Lecture Labour market economics: Chapter 9 - Dwayne Benjamin, Morley Gunderson, Craig Riddell

Chapter 9 - Human capital theory: Applications to education and training. This chapter presents the following content: Factors that determine the market rate of return to education, Is education economically worthwhile? Is education a predictor of greater productivity? Market signaling and screening, government-funded training programs.

© 2002 McGraw-Hill Ryerson Ltd Chapter 9-1

Chapter Nine

Human Capital Theory: Applications

to Education and

Training

  Created by: Erica Morrill, M.Ed

      Fanshawe College

© 2002 McGraw­Hill Ryerson Ltd Chapter 9­2

Chapter Focus

 Factors that determine the market rate

of return to education

 Is education economically worthwhile?

 Is education a predictor of greater

productivity?

 Market signaling and screening

 Government-funded training programs

© 2002 McGraw­Hill Ryerson Ltd Chapter 9­3

Human Capital Theory

 Investments are made to improve

productivity and earnings

 Costs incurred with the expectation of future benefits

 Benefits must exceed costs by a

significant amount

 Private Costs/Social Costs

 Real Costs/Pecuniary or transfer costs

© 2002 McGraw­Hill Ryerson Ltd Chapter 9­7

Choosing an Income Stream

 Simplifying assumptions

 no direct utility or disutility from education

 hours of work are fixed

 income streams associated with education amounts are known

 individuals can borrow and lend at the real interest rates

 Human capital wealth

 can be distributed by borrowing and lending

 Increase education until…

 present value of benefits of additional year equals present value of additional costs

© 2002 McGraw­Hill Ryerson Ltd Chapter 9­9

Implications of Theory

 Investment should be made early in

one’s life

 Little incentive for individuals

experiencing discontinuity in workforce

© 2002 McGraw­Hill Ryerson Ltd Chapter 9­11

Optimal Human Capital

Investment

Expressed in terms of…

 Costs and benefits

 Marginal costs and benefits

 Rate of return on investment

© 2002 McGraw­Hill Ryerson Ltd Chapter 9­16

Empirical Evidence Education

and Earnings

 Earnings increase with age experience

 Increase is most rapid to age 45 or 55 for individuals with the most education

 Differential is wider between groups at ages 45-50 than 20-30

© 2002 McGraw­Hill Ryerson Ltd Chapter 9­17

Human Capital Earnings

Function

 Estimates the rate of return to education

 Least-squares regression of earnings

on education

 Controls for other factors that may

affect earnings

© 2002 McGraw­Hill Ryerson Ltd Chapter 9­18

Signaling, Screening and Ability

 Determinants difficult to control

 innate ability

 Signaling/screening

 Private return on education

 Social return on education

© 2002 McGraw­Hill Ryerson Ltd Chapter 9­19

Addressing Ability Bias

 Natural experiments

 isolate the influence of education from

unobserved ability factors

 research on twins

 compulsory school attendance laws

 proximity to college findings

© 2002 McGraw­Hill Ryerson Ltd Chapter 9­21

Training

General Training

 Skills used in various firms

 Firms will offer higher wage

for this training

 Trainee willing to bear the

cost since higher wages

offered for these skills

 Firm does not have to pay higher wages because other firms are not competing for such trainees

W t

W*

© 2002 McGraw­Hill Ryerson Ltd Chapter 9­25

Appropriate Role of Government

 Private markets may not provide socially

optimal amounts of training

 imperfect information

 regulatory restrictions

 contract problems

 Training subsidies to disadvantaged could

 increase working hours

 raise wages above the poverty line

© 2002 McGraw­Hill Ryerson Ltd Chapter 9­27

End of Chapter Nine