Human capital accumulation and economic growth

The origin of the concept of Human Capital

In a paper I wrote some years ago I explained the origin of that concept of human capital as follows:

The term ‘human capital’ was initially controversial, but the analytical concept was not. The analysis of human capital has many famous parents and grandparents (Kiker 1966).

Sir William Petty published the first analysis of the value of human capital in 1690. There were sophisticated analyses of investments in education and training and their implications for wage differentials, labour productivity and occupational choice by Adam Smith in 1776, Alfred Marshall in 1890 and Milton Friedman and Simon Kuznets in 1945.

Richard Cantillon, John Locke, John Stuart Mill, Adam Smith and Karl Marx all proposed that training rather than natural ability was more important in understanding occupational wage differentials. Adam Smith and Alfred Marshall referred to education and training as capital investments in human beings.

Irving Fisher in 1912 and Arthur Pigou in 1928 pioneered the explicit use of the term ‘human capital’. Jacob Mincer, Theodore Shultz and Gary Becker popularised the use of the term in the mid-20th century. See Kiker (1966) for a history of the concept of human capital.

Robert Lucas on the role of the family in economic development

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Gary Becker summarises the analysis of human capital

Human capital analysis starts with the assumption that individuals decide on their education, training, medical care, and other additions to knowledge and health by weighing the benefits and costs. Benefits include cultural and other non-monetary gains along with improvement in earnings and occupations, while costs usually depend mainly on the foregone value of the time spent on these investments.

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Trends in Income Inequality and its Impact on Economic Growth – OECD – is it all about not enough graduates – updated?

The analysis of the OECD published overnight depends crucially upon how greater inequality reduces the ability of the lower income families to invest in human capital.

The OECD theory of inequality and lower growth is there is a financing constraint because of inequality that reduces economic growth because of less human capital accumulation by lower income families.

Proportion of adults aged 25–64 years with an educational qualification of at least upper secondary level and tertiary level, 1991–2009

Figure K4.1 Proportion of adults aged 25–64 years with an educational qualification of at least upper secondary level and tertiary level, 1991–2009

In a nutshell, not enough people are going to university. Apparently,  the explosion in tertiary educational attendance over the last generation, an increase of about 150%  for the adult population aged 25 to 64, was just not good enough.

But what about adults aged 25 to 34, recent graduates, how many of them are there?

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There was an explosion of young New Zealanders in the late 1990s who qualified for a degree from a university or diploma from a Polytech.

Under the hypothesis of the OECD about financial constraints retarding the accumulation of human capital among the lower middle class – the fourth decile of the income distribution –  even more young New Zealanders should have gone to university or Polytech.

Are there many New Zealanders left who are qualified and suited to tertiary education who do not go?

That is the crux of the OECD position: not enough lower-middle-class New Zealanders go on to obtain higher education and upgrade their skills because of financial constraints in a country was in interest free student loans,  means tested student allowances, and the government subsidises for 75% of all tuition fees. Tuition fees only equal 25% of the actual cost  and any one can get a student loan to cover this fee.

The Economic Case Against Majoring in Fun Things – The Atlantic

via http://www.theatlantic.com/business/archive/2014/11/the-economic-case-against-majoring-in-fun-things/383008/

I told you so – The Psychology Behind Messy Rooms: Why The Most Creative People Flourish In Clutter

via The Psychology Behind Messy Rooms: Why The Most Creative People Flourish In Clutter.

Deirdre McCloskey on Piketty’s definition of wealth in the Age of Human Capital

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The day that sex discrimination died – Solomon Polachek on the gender wage gap

Solomon Polachek was minding his own business back in 1975 looking for evidence to show occupational crowding and that women were pushed into low paid occupations by sex discrimination, and in particular, employer discrimination. About 60 per cent of women still work in just 10 occupations. the occupations which are female-dominated are often relatively poorly paid jobs

By chance, Polachek departed from the usual empirical strategy for estimating the male-female wage gap at that time.

