[2023]EC4311_Lecture_6_Human_Capital

Education and Human Capital
Ratjomose P. Machema
rpmachema@nul.ls
Department of Economics
National University of Lesotho (NUL)
EC4311: Labour Economics
R.P. Machema, (NUL ) Lecture 6 Human Capital EC4311 1 / 67

Table of Contents
1 Introduction
Background
Basics
2 The theory of human capital
Human capital
Present Value
The Schooling Model
3 Education as a signaling device
Equilibrium when ability is unobservable
Overeducation or Undereducation
4 Identifying the causal relation between education and income
The theory of human capital: from the model to estimation
The selection problem
5 The returns to education
Private returns to education
Social returns to education
Outline
What we expect to learn

The theory of human capital
The signaling effect of the length of education on individual
abilities to the future employer
Estimation of (individual and social) return to education
The example of Angrist and Krueger (1991) using the method of
instrumental variables
An overview of the principal results concerning the returns to
education

Table of contents
1 Introduction
Background
Basics
Human capital
Present Value
The Schooling Model
Outline
1 Introduction
Background
Basics
Human capital
Present Value
The Schooling Model
Introduction
Many labour supply choices require a substantial initial investment on
the part of the worker. Workers undertake three major kinds of
labour market investments:
education and training,
migration, and
search for new jobs.
All three investments involve an initial cost, and all three are made in
the hope and expectation that the investment will pay off well into
the future.
To emphasize the essential similarity of these investments to
other kinds of investments, economists refer to them as
investments in human capital, a term that conceptualizes
workers as embodying a set of skills that can be “rented out” to
employers.
The value of this productive capital is derived from how much
these skills can earn inLecture
R.P. Machema, (NUL )
the labor market.
6 Human Capital EC4311 6 / 67
Introduction
Human capital includes accumulated investments in such activities as
education and training, including the learning that experience yields, job
training, and migration.
Investment in the knowledge and skills of workers takes place in three
stages.
First, in early childhood, the acquisition of human capital is largely
determined by the decisions of others.
Second, teenagers and young adults go through a stage in which they
acquire knowledge and skills as full-time students in a high school,
college, or vocational training program.
Finally, after entering the labour market, workers’ additions to their
human capital generally take place on a part-time basis, through
on-the-job training, night school, or participation in relatively short,
formal training programs.
Individuals’ decisions about investing in human capital are affected by the
ease and speed with which they learn, their aspirations and expectations
about the future, and their access to financial resources.
Introduction
A decent amount of education is often seen as a basic necessity for

winning a well-paid job. Two of the reasons offered for this include:
Theory of human capital (Becker, 1964): According this theory,
education is an investment that produces knowledge acquisition
and increased productivity, which in turn lead to higher income.
Signalling Mode (Spence, 1973): From this perspective, the
educational system plays the role of a filter: it selects individuals
on the basis of their intrinsic ability, allowing them to signal their
abilities to potential employers.

Introduction
Recall, the theory of compensating differentials suggests that wages will

vary among workers because jobs are different.
Wages also will vary because workers are different: they each bring into the
labour market a unique set of abilities and acquired skills, or human capital.
Therefore, wages are also paid to compensate workers for the costly process
of acquiring human capital, like education or training.
We acquire most of our human capital in school and in formal and
informal on-the-job training programs. The skills we acquire in school
make up an increasingly important component of our stock of
knowledge.
This chapter discusses how we choose the particular set of skills that we
offer to employers and how our choices affect the evolution of earnings over
the working life.

Table of Contents
1 Introduction
Background
Basics
Human capital
Present Value
The Schooling Model
Outline
1 Introduction
Background
Basics
Human capital
Present Value
The Schooling Model
The theory of human capital (Becker, 1964) assumes education as an
investment producing earnings in the future
Education is a source of future earnings if wages reflect
differences in productivity
The relation between earnings and human capital
Becker distinguishes general training from specific training
General training enhances the productivity of an individual
concerned by all types of jobs
Specific training enhances productivity for one particular type of
job
This distinction is clearly theoretical, to the extent that all
training has a certain degree of specificity, but it is analytically
useful.
Investment in Human Capital
Like any other investment, an investment in human capital
entails costs that are borne in the near term with the
expectation that benefits will accrue in the future.
Can divide the costs of adding to human capital into:
Out-of-pocket or direct expenses, including tuition costs and
expenditures on books and other supplies.
Forgone earnings that arise because during the investment
period, it is usually impossible to work, at least not full-time.
Psychic losses that occur because learning is often difficult and
tedious.
The expected returns of educational and training investments
are in the form of
higher future earnings,
increased job satisfaction over their lifetime, and
a greater appreciation of nonmarket activities and interests
Outline
1 Introduction
Background
Basics
Human capital
Present Value
The Schooling Model
The Concept of Present Value
When an investment decision is made, the investor commits to a current

