Unit 12 Human capital

Labour is heterogeneous. Workers differ no merely in sex and race but in age, experience, education, training, innate ability, and in whether or not they belong to a trade union. All these differences affect pay. In manual jobs women earn only two-thirds as much per hour as men and the difference is even larger in non-manual jobs. To some extent these differences may reflect continuity of employment. Single women do considerably better than married or divorced women and earn almost 90 per cent as much per hour as men. There are several sources of pay differentials. People with more schooling and higher educational attainments earn higher wages but the value of these qualifications depends on the type of job. Economics and engineering degrees are much more useful in non-manual jobs such as running a factory than in manual jobs such as plumbing or brick-laying. It is relevant or vocational degrees that contribute to higher non-manual earnings. How are we to explain the fact that history and philosophy graduates also seem to earn more, especially in non-manual jobs?

The second source of pay differentials is job experience. In most industries, workers learn skills on the job. Earnings tend to rise with the number of years of job experience.

Non-whites, especially West Indians, earn lower wages even after allowing for differences in education and experience. Finally, an industry with complete trade union membership in manual activities will pay 5.6 per cent higher wage rates than it would with no union members. In contrast, highly unionized activities in non-manual jobs earn lower wages.

Now let’s examine how education, experience and skill contribute to earning by increasing workers’ human capital — the stock of relevant expertise they have accumulated. We then examine the role of education as a filter that screens out the high ability workers with high-career potential. History degrees may signal general intelligence, even though they provide little training of direct relevance for most non-manual jobs.

As with physical capital such as plant and machinery, human capital is the result of past investment and its purpose is to generate future incomes. For example, in order to invest in another year of school education or a further qualification people may have to make a direct payment, as with fees for private schools, but they also forego the opportunity to earn immediate income by working. The anticipated benefit of this initial expenditure is either a higher future monetary income or a future job yielding greater job satisfaction.

Education and work experience contribute to higher earnings. People with more educational qualifications typically earn more. Healthy young people with qualifications can work hard and make quite good money. Initially they are at only a moderate pay disadvantage. But they cannot look forward to steadily rising real wages. Indeed, by the time they reach their early thirties their earnings have already peaked. In contrast, the most highly educated start at wage rates only a moderate amount above those of the completely unqualified but they can then look forward to steadily rising incomes over most of their working lifetime. With increasing experience and mastery of the job, productivity and salaries rise steadily.

There are two completely different interpretations of why the most educated get the highest earnings. The first one is that education directly increases workers’ productivity and allows them to command higher earnings sooner or later. The competing view is that education does not contribute the expertise that increases worker productivity. Rather, people have different innate abilities. High-ability people have high productivity because they can learn difficult jobs. Also, they like studying and are good at it. They happen to amass a lot of educational qualifications, but they earn good money because of the skills they were born with.

The premium on higher education is now so high that more people decide to acquire education.

Consider the decision of a school-leaver whether to continue in education or take a job immediately. Does investment in further education make sense? There are two costs and two benefits. The immediate costs are (1) the cost of books, fees, etc., for continuing in education and (2) the income that could have been earned ( the opportunity cost) by taking a job immediately rather than having been unpaid while remaining in further education, minus any income received from the government as an educational grant.

The first benefit occurs in the future and is the stream of extra wages that workers with higher education can earn. The second occurs immediately but in a non-monetary form. It is the fun or consumption value of going to college or university. Most people, and most students themselves, think that students have a good time. They meet new people, try new sports, discover new rock bands, and do whatever students do.

Like any investment decision, the decision whether or not to continue in higher education rests on comparing current costs and benefits (usually a net cost) with the stream of future costs and benefits (usually a stream of net benefits). If the present value, however calculated, of the benefits outweighs the present value of the costs incurred, the educational investment in improving human capital by going to university or college makes sense. If the present value of the benefits is less than the present value of the costs, higher education is a bad investment. It is better to start work immediately.

In Britain the school-leaving age, the minimum age at which people can leave school, is 16. There is a very strong relationship between the number of people who get two A-levels, the typical university entrance requirement, and the number of people who in fact go on to university. Effectively, people decide at 16 whether to leave school immediately or to embark on A-levels with a view of going to university. Of course, some people fail their A-level exams and some people stay on at school after 16 to do more of the lower-level GCSE exams.

The fraction of 16-year-olds embarking on the A-level university route is well explained by three factors: (1) a measure of expected future incomes in general, (2) as viewed from the age of 16, the present value of the extra income that university graduates enjoy after age 21 minus the present value of the income forgone (after adjusting for university grants) by not working between the ages of 16 and 21, and (3) the level of unemployment. The more the present value of the extra income outweighs the present value of the costs of more education, the more people will go on in education. Factor (3) says that higher unemployment tends to make people stay on at school and go to university. High unemployment hit unqualified school-leavers very hard. By leaving school at 16 a school-leaver may not in fact earn the income that the present calculations suppose. Conversely, although some university graduates cannot find jobs, the unemployment rate is lower for graduates than for unqualified school-leavers. Hence, for given pay scales for graduates and non-graduates, an increase in unemployment increases the effective return to embarking on the route of higher education.