Rather than include a dummy variable to estimate discrimination after various factors have been taken into account, he introduced dummy variables that took account of both gender and marital status. His results were startling.

He previously was able to explain about 35% of the wage gap using the data at hand and variables he was using.

This 35% gap dropped to 18% for single never married males and females, but his ability to explain the gender wage gap increased dramatically to over 60% for married spouse present males and females.

What more, the presence of children exacerbated the gender wage gap. Each child of less than 12 years old widened the female male pay disparity by 10%. Furthermore, large spacing intervals between children widened this gender wage disparity even further.

Subsequent research showed that marital status had the same effects on gender wage gaps in Germany, the UK, Austria, Switzerland, Sweden, Norway and Australia. Factors associated with dropping out of the labour market to care for children could explain up to 93% of the gender wage gap.

These findings are devastating to the notion that there is some sort of discrimination against women on the demand side of the labour market. As Polachek explains:

The gender wage gap for never marrieds is a mere 2.8%, compared with over 20% for marrieds. The gender wage gap for young workers is less than 5%, but about 25% for 55–64-year-old men and women.

If gender discrimination were the issue, one would need to explain why businesses pay single men and single women comparable salaries. The same applies to young men and young women.

One would need to explain why businesses discriminate against older women, but not against younger women. If corporations discriminate by gender, why are these employers paying any groups of men and women roughly equal pay?

Why is there no discrimination against young single women, but large amounts of discrimination against older married women?

… Each type of possible discrimination is inconsistent with negligible wage differences among single and younger employees compared with the large gap among married men and women (especially those with children, and even more so for those who space children widely apart).

The main drivers of the gender wage gap is simply unknown to employers such as whether the would-be recruit or employer is married, their partner is present, how many children they have, how many of these children are under 12, and how many years are there between the births of their children. These are the main drivers of the gender wage gap – all of which are factors totally unknown to employers and of no relevance to them in making a profit.

The drivers of the gender wage gap on the supply side of the labour market regarding the choices women make about having children, when they have children, and how this influences their investment in human capital, and in particular, in human capital that does not depreciate by that much because of intermittent labour force participation due to motherhood.

Occupational crowding hypotheses of the gender wage gap have the drawback of being an invisible hand explanation of social outcomes. Each individual, acting only to best secure her own rights and interests, act in such a way that the unintended outcome of a complex social interaction.

The specific unintended outcome that must arise from millions of choices of people acting in their own interest  throughout their lives is occupational segregation.

The market process of the invisible hand has both a filter and  and equilibrating mechanism. The filter is profits and loss to exclude through insolvency and bankruptcy those entrepreneurial choices that do not further consumer’s interests. The equilibrating mechanism – the mechanism that tells people which choices they should make – is price signals. Price signals guide individual choices towards the unintended outcome.

Those that argue that women are socialised to make particular choices such as mother were not paying attention to the 20th century and the radical social change over the course of that century, in particular in the role of women. As Gary Becker explains:

… major economic and technological changes frequently trump culture in the sense that they induce enormous changes not only in behaviour but also in beliefs.

A clear illustration of this is the huge effects of technological change and economic development on behaviour and beliefs regarding many aspects of the family.

Attitudes and behaviour regarding family size, marriage and divorce, care of elderly parents, premarital sex, men and women living together and having children without being married, and gays and lesbians have all undergone profound changes during the past 50 years.

Invariably, when countries with very different cultures experienced significant economic growth, women’s education increased greatly, and the number of children in a typical family plummeted from three or more to often much less than two.

 

The impact of street capital on the labour market prospects of inner-city youth

Dionissi Aliprantis wrote a superb paper on how the social skills developed to survive in the inner cities of America are not the skills that help you graduate from high school and get a job.

In the NLSY97, 26% of black inner-city youth report seeing someone shot by age 12, and 43% of black inner-city youth report the same by age 18.

