Human Capital (Literature Review)

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Human Capital (Literature Review)

  1. 1. Cairo UniversityFaculty of Economics and Political Science Master Program Spring, 2009
  2. 2. Mohamed Ismael Elshiekh
  3. 3. Methodology [ The Concept of Human Capital ]Definition Components Accumulation Formula Early can be defined as Skillsskills, attitudes, aptitu knowledge, Ability des, and other acquired traits contributing to production
  4. 4. FormulaThe present value of an individual at any given age a is defined as the sum of his discounted expected futureInput-based Output-based earnings (equal to the value of productivity)by summing up the by consideringrepresents the probability of an individual of age a to becosts of alive at age t and r is capitalized earnings production the discount rate
  5. 5. Accumulation of human capital post school training providedoff-the-job training by "for-profit" proprietary institutions post-school training providedon-the-job training by the current employer the individual devotes his Formal schooling whole time to learning
  6. 6. Human Capital Literature The micro The macrolabor literature growth literature
  7. 7. Framework of the Paper General Vs Specific Human Capital The life-cycle ofThe Rate of Return to Education earnings Skills FunctionThe Education Production Ability Signaling Approach
  8. 8. General Vs Specific Human Capital
  9. 9. General Vs Specific Human Capital General Specific is defined to be not increases the only useful with the Theoretical Framework productivity of the current employer but worker only in his also withEmpirical Studies other current job potential employersPerfect Markets Imperfect Markets
  10. 10. General Human Capital : Perfect Markets Theory Empirical studiesOn the one hand,labor markets, where workers receive In competitive it is supported by the empirical analysis ofwages equal tohe finds that firm-sponsored training is Veum (1999), their marginal product, firms cannot recoup investments inrelated to starting wages, butthat indeed negatively general skills, which implies they refuse to pay for generalgrowth . positively related to wage training This "hold-up" problem arises due to incompleteFurthermore, workers can finance such investments quite On the other hand, many analyses question the validitycontracts which means that one party (i.e. the employer) of easily by accepting a wage below their productivity this by showing that there are investments in general pays the costs of the investment in human capital, while human capital which are financed by the employer during the period of training another party (i.e. the worker) shares in the return
  11. 11. Sources of Labor Market Imperfection2.the presence of asymmetric informationdue tobetween3. The presence of asymmetric information the worker4. wage compression may arise between the1. The presence other potentialworker’s effortand the currentof generaltransaction skillsthe current firm and of and specific costsinteraction employer concerning the employers For example If general 2 possible types of are complements in the due to matching and search skills asymmetric information There are and specific frictions, imperfect information Hence, wages must satisfy the about potential output, partners, the absence of perfect production ofcontractual the presence of specific skills incentive compatibility constraints The first concerns the amount of training the worker has received. If insurance markets, limited mobility, congestion dueand large increases the productivity of general human capital potential employers cannot observe the correct productivity to thus pay numbers, and the marginal product, the wage structure is compressed a wage below other similar factors . which leads to a compressed wage The second is about structure In practice, it is difficult the innate ability of thetheir existing jobs for workers to quit worker (hidden On the other hand, the learns aboutfirm-specific skills by knowledge), i.e. the employer value of the ability of the worker and find new suitable employers. Similarly, it is costly for firms when general general training providing increasestheir employees skills are acquired to replace
  12. 12. General Human Capital : Imperfect Markets Theory Empirical studies Concerning the empirical evidence, Loewenstein and If the wage structure is compressed, general skills are Spletzer (1998) find that general training raises futureturned into specific skills and firms manage to skim labor wages more for workers who change their job than for market rents depending on the amount of training workers who remain with the training firm.Hence, the wage function increases withshows thattraining less As aFurthermore, Brunello (2002) the level ofworkers to consequence, firms prefer more skilled wage steeply than productivity (i.e. the wage structure iscompression andand invest inthegeneral training show a less skilled ones the amount of firm’s profit, equal to the compressed), which implies that general training until the positive gap and significant correlation positive level of training satisfies desired between productivity and wage
  13. 13. General Human Capital : Perfect Markets Theory Empirical studiesLynch (1991) finds(1964), training in specific on-the-job training are less According to Becker that individuals with human capital is different from general training because workers do not benefit from higher productivity after likely to leave their current employer while individuals with off- changing their jobs. Both in perfect and imperfect labor markets, firms canthe-job investments in more likely andquit indeed negatively related to recoup training are specific skills to thus are willing to share some of the starting wages, costspositively related to wage growth but of these investments Both in perfect and forspecific labor markets, leads can In almost the study of Switzerland shows thatfirms to An empirical same manner, Loewenstein and specific The accumulation imperfect human capital Spletzertraining investments in specificboth firmsand job mobility recoup reduces both because skills and thus workers (1999) find that specificsearch activity and are willing lower fluctuations job training and job mobility are while general training significantly increases job search to share fromnegatively correlated. investments benefit somekeepingcosts of these of the their contractual partner
  14. 14. General Vs Specific Human CapitalType of Labor Firms Workers Total investment skill marketsgeneral perfect no yes efficientgeneral imperfect yes yes generally inefficientspecific perfect yes yes generally inefficientspecific imperfect yes yes generally inefficient
  15. 15. Framework of the Paper General Vs Specific Human Capital The life-cycle ofThe Rate of Return to Education earnings Skills FunctionThe Education Production Ability Signaling Approach
  16. 16. The Rate of Return to Education
  17. 17. The Rate of Return to EducationTheoretical Empirical Approach Studies Criticism
  18. 18. Theoretical ApproachMethods
