Tommie Njobvu, PHD: Unza, 2020 Eap 9075

The
Human
Capital
Theory
(HCT)
Tommie NJOBVU, PhD
UNZA, 2020
EAP 9075
The
Human
Capital
Theory
•Analyzes the
importance of
education and
training.
•Human capital:
embodied in
worker; invest
in HK just like
invest in other
types of K.
Why invest in
HK?
–Because
workers
expect a
return in
enhanced
earnings.
In labor
economics we
think of the set
of marketable
skills of
workers as a
form of capital
in which
workers make a
variety of
investments.
This
perspective is
important in
understanding
both investment
incentives, and
the structure of
wages and
earnings.
HC corresponds
to any stock of
knowledge or
characteristics
the worker has
(either innate or
acquired) that
contributes to his
or her
“productivity”.
This definition is
broad, and this has
both advantages and
disadvantages.
The advantages are
clear: it enables us
to think of not only
the years of
schooling, but also
of a variety of other
characteristics as
part of human
capital investments.
These include school
quality, training,
attitudes towards
work, etc. Using this
type of reasoning, we
can make some
progress towards
understanding some
of the differences
in earnings across
workers that are not
accounted for by
schooling differences
alone.
How does
one
interpret
wage
differences?
Think of human
capital investments
and the incentives for
investment, but strike
the right balance
between assigning
earning differences to
unobserved
heterogeneity,
compensating wage
differentials and labor
market imperfections.
1) Compensating
differentials:
a worker may be paid
less in money,
because he is
receiving part of his
compensation in
terms of other (hard-
to-observe)
characteristics of the
job, which may
include lower effort
requirements, more
pleasant working
conditions, better
amenities etc.
2) Labor market
imperfections:
Two workers with
the same human
capital may be paid
different wages
because jobs differ in
terms of their
productivity and pay,
and one of them
ended up matching
with the high
productivity job,
while the other has
matched with the
low productivity one.
3)
Discrimination:
Employers
may pay a
lower wage to
a worker
because of the
worker’s
gender or race
due to their
prejudices.
Uses of
Human
Capital
(i)The Becker view:
Human capital is directly
useful in the production
process. More explicitly,
human capital increases
a worker’s productivity
in all tasks, though
possibly differentially in
different tasks,
organizations, and
situations.
In this view, although the role
of human capital in the
production process may be
quite complex, there is a sense
in which we can think of it as
represented (representable) by
a unidimensional object, such
as the stock of knowledge or
skills, h, and this stock is
directly part of the production
function.
(ii)Gardener
views human
capital as
unidimensional,
since there are
several
dimensions or
types of skills.
A simple version of this
approach would emphasize
mental vs. physical abilities
as different skills.
Let us dub this the Gardener
view after the work by the
social psychologist Howard
Gardener, who contributed
to the development of
multiple-intelligences
theory, in particular
emphasizing how many
geniuses/famous
personalities were very
“unskilled” in some other
dimensions.
Despite their differences,
the first three views are
quite similar, in that
“human capital”
will be valued in the
market because it
increases firms’ profits.
This is straightforward in
the Becker and Schultz
views, but also similar in
the Gardener view.
Sources of
Human
Capital
Differences
(1) Innate ability: workers
can have different amounts of
skills/human capital because
of innate differences.
Research in biology/social
biology has documented that
there is some component of
IQ which is genetic in origin
(there is a heated debate
about the exact importance of
this component, and some
economists have also taken
part in this).
The relevance of this observation for labor
economics is twofold: (i) there is likely to
be heterogeneity in human capital even
when individuals have access to the same
investment opportunities and the same
economic constraints; (ii) in empirical
applications, we have to find a way of
dealing with this source of differences in
human capital, especially when it’s likely