outlay of expenses in return for a stream of expected future benefits.
Investment returns are clearly subject to an element of risk (because no one
can predict the future with certainty),
but they are also delayed in the sense that they typically flow in over
what may be a very long period.
The investor needs to compare the value of the current investment outlays
with the current value of expected returns but in so doing must take into
account effects of the delay in returns.
The notion of present value allows us to compare dollar amounts
spent and received in different time periods.

The Concept of Present Value
Suppose a woman is offered M100 now or M100 in a year. Would she be equally
attracted to these two alternatives?
No, because if she received the money now, she could either spend (and
enjoy) it now or she could invest the M100 and earn interest over the next
year.
In general, the present value of a payment of, say, y dollars next year is given by
y
PV = 1+r
where r is the rate of interest, which is also called the rate of discount.
The quantity PV tells us how much needs to be invested today in order to
have y dollars next year.
In effect, a future payment of y dollars is discounted so as to make it comparable
to current dollars.
The present value of y dollars received t years from now equals
y
PV = (1+r )t

Outline
1 Introduction
Background
Basics
Human capital
Present Value
The Schooling Model
The Schooling Model
Education is associated with lower unemployment rates and higher earnings. So
why don’t all workers get doctorates or professional degrees?
To answer this question, we assume that:
workers acquire the education level that maximizes the present value
of lifetime earnings, such that education and other forms of training
are, therefore, valued only because they increase earnings.
Key points regarding the investment in and returns to education:
the increase in wages associated with the acquired skill is a “pure”
compensating differential –that is, it is merely compensation to the
individual for making the investment;
the costs of education particularly include the opportunity costs of other
pursuits, in terms of both time (the wages of common labour) and other
investments; and
the analytic framework for the individual decision is analogous to the
investment in physical capital.

Education and Age-Earnings Profiles
The shapes of the age-earnings profiles, reflect two key factors:

Earnings increase with age but at a decreasing rate. This is because
individuals continue to make human capital investments (i.e.
on-the-job-training) and gain work experience once they have entered the
labour force.
Earnings of individuals with more years of education generally lie above
those with fewer years of education.
This is because education provides skills that increase the individual’s
productivity and, thus, earning power in the labour market.

Investment in Human Capital

Education and Age-Earnings Profiles
At age 16, an individual drops out of high school (gets Stream A); At age 18, an
individual completes high school (costs a forgone earnings buts gets Stream B);
At age 22, an individual gets university education (costs b + c + d, but gets

Human Capital Investment Decision (how much
education?)
Assumptions:
The individual does not receive any direct utility or disutility from the
educational process. This implies that education is purely an investment.
Hours of work (including work in acquiring education) are fixed. That is,
amount of leisure is the same across income streams.
The income streams associated with different amounts of education are
known with certainty.
Individuals can borrow and lend at the real interest rate r. That is capital
markets are perfect.
The individual will choose the quantity of education that maximizes the net
present value of lifetime earnings.
Once this choice is made, total net lifetime earnings (or human capital
wealth) can be distributed across different periods as desired by borrowing
and lending.

education?)
The net present value of annual earnings (Y ) for an 18 year old who retires at
age T is given as
y y y P y y
PV = (1+r )0 + (1+r )1 + ... + (1+r )T −18 = y + (1+r )t ≈ y + r
The marginal cost (MC) of investing in further education is direct cost of
schooling, D, plus the foregone earnings while attending school, Y :
MC = Y + D.
Assuming that a further year of schooling permanently increases the
earnings by ∆Y , annual earnings are now Y + ∆Y .
The NPV of income with one further year of schooling is
PV ∗ ≈ Y +∆Y
r −D
The net gain from an additional year of schooling is given by the difference in the
two present values:
PV ∗ − PV ≈ ∆Y r − (Y + D)
∆Y = r is MB. An individual will invest in education up to a point where MB =
MC.
education?)

