chapter 7 human capital. introduction people bring into the labor market a unique set of abilities...
TRANSCRIPT
Chapter 7
Human Capital
Introduction
People bring into the labor market a unique set of abilities and acquired skills known as human capital
Workers add to their stock of human capital throughout their lives, especially via job experience and education
Education: Stylized Facts
Education is strongly correlated with: Labor force participation rates Unemployment rates Earnings
Present Value: Borrowing a Technique from Finance
Present value allows comparison of dollar amounts spent and received in different time periods
PV = y/(1+r)t
r is the discount rate
0 1 2 3 4 5
Discount Rate
Money in Period 1
Money in Period 2
Money in Period 3
Money in Period 4
Money in Period 5
Money in Period 6
1000 0.01 1000 1000 1000 1000 1000 1000
Present Value of
Cash 5853.4 1000.0 990.1 980.3 970.6 961.0 951.5
Potential Earnings Streams Faced by a High School Graduate
18 6522Age
wCOL
wHS
-H
Dollars
Goes to College
Quits After High School
0
A person who quits school after getting his high school diploma can earn wHS from age 18 until the age of retirement. If he decides to go to college, he foregoes these earnings and incurs a cost of H dollars for 4 years and then earns wCOL until retirement age.
The Schooling Model Real earnings (earnings adjusted for inflation) Age-earnings profile – the wage profile over a
worker’s lifespan The higher the discount rate, the less likely
someone will invest in education (since they are less future oriented)
The discount rate depends on: The market rate of interest “time preferences” (how a person feels about giving up today’s
consumption in return for future rewards)
The Wage-Schooling Locus
What salary will firms be willing to pay workers for given levels of schooling
Three properties: The wage-schooling locus is upward sloping The slope of the wage-schooling locus indicates the
increase in earnings associated with an additional year of education
The wage-schooling locus in concave
The Wage-Schooling Locus
The wage-schooling locus gives the salary that a particular worker would earn if he completed a particular level of schooling. If the worker graduates from high school, he earns $20,000 annually. If he goes to college for 1 year, he earns $23,000.
013 14 1812
30,000
20,000
23,000
25,000
Years of Schooling
Dollars
Education and the Wage Gap Observed data on earnings and schooling does
not allow us to estimate returns to schooling In theory, a more able person gets more from
an additional year of education Ability bias – the extent to which unobserved
ability differences exist effects estimates on returns to schooling (since the ability difference may be the true source of the wage differential)
The Schooling Decision
Years of Schooling
Rate of Discount
s*s
r
r
MRR
The MRR schedule gives the marginal rate of return to schooling, or the percentage increase in earnings resulting from an additional year of school. A worker maximizes the present value of lifetime earnings by going to school until the marginal rate of return to schooling equals the rate of discount. A worker with discount rate r goes to school for s* years.
Schooling and Earnings When Workers Have Different Rates of Discount
Years of Schooling
Years of Schooling
Rate of Interest
1212 1111
rBO
rAL
MRR
Dollars
wDROP PAL
PBO
wHS
Schooling and Earnings When Workers Have Different Abilities
Years of Schooling
Years of Schooling
Rate of Interest
1211
r
MRRACE
MRRBOB
Dollars
1211
wHS
wACE
PACE
wDROP
Z
Bob
Ace
Ace and Bob have the same discount rate (r) but each worker faces a different wage-schooling locus. Ace drops out of high school and Bob gets a high school diploma. The wage differential between Bob and Ace (or wHS - wDROP) arises both because Bob goes to school for one more year and because Bob is more able. As a result, this wage differential does not tells us by how much Ace’s earnings would increase if he were to complete high school (or wACE - wDROP).
Estimating the Rate of Return to Schooling A typical study estimates a regression of
the form: Log(w) = β*s + other variables
w is the wage rate s is the years of schooling β is the coefficient that estimates the rate
of return to one added year of schooling
Trostel, Walker, and Wooley (2002)“Estimates of the Economic Return to Schooling for 28 Countries,” Labour Economics 9 (Feb 2002): 1-16
Trostel, Walker, and Wooley (2002)“Estimates of the Economic Return to Schooling for 28 Countries,” Labour Economics 9 (Feb 2002): 1-16
Some Evidence
In studies of twins, presumably holding ability constant, valid estimates of rate of return to schooling can be estimated
Generally, the rate of return to schooling is higher for workers who were born in states with well-funded education systems
Duflo Paper
School Quality and the Rate of Return to Schooling
2
3
4
5
6
7
8
15 20 25 30 35 40
Pupil/teacher ratio
Rat
e of
ret
urn
to s
choo
ling
2
3
4
5
6
7
8
0.5 0.75 1 1.25 1.5 1.75 2
Relative teacher wage
Rat
e of
ret
urn
to s
choo
ling
Source: David Card and Alan B. Krueger, “Does School Quality Matter? Returns to Education and the Characteristics of Public Schools in the United States,” Journal of Political Economy 100 (February 1992), Tables 1 and 2. The data in the graphs refer to the rate of return to school and the school quality variables for the cohort of persons born in 1920-1929.
