HUMAN CAPITAL.

Human capital refers to the knowledge, skills, and capabilities of individuals that generate economic output. Human capital averages about two-thirds of the total value of the capital of most economies, which includes land, machinery, and other physical assets as well as the skills and talents of people. The value of human capital is often apparent after physical destruction, as during World War II—many of the German and Japanese cities that were bombed intensely were able to recover 80 to 90 percent of their previous levels of production within months.

More than two centuries ago, Adam Smith observed in Wealth of Nations (1776) that an educated man must earn more than "common labor" to "replace to him the whole expense of his education." Human capital was first discussed extensively by two Nobel Prize–winning economists, Theodore Schultz (1979) and Gary Becker (1992), to explain how any personal decision to sacrifice today for a return tomorrow can be analyzed in the same way that a business considers an investment decision, such as whether to buy new machinery. A nation's stock of human capital and thus its economic growth potential could be increased, they reasoned, if governments reduced the cost and increased the benefits of schooling, the human capital embodied in individuals.

Human capital is rented in the labor market rather than "sold." Individuals exchange effort for reward, and acquire human capital in the expectation that their incomes will be higher. Human capital takes time to acquire, and the basic model of human capital acquisition compares the income stream from going to school with that of going to work immediately. The costs of going to school include the direct costs, in the form of tuition and books, as well as the indirect costs, the forgone earnings that could have been received from working. The benefits of more schooling are higher earnings in the future.

Costs and Benefits

These costs and benefits must be brought to a single point in time so that the present value of the higher average lifetime earnings with more schooling and the lower average earnings with less schooling can be compared. A rational individual chooses the education and work profile that maximizes the present value of lifetime earnings.

This investment approach to education yields several important predictions about behavior. First, most people will get some education, and most students will be young, because the early years of education have few direct costs, and there are no forgone earnings because most societies prohibit children from working; younger people also have a longer period over which they can recoup their educational investment in the form of higher earnings. The analysis gets more interesting when young people reach the age at which they can work, sixteen or eighteen in most industrial countries, and twelve to fifteen in many developing countries. Youth in industrial countries tend to stay in school because the direct costs are often low and the for-gone earnings may be low (working as a teen is often at the minimum wage), while earnings with a college education can be significantly higher. The interest rate used to compare future and present earnings is also important; if this interest rate is low because of subsidized loans, more people will choose to get more education.

Second, government policies shape individual decisions about how much human capital to acquire by affecting the cost of schooling and the payoff from work. Social attitudes also play a role, encouraging young people to stay in school, or to go to college with friends in industrial countries, but in developing countries often encouraging children to help support the family as soon as possible. More forward-looking people, those most able to sacrifice now for future returns, are likely to get the most education, such as those willing to undergo rigorous and time-consuming medical education.

In the United States a combination of higher lifetime earnings, government policies, and social attitudes has increased the percentage of high school graduates who go to college. In 1960, about 45 percent of all high school graduates enrolled in college in the following twelve months, 54 percent of men and 38 percent of women. By 1980, 49 percent of high school graduates enrolled in college: men dropped to 47 percent, and women rose to 52 percent. In 1999, the most recent data available, 63 percent of high school graduates enrolled in college, 61 percent of men and 64 percent of women. Most studies find that men are more present-oriented to immediate earnings opportunities than women, explaining why more women are in college.

The average earnings of college-educated persons are higher than the earnings of high school graduates, and rose in the late twentieth century. In 1979, male college graduates earned 33 percent more than high school graduates, the so-called college earnings premium, and female college graduates earned 41 percent. By 2000, these college earnings premiums rose to 84 percent for men and 67 percent for women, in part because the real earnings of those with less education fell as a result of globalization, which reduced the wages of many high school graduates employed in manufacturing.

Education is generally a good investment: the private rate of return to a college education ranges from 12 to 40 percent in most countries, more than the return on investments in stocks and bonds. Around the world, the rate of return to primary school education was estimated to be 29 percent in the early 1990s, 18 percent for secondary schooling, and 20 percent for higher education. In developing African countries, these rates were 39, 19, and 20 percent, respectively, while in the industrial countries that are members of the Organisation for Economic Co-Operation and Development (OECD), the rates were 22, 12, and 12 percent, respectively. The high rate of return on primary education suggests that countries should subsidize it most.

It is very hard to compute average rates of return for higher levels of education because it is likely that the most capable individuals go to college, so that colleges transmit knowledge that increase productivity and also serve as screening institutions for employers seeking the best workers; some economists argue that the screening role is more important than the productivity-increasing role. On the other hand, the private rate of return to a college education may be higher if more highly educated individuals have both higher incomes as well as more fringe benefits and better or more prestigious jobs. The social rate of return may be even higher than the private rate if highly educated individuals provide more leadership and commit fewer crimes.

Any personal investment that raises productivity in the future can add to an individual's human capital, including onthe-job training and migration. A job that offers training, for example, may have lower earnings but still be attractive because a person knows that, after completing the military, aviation, or stockbroker course, earnings will rise. On-the-job training that makes the person more useful to the employer who provided it is called job-specific training, while training that transmits general skills that make the trained individual useful to many employers is called general training. Employers are more likely to pay for specific than general training. Employers do a great deal of training; by some estimates, U.S. employers spend almost as much on training as is spent at colleges and universities.

Migration of Human Capital

If people truly are the "wealth of a nation," should developing countries worry about a "brain drain" if their doctors, nurses, and scientists migrate to richer countries? The answer depends on the 3 R's of recruitment, remittances, and returns. Recruitment deals with who migrates abroad: Are the emigrants employed managers whose exit leads to layoffs, or unemployed workers who have jobs and earnings abroad but would have been unemployed at home? Remittances are the monies sent home by migrants abroad: Are they significant, and fuel for investment and job creation, or small and not used to speed development? Returns refers to whether migrants return to their countries of origin: Do they return after education or a period of employment abroad with enhanced skills, or do they return only to visit and retire?

During the 1990s the migration of highly skilled workers from developing to more developed countries increased, reflecting more foreign students as well as aging populations able to pay for more doctors and nurses and the internet-related economic boom. International organizations are exploring ways in which the more developed countries could replenish the human capital they take from the developing world via migration, perhaps by contributing to or backing loans to improve their educational systems. If the human capital that migrates is not replenished, global inequalities may increase.

See also Education ; Globalization ; Social Capital .

bibliography

Becker, Gary S. Human Capital. A Theoretical and Empirical Analysis, with Special Reference to Education. New York: National Bureau of Economic Research, 1964.

Blaug, Mark. "The Empirical Status of Human Capital Theory: A Slightly Jaundiced Survey." Journal of Economic Literature 14 (September 1976): 827–855.

Mincer, Jacob. Schooling, Experience, and Earnings. New York: Columbia University Press, 1974.

Organisation for Economic Co-Operation and Development. Human Capital Investment: An International Comparison. Paris: OECD, 1998.

Psacharopoulos, George. "Returns to Investment in Education: A Global Update." World Development 22, no. 9 (1994): 1325–1343.

Smith, Adam. An Inquiry into the Nature and Causes of the Wealth of Nations. Dublin: Whitestone, 1776.

Philip L. Martin