Indifference Curves Relating the Wage and the
Probability of Injury on the Job
Peter lives for three periods. He
is currently considering three
alternative education-work
options.
1 He can start working
immediately and earn
M100,000 in period 1;
M110,000 in period 2; and
90,000 in period 3
2 He can attend college and The present discounted values of Peter’s
Pay M50,000 in period 1; earnings associated with each of the
alternatives are
Earn M180,000 in period 2;
High school PV = 254000
and Earn M180,00 in period
College PV = 225000
3
PhD PV = 228000
3 He can get a doctorate in
The best option is only high-school.
economics and Pay the Calculate PV from the three alternatives with
M50,000 in period 1; Have r=10%
The Wage-Schooling Locus
This stopping rule tells the individual when it is optimal to quit school and enter
the labor market. The wage-schooling locus gives the salary that a particular
worker would earn if he completed a particular level of schooling. If the worker
graduates from high school, he earns 20,000 annually. If he goes to college for
one year, he earns 23,000.

The Wage-Schooling Locus
The wage-schooling locus shown in Figure 6-2 has three important properties:
1 The wage-schooling locus is upward sloping. Workers who have more
education must earn more as long as educational decisions are motivated
only by financial gains. To attract educated workers, employers must
compensate those workers for the costs incurred in acquiring an education.
2 The slope of the wage-schooling locus tells us by how much a
worker’s earnings would increase if he were to obtain one more year
of schooling. The slope of the wage-schooling locus, therefore, will be
closely related to any empirical measure of “the rate of return” to school.
3 The wage-schooling locus is concave. The monetary gains from each
additional year of schooling decline as more schooling is acquired. In other
words, the law of diminishing returns also applies to human capital
accumulation.6 Each extra year of schooling generates less incremental
knowledge and lower additional earnings than previous years.

The Marginal Rate of Return to Schooling
The slope of the wage-schooling locus (or ∆w/∆s) tells us by how much earnings
increase if the person stays in school one more year. For example, the first year of
college increases annual earnings in the postschool period by 3000 or 15%.
In other words, the worker gets a 15 percent wage increase from staying in
school and attending that first year of college. We refer to this percentage
change in earnings resulting from one more year of school as the marginal
rate of return to schooling.
The marginal rate of return to schooling gives the percentage increase in earnings
per dollar spent in educational investments.
For instance, the high school graduate who delays his entry into the labour
market by one year is giving up $20,000 so that his future earnings would
increase by 3,000 annually, thus yielding an annual 15% rate of return for
the first year of college.
Because the wage-schooling locus is concave, the marginal rate of return to
schooling must decline as a person gets more schooling. Each additional year of
schooling generates a smaller salary increase and it costs more to stay in school.

Implications of the Theory
Human capital investments should be made early in one’s lifetime.
Educational investments made at later stages earn a lower financial return
because foregone earnings increase with work experience and because of the
shorter period over which higher income is earned.
Individuals expecting to be in and out of the labour force, perhaps in order to
raise children, have less financial incentive to invest in education and will (other
factors being equal) earn a lower return on any given amount of human capital
investment.
This framework can be used not only to explain human capital investment
decisions but also to predict the impact of changes in the economic and social
environment and in public policy on levels of education.
For example, what is the effect of ending the National Manpower
Development Loan Bursary scheme?
Such policies would alter the total and marginal costs of education, and thus
levels of educational attainment.

Predictions of the Theory
Present-Orientedness – Present-oriented people are less likely to go
to college than forward-looking people (other things equal). –
present-oriented people tend to have higher rates of discount (r) and
they impute smaller benefits to college education in comparison to
future- looking people
Age – Most college students will be young. – Young people have
larger PV of total benefits than older workers because the younger
workers would have longer labor market experience, therefore, T is
greater for younger people than for older ones
Costs – College attendance will decrease if costs of college rise –
Human capital investments are more likely when costs are lower.
Earnings Differentials – College attendance will increase if the gap
widens between the earnings of college and HS graduates. – The
demand for education is positively related to the increases in expected
(but uncertain) lifetime earnings/benefits that a college education
allows
Predictions of the Theory
Other Factors That Can Affect the Demand for a College Education after
Controlling for Parental Influence
Friends – friends could be important in human capital decisions
(fit with the crowd)
Ethnic affiliation/origin – The importance attached to human
capital investments varies across ethnic groups.
Neighborhoods in the human capital decisions of individuals –
Human capital investments decisions in affluent neighborhoods
will not be the same as those in poor-inner-city neighborhoods.

