4 minute read

Human Capital

Costs And Benefits

These costs and benefits must be brought to a single point in time so that the present value of the higher average lifetime earnings with more schooling and the lower average earnings with less schooling can be compared. A rational individual chooses the education and work profile that maximizes the present value of lifetime earnings.

This investment approach to education yields several important predictions about behavior. First, most people will get some education, and most students will be young, because the early years of education have few direct costs, and there are no forgone earnings because most societies prohibit children from working; younger people also have a longer period over which they can recoup their educational investment in the form of higher earnings. The analysis gets more interesting when young people reach the age at which they can work, sixteen or eighteen in most industrial countries, and twelve to fifteen in many developing countries. Youth in industrial countries tend to stay in school because the direct costs are often low and the for-gone earnings may be low (working as a teen is often at the minimum wage), while earnings with a college education can be significantly higher. The interest rate used to compare future and present earnings is also important; if this interest rate is low because of subsidized loans, more people will choose to get more education.

Second, government policies shape individual decisions about how much human capital to acquire by affecting the cost of schooling and the payoff from work. Social attitudes also play a role, encouraging young people to stay in school, or to go to college with friends in industrial countries, but in developing countries often encouraging children to help support the family as soon as possible. More forward-looking people, those most able to sacrifice now for future returns, are likely to get the most education, such as those willing to undergo rigorous and time-consuming medical education.

In the United States a combination of higher lifetime earnings, government policies, and social attitudes has increased the percentage of high school graduates who go to college. In 1960, about 45 percent of all high school graduates enrolled in college in the following twelve months, 54 percent of men and 38 percent of women. By 1980, 49 percent of high school graduates enrolled in college: men dropped to 47 percent, and women rose to 52 percent. In 1999, the most recent data available, 63 percent of high school graduates enrolled in college, 61 percent of men and 64 percent of women. Most studies find that men are more present-oriented to immediate earnings opportunities than women, explaining why more women are in college.

The average earnings of college-educated persons are higher than the earnings of high school graduates, and rose in the late twentieth century. In 1979, male college graduates earned 33 percent more than high school graduates, the so-called college earnings premium, and female college graduates earned 41 percent. By 2000, these college earnings premiums rose to 84 percent for men and 67 percent for women, in part because the real earnings of those with less education fell as a result of globalization, which reduced the wages of many high school graduates employed in manufacturing.

Education is generally a good investment: the private rate of return to a college education ranges from 12 to 40 percent in most countries, more than the return on investments in stocks and bonds. Around the world, the rate of return to primary school education was estimated to be 29 percent in the early 1990s, 18 percent for secondary schooling, and 20 percent for higher education. In developing African countries, these rates were 39, 19, and 20 percent, respectively, while in the industrial countries that are members of the Organisation for Economic Co-Operation and Development (OECD), the rates were 22, 12, and 12 percent, respectively. The high rate of return on primary education suggests that countries should subsidize it most.

It is very hard to compute average rates of return for higher levels of education because it is likely that the most capable individuals go to college, so that colleges transmit knowledge that increase productivity and also serve as screening institutions for employers seeking the best workers; some economists argue that the screening role is more important than the productivity-increasing role. On the other hand, the private rate of return to a college education may be higher if more highly educated individuals have both higher incomes as well as more fringe benefits and better or more prestigious jobs. The social rate of return may be even higher than the private rate if highly educated individuals provide more leadership and commit fewer crimes.

Any personal investment that raises productivity in the future can add to an individual's human capital, including onthe-job training and migration. A job that offers training, for example, may have lower earnings but still be attractive because a person knows that, after completing the military, aviation, or stockbroker course, earnings will rise. On-the-job training that makes the person more useful to the employer who provided it is called job-specific training, while training that transmits general skills that make the trained individual useful to many employers is called general training. Employers are more likely to pay for specific than general training. Employers do a great deal of training; by some estimates, U.S. employers spend almost as much on training as is spent at colleges and universities.

Additional topics

Science EncyclopediaScience & Philosophy: Heterodyne to Hydrazoic acidHuman Capital - Costs And Benefits, Migration Of Human Capital, Bibliography