The code of the street, the street smarted skills that inner-city black youth learn as teenagers to stay alive, do not pay off in regular society:

growing up in the ’hood means learning to some degree the code of the streets, the prescriptions and proscriptions of public behaviour. He must be able to handle himself in public, and his parents, no matter how decent they are, may strongly encourage him to learn the rules

The behaviours that do not help you survive in the street of the poor inner cities of America include include doing well in school, being civil to others, and speaking Standard English.

These skills that are the antithesis of the code of the street are exactly the skills valued by employers, especially employers of low paid workers. Employers of the low paid essentially want to recruit people who are friendly and reliable.

Dionissi Aliprantis found that exposure to street violence during childhood explains 20-35% of the high school dropout rate of inner-city youth.

Alfred Marshall as a pioneer of human capital theory

Marshall viewed education as an instrument capable of lifting up the poor and relocating them into the middle class. The direct benefits come from eliminating much of

that wasteful negligence which allows genius that happens to be born of lowly parentage to expend itself in lowly work

The indirect benefits of education came from character formation:

[Education] confers great indirect benefits even on the ordinary workman. It stimulates his mental activity, it fosters in him a habit of wise inquisitiveness: it makes him more intelligent, more ready, more trustworthy in his ordinary work; it raises the tone of his life in working hours and out of working hours; it is thus an important means toward the production of material wealth; at the same time that, regarded as an end in itself, it is inferior to none of those which the production of material wealth can be made to subserve.

Marshall’s primary solution to the problem of poverty is education, but he also exhorts individuals to behave responsibly, with thrift and self control.

Adam Smith as a pioneering labour economist

Adam Smith anticipated much of labour economics by basing it on his principle that individuals invest resources to earn the highest possible return. All uses of a resource must yield an equal rate of return adjusted for relative riskiness for otherwise reallocation would result.

The whole of the advantages and disadvantages of the different employments of labour and stock must, in the same neighbourhood, be either perfectly equal or continually tending to equality.

If in the same neighbourhood, there was any employment evidently either more or less advantageous than the rest, so many people would crowd into it in the one case, and so many would desert it in the other, that its advantages would soon return to the level of other employments.

Smith used this insight on  be equality of returns to explain why wage rates differed. Workers care about the whole aspects of the job, not only the cash wage payment: it is the “whole advantages and disadvantages” of the job that is equated across jobs in a competitive market, not wage alone. Smith set out criteria that determined how wages compensated or were discounted for the different characteristics of specific jobs:

  1. the agreeableness or disagreeableness of the employments themselves: better for more enjoyable working conditions will lead an individual to accept lower wages for their labour. Likewise, unpleasant work will have a higher wage. Wages vary with the ease or hardship, the cleanliness or dirtiness, the honourableness or dishonourableness of a job.
  2. The easiness and cheapness, or the difficulty and expense of learning them: jobs that are difficult or time-intensive to learn will pay more. Those who invest the time are being compensated for their additional effort with higher wages. The opportunity cost of forgoing the time-spent in training will be compensated for through higher wages. The difference between the wages of skilled labour and common labour is founded upon this principle.
  3. The constancy or inconstancy of employment: workers who face only partial or inconsistent employment throughout the course of the year, such as seasonal workers of agriculture, must be paid more for their labour. Their wages carry them not only during times of employment, but also during times of unemployment.
  4. The small or great trust which must be reposed in those who exercise them: individuals who have high levels of responsibility  in their jobs will be compensated with higher wages.
  5. The probability or improbability of success: this is an entrepreneurial element in wages. Employment where the chance of success is high will be paid lower than those who take more risks. If individuals were not compensated for risk, there would lack an incentive to seek employment that may not be successful.

The supply and demand for labour in different industries  determines relative wages and the relative numbers of employees in different occupations. Individuals are willing to make a trade-off between less desirable occupations and increased income. Smith spoke of how these five circumstances  listed above  lead to considerable inequalities in the wages and profits.