Factor (1) recognizes that there are non-monetary benefits to education. Earlier we pointed out that students usually have a good time. But some people also think that going to university broadens one’s horizons and generally allows people to get more out of life. If education does have this consumption value, in the same way that reading books or going to the theatre have consumption value, we could probably expect this good or service to be a luxury. Higher real incomes per person will lead to a large rise in the quantity demanded. This is what factor (1) confirms.

Why can a history graduate go on to earn big money in banking? There is a theory of investment in education, the theory of signalling. This theory may be helpful in explaining why history graduates go on to earn big money in banking.

The theory assumes that people are born with different innate ability. Some people are good at most things, other people are less smart and on average less productive. But smart people do not all have blue eyes and less smart people brown eyes. The problems for firms is to tell which applicants will turn out to be the smart ones with high productivity. Looking at their eyes is not enough.

For the sake of the argument, suppose higher education contributes nothing to productivity. Before making this costly investment in human capital, how can school-leavers be assured that they will earn wages in future to offset the initial cost? Signalling theory says that, in going on in education, the smart people are sending a signal to employers that they are the high-productivity workers of the future. Higher education is screening out the smart high-productivity workers. Firms can pay university graduates more because they can be assured that they are the high-ability workers.

To be effective, the screening process must indeed separate the high-ability workers from the others. Why don’t lower-ability workers go to university and fool firms into offering them high wages? There are two answers. First, the lower ability workers could not be confident of passing. Here we have an interesting comparison between the two theories of investment in education. If it is studying that adds to productivity, firms should offer higher wages to people who have attended university, whether or not they pass the final exam. But if university works by screening out the good people, firms should be interested not in attendance but in passing.

Some firms hire university students before they sit their final exams. Is this evidence against the signalling theory? Not necessarily, for screening works in a second way. The lower-ability people may decide not to go to university for two reasons: first, because they do not expect to pass, and second, because they may feel that in order to scrape through they will have to work enormously and unpleasantly hard. Since most people know their own ability, firms may take it on trust that people who have stuck it out till their final year at university believe themselves to be at the higher end of the ability range.

It seems quite probable that education (even at the highest levels) contributes something to productivity. But there may also be an element of screening in all except purely vocational courses. Engineering, law, and business degrees presumably contribute more to productivity than philosophy, history, or politics.

There is one final issue to consider before we leave investment in education. It concerns the distinction between what is good for the individual and what is good for society as a whole. We know that university graduates earn more. It makes sense for many people to take the individual decision to invest in this human capital. If education raises productivity directly, it is also good for society. It raises the amount of output that the labour force can eventually produce.

Suppose, however, that the only function of higher education was to signal which were the higher — ability workers. It still makes sense for individuals to go to university, but does it make sense for society as a whole? There is a social gain in learning which are the smart workers. By matching smart workers to difficult jobs, society will achieve a higher output. It will not give lower-ability people jobs they are unable to do. Nor will it lead higher-ability workers to become bored in jobs that are too easy for them. But if the only function of higher education is to screen out the high-ability workers, there may be a cheaper way for society to achieve the same result. A national IQ test, with results adjusted for disadvantages of background and previous opportunity to learn, might screen almost as well (possibly even better!) at much less cost to society as a whole.

Notes

1. labour is heterogeneous — рабочая сила неоднородна;

2. continuoty of employment — стаж работы;

3. do considerably better — работают значительно лучше;

4. on the job — на работе;

5. even after allowing for differences in education and experience — даже с учетом различий в уровне образования и опыте работы;

6. the stock of relevant expertise they have accumulated — запас соответствующих трудовых навыков, которые они накопили;

7. they provide little trainig of direct relevance for most non-manual jobs — они почти не дают навыков, напрямую связанных с большинством видов умственного труда;

8. forego the opportunity — отказываются от возможности;

9. initially they are not at only a moderate pay disadvantage — на начальном этапе они получают за труд чуть меньшее вознаграждение;

10. only a modest amount above — немногим выше;

11. to command higher earnings — иметь более высокие заработки;

12. the stream of extra wages — поток дополнительных заработков;

13. consumption value — потребительская ценность;

14. with a view to going to university — с тем, чтобы впоследствии поступить в университет;

15. and (don’t) fool firms into offering them high wages — не добиваются обманным путем, чтобы фирмы платили им высокие зарплаты;

16. who have stuck it out till their final year at university believe themselves to be at the higher end of the ability range — которые выдержали учебу в университете и закончили его, считают, что они обладают большими способностями;

17. national IQ test (intelligence quotient test) — государственный тест умственного развития.