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CHAPTER ONEInvestment in Human Capital Development: A Theoretical and Empirical Review

Human capital is a broad concept, covering many characteristics contributing to grow an individuals, firms or societys productivity. It includes not only knowledge and skills but also talents, leadership qualities, work ethics and health etc. According to economists, the ability of an economy to accumulate a high quality of human capital is an important factor of economic development. Human capital theory assumes that education is highly instrumental and necessary to improve the productive capacity of a population.

The aim of this chapter is to describe briefly the human capital theory, importance of education, mainly the Technical Education and Vocational Training (TVET), positive experiences gained by some developed countries and importance of TVET for developing countries like Sri Lanka in human capital development.

This chapter is divided into four sections. The first section is devoted to discuss the theoretical background of human capital and effects of human capital on economic development. The second section analyses the importance of education in human capital development. The third section presents definitions of the term Technical and Vocational Education and Training (TVET), and then examines the importance of Technical and Vocational Education and Training in human capital development and the relevant positive experiences of developed countries. The fourth section touches on the importance of TVET for developing countries in their development struggle.

1.1 Human Capital Theory

In general terms, human capital is considered as the investment an individual makes in him/herself to enhance his/her economic productivity. In a broader sense, human capital is the stock of competencies, knowledge, social and personality attributes, including creativity, embodied in the ability to perform labor so as to produce economic value. The definition of human capital is referred to as the knowledge, skills, competencies, and attributes embodied in individuals that facilitate the creation of personal, social and economic well-being (Organization for Economic Co-operation and Development OECD, 2001: 18).

British economists, Sir William Petty (1623-1687) and Adam Smith (1723-1790) are recognized as the developers of human capital theory. Petty in his Treatise of Taxes and Contributions (1662) examined the role of the state in the economy and presented the idea on the value of labor. Adam Smith established the basis of the economics of human capital (Becker, 1992). In his masterpiece, The Wealth of Nations (1776), Smith elaborated his theories with the prosperity or a wealth of a nation. According to Smith, the main cause of prosperity was increasing division of labor. He is recognized as the first to make a connection between the skill of the worker and higher wage levels (Becker, 1992). However, traditional economists considered land, labor and physical capital as factors of production. From the perspective of classical economic theory, human capital considers labor as a commodity which can be traded in terms of purchase and sale. In 1958, Schultz, in his essay on The Emerging Economic Science and its Relation to High School Education, elaborated people as the source of economic growth and described human capital as follows; Consider all human abilities to be either innate or acquired. Every person is born with a particular set of genes, which determines his innate ability. Attributes of acquired population quality, which are valuable and can be augmented by appropriate investment, will be treated as human capital (quoted in Fitz-enz, 2000: 21).

In the early 1960s increasing attention was paid to the level of education and training in the work place and it gave rise to the concept of human capital (OECD: 2001). Two schools of thought regarding human capital concept emerged, over the next two centuries. The first school of thought distinguished between acquired capacities that were classified as capital on the one hand and human beings themselves who were not capital on the other. The second school of thought claimed that human beings themselves were capital. In modern human capital theory, all human behavior is based on the economic self-interest of individuals operating within a freely competitive market (Barro, 1999).

According to modern economists, human capital is rooted in the field of macro-economic development theory (Schultz, 1993). The concept of human capital arose from a recognition that an individuals or firms decision to invest in human capital (i.e. invest in education and training) is similar to decisions on other types of investments as for example on machinery, building and land etc. by individuals or firms. Unlike the traditionally associated meaning of the term labor, human capital refers to the knowledge, expertise, skills and other attributes of individuals, which include a range of personal, economic and social values. Generally, one accumulates these largely through education and training, but may also reflect innate capacities. Some aspects of motivation and behavior, as well as attributes such as the physical, and mental health of individuals are also considered as human capital (OECD: 2001).

There are three main components of human capital: a) early ability (whether acquired or innate); b) qualifications and knowledge acquired through formal education and c) skills, competencies and expertise acquired through training on the job (Blundell et.al. 1999).

Beckers (1993) study on Human Capital: A Theoretical and Empirical Analysis with Special Reference to Education further described the concept of human capital. According to him, there are different types of capitals which include schooling, training, fees on education and medical care etc. He considered the ethics such as honesty, punctuality, commitment, responsibility and hard work etc. also as human capital. Emphasizing the social and economic importance of human capital theory, Becker (1993) highlighted that the most valuable of all capital is investment in the human being. He distinguished firm/company specific human capital from general-purpose human capitals. Expertise gained through education and training in management, accounting, information technology and other expertise were taken by Becker as examples of company specific human capitals, while knowledge gained through education and training in areas of value to a variety of companies such as generic skills in human resource development considered general purpose of human capital. However, Becker (1993) considered education and training as the most important investment in human capital.

This theory has further been described by Garavan et.al. (2001) and they have pointed out four key attributes of human capital as follows: a) flexibility and adaptability; b) enhancement of individual competencies, c) the development of organizational competencies and d) individual employability. Rastogi (2000) also considered human capital as an important input of organizations, especially for continuous improvement of employees mainly knowledge, skills, and abilities.

Human capital is developed in the contexts of: learning within family and early child care settings; formal education (primary to tertiary, technical & vocational, labor market training and adult education etc.); work place training (in-service training, research, innovation participation in professional net-works etc.); informal learning (on-the-job and civic participation) (OECD: 2001).Measuring the economic impact of human capital can be done through the calculation of productivity or earnings-based rates of return on investments in learning. Private rates of return can be estimated using data on private costs and post-tax earnings over a life time. Such private rates of return should include the non-monetary benefits like pleasure of learning, and the job satisfaction etc. Social rates of return should include the public and societal costs and benefits involved in investing in more human capital. However, in practice, there are many difficulties in measuring correctly the full benefits of human capital (OECD, 2001).

The concept of human capital plays a major role in modern treatments of growth theory and of labor economics. In one sense, the distinction between the two is in levels of aggregation. At the macro-economic level, the social stock of human capital and its growth are central to the process of economic growth; at the micro level differences in human capital stock and in their growth can explain much of the observed variation in the wage structure and in the wage distribution among individuals and groups.

In a macro-economic approach, the development of human capital improves labor productivity, facilitates technological innovations, increases returns to capital and makes sustainable economic growth, which in turn, helps to reduce poverty. From a microeconomic perspective, education increases the probability of being employed in the labor market and improves earning capacity. At the micro level, human capital is regarded as the component of education that contributes to an individuals labor productivity and earnings while being an important component of firm production. In this sense, human capital refers to the ability and efficiency of people to transform raw materials and capital, into goods and services and the consensus is that those skills can be learned through the educational system. Therefore, human capital development is important for overall development of a country for its intrinsic value as a development goal in its own right (Cohen and Soto, 2007).

Although pursued independently these applications view human capital and its growth as a cause of economic growth: of the economy as