Table of Contents
1 Introduction
Background
Basics
Human capital
Present Value
The Schooling Model
Education as a signaling device
Imperfect information is a common feature of many labour markets.
An employer seeking to hire workers is never completely sure of the actual
productivity of any applicant, and in many cases, the employer may remain
unsure long after an employee is hired
Apart from observing certain indicators (age, experience, education,
and personal characteristics) that are correlated to productivity,
employers cannot determine the actual productivity of any applicant
during the interviewing and hiring process, therefore, they rely on the
formal education that workers acquire.
Some see the educational system as a means of finding out who
is productive, not of enhancing worker productivity.
Employers use education as a signaling device, which enables
them to sort workers into different levels or categories of
productivity rather than assume that all workers/applicants are
“average.”
Employers and employees may therefore use education as signalling or
sorting device: That is education
R.P. Machema, (NUL )
may act as a signal to work EC4311
Lecture 6 Human Capital
productivity.
33 / 67
Schooling as a Signal: Assumptions
Education has no effect on productivity. Therefore job market signalling

provides an alternative explanation of the positive correlation between
education and earnings.
Employers do not know the individual workers’ productivity prior to hiring.
Employers observe certain characteristics(e.g. education) of prospective
employees.
Employers form beliefs about worker attributes (e.g. education) and
productivity. They believe that more-educated workers are more productive.
Employers’ beliefs about worker productivity are fulfilled by actual
subsequent experience. They therefore offer higher wages to workers with
more education.
Workers choose the amount of education that provides the highest rate of
return.

Schooling as a Signal: The Model
How then do workers decide how much schooling to get when education
plays only a signaling role?
Suppose there are two types of workers: Low ability workers (type L) with
marginal product of 1 (MPL = 1); and High ability workers (type H) with
MPL = 2.
Low ability workers acquire s units of education at a cost of s Maloti.
High ability workers acquire s units of education at a cost of s/2
Maloti. That is, high ability workers acquire education cheaply.
Market equilibrium: Suppose that employers’ beliefs are as follows:
If s < s ∗ then MPL = 1
If s % s ∗ then MPL = 2, where s ∗ is the critical value of education
(say high school completion, or university degree)
If the labour market is competitive, low ability workers will acquire 0 units
of education, and high ability workers will acquire s ∗ units of education.

The Signalling Market Equilibrium

The Signalling Market Equilibrium
At equilibrium:
the net wage for Low ability workers with 0 units of education and
MPL = 1 is w = M1
the net wage for High ability workers with s ∗ units of education
∗
MPL = 2 is w = (M2 − s /2) > M1
Given the offered wage schedule, if 1 < s ∗ < 2, the low-ability workers will
choose s = 0 and the high-ability workers will choose s = s ∗ . Employers’
beliefs about the relationship between education and worker productivity
will be confirmed.
In this model, education acts strictly as a signalling or sorting device.
This theory has been used to explain the use of:
high prices to signal product quality,
product warranties to signal product quality, and
an applicant’s employment experience (number of jobs, time spent
unemployed, etc) by employers to signal worker quality.

The positive correlation between duration of studies and

earnings does not prove the existence of a causal impact of
education on productivity
The premise of Spence (1973) is that those persons who perform
most effectively in active life are also the ones who perform best
while studying, hence education is a signal for the agent’s
efficiency
Spence (1973) shows that workers over-educate themselves, if
education does serve to signal their productive capacities to
employers

Employers use education to classify workers with less than e*

years of education as lower-productivity workers that should be
rejected or prevented from any job paying a wage above 1.
Those workers with at least e* or more years of education
beyond high school are considered to be the higher-productivity
workers who can obtain a wage of 2.
Note that if education is a signaling device which yields a wage
of 2, all workers would want to acquire the signal of e* if it were
costless for them to do so.