Do Workers Maximize Life-Time Earnings? The schooling model assumes that workers select their
level of education to maximize the present value of lifetime earnings
The only way to test this hypothesis is if we can observe the age-earnings profile of a worker in two ways: if he chooses college, or if he stops education investments
Unfortunately, once a choice is made, we cannot observe the earnings stream associated with the non-choice
Thus, using the observed wage differential to determine if the worker selected the “right” earnings stream yields meaningless results
Self-Selection Bias
Workers may select themselves into jobs for which they are better suited
Therefore, wage differentials may not be associated with education
Then what is the point of investing in education?
Schooling as a Signal Education reveals a level of attainment which
signals a worker’s qualifications to potential employers
Information that is used to allocate a workers in the labor market is called a signal
There could be a “separating equilibrium” Low-productivity workers choose not to obtain X years of
education, voluntarily signaling their low productivity High-productivity workers choose to get at least X years of
schooling and separate themselves from the pack
Education as a Signal
Workers get paid $200,000 if they get less than y years of college, and $300,000 if they get at least y years. Low-productivity workers find it expensive to invest in college, and will not get y years. High-productivity workers do obtain y years. As a result, the worker’s education signals if he is a low-productivity or a high-productivity worker.
300,000
25,001 y
20,000 y
200,000
0
Dollars
Years of Schooling
Costs
Slope = 25,001
300,000
200,000
0
Dollars
Years of Schooling
Costs
Slope = 20,000
(a) Low-Productivity Workers
y y
(b) High-Productivity Workers
Implications of Schooling as a Signal Education is more than a signal, it alters
the stock of human capital Social return to schooling (percentage
increase in national income) is likely to be positive even if a particular worker’s human capital is not increased
Post-School Human Capital Investments Three important properties of age-
earnings profiles: Highly educated workers earn more than less
educated workers Earnings rise over time at a decreasing rate The age-earnings profiles of different education
cohorts diverge over time (they “fan outwards”) Earnings increase faster for more educated
workers
Age-Earnings Profiles
Men
200
500
800
1100
1400
1700
2000
18 25 32 39 46 53 60
Age
Wee
kly
Ear
nin
gs
Some college
College Graduates
High school graduates
High school dropouts
Age-Earnings Profiles
Women
200
400
600
800
1000
1200
18 25 32 39 46 53 60
Age
Wee
kly
Ear
nin
gs
Some college
High school graduates
College Graduates
High school dropouts
On-The-Job Training
Most workers augment their human capital stock through on-the-job training (OJT) after completing education investments
Two types of OJT: General: training that is useful at all firms once it is
acquired Specific: training that is useful only at the firm where it
is acquired
Implications
Firms only provide general training if they do not pay the costs
If the firm and the worker share the returns to specific training the possibility of separation in the post-training period is eliminated
The Acquisition of Human Capital Over the Life Cycle
MC
MR20
MR30
Dollars
0 Q30 Q20
Efficiency Units
The marginal revenue of an efficiency unit of human capital declines as the worker ages (so that MR20, the marginal revenue of a unit acquired at age 20, lies above MR30). At each age, the worker equates the marginal revenue with the marginal cost, so that more units are acquired when the worker is younger.
Age-Earnings profiles and OJT
Human capital investments are more profitable the earlier they are taken
The Mincer earnings function: Log(w) = a*s + b*t – c*t2 + other variables The “overtaking age” is t* and indicates the time when
the worker slows down acquisition of human capital to collect the return on prior investments so as to “overtake” earnings of those that do not undertake similar investments
The Age-Earnings Profile Implied by Human Capital Theory
Dollars
Age-Earnings Profile
Age
The age-earnings profile is upward-sloping and concave. Older workers earn more because they invest less in human capital and because they are collecting the returns from earlier investments. The rate of growth of earnings slows down over time because workers accumulate less human capital as they get older.
Policy Application: Evaluating Government Training Programs
Aimed at exposing disadvantaged and low-income workers to training programs
$4 billion (Federal) spending per year Studies of the return to these human
capital investments are unclear (self-selection bias)
Social Experiments
National Supported Worker Demonstration (NSW)
The study suggests a 10% return to investments in human capital for workers treated under the program