Thursday, 21 September 2017

Gary Becker on human capital

In ECON110 this week, we've been covering the economics of education. In this topic we theorise that, from the perspective of the individual, education is an investment in human capital. This 'human capital theory' comes from the works of Jacob Mincer and from 1992 Nobel Prize winner Gary Becker, who sadly passed away in 2014 (although it was Arthur Pigou who much earlier coined the term human capital). So it is timely that the Economist has had two excellent articles on Gary Becker and human capital over the last couple of months. It was the second one, from The Economist Explains, that caught my attention this week, but I think the earlier article from August is better so I'll quote from that one:
...human capital refers to the abilities and qualities of people that make them productive. Knowledge is the most important of these, but other factors, from a sense of punctuality to the state of someone’s health, also matter. Investment in human capital thus mainly refers to education but it also includes other things—the inculcation of values by parents, say, or a healthy diet. Just as investing in physical capital—whether building a new factory or upgrading computers—can pay off for a company, so investments in human capital also pay off for people. The earnings of well-educated individuals are generally higher than those of the wider population...
Becker observed that people do acquire general human capital, but they often do so at their own expense, rather than that of employers. This is true of university, when students take on debts to pay for education before entering the workforce. It is also true of workers in almost all industries: interns, trainees and junior employees share in the cost of getting them up to speed by being paid less.
Becker made the assumption that people would be hard-headed in calculating how much to invest in their own human capital. They would compare expected future earnings from different career choices and consider the cost of acquiring the education to pursue these careers, including time spent in the classroom. He knew that reality was far messier, with decisions plagued by uncertainty and complicated motivations, but he described his model as an “economic way of looking at life”. His simplified assumptions about people being purposeful and rational in their decisions laid the groundwork for an elegant theory of human capital, which he expounded in several seminal articles and a book in the early 1960s.
His theory helped explain why younger generations spent more time in schooling than older ones: longer life expectancies raised the profitability of acquiring knowledge. It also helped explain the spread of education: advances in technology made it more profitable to have skills, which in turn raised the demand for education. It showed that under-investment in human capital was a constant risk: young people can be short-sighted given the long payback period for education; and lenders are wary of supporting them because of their lack of collateral (attributes such as knowledge always stay with the borrower, whereas a borrower’s physical assets can be seized).
So many of the things we covered in class this week are found there, including the decision about private investment in education, the credit constraints that low income students face in borrowing towards their education costs (which is part of the rationale for a system of student loans), and one of the rationales for government involvement (that students would under-invest in their own education). Even though, as the article notes, behavioural economics has been used to attack the foundations of Becker's theories, on that last point I think behavioural economics actually makes the case stronger. One of the biases that behavioural economics has identified is present bias - quasi-rational decision-makers heavily discount the future (much more so that a standard time-value-of-money treatment would). Since the benefits of education happen in the future, those benefits are discounted greatly compared with the costs of education that occur in the present. So, quasi-rational people would tend to under-invest in education because they under-weight the value of the future benefits relative to the current costs.

The whole article (or both articles) is a good introduction to Becker's work on human capital. For a broader perspective on Becker's work, from the man himself, I highly recommend his 1992 Nobel lecture.

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