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 NPV=B1/(1+r) + B2/(1+r)^2 + B3/(1+r)^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 r=0.06, benefits payable in 30 years will receive a weight which is 17% of the weight placed on immediate benefits 1/(1+0.06)^30 = 1/(1.06)^30=1/5.74 and 1/5.74=0.17

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/(1+r) + B2/(1+r)^2+�+BT/(1+r)^T>C

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/(1+0.03) + 7000/(1+0.03)^2 + 10000/(1+0.03)^3 = 18662.20 So undertake project since NPV exceeds Cost

10. Optimum acquisition of HC Figure 9.1 (page 291)

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

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 one�s 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

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 worker�s MP is less than wage while after training worker�s 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

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 women�s 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 20�s 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

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 person�s 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

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 > e* earn 2 while those with education < 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 one�s 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 Figure 9.8

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