The information about the productivity of workers is imperfect.

Hence, employers take the educational degree to measure their
efficiency
In this context, workers over-invest in education to signal their
abilities
The model of signaling is based on the following assumptions:
A continuum of individuals whose productivities are different
Productivities are innate and do not vary over time
Each individual chooses her duration of schooling (=education
level)

The preferences of a worker are represented by:
u(R, s, h) = R − (s/h)
R designates earnings equal to wages if employed or zero otherwise

s ≥ 0 designates level of education
h designates worker’s ability (a worker with ability h can produce h
units of goods)
h+ and h− respectively refers to high productive and low productive
worker
Decisions unfold in the following sequence:
1 Workers, knowing which of the two types they belong to, choose their
level of education s
2 Firms enter the labor market freely, observe the signals s, and make
simultaneous wage offers to worker

3 workers accept or refuse the offers made to them
Free entry assumption implies w (h) = h for h ∈ {h+ , h− }

Outline
1 Introduction
Background
Basics
Human capital
Present Value
The Schooling Model
When abilities are unobservable, the signal becomes a way for the
most efficient workers to bring themselves to the attention of firms
To that end, it is sufficient for them to choose a level of education
that is costly enough for inefficient workers/ the low-ability workers,
In this case, firms can distinguish between the two types of workers
according to their respective signals, and the equilibrium is called
separating equilibrium.
For the equilibrium to be separating, it must be verified that no
person of type h− has an interest in deviating by choosing a
signal identical to that sent by higher-ability workers.
So the model of Spence (1973) portrays the role played by education
in a very negative light: all it does is select workers according to their
ability, without improving the allocation of resources.

Outline
1 Introduction
Background
Basics
Human capital
Present Value
The Schooling Model
More generally:
Education might improve the allocation of resources in certain
circumstances through its role as a signal
The signaling role of educationcan lead to “too much" education
in relation to what the collective optimum requires
In this case, it is generally desirable to reduce signaling through
cross-subsidization, financed by lump-sum taxes.
This policy consists of reducing the earnings differential between
workers with different signals so as to reduce the incentive to acquire
education, while preserving positive levels of education.

Table of Contents
1 Introduction
Background
Basics
Human capital
Present Value
The Schooling Model
Outline
1 Introduction
Background
Basics
Human capital
Present Value
The Schooling Model
The aim of estimating earnings functions is to evaluate the

returns to education
This correlation betrays a causal link between education and
earnings.
Through estimation, this research tries to determine
if education serves to accumulate knowledge that has value in
the labor market, as in the theory of human capital, or
if its main function is to select the most efficient individuals,
without teaching them a great deal (a signaling device)
The main prediction of the theory of human capital is that
education is the source of an accumulation of competences,
which increases earnings

From model to estimates
The theory of human capital predicts that education is the source of an accumulation of
competencies that make it possible to increase income.
This result is assesed by estimating earnings functions, which relate income to investment
in education.
Mincer (1974) proposed a form of earnings function which arrives at an estimate of the
internal rate of return to educational investment.
The internal rate of return to education
The empirical studies estimate the rate of return to education
The internal rate of return to education equalizes the gain and the cost
The internal rate of return ρ can be interpreted as the relative increase in earnings
flowing from an extra year of schooling
The internal rate of return can be estimated with the equation:
ln w (s) = ln w (0) + ρs
w (s) denotes the wage of an individual with s year of education

w (0) that of an individual with zero year of education

Outline
1 Introduction
Background
Basics
Human capital
Present Value
The Schooling Model
Selection problem
The correlation between duration of schooling and income does

not mean causal relation
The correlation can stem from the fact that the most efficient
individuals have higher earnings and stay in school longer
(selection problem)
The theory of human capital and signaling theory both predict
that the most productive individuals have an interest in studying
for the longest period, entailing the possibility of the so called
ability bias

Selection problem
The relation between the wage and the number of years of education is
given by ln w (s) = ln w (0) + ρs
The population regression coefficient ρ minimizes the expected squared
errors in the population as a whole, E (w − ρs)2 , where W = ln w . This
coefficient is given by:
Cov (s, W )
ρOLS =
Var (s)
This equation shows that the population regression coefficient ρOLS is equal
to the parameter ρ of the Mincer equation only if the length of education is
independent of the error term
The instrumental variable method consists in estimating the returns to
education using a variable that influences the duration of studies while
remaining independent of individual capacities
Angrist and Krueger (1991) have made an interesting contribution, which
consists of exploiting the existence of events that are much like natural
experiments.

