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.

Chapter Nine Human Capital Theory: Applications to Education and Training  Created by: Erica Morrill, M.Ed           Fanshawe College © 2002 McGraw-Hill Ryerson Ltd Chapter 9-1 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 9­2 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 © 2002 McGraw­Hill Ryerson Ltd Chapter 9­3 Costs  Direct costs  books, tuition  Opportunity  cost income forgone  Private Costs/Social Costs  Real Costs/Pecuniary or transfer costs © 2002 McGraw­Hill Ryerson Ltd Chapter 9­4 Figure 9.1 Alternative Income Streams Earnings f e b Stream B Stream A c a Direct costs d 16 Stream C 18 22 © 2002 McGraw­Hill Ryerson Ltd Chapter 9­5 Age-Earnings Profiles  Increase with age but at a decreasing rate  Higher for those with more education © 2002 McGraw­Hill Ryerson Ltd Chapter 9­6 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 © 2002 McGraw­Hill Ryerson Ltd Chapter 9­7 Human Capital Investment Decision  Quantity of education   Human capital wealth   maximizes the net present value of lifetime earnings 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 9­8 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 9­9 Factors Influencing Education  Income tax  increase in progressivity of taxes reduce demand for education  Student loans  alter marginal cost of education and levels of educational attainment © 2002 McGraw­Hill Ryerson Ltd Chapter 9­10 Figure 9.3 Education and Market Equilibrium UA Wage EA UB I EB I Years of Education © 2002 McGraw­Hill Ryerson Ltd Chapter 9­13 Education as a Filter  Education acts as a signal of the productivity of employees  Higher wages are offered if employers believe that education increases productivity © 2002 McGraw­Hill Ryerson Ltd Chapter 9­14 Figure 9.4 Offered Wage and Signaling Cost Schedules CL(y) Wages W(y) Cost of education C(y) W(y) CH(y) 1 y* Education © 2002 McGraw­Hill Ryerson Ltd Chapter 9­15 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 9­16 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 9­17 Signaling, Screening and Ability  Determinants  innate difficult to control ability  Signaling/screening  Private return on education  Social return on education © 2002 McGraw­Hill Ryerson Ltd Chapter 9­18 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 9­19 Increased Returns to Education and Inequality  Variation of returns to schooling over time  Increased returns have coincided with increases in income inequality © 2002 McGraw­Hill Ryerson Ltd Chapter 9­20 Training Specific Training General Training  Skills used in various firms  Training useful to the firm that provides the training  Firms will offer higher wage  Trainee is unwilling to bear for this training the cost because no higher  Trainee willing to bear the earnings cost since higher wages  Firm does not have to pay offered for these skills higher wages because other firms are not competing for such trainees © 2002 McGraw­Hill Ryerson Ltd Chapter 9­21 Costs, Benefits and Financing of Training Figure 9.7 a Costs and Benefits of Training Wages VMP VMP* benefits costs Wa=VMPa VMPt training t* Time © 2002 McGraw­Hill Ryerson Ltd Chapter 9­22 Costs, Benefits and Financing of Training Figure 9.7 b Specific training as a shared investment VMP* Wages VMP Employer’s benefits Employee’s benefits W* Wa=VMPa Wt Employee’s costs Employer’s costs VMPt training t* Time © 2002 McGraw­Hill Ryerson Ltd Chapter 9­23 Costs, Benefits and Financing of Training Figure 9.7 c Earnings growth with gradual training Wages VMP VMP* Employee’s costs Wt VMP0 Employer’s benefits W* Employee’s benefits Wa=VMPa Employer’s costs Time © 2002 McGraw­Hill Ryerson Ltd Chapter 9­24 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 9­25 Evaluation of Government Training Programs  Difficulties in evaluation  no opportunity to observe earnings in the absence of training  no control group  many variables © 2002 McGraw­Hill Ryerson Ltd Chapter 9­26 End of Chapter Nine © 2002 McGraw­Hill Ryerson Ltd Chapter 9­27 ... © 2002 McGraw­Hill Ryerson Ltd Chapter 9 4 Figure 9. 1 Alternative Income Streams Earnings f e b Stream B Stream A c a Direct costs d 16 Stream C 18 22 © 2002 McGraw­Hill Ryerson Ltd Chapter 9 5 Age-Earnings Profiles... © 2002 McGraw­Hill Ryerson Ltd Chapter 9 12 Figure 9. 3 Education and Market Equilibrium UA Wage EA UB I EB I Years of Education © 2002 McGraw­Hill Ryerson Ltd Chapter 9 13 Education as a Filter  Education... © 2002 McGraw­Hill Ryerson Ltd Chapter 9 14 Figure 9. 4 Offered Wage and Signaling Cost Schedules CL(y) Wages W(y) Cost of education C(y) W(y) CH(y) 1 y* Education © 2002 McGraw­Hill Ryerson Ltd Chapter 9 15 Empirical