George Stigler thought that the second greatest triumph of Adam Smith in his Wealth of Nations was his famous list of cost factors that generate apparent but not real differences in rates of wages and profits because of training, hardships, unemployment, risk and trust. This list was quoted almost verbatim by his successors  down to this day and is the direct ancestor of both Alfred Marshall’s famous chapters on wages and of the modern theory of human capital.

Teachers count

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The Case Against Education – Bryan Caplan–updated with Japanese evidence

Bryan Caplan  says that:

When you actually experience education, though, it’s hard not to notice that most classes teach no job skills.

The labour market heavily rewards educational credentials even though academic curriculum is seriously disconnected from the jobs people actually do.

The best explanation for this strange fact is that education is a strong signal of pre-existing worker productivity.

Caplan argues with annoying persuasiveness that education signals desirable employee traits such as intelligence, conscientiousness, conformity and a willingness to learn boring things:

  • Most education is for sending a signal to employers that you can jump through hoops to show off your IQ, work ethic, and conformity.
  • Schools and universities do not to produce wisdom, information, critical thinking or human capital.
  • Subsidising education creates an arms race of credentialism as each student attempts to acquire more and more education than their rival job applicants.

His particular focus is the educational psychology literature on the transfer of learning. That literature started long ago with the question did learning Latin give you muscle to learn other subjects. The educational psychology literature  has been looked at the transfer of learning for 100 years.

Educational psychologist found that Latin does not help much in studying other languages and other subjects. No significant differences were found in deductive and inductive reasoning or text comprehension among students with 4 years of Latin, 2 years of Latin, and no Latin at all.

The trouble is you do this in a race and many try to win the race by lengthening the race by going to and spending more time at university such as taking honours and master’s degrees etc.

Grades do not signal anything in Japan because everyone graduates with an A. It is the lecturer’s fault if you fail.

Japanese universities and employers make up for this everyone gets a A with strict entrance exams.

Getting into a top university signals intelligence and conscientiousness in preparing for their entrance exam. Few go to graduate school in Japan, preferring to learn more on the job.

Japanese students are lazy because everyone passes and therefore grades signal little in the way of intelligence, conscientiousness, conformity to employers.

I had great trouble getting my Japanese students to come to class. Other lecturers got around this by giving marks for attendance and replacing final exams with a pop quiz at the start of every class.

Nonetheless, something of value is acquired through 4-years at a Japanese university because otherwise why not skip straight from passing a university entrance exam to the employer exams.

The crucial objection to Caplan is that if most education expenditures are primarily about signalling, it should be possible to find other, cheaper ways to signal desirable traits to employers. As Bill Dickens noted:

For one thing I find it very hard to believe that we would waste so many resources on a nearly unproductive enterprise.

There are plenty of entrepreneurs out there trying to make money by selling cheaper, in time and money, versions of education and they aren’t very successful.

Mainstream schools have experimented with programmed learning, lectures on video, self-paced learning, etc. and none of the methods have caught on. Why wouldn’t they if they worked?

The spread of charter schools is an example of the rapid diffusion of an educational innovation valued by parents.

A major driver of the doubling of college tuition fees in the U.S. is demand for greater quality. As Becker and Murphy explain:

Indeed, it appears that the increases in tuition were partly induced by the greater return to col­lege education. Pablo Peña, in a Ph.D. dissertation in progress at the University of Chicago, argues con­vincingly that tuition rose in part because students want to invest more in the quality of their education, and increased spending per student by colleges is partly financed by higher tuition levels

What specific and general skills are learnt at school and at university matters too, as Bill Dickens explains:

Education isn’t mainly about learning specific subject matter.

Rather education is mainly about practicing the sort of self-discipline that is necessary to be productive in a modern work environment.

High school allows you to practice showing up on time and doing what you are told.

College allows you to practice and work out techniques that work for you that allow you to take on and complete on time complicated multi-part tasks in an environment where you have considerable freedom about how you spend your time.

