Human Capital: Theory

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Human CapitalTheory

• Lent Term
• Lecture 2
• Dr. Radha Iyengar

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What is Human Capital?

• Part of original conception of inputs in
  production. Adam Smith said that there were 4
  inputs in which we might invest
• Machines or mechanical inputs
• Building/infrastructure
• land
• human capital

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Education and General Human Capital

• Were going to study first education (schooling
  including college/graduate education)
• This is important because it is
• Expandable and maybe doesnt depreciate (like
  physical capital)
• Transportable and shareable (not true with
  specific capital)

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What are we going to study?

• Theory
• Static Model (Card)
• Dynamic Model (Heckman)
• The goal of theory is to motivate the large body
  of empirical work
• Empirics
• Some talk of methods (identification,
  diff-in-diff, IV)
• Reconciling different estimates
• Economics of Education (briefly!)

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A Static Model of Human Capital Acquisition

• (for details see David Card, Causal Effect of
  Education on Earnings Handbook of Labor
  Economics)

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A Static Model of Education and Earnings

• Because of its tractability, Card uses a static
  model that abstracts away from the relationship
  between completed schooling and earnings over the
  lifecycle. (well do a dynamic model next).
• Two assumptions
• that most people finish schooling and only then
  enter the labor force (smooth transition).
• the effect of schooling independent of experience
  (Separability above)

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The basics

• Simple Linear regression first introduced by
  Mincer
• Takes the general form of linearity in Schooling,
  quadratic in experience.
• Assumptions
• separability of experience and education.
• log-earnings are linear in education.
• correct measure of schooling is years of
  education
• each year of schooling is the same. (more on this
  later)

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Wages or earnings?

• Earnings conflates hours and wages
• Card reports that about two-thirds of the returns
  to education are due to the effect of education
  on earningsthe rest attibutable to the effects
  on hours/week and week/year.
• The specification in (1) explains about 20-30
  percent of the variation in earnings data.

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Why use Semi-Log Specification?

• log earnings are approximately normally
  distributed.
• Heckman and Polachek show that the semi-log form
  is the best in the the Box-Cox class of
  transformations. (we can talk about this more
  later in the empirical part)

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Defining some Terms

• Let our utility function U(S, y) log(y) h(s)
  where y is earnings, S is years of schooling, and
  h(s) is an increasing, convex function. Then,
  define our discounted present value (DPV)
  function

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Simple relationship between returns and costs

• So that we have h(S) rS
• more generally we could have a convex h(.)
  function if the marginal cost of each year of
  schooling increases faster than the foregone
  earnings for that yearmaybe because of credit
  constraints)

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Results

• Optimal schooling is implicitly defined by
• That is there are two sources of heterogeneity
• Differences in costs (represented by h(S))
• Difference in marginal returns (represented by
  y(S)/y(S))

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Optimal Schooling

• a simple specification of these two components
• (define E(b) b and E(r) r and k1, k2gt 0)
• This gives us the optimal schooling expression

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