Illustration - Angrist and Krueger (1991)
Angrist and Krueger (1991) noted that individuals born early in

the calendar year have shorter durations of schooling than those
born later
This effect is owing to the compulsory duration of schooling
where compulsory schooling laws require students to remain in
school until their 16th or 17th birthday
By assuming that the date of one’s birth is independent of
factors influencing abilities and preferences, this phenomenon
can entail an exogenous variation in the duration of schooling,
which may be used as an instrument

Selection problem
Another method used to evaluate the returns to education consists of using

data about individuals whose abilities are as alike as possible
Therefore, several contributions estimate the returns to education for
siblings or twins (whose unobserved characteristics are assumed to be
similar)
Then, it is possible to estimate without bias the returns to education using
the OLS, on condition that the differences in duration of study between
twin members are not correlated to differences in aptitude that may
influence their gains
However, if the duration of education is different between the twins, they
are not perfectly identical anymore. In this case, the assumption that the
difference of schooling durations is not correlated to their future earnings is
not valid

Selection problem
Ashenfelter and Rouse (1998) find that the differences in the returns
to education between genetically identical individuals are slightly
weaker than those obtained by comparing the duration of schooling
and incomes of any two random individuals
Oreopoulos and Salvanes (2011) have used Norwegian administrative
records that supply information on the educational and professional
trajectories of all persons born since 1920
They found that siblings with one more year of schooling have
more annual income than their less educated siblings, which
confirms the results of Ashenfelter and Rouse

Table of Contents
1 Introduction
Background
Basics
Human capital
Present Value
The Schooling Model
Outline
1 Introduction
Background
Basics
Human capital
Present Value
The Schooling Model
The Mincer model assumes that every year of schooling has the same
return. However, it is possible to relax this assumption by modeling
different returns every year
In this section, we set aside the problems of selection bias previously studied
in order to concentrate on the specification of the model estimated
Reminder of the Mincer model’s assumptions:
The rate of return to an added year of schooling is independent of
duration of study
The cost of an added year of schooling is proportional to the wage
Career duration is sufficiently long
Career duration is independent of duration of schooling

Evaluations of returns to schooling have their limitations

The direct costs of education are based on the private
expenditure per year and the length of education in each country
The indirect costs of education are also taken into account by
the portion of foregone wages
The benefits of education are based on differences in earning between
those who have a given degree and those who do not have such a
degree but do have the degree just below

Private nonpecuniary returns to education
Private gain from years of study does not boil down to the chance of a
better wage
Schooling exerts effects in a range of dimensions by promoting better
decision, making in the areas of health, choice of partner, and the schooling
of one’s children
Grossman (2006) suggests increased satisfaction with longer duration
of schooling
Oreopoulos and Salvanes (2011) stress that schooling may affect
individual preferences so as to be more patient, more goal-oriented
and less likely to engage in risky behavior

Outline
1 Introduction
Background
Basics
Human capital
Present Value
The Schooling Model
Social returns
Education exerts positive externalities and its social returns are

estimated to be superior to the private returns.
Social engagement: Putnam (2007) asserts that “education is
one of the most important predictors of many forms of social
engagement, from voting to charging a local committee to
hosting a dinner party to trusting others"
Criminality and violence: Lochner and Moretti (2004) find that
education has a negative impact on criminality and that the
externality connected to the reduction of criminality represents
between 14% and 26% of the private returns to education

Social returns
Labor mobility: Machin, Pelkonen and Salvanes (2011) find that

the length of compulsory education has a causal impact on
mobility of individuals at the lowest levels of educational
attainment
Spillover on children: Currie and Moretti (2003) estimate that
better education of mothers exerts a positive impact on the
health of their offspring
Knowledge externalities: Rauch (1993) estimates that knowledge
externalities increase the returns to education by 3 to 5
percentage points