  19. 19. The "full" or "elaborate" methodThe elaborate method amounts to working with detailed age-earnings profiles by level of education and findingthe discount rate that equates a stream of education benefits to a stream of educational costs at a given point in time.The annual stream of benefits The stream of costs consists ofis typically measured by the foregone earnings of the1. the earnings advantage of a graduate individual while in school of the educational level to which the (measured by the mean earnings rate of return is calculated, and of graduates of the educational2. the earnings of a control group of level that serves as control graduates of a lower educational level group)
  20. 20. The basic "earnings function" methodIn this semi-log earnings function specification the coefficient oninvolves the fitting of a semi-log ordinary least squares regressionyears of schooling can be the natural as the average privatethe dependent variable ; interpreted logarithm of earnings rate ofreturn to one additional years of schooling and potential yearsIndependent variables; year of education, regardless of the ofeducational level to which this year of schooling refers tolabor market experience and its square Linear Non-Linear
  21. 21. The Extended "earnings function" methodby converting the continuous years of schooling variable into aseries of dummy variables referring to the completion of the mainschooling cycles, i.e. primary, secondary and higher education, orreferring to drop outs of these levels, or even to different types ofcurriculum (say, vocational versus general) within a given levelAfter fitting such extended earnings function the private rate ofreturn to different levels of education can be derived bycomparing adjacent dummy variable coefficients
  22. 22. Theoretical ApproachOther Factors determining the return
  23. 23. The type of acquired skillFinally, Rubb (2003) investigates the effects of overeducationa, According to Wasmer (2006), specific human capital yieldsrequired education general human capital investmentsthe higher return than and undereducation by estimating if thefollowing log-linear wage equation for individual job-finding rate is lowFurthermore, individuals who completed schooling withsome formal qualification have significantly larger returnsthan individuals with the same amount of schooling butwithout any formal qualification (Dearden (1998)).
  24. 24. The Rate of Return Depending on GenderStudies find that investments in women’s education tend to yield higher rates of return than investments in men’s education. This gender difference in the returns to education arises because the earnings of women are considerably lower than those of men Another explanation for the gender wage gap may be the fertility decision of women which leads to labor market interruptions. This gives rise to gender differences in the turnover rate and thus in employment and wages
  25. 25. The Rate of Return Depending on Time the individual returns to education change over time due tothe increased interaction between demand for and supply of workers at each qualification level Individuals working in an industry with rapid technologicalchange have above-average returns to education, which can be attributed to the positive correlation of education and adaptability to new technologies in high-tech firms
  26. 26. The Rate of Return to EducationTheoretical Empirical Approach Studies Criticism
  27. 27. Rate of Return to Education Empirical Studies Study Estimate Becker (1964) 13%-28% Mincer (1974) 11.50% Ashenfelter and Krueger (1994) 12%-16% Psacharopoulos (1994) 5%-15% Dearden (1998) 5.50%-9.30% Ashenfelter, Harmon, and Oosterbeek (1999) 6.60%-9.30% Arias and McMahon (2001) 11.70%-13.30% Wilson (2001) 5%-10%
  28. 28. Rate of Return to Education Empirical Results
  29. 29. Rate of Return to Education Problems of Empirical Results
  30. 30. Framework of the Paper General Vs Specific Human Capital The life-cycle ofThe Rate of Return to Education earnings Skills FunctionThe Education Production Ability Signaling Approach
  31. 31. Signaling ApproachHuman Capital Signalingeducation as productivity- education as indication enhancing activity of innate ability HC models do not naturally generate a positive correlation between ability differences and education while in sorting models there is appositive correlation between the ability to learn and the length of schooling chosen
  32. 32. Framework of the Paper General Vs Specific Human Capital The life-cycle ofThe Rate of Return to Education earnings Skills FunctionThe Education Production Ability Signaling Approach
  33. 33. The Education Production FunctionAccording to Hanushek (1971), the severest problem in educational research is the complexity of the educational process. Hence, there is considerable confusion about how empirical studies should be conducted and interpreted Inputs in Educational Production
  34. 34. Input Empirical evidence level of resources ambiguous class size weakschool competition weak private schools ambiguous teacher quality strongteacher incentives strong early education strong individual ability strongparental education strong family income weak neighborhood weak peer groups strong segregation ambiguous
  35. 35. Framework of the Paper General Vs Specific Human Capital The life-cycle ofThe Rate of Return to Education earnings Skills FunctionThe Education Production Ability Signaling Approach
  36. 36. The life-cycle of earningsTo summarize the results human capital literature deals An important stream of with the life-cycle of earnings. and increasing points out decreasing marginal returns Mincer (1958) marginal coststhe difference between normally distributed that lead to an optimal amount of human capital investment that negatively depends on age abilities and the positively skewed distribution ofincomes must be due to investments in human capital over the life-cycle Limitation Earnings maximizing Utility maximizingBecker (1964) suggests that earningshuman capital theory to A serious problem of the empirical application of increase with age life-cycle models in earnings is that post-school investments are not differences models but at a declining rate because younger workersdirectly observable. As a consequence, measurement problems arise because areceive theactivities might educationon-the-joblonger(Hanushek wide range of returns to be viewed as over a training period and the investment risk increases with age and Quigley (1985)).
  37. 37. Implications of Pension Systems for Human Capital Formation the return to human capital investments is affected by the pension system if finite horizon economies are considered because the PAYG pension system generates distortions in labor supply and thus provides incentives for earlyretirement, aggregate human capital is lower than with a capital funded system of old-age provision. The reason is that the PAYG system discourages human capital formation both directly and indirectly via the retirement age

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