Ch' 9: Human Capital Theory: Applications to Education and Training

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Lecture 8

• Ch. 9 Human Capital Theory Applications to
  Education and Training
• Relationship between wages and educational
  attainment
• Human capital theory
• Empirical evidence
• Workplace training
• In other textbooks (D H Ch. 12 E,S, C Ch.
  9)
• Reference Article Peter Cappelli (2004)

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University Enrollment, Canada, 1970-1998 (males)
Source Statistics Canada, 2001 Canadian Census
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Canadahighest PSE attainment
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Average Salary by Educational Attainment, Canada,
2000
Source Statistics Canada, 2001 Canadian Census
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Human Capital Theory

• Definition
• Investment decision
• Example Attending university.
• What are the costs?
• What are the benefits?

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Human Capital Theory (contd)
Earnings and Costs ()
Alternative Income and Earning Streams
University
48,287
25,807
High school
0
-10,000
18
22
65
Age
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Human Capital Theory (contd)

• Example (contd)
• Present value of costs versus benefits
• Direct costs
• 10,000 10,000/(1i)1 10,000/(1i)2
  10,000/(1i)3
• Indirect costs
• 25,807 25,807/(1i)1 25,807/(1i)2
  25,807/(1i)3
• Benefits
• 22,480/(1i)4 .. 22,480/(1i)46

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Human Capital Theory (contd)

• Example (contd)
• Present Value of direct costs
• 37,232.48
• Present value of indirect costs
• 96,085.86
• Present value of benefits
• 340,725.30
• Net present value

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Human Capital Theory (contd)

• What does human capital investment decision
  depends upon?
• Fairly easy to make predictions about student
  demand for university
• Assumptions for HC theory to predict behaviour
• No direct pleasure or pain from educational
  process
• Future incomes known with certainty
• Can borrow (at interest rate i)

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Human Capital Theory (contd)

• Private versus social costs and benefits
• The Socioeconomic Benefits Generated by 24
  Colleges of Applied Arts and Technology in
  Ontario (See my Web site for exec. summary)
• What are some criticisms with their approach?

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Competing explanations for wage education
relationship

• Human capital theory explanation (again)
• More education ? Higher productivity ? Higher
  
  earnings
• Socioeconomic benefits study followed this
  explanation (re. earnings, health, crime,..)
• More education ? Less likely to commit crimes ?
  Savings for government
• OR
• Hard working/smart people ? Less likely to
  commit ? crimes
• More likely to get more education

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Competing explanations for wage education
relationship (contd)

• Education as a signal or filter
• High ability people ? More education
• ?
• Higher earnings
• Implications
• If productivity/ability is easily measured, what
  is role of education?
• Private benefits versus social benefits

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Competing explanations for wage education
relationship (contd)

• Education as a signal or filter (contd)
• Both human capital and signalling theory have
  validity depending on the circumstance
• Medical school graduates versus economics grads
  (BA versus MA)
• Policy implications

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Competing explanations for wage education
relationship (contd)

• Job Competition Model (Lester Thurow)
• A particular type of screening argument
• Wages attached to job, not individual
• Explanation for overqualification
• Policy implication regarding funding of PSE.

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Empirical Evidence

• What factors, in addition to years of education
  explain variation in earnings?
• (Basic) human capital earnings function
• W ß0 ß1S ß2 EXP e
• Where, W is hourly wage ()
• S years of education
• EXP years of work experience

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Empirical Evidence (contd)

• Human capital earnings function (contd)
• ln (E) ß0 ß1S ß2 EXP ß3 EXP2 e
• Where, E is annual earnings

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Empirical Evidence (contd)

• Human capital earnings function (contd)
• ln (E) 8.473 0.075S 0.056 EXP - .0007EXP2
• If S 16 and EXP 1? ln (E) 9.7283
• E 16,785.99
• If S 12 and EXP 5? ln (E) 9.5998
• E 14,761.83

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Empirical Evidence (contd)

• What (important) variables were omitted from the
  earnings function?
• Do parameter estimates suffer from omitted
  variable bias?
• Ability bias
• What is it?
• Ways to deal with it in estimations of returns to
  schooling

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Empirical Evidence (contd)

• W ß0 ß1SR ß2SE ß3SU e
• Where SR years of required schooling, SE
  years of excess schooling, and SD years of
  deficit schooling
• Ph.D. driving a taxi cab SR 12, SE 8
• Grade 5 grad driving a cab SR 12, SD 7
• Testing models
• ß2 0, ß3 0 (Job competition model)
• ß1 ß2 ß3 (Human capital model)

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Wage differentials and schooling
S1
S2
Rate of return ()
r1
r2
D1
D2
q2
q1
Number of university graduates / Total labour
force
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Wage differentials and schooling (contd)

• Job competition model provides a different
  explanation for wage inequality between
  university and high school educated workers.
• When a new, larger, effective supply of college
  graduates comes into the market, they essentially
  take what used to be the best jobs away from high
  school educated workers immediately below them in
  the skill distribution. (Thurow, 1998)

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Wage differentials and schooling (contd)

• Job competition model Example
• University graduate Teacher 40,000 per year
• High school graduate Bus Driver 35,000 per
  year
• What if too many university graduates?
• University grads as bus drivers 35,000 per year
• High school grads as retails clerks 25,000 per
  year

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Workplace Training

• Workplace training is another type of human
  capital investment.
• General training versus firm specific training
• Formal training versus informal training
• Which is more important?
• Which is more easily measured?
• Statistics Canadas Workplace and Employee Survey

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Source Statistics Canada, Workplace and Employee
Survey, 1999
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Canada Low in Training
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Workplace Training (contd)

• Who (theoretically) should pay for the training?
• Human capital theory predicts that it depends on
  the type of the training.
• Why?
• How can the individual pay for training?

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Costs Benefits of General Training
Wages MRP
benefits
WaMRPa
costs
Time
Retirement
0
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Paper by Peter Cappelli (2004)

• Why do employers pay for college?
• This is the classic example of a general skill
• 3 possibilities that Cappelli tested
• Employees pay through reduced wages
• Tuition benefit pays for itself by
• attracting higher quality employees
• reducing turnover/ increasing tenure

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Why dont employers train more?

• Poaching
• Solutions to poaching problem
• Contracts
• Government actions
• Government solutions
• Payroll Tax
• Training tax credit