Investments in Human Capital: Education and Training

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Chapter 9

• Investments in Human Capital Education and
  Training

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A decision today about how much education to
acquire will be reflected by future changes in
earnings.
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Human Capital

• skills of an individual which he or she can rent
  out to an employer.
• How can we analyze the decision of whether or not
  to attend college and get a degree?
• What's important?

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COSTS

• Tuition and fees, foregone earnings, psychic
  costs
• 15,000 a year minimum.

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BENEFITS

• Future earnings in terms.

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Age-Earnings Profiles
College
High School
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Direct Costs
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Indirect costs
Direct Costs
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Future Benefits
Indirect costs
Direct Costs
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Human Capital Models Can Explain Why

• earnings typically increase with age but at a
  decreasing rate.
• unemployment rates tend to be inversely related
  to the level of skill.
• younger workers change jobs more frequently and
  tend to receive more on the job training than
  older workers.
• persons with greater ability receive more
  education and other kinds of training than others.

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How can we derive a model that explains all of
these?
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Assume

• The increased amount of human capital affects
  only the wage rate.
• Each person produces his own human capital by
  using his own time and goods to attend classes,
  receive on the job training, etc.

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If the present value of net benefits is greater
than the present value of costs, the individual
will invest in human capital
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Future Benefits
Indirect costs
Direct Costs
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Definitions

• Let Xt earnings with college degree in time
  period t
• Let Yt earnings with high school degree in time
  period t
• Let r the discount rate (interest rate)
• Let R retirement age

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Two methods to use to determine whether or not
the investment in college is worth it or not

• present value method - specify the discount rate
  and determine if PV(BENEFITS) gt PV(COSTS)
• internal rate of return method - How large of a
  discount rate is necessary to make college
  profitable?

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Present Value Method
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PREDICTIONS

• what happens when X, Y, C, r and R change?

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As r rises, the present value of the difference
falls

• Present oriented people are less likely to go to
  college than future oriented (forward looking)
  people.
• Being present oriented implies that the discount
  rate is high.
• Present oriented individuals discount the future
  more heavily.

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College attendance will increase if costs fall.
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College attendance will increase if the gap
between earnings of college and high school
graduates increases.

• Likewise, people with a higher opportunity cost
  of foregone earnings may be less likely to attend
  college, other things equal.

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College
High School
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College
High School
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What happens during a recession?

• unemployment is less likely for educated workers
• this implies that Y does not change
• high school workers are more likely to be
  unemployed
• this implies that X may become 0
• thus, (Y-X) increases during recession years

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Our model predicts an increase in investment in
human capital during a recession.
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Is education a good investment?

• Some studies estimate the rate of return to
  education after adjusting for inflation is 5 to
  15 percent
• This is similar to the return on other
  investments

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These estimates have biases some of which
overstate the return on education and some which
underestimate the return on education.
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Overestimating the return on education

• we cannot separate ability from schooling level
• this is called a selection bias problem
• if those who are most able are the ones who go to
  school we could be seeing increased earnings from
  higher ability and not from increased schooling

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Underestimating the return on education

• we cannot measure all returns from education such
  as psychic benefits
• fringe benefits are often not included, but
  generally are higher with higher earnings

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Education As A Social Investment

• U.S. spends 7 of GDP on education (if we include
  foregone earnings for college education this is
  10 of GDP)
• education has social payoffs in some fields
  (i.e., engineers)
• but education may act as more as a sorting device
  in the labor market

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The education of workers may make some workers
more productive and employers can then use
education as a screen.
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Signaling

• Firms often observe certain indicators that they
  believe are correlated with productivity
• examples include age, race, sex. experience,
  education, etc.

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An individual has little control over some
signals (age, race) but some can be changed

• One of the best examples of a signal which can be
  changed is education
• This signal can help firms discern which workers
  have higher productivity

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Even if education does not add to productivity,
it can act as a signal which distinguishes
workers by productivity.

• How?

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What type of individual is most likely to get
education?

• someone for whom the costs are low

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What type of individual is likely to face low
costs of attending school?

• someone who learns easily

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Thus, individuals who learn easily are more
likely to attend college than those who dont.

• Education level then works well as a signal to
  employers of which workers are most easily
  trained.

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The End