to be correlated with other variables of
interest.
Pattern of
Education and
Earnings for both
Men and Women
• Shows age-earnings
profiles for different levels
of education.
• Specific features:
– 1.
– 2.
– 3.
Human
Capital
Model
A framework in
which individuals
compare the
benefits against
the costs of when
deciding whether
to obtain
education.
Gary Becker;
explains the
decision to invest
in human capital
that is rewarded
with higher
future earnings
Education as
an Investment
• Is education a
good investment?
• Compare costs to
benefits across the
entire lifetime.
• Costs include
opportunity costs.
• Overall:
Present value
Value of today’s
earnings received
in the future
Net present
value
Difference in
value (in today's
dollars) between
the benefits and
costs of an asset
Diminishing
Marginal
Returns
Each
additional unit
of schooling
brings less
additional
benefit.
Market
rate of
return
Financial return
an individual can
expect from
investing money
in typical
financial vehicles,
like stocks or
bonds
Foregone
Earnings
Earnings one
would have
received in labor
market during
period of
enrollment in
school if he had not
been in school
Net
present
value
Value today of the
change in wages that
will be earned
sometime in the future
because of the
increase in education
net of the cost of
investing in an
education today
Marginal
rate
of return
Percentage
change in
earnings, net of
costs, to
obtaining an
extra year of
education
HK Investment
Decision
• Compare two “life
strategies”:
• 1) Finish high school and
start working FT at age
18 to age 65.
• 2) After h.s., go to
college for four years,
then work FT from age 22
to age 65.
– * direct costs:
– * opportunity costs:
The Two Strategies
• Compare lifetime earnings
for HS versus C: $ earnings:
– HS:
– C:
• BUT need to know these
two figures in present
value terms.
– HS:
– C:
– Present value: more distant
in time the $ is received, the
lower its current/present
value.
– FV = $106; PV = $100.
– FV must be discounted to get
PV.
Implications of
HK Theory
• 1.  college costs should
lead to  college
attendance due to  net
return. (yes observed in
real world)
• 2. Most students young.
(yes)
• 3. Lower enrollment
rates for those not
expecting to work
continuously (yes).
• 4. Individual with more
education has higher
earnings in peak years
(yes).
Formal Model of
HK Investment
• Developed by Becker;
has D for HK curve and
S of investable funds
curve.
• These S and D curves
differ across
individuals; implies
existence of earnings
differentials too.
• Why differences in S?
Due to differences in
opportunity:
More on Formal
Model
• Why differences in D?
– 1.
– 2.
– 3.
• Policy solutions:
– 1.
– 2.
– 3.
• Extension to HK Theory:
HK as signal (screening
device).
On-the-Job
Training
(OJT)
• OJT like any other
HK investment but
now some of OJT
investment costs
(and benefits) will be
shared between
worker and
employer.
• General OJT:
• Specific OJT:
Who Pays for Training?
• General OJT: worker can

use this training to 
productivity at many firms
so employer won’t pay;
worker must pay with
reduced wages during
training but then benefits
with increased wage after
training.
• Specific OJT: the training
is specific to this firm;
worker can’t “take it with
him” so firm willing to pay
for it, but then reaps some
of the benefits of the
increased productivity
post-training.
4. Implications of
Investment in OJT
• 1. For workers
w/specific training:
• 2. Wmin might 
firm’s willingness to
provide training
since cannot w
during training.
• 3. Specific OJT:
• 4. Shape of age-
earnings profile:
Intermittent Work
and Women’s
Earnings
• See Figure 7.10: shows
age/earnings profiles
for men and women
(college grads and just
HS).
• Two things to note:
• 1)
• 2)
Why Differences in
Age/Earnings Profiles?
• Three reasons:
• 1.
• 2.
• 3.
• Why intermittent work causes
flatter age/earnings profiles?
• 1. Less OJT investment (due
to less chance of return to
investment).
• 2. Less access to
occupations with much
specific OJT (so women stuck
in secondary sector).
• 3) HK depreciates during
time out of LF  difficulty of
mid-career re-entry

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• General OJT: worker can

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