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• Schultz, 1961
– As economic growth occurs economies tend to use less traditional capital – Income has risen faster than the combined growth in land, labor and physical capital
• All these can be explained if we add human capital to our explanations
• Becker, 1962
– Unemployment rate negatively related to skill levels – Younger workers change jobs more frequently than older workers – Abler persons receive more training and education than older workers
Forms of Capital • • • • • Financial Capital Human Capital Social Capital Intellectual Capital Knowledge Capital .
The Theory of Human Capital • When does it pay to invest in higher education? • When does it pay to train a worker? • How can the training costs and rewards be structured so as to make both the shareholders and workers better off? • Does a firm have to pay its trained workers more? .
The Theory of Human Capital • What kind of training should be given? Should it be as general as possible. or should it be idiosyncratic to the current firm? • What can be done about retention of trained workers? How can they be tied to the firm? .
• What kinds of workers are the best candidates for the training program? • Who should be laid off if downsizing is necessary? The Theory of Human Capital .
Both scholars were pioneers in human capital analysis. • Human capital theory applies to the acquisition of skills. HUMAN CAPITAL: SOME BASIC THEORY .• Theodore Schultz and Gary Becker were awarded the Nobel Prize in Economic in 1979 and 1992.
and health care…etc.Skills can be acquired in a number of ways: • • • • Formal education The primary way to acquire human capital. enrichment courses. On-the-job training (OJT) The most important kind of human capital in its impact on business practice. • Other human capital investment • Exercise. personal beautification expenditures. .
a manager decides to buy a machine if the present value of the flow of additional revenues generated by the machine exceeds the operating and purchasing cost of the machine. . • Similarly. • In the theory of investment in physical capital.Formal Schooling • What made you decide to go to college? • Career considerations. the individual must bear a cost now to pay for schooling or other training in hopes that it will bring higher earnings in the future.
books. living expenses • Opportunity cost – Forgone salary .The Cost of Going to School • Direct Costs – tuition.
• r: interest rate • C0: direct cost of schooling.• Choosing Whether to Stay in School K : salary of those with a high school diploma will t earn in year t. • The individual will invest in the final year of school if the following condition holds: T t t 0 0 t t =1 K −D C +D <∑ (1 + r ) . • Dt: salary of those who drop out after 11th grade.
Choosing Whether to Stay in School Direct cost of schooling Forgone salary K t − Dt C0 + D0 < ∑ t t =1 (1 + r ) T The discount factor: to bring the earning differentials back to present value. Year to retirement The earning differentials between a high school graduates and a high school dropout. .
Suppose that 2 year expenses at RSOM is Rs 150.06 • C0: Direct cost of schooling.000 . assuming starting salary D1=35.. assuming r=.000) = Rs 235.000. • Suppose your salary increase by 5% every year. • A college graduate’s annual increase = 3% Direct cost (Rs 150. more than a college graduate. .000 • r: interest rate.000) + forgone salary (approximately Rs 85. assuming starting salary K1=40.Why get an Master degree? • Kt: Your monthly salary.000 • Dt:Monthly salary of those with a college degree.
Suppose that after taking this course. your annual salary increase in the next 20 years will be 10% rather than 5%! . from 90 to 140. As a result. say. your IQ level improved substantially.
. • Second. For early years of schooling.• Two reasons: • First. there is much to be learned when an individual knows very little. the returns to schooling exceed the costs. • With public subsidies to education. direct costs are virtually zero up through high school. • A little bit of school can affect productivity dramatically. the costs of going to school are very low during the early years of schooling. • The forgone earnings are low during the early years.
. • It pays for everyone to invest in some formal education. and there is also an optimal stopping date for each individual as well. • The stopping date is the year when the inequality in the equation switches… ..The above discussions implies that.
but that is usually not the case. The rate of return for an MHRM is better characterized by an exponential function.Are you making a wrong investment? The above example assumes a constant rate of return. .
. more flexibility.. The rewards can take the form of higher status.Non-pecuniary benefits of schooling • People attend school for other reasons as well. • We need only to think of K as the value of improvement in well-being at work that result from additional schooling. learning may be regarded as a form of intrinsic reward in itself… • Additional schooling may put you in a position for a more rewarding job. • For example. more interesting assignments…etc. .
.• Increases in tuition rates decrease school enrollment. Effects of Costs and Benefits of Education on the Optimal Amount of Schooling K t − Dt C0 + D0 < ∑ t t =1 (1 + r ) T Individuals who already have high-paying jobs will be reluctant to go back to school to acquire an MBA.
the lower is the value of future earning. The higher is the interest rate. the better it is to work and put your money in the bank.Effects of Costs and Benefits of Education on the Optimal Amount of Schooling • Increases in the interest rate mean less schooling. Schooling is a better investment when the alternative investment are poor choices. . K t − Dt C0 + D0 < ∑ t t =1 (1 + r ) T The higher the interest rate.
This means that children whose parents are poor might face much higher borrowing costs and consequently . Financial aid programs that target the poor could offset this tendency. Banks are generally reluctant to lend to students whose only collateral is their future earning power. .Effects of Costs and Benefits of Education on the Optimal Amount of Schooling • High interest rate increases cost of borrowing. would drop out of school to work at an earlier age.