Some people may be more talented than others at this sort of thing (you come to mind as someone who is particularly talented at self-discipline), but this is also an acquired skill that one can develop with practice, and everyone needs to develop certain work habits that make one more productive at both types of tasks.

The debate really turns on the extent to which it is possible to find easier and cheaper ways to signal conscientiousness and conformity. As Bill Dickens noted as his fall-back position, which is based on comparative institutional analysis:

most of the return to education is due to it signalling desirable characteristics, but that there is no more efficient way to sort the capable from the incapable.

I also think that signalling performs a valuable sorting function that no alternative process can out-compete. But, as Caplan notes, a conventional education benefits from large government and private subsidies as compared to other sorting devices.

Table of Contents – The Case Against Education – Bryan Caplan

Introduction

Chapter 1: The Magic of Education

Chapter 2: Useless Studies with Big Payoffs: The Puzzle Is Real

Chapter 3: Signalling Explained

Chapter 4: Measuring Signalling

Chapter 5: Who Cares If It’s Signalling? The Private, Familial, and Social Returns to Education

Chapter 6: Is Education Good for the Soul?

Chapter 7: We Need Lots Less Education

Chapter 8: We Need More Vocational Education

Conclusion

The Book’s basic plot:

The labor market heavily rewards educational credentials even though academic curriculum is seriously disconnected from the jobs people actually do.  The best explanation for this strange fact is that education is a strong signal of pre-existing worker productivity. (chapter 1)

While the return to education is often overstated, it remains high after making various statistical adjustments.  Degrees in useless subjects really do substantially raise wages. (chapter 2)

Education signals a package of desirable employee traits: intelligence of course, but also conscientiousness and conformity.  Many people dismiss the signalling model on a priori grounds, but educational signalling is at least as plausible as many widely accepted forms of of statistical discrimination. (chapter 3)

Empirically distinguishing signalling from human capital is notoriously difficult.  But literatures on the sheepskin effect, employer learning, and the international return to education confirm that signalling is moderately to highly important. (chapter 4)

How much education should you get?  The human capital-signalling distinction isn’t important at the individual level, but the policy implications are enormous. (chapter 5)

The non-pecuniary benefits of education are over-rated, and the non-pecuniary costs (especially boredom) are under-rated.  There’s a massive selection bias because the kind of people who hate school rarely publicize their complaints. (chapter 6)

The most important implication of the signalling model is that we spend way too much money on education.  Education spending at all levels should be drastically reduced, and people should enter the labor force at much younger ages. (chapter 7)

The education we offer should be more vocational.  Especially for weaker students, vocational education has a higher private and social return than traditional academic education. (chapter 8)

Caplan has also posted this nice topology below to allow you to select your starting point:

Model Effect of Education on Income Effect of Education on Productivity Notes
Pure Human Capital WYSIWYG

(What You See Is What You Get)

WYSIWYG Education may raise productivity by directly teaching job skills, but character formation, acculturation, etc. also count.
Pure Ability Bias Zero Zero “Ability” includes not just pre-existing intelligence, but pre-existing character, acculturation, etc.

Pure Ability Bias is observationally equivalent to a Pure Consumption model of education.

Pure Signalling WYSIWYG Zero Pure educational signalling can consist in (a) learning and retaining useless material, (b) learning but not retaining material regardless of usefulness, (c) simply wasting time in ways that less productive workers find relatively painful, leading to a positive correlation between education and productivity.
1/3 Pure Human Capital,
1/3 Pure Ability Bias,
1/3 Pure Signalling
2/3*WYSIWYG 1/3*WYSIWYG A good starting position for agnostics.
0.1 Pure Human Capital,
0.5 Pure Ability Bias,
0.4 Pure Signalling
.5*WYSIWYG .1*WYSIWYG Caplan’s preferred point estimates.  He knows they’re extreme, but his book will explain his reasons and try to win you over.

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