within each
    occupation they work fewer hours

Women and the acquisition of human capital
  • Shorter work-life caused primarily by womens
    historic role in child bearing and household
  • This traditional role, while undergoing
    significant changes, has caused many women to
    drop out of the labor market during childbearing
  • Thus female workers often lack the continuity
    that male workers have From historic experience
    and expecting this discontinuity women often do
    not invest in occupation where skills depreciate
    during discontinuity

Women and the acquisition of human capital
  • Also historic experience can cause employers to
    avoid hiring women for jobs requiring much
    on-the-job training - a practice that will itself
    affect the returns women can expect from a human
    capital investment
  • Recent changes in the labor market conditions and
    laws are causing dramatic changes in the
    acquisition of human capital by women

Women and job training
  • Little doubt that women receive less job training
    than men
  • A study of formal company given to workers in
    their 20s found that between 1986 and 1991 a
    lower percentage of women received on-the-job
    training and those who did get training received
    fewer hours of training

Women and job training
  • Flatter age-earnings profile may be explained
    partly by this
  • But does it arise from employer or employee is
  • We said things are changing
  • Take a look at Figure 9.6 (page 309)
  • In 1977 a 32 year old female college grad earned
    26 more than 21 year college-grad, in 1992 it
    was 59 more

The Increased Concavity of Womens Age/Earnings
Figure 9.6
Women and formal schooling
  • Table 9.3 (page 310)
  • 54 of B.S. women in 1991 47.2 business majors
    large increase in law and medicine 6.3 to 39

Is Education a good investment?
  • Is there evidence that the investment in
    education pays for the typical student?
  • Several studies have tried to answer this
    question by calculating the internal rates of
    return to educational investments
  • These studies normally estimate benefits by
    calculating earnings differentials at each age
    from age/earnings profiles such as those in
    Figures 9.3 and 9.4

Is Education a good investment?
  • The rates of return typically estimated for the
    Unites States generally fall in 5-15 range
    (after adjusting for inflation). These findings
    are interesting because most other investments
    generate returns in the same range. Thus, it
    appears that an investment in education is about
    as good as an investment in stocks, bonds or real
  • We do need to keep in mind though that there are
    some biases at work in these estimates

Is Education a good investment?
  • Upward Bias
  • The typical estimates of the rate of return on
    further schooling may overstate the gain an
    individual student could obtain by investing in
    education because they are unable to separate the
    contribution of ability and schooling.
  • The problem is that (a) people who are smarter,
    harder working and more dynamic are likely to
    obtain more schooling and (b) such people may be
    more productive and earn higher wages

Is Education a good investment?
  • Upward Bias
  • Recent studies have attempted to control for the
    ability bias by looking separately at the
    impact of schooling and aptitude tests in
  • Others look at what happens when a random event
    and not ability affects years of schooling
  • Others look at family members or even identical
  • The consensus is that ability bias is usually

Is Education a good investment?
  • Downward Bias
  • (1) some benefits of college attendance do not
    show up in higher productivity/earnings but
    contribute to a persons way of thinking
  • (2) studies measure earnings and not benefits
    but better jobs may have not only better earnings
    but better job security and other ancillary
    benefits which are not accounted for
  • (3) Psychic of non-monetary benefits - more
    pleasant working conditions at better jobs

Is Education a good investment?
  • Selection bias
  • There is a selectivity problem. Going to college
    is a choice made by some and not by others
  • Usual studies look at the internal rates of
    return for what someone makes with a college
    degree and what the same person would have made
    in the absence of a college degree
  • But this may understate returns to college
    education and overstate the returns of those who
    did not attend college. But again this bias is

Is Education a good social investment?
  • (1) product markets have become more global
    increasing the elasticities of both product and
    labor demand. As a result American workers are
    facing more competition from foreign workers.
  • (2) Growing availability of high-tech capital
    requires workers to have greater cognitive skills
    and to be adaptable, efficient learners. Recent
    studies indicate that returns to workers with
    greater quantitative skills have risen in recent

Is Education a good social investment?
  • (3) U.S. elementary and secondary school students
    score poorly relative to students elsewhere in
    language proficiency, scientific knowledge and
    especially mathematical skills. See Table 9.4.
    This causes concern about the productivity of the
    future workforce
  • Increased educational investments increase worker
    productivity and such investments enhance the
    earnings potential

Is Education a good social investment?
  • It is also believed the education serves as a
    signal of worker productivity
  • An employer seeking workers is never completely
    sure of the actual productivity of the applicant
    and an learn about it only after a certain period
    of time has elapsed
  • Some indicators such as age are immutable
  • Others like education are acquired

The signaling model
  • There are two types of applicants - one a high
    type with productivity 2 (with wage 2) and a low
    type with productivity 1 (with wage 1) and
    these productivity levels are given
  • Employers cannot readily distinguish between the
    two types but they know that the two types exist
  • If the employers are unable to distinguish
    between the two types then they would be forced
    to assume that all applicants are average that
    is of type 1.5 and would offer wage 1.5

The signaling model
  • With wages 1.5 low type workers are getting
    paid more than they are worth. Firms could
    increase profit if they could distinguish the two
    types of workers
  • It turns out that using educational attainments
    as a hiring standard - even if education does not
    enhance productivity - is profitable to the
    employer if it so happens that there is a
    positive correlation between educational
    attainment and worker productivity or a negative
    one between the cost of education and worker

The signaling model
  • Figure 9.7

Years of education beyond high school
The signaling model
  • Suppose employers believe that workers with at
    least e years of schooling beyond high school
    are the ones with productivity of 2 while the
    others have productivity of 1.
  • So any worker with less-then-e years of
    schooling would be rejected for a job paying
    greater than 1
  • While workers with more-than-e would find
    competition among employers driving wages upto 2

The signaling model
  • If additional schooling does not enhance
    productivity then is there any point in attaining
    the cut-off level of education e ?
  • Yes, if the costs of acquiring additional
    schooling is negatively related to productivity
  • If workers with education gt e earn 2 while those
    with education lt e earn 1 then everyone would
    get e education if it were costless to do so

The signaling model
  • Schooling costs are different for different
    individuals - in particular the psychic costs of
    schooling are related inversely to ones ability
  • Those who learn more easily can acquire the
    educational signal more cheaply
  • If those who have lower costs of acquiring
    education are also those who have higher
    productivity then requiring educational signals
    can be useful for employers

The signaling model
C (Educational cost of less prod worker)
  • Figure 9.8

PV of earnings
C/2 (Educational cost of more prod worker
Years of education beyond high school
The signaling model
  • Figure 9.8 is similar to 9.7 except we have
    replaced wage with Present Value of Lifetime
  • For a low type worker each year of education
    costs C while for the high type it costs 0.5C
  • Workers will now choose the level of education to
    maximize the difference between lifetime earnings
    and costs

The signaling model
  • For low productivity workers with cost C. the
    difference is maximized at 0 years of schooling
    beyond high school
  • For these workers the net benefit of e years of
    schooling beyond high school (given by distance
    BD on the graph) is less than the benefit of
    zero years of schooling beyond high school (shown
    by the distance AO on the graph)

The signaling model
  • For high productivity workers with cost of C/2
    however the extra years of schooling beyond high
    school makes sense
  • Their benefit from e years of schooling is given
    by BF on the graph and that is greater than AO
    which is the benefit from zero years of extra
  • Therefore only those with costs C/2 - workers of
    productivity 2 - find it beneficial to invest in
    the extra schooling

Appendix 9A Cobweb model
  • Figure 9A.1

Number of engineers