K t − Dt C0 + D0 < ∑ t t =1 (1 + r ) T .Effects of Costs and Benefits of Education on the Optimal Amount of Schooling • The longer the work life. the more investment in schooling.
which have more general applicability. ==> Even if women are less likely to spend time in the labor market. their training may be valuable in increasing their productivity at home. More educated people may be better at raising children? . • No. Future housewives may take more humanities and education courses.Effects of Costs and Benefits of Education on the Optimal Amount of Schooling • Will women obtain less schooling than men? • Yes. ==> The average woman spends less time in the labor market than the average man.
and therefore would be expected to increase education. Improvement in school quality would be expected to have a positive effect on K. K t − Dt C0 + D0 < ∑ t t =1 (1 + r ) T (K . school attendance should rise.D) is likely to reflect differences in productivity. .D) increases. Education is complementary with a technologically advanced society.Effects of Costs and Benefits of Education on the Optimal Amount of Schooling • When the difference in earnings between educated and less educated worker (K .
• Firm-specific on-the-job training: It makes a worker more productive at the current firm.On-the-Job Training • General on-the-job training: an investment in human capital that is effective in raising productivity at the firm providing the training and at some other firms by an identical amount. An account manager who knew a great deal about the idiosyncrasies of the company’s major clients. • Example: Database programmer at Formosa Plastics. but has no effect on productivity elsewhere. .
General On-the-Job Training • Suppose that the firm has the opportunity to provide a 25-year-old worker with one year of on-the-job training.000 per year thereafter. • The training costs Rs 2500 during the first year. raises the worker’s productivity by Rs 50. • What wage should the firm pay the worker? .
• But why would a firm bear a Rs 25000 cost to make the worker more productive when it can capture none of the gain to that productivity? . the original firm will be forced to raise wages up to the new level of worker productivity.General On-the-Job Training • If the firm leave the worker’s wages unaltered.000 of increased productivity. • To keep the worker. rival firms can easily pick off the worker by giving the worker a raise up to the full Rs 50.
he buys himself a raise of Rs 50000. which persists for each year that he works hereafter. the worker will be happy to do so.General On-the-Job Training • Although the firm will be unwilling to pay for the investment. . • Thus the worker should offer to pay the firm for the on-the-job training and the firm should be happy to oblige. • By paying Rs25000 at the outset.
Do workers actually pay firms for training? . • Young cooks work in established restaurants at low wages. • Assistant professors are often willing to take lower salary in major universities.• Workers do pay for their training by accepting lower wages than they would otherwise receive. • Example: • Apprenticeships in the early days.
Summary .• When on-the-job training is general. • The workers most likely to select jobs that offer training at the cost of low initial wages are young workers and others who plan to remain in the labor market for a long period of time. This means that any worker who would like to undertake the training program should be given the opportunity to do so. workers must pay for it themselves through reduced wages.
• Workers’ firm-specific OJT cannot be pirated by other firms. Since the skills are firm specific. • This suggests that the firm should be willing to pay for firm-specific OJT. • But such is not the case. Firm-specific On-the-job Training . the firm can offer higher wage than outside firm.
The worker knows that if he quits. the worker is indifferent between working here and working elsewhere because the wage is the same. Further. • The worker can ask for a higher wage. the firm loses its investment.Firms bear the full cost of training • Suppose that the firm agreed to finance all the training. . in return for which the firm would expect to receive the entire difference between productivity and outside wage.
but highly paid worker and hiring the unskilled. • Now the worker is at a disadvantage. • But this will make the firm indifferent between hiring the skilled. less well-paid worker.Workers bear the full cost of training • Since the worker has borne the full cost of Since the worker has borne the full cost of investment. The firm can threaten to fire the worker unless the worker takes a lower wage. he expects to get the full return. .
• Since the firm needs to give up some of the profit from investing the worker. .Solution • The solution is to split the costs and benefits. • Since the worker knows that the firm will be able to force him to accept a wage less than his productivity when he is skilled. it can ask the worker to bear some of the costs. he can ask the firm to bear some of the cost.
The worker is worth more to this firm than to any other. • The scheme that shares the costs and benefits makes separation much less likely to occur. The worker earns more at the current firm than he does at any other firm.• The shared benefits mean that both worker and firm have incentives to remain together. Mutual beneficial Arrangement The shared benefits mean that both worker and .
Summary • Since workers may not always have the best information about their departure probabilities and since firms bear costs when workers with firm specific human capital leave. The workers that the firm wants to train are those with low turnover probabilities whose productivity will be greatly enhanced by the training. . a firm takes a more active role in selecting workers to offer firm-specific OJT than it does for general OJT.
then it can be inferred that the human capital obtained at the first firm must be general. it can be inferred that some of the human capital was probably firm specific. Determining specificity of human capital . If wages are lower for those who leaves the firm than for those who stays.• • • Experience--total time in the labor market Tenure--experience in a particular firm If there is no systematic difference in wages between those who stays with the firm and those who leaves.
• The extent to which skills are general or specific may not be know in advance. Determining specificity of human capital . but who has less than 10 years of tenure in the firm. • The company can also compare the productivity of workers with 10 years of tenure at the firm to that of workers with 10 years of total experience. A firm may be trying to decide whether it will lose much by hiring from the outside rather than training its own workers.
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