Other important factors of education
There exist factors other than the duration, which influence the
accumulation of human capital
Hanushek and Rivkin (2012) suggest that the quality of
education is an essential determinant of the returns
Card and Krueger (1992), using US data, show that the returns
to education is higher when the pupil/teacher ratio is lower
Other studies using US data in randomized or natural
experiments find a positive impact of reductions in class size on
returns to education, namely using Tennessee Student/Teacher
Achievement Ratio

Jaeger and Page (1996) estimate that the acquisition of a

degree has a significant impact on hourly wages
Numerous empirical studies find that non-cognitive1 factors as a
whole have at least as much influence as cognitive ones on the
behavior of individuals
Heckman (2000) and Carneiro and Heckman (2003) find that
expenditure per student and class size have a weakly significant
impact on the probability of longer schooling and on future
earnings
1
Non-cognitive factor is a collective term for motivation, personality, temporal
preferences, the ability to co-operate, conscientiousness etc.
Cunha and Heckman (2010) find that targeted intervention from an early
age has strong and long-lasting effects
Their studies consist of a controlled experiment (Hihg/Scope Perry
Preschool Program, which started in 1962 in the state of Michigan)
on an initial population of 123 African American children aged 3 and
4 from disadvantaged backgrounds and with low IQs (between 70 and
85)
58 out of 123 benefited from special classes with low teacher/pupil
ratios over 2 years
The performance of the children from the test group increased
compared to the control group
Another much-studied program is that of the Chicago Child-Parent Centers,
which were launched in 1967 in 11 public schools in poor neighborhoods of
Chicago. Each center offered a preschool program for 3 hours per day, over
a 9-month period, to children aged 3 and 4

Summary and conclusions
Expenditure on education is significant and growing percentage of

GDP across countries
The theory of human capital justifies educational choices by assuming
that education favors the accumulation of competences and increases
wage earnings
Signaling activity may lead to overeducation
The estimated returns to education are heterogeneous across
individuals
The private and social returns to investment in education are higher
when the investments are made in young and ones from lower-class
backgrounds

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Education and Human Capital

EC4311: Labour Economics

R.P. Machema, (NUL ) Lecture 6 Human Capital EC4311 1 / 67

What we expect to learn

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A decent amount of education is often seen as a basic necessity for

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Recall, the theory of compensating differentials suggests that wages will

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When an investment decision is made, the investor commits to a current

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The shapes of the age-earnings profiles, reflect two key factors:

R.P. Machema, (NUL ) Lecture 6 Human Capital EC4311 19 / 67

R.P. Machema, (NUL ) Lecture 6 Human Capital EC4311 20 / 67

At age 22, an individual gets university education (costs b + c + d, but gets

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Education has no effect on productivity. Therefore job market signalling

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The positive correlation between duration of studies and

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Employers use education to classify workers with less than e*

R.P. Machema, (NUL ) Lecture 6 Human Capital EC4311 39 / 67

The information about the productivity of workers is imperfect.

R.P. Machema, (NUL ) Lecture 6 Human Capital EC4311 40 / 67

R designates earnings equal to wages if employed or zero otherwise

simultaneous wage offers to worker

Free entry assumption implies w (h) = h for h ∈ {h+ , h− }

R.P. Machema, (NUL ) Lecture 6 Human Capital EC4311 41 / 67

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R.P. Machema, (NUL ) Lecture 6 Human Capital EC4311 45 / 67

The aim of estimating earnings functions is to evaluate the

R.P. Machema, (NUL ) Lecture 6 Human Capital EC4311 48 / 67

w (s) denotes the wage of an individual with s year of education

R.P. Machema, (NUL ) Lecture 6 Human Capital EC4311 49 / 67

The correlation between duration of schooling and income does

R.P. Machema, (NUL ) Lecture 6 Human Capital EC4311 51 / 67

R.P. Machema, (NUL ) Lecture 6 Human Capital EC4311 52 / 67

Angrist and Krueger (1991) noted that individuals born early in

R.P. Machema, (NUL ) Lecture 6 Human Capital EC4311 53 / 67

Another method used to evaluate the returns to education consists of using

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Evaluations of returns to schooling have their limitations

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R.P. Machema, (NUL ) Lecture 6 Human Capital EC4311 60 / 67

Education exerts positive externalities and its social returns are

R.P. Machema, (NUL ) Lecture 6 Human Capital EC4311 62 / 67

Labor mobility: Machin, Pelkonen and Salvanes (2011) find that