Accounting for Human Capital: Approaches and Data Needs

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Accounting for Human Capital Approaches and
Data Needs

• Katharine G. Abraham
• University of Maryland
• November 3, 2008

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Human capital a broad concept

• Many forms of human capital investment
• Early childhood development of cognitive,
  emotional and social abilities
• Formal education primary, secondary, and
  tertiary schooling
• On-the-job training informal and formal
• Health care exercise, diet, environment and
  medical care
• Remarks today focused on accounting for
  investments in formal education
• Future work will need to consider the investment
  of parents and others to ready children for
  formal schooling, other investment in working
  adults
• Background Beyond the Market, Abraham and
  Mackie, eds. (2005)

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General principles for development of nonmarket
accounts

• Satellite accounts to complement existing
  economic accounts
• Satellite accounts a framework for
  experimentation
• Most useful if published on a regular schedule
• Monetary rather than physical metrics
• Double-entry bookkeeping
• Seek to measure value and quantity of both
  outputs and inputs
• Valuations based to maximum extent possible on
  outcomes of market transactions

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Double-Entry Bookkeeping for Nonmarket Accounts

• Double entry accounts measure value of output and
  cost of production inputs
• In market accounts, two sides of ledger are
  expected to balance
• Size of statistical discrepancy an indicator of
  the quality of the estimates
• In nonmarket accounts, large imbalances possible
• Discrepancies between value of output and value
  of inputs may reflect resource allocation
  failures or failure to measure all relevant
  inputs
• May balance account by treating one factor of
  production as the residual claimant who earns all
  profits or bears all losses, but whether this
  is useful or appropriate depends on the research
  question

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Values, prices and quantities

• Complete accounting structure includes estimates
  of values, prices and quantities
• Related by identity VpQ
• For market outputs and inputs, most common to
  start with information on V (expenditures) and p
  (price indexes), derive Q
• For nonmarket outputs and inputs, goal the same,
  but more common to start with Q and p, derive V

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Valuing nonmarket outputs

• Examples of possible approaches
• Consumption goods and services with close market
  substitutes Estimate units of output produced
  and assign price of market substitutes
• Nonmarketable assets that yield a flow of
  marketable services over time Estimate the
  present value of the service flow
• Nonmarketable assets that yield a flow of
  nonmarketable services over time Use
  information from market transactions to value
  nonmarketed services, then estimate the present
  value of the service flow
• Public goods and services Draw inferences from
  variation in house prices or from
  willingness-to-pay studies
• Several of these approaches could in principle be
  used to value investments in human capital

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Valuing nonmarket inputs

• Most important nonmarket input the time that
  people devote to producing nonmarket outputs
• Good data on allocation of time required to
  develop nonmarket accounts
• Major questions about how to value that time

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Cost of nonmarket labor inputs

• Past approaches to valuing labor input
• Replacement cost (generalist wage)
• Replacement cost (specialist wage)
• Opportunity cost (own wage)
• Conceptual ideal for work that 3rd party could
  have been hired to perform Replacement cost
  adjusted for differences in levels of skill and
  effort between paid service provider and the
  nonmarket worker
• Conceptual ideal for activities for which own
  time required Opportunity cost adjusted for
  value of enjoyment derived from nonmarket work as
  compared to paid work

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Adjusted Replacement Cost

• Consider production function relating nonmarket
  output to labor and capital inputs
• Q f(bL, K)
• where b is the relative efficiency of nonmarket
  as compared to market labor
• Wage assigned to nonmarket production time would
  be bWR
• If a high-wage individual chooses to perform a
  task for which market price lower than foregone
  earnings, infer that he/she derives enjoyment
  from the task valued at difference between the two

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Adjusted Opportunity Cost

• An individuals opportunity cost need not equal
  the market wage he/she earns, but one would
  expect higher wage individuals to have higher
  opportunity costs
• People may not be able to vary their hours freely
  on a given job, but may be able to choose jobs
  with shorter or longer hours with corresponding
  variation in earnings
• In principle, the opportunity cost of time spent
  investing in human capital should be adjusted to
  account for the relative enjoyment of that
  activity as compared to the relevant market work
  opportunity

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Education Satellite Account
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Measurement approaches

• Measurement of educational output
• Indicator approach
• Incremental earnings approach
• Measurement of nonmarket inputs
• Time the most important nonmarket input

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Indicator approach to quantifying investment in
education

• Indicator approaches typically track student
  exposure to educational system
• Number of students or total student hours
• May be broken out by level and type of education
  (e.g., primary versus secondary) or by type of
  student served (e.g., regular versus special
  education)
• Would like data on expenditures broken out in
  same way as student data to construct appropriate
  weighted index
• Raw indicators may be adjusted based on change in
  some quality metric. For example
• Teacher qualifications (degrees, whether trained
  in subject taught, years of experience)
• Average class size
• Shares of student time in classes where lessons
  rated good, average or poor
• Share of students who graduated during year
• Average student scores on standardized tests

