Investments in Human Capital

1
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
  employers
• Initial outlay which will pay-off in the long run

2
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

3
Investments in Human Capital

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

4
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

5
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...

6
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
  1/5.740.17

7
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

8
Example

• 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?

9
NPV

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

10
Optimum acquisition of HC

• Figure 9.1 (page 291)

MC, MB
MC,MB
MC
MC
MC
MB
MB
MB
HC
HC
11
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
  1993
• as measured by the percentage of graduating high
  school seniors who enroll in college

12
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

13
Alternative Earnings Streams
Figure 9.2
14
Demand for College Education

• Four predictions
• 1. Present oriented people are less likely to go
  to college than forward looking people (all else
  equal)
• 2. Most college students will be young
• 3. Attendance decreases with costs of college
• 4. Attendance increases with an increasing premium

15
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)

16
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)

17
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

18
Figure 9.3
Money Earnings (Mean), for Full-Time,
Year-Round Male Workers, 1997
19
Money Earnings (Mean), for Full-Time, Year-Round
Female Workers, 1997
Figure 9.4
20
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
  ones

21
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

22
Investment in On-the-Job Training over the Life
Cycle
Figure 9.5
23
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
  off

24
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

25
Women and the acquisition of human capital

• Shorter work-life caused primarily by womens
  historic role in child bearing and household
  production
• This traditional role, while undergoing
  significant changes, has caused many women to
  drop out of the labor market during childbearing
  years
• 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

26
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

27
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

28
Women and job training

• Flatter age-earnings profile may be explained
  partly by this
• But does it arise from employer or employee is
  debatable
• 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

29
The Increased Concavity of Womens Age/Earnings
Profiles
Figure 9.6
30
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

31
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

32
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
  estate.
• We do need to keep in mind though that there are
  some biases at work in these estimates

33
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

34
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
  earnings.
• Others look at what happens when a random event
  and not ability affects years of schooling
• Others look at family members or even identical
  twins
• The consensus is that ability bias is usually
  small

35
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

36
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
  small

37
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
  years.

38
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

39
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

40
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

41
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
  productivity

42
The signaling model

• Figure 9.7

wage
2
1
e
Years of education beyond high school
43
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

44
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

45
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

46
The signaling model
C (Educational cost of less prod worker)

• Figure 9.8

PV of earnings
B
PV2
D
C/2 (Educational cost of more prod worker
A
PV1
F
e
O
Years of education beyond high school
47
The signaling model

• Figure 9.8 is similar to 9.7 except we have
  replaced wage with Present Value of Lifetime
  Earnings
• 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

48
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)

49
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
  schooling
• Therefore only those with costs C/2 - workers of
  productivity 2 - find it beneficial to invest in
  the extra schooling

50
Appendix 9A Cobweb model

• Figure 9A.1

S
wage
w1
W
w0
D1
D0
Number of engineers