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Indicator approach to quantifying investment in
education (continued)

• Can raise questions about all of the quality
  metrics
• Teacher qualifications, class size and lesson
  quality are educational inputs, not educational
  outputs
• Graduation requirements may change over time
• Many factors affect test scores
• Methods for making quality adjustments to output
  indexes
• For input metrics, estimate production functions
  that relate test scores to the designated inputs
• A concern here is that past efforts have not
  produced a consensus about what matters and how
  much
• Attach a value to test score improvements by
  relating wages to test scores or relating house
  prices to test scores

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Indicator approach to quantifying investment in
education (continued)

• Would like to consider a broader set of inputs
• Could count student homework time in addition to
  student time in school in forming the output
  index
• Could treat parent time, volunteer and other time
  (e.g., time of mentors, time of tutors), and
  perhaps selected features of the social
  environment as quality metrics affecting the
  productivity of student time
• Historical data needed to construct measure of
  stock of educational capital from annual measures
  of investment in education
• Need for historical data will limit quality
  adjustment options

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Incremental earnings approach to valuing
investment in education

• Incremental earnings approach pioneered by
  Jorgenson and Fraumeni (1989, 1992)
• Begin by defining value of future flow of
  earnings for individual with given education
• Education assumed to raise value of time spent in
  both market and nonmarket activities (up to 14
  hours per day)
• Estimates of return to an additional year of
  schooling built up by comparing the expected
  lifetime incomes of people who have the same sex,
  the same age, the same birth year, and the same
  number of years of school completed, but with one
  enrolled in an extra year of schooling and the
  other not.

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Incremental earnings approach to valuing
investment in education (contd)

• Data requirements for method implemented in
  original papers
• Number of people each year by age, educational
  attainment and enrollment status
• Current earnings by age and educational
  attainment
• Probabilities that someone enrolled in grade e
  will remain in school for grade e1
• Probabilities of survival to different ages
• Must make additional assumptions
• Growth rate of real earnings of Y percent per
  year
• Discount rate of Z percent per year
• Future differences in earnings by age and
  education will look like current differences
  (though also can allow for revaluations)

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Incremental earnings approach to valuing
investment in education (contd)

• Given estimated return to education, easy to
  calculate
• Value of stock of human capital
• Sources of change in value of stock (e.g., new
  investment, retirements and deaths)
• Estimates of return to education can be
  questioned
• Years of schooling are endogenous
• Returns to education of different vintages may
  have varied, both because quality of education
  has varied and for other reasons
• Estimated return to education may reflect greater
  investments by parents at young ages plus greater
  returns to on-the-job training for educated
  workers

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Incremental earnings approach to valuing
investment in education (contd)

• Debatable whether nonmarket returns should be
  included
• Plausible that educated workers have higher
  productivity in certain tasks (e.g., helping
  children with their homework) but less plausible
  in others (e.g., preparing childrens breakfast)
• Does not seem appropriate to assume educated
  workers derive greater benefits from leisure
  activities
• Data on time use could be used to differentiate
  nonmarket time by type of activity
• Alternatively, could argue that educated
  individuals have the capacity to work even if
  they choose not to do so (seems odd to say that
  value of human capital stock has risen simply
  because female labor force participation rate has
  risen)
• On the other hand, education may have public as
  well as private returns

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Accounting for student and parent time inputs to
education

• Need data on hours devoted to education
• Administrative records may provide information on
  student time in school
• Time diaries can provide measures of student
  homework time, time that parents and other adults
  spend volunteering at schools, helping with
  homework, etc.
• Many time use surveys have not included
  school-age children or young teenagers
• Coding of activities varies over time and across
  countries, often not detailed enough to identify
  adult time that contributes to childrens
  education
• Need to attach a value to student, parent and
  other adult hours

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Accounting for student and parent time inputs to
education (continued)

• Apply general concepts discussed earlier
• Valuing student time Opportunity cost, adjusted
  for value of enjoyment derived from being in
  school rather than working
• Valuing parent and volunteer time Replacement
  cost, adjusted for differences in levels of skill
  and effort between paid tutors, counselors, etc.
  and the parent or volunteer
• In practice, unlikely to have data that would be
  needed to adjust for value of enjoyment,
  differences in skill levels

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Looking to the future

• Other investments affecting worker productivity
  should be accounted for in a more comprehensive
  human capital account
• Investment of parents in children prior to entry
  into formal schooling
• On-the-job training that occurs after the
  conclusion of formal schooling
• Better data on time use essential
• How children spend their time
• More detail on adult time helping children
• Would like to measure social benefits and private
  nonmarket benefits of education in addition to
  private market benefits (higher earnings)