FEM 4204 HUMAN CAPITAL: INVESTING IN ONESELF AND ONE’S FAMILY

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FEM 4204FEM 4204HUMAN CAPITAL: INVESTING IN HUMAN CAPITAL: INVESTING IN

ONESELF AND ONE’S FAMILYONESELF AND ONE’S FAMILY

ZURONI MD JUSOHZURONI MD JUSOHRESOURCE MGT AND CONSUMER STUDIES, RESOURCE MGT AND CONSUMER STUDIES,

FACULTY OF HUMAN ECOLOGYFACULTY OF HUMAN ECOLOGY

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REFERENCESREFERENCES

• Begg, D., Fischer, S., and Dornbusch, Begg, D., Fischer, S., and Dornbusch, R. (1987) R. (1987) EconomicsEconomics, McGraw Hill, McGraw Hill

• Bryant, W. K (1990) Bryant, W. K (1990) The Economic The Economic Organization of the HouseholdOrganization of the Household, , Cambridge Univ PressCambridge Univ Press

• Rahmah Ismail (1996) Rahmah Ismail (1996) Modal Manusia Modal Manusia dan Perolehan Buruhdan Perolehan Buruh, , Dewan Bahasa Dewan Bahasa & Pustaka& Pustaka

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OUTLINEOUTLINE

• IntroductionIntroduction• Human capital and the labor marketHuman capital and the labor market

– The rate of return for formal educationThe rate of return for formal education• Human Capital TheoryHuman Capital Theory• Signaling TheorySignaling Theory

• Human capital as a household activityHuman capital as a household activity– Study time, part time and academic performanceStudy time, part time and academic performance– Expectation and the sex typing of human capital Expectation and the sex typing of human capital

investmentinvestment– Health as a human capital investmentHealth as a human capital investment– Human capital, marriage and divorceHuman capital, marriage and divorce

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IntroductionIntroduction

• RecallRecall: Types of investment in family members:: Types of investment in family members:– Formal schoolingFormal schooling– OJT and experience – will be discussed in HKI by firmsOJT and experience – will be discussed in HKI by firms

• Take time out from one’s market job or in household activity Take time out from one’s market job or in household activity in order to learn how to do it betterin order to learn how to do it better

– HealthHealth• i.e spending time and money in maintaining and augmenting i.e spending time and money in maintaining and augmenting

one’s health – e.g aerobic class, dental check ups, gd one’s health – e.g aerobic class, dental check ups, gd nutritionsnutritions

– MigrationMigration -- in search of better job or different lifestyle -- in search of better job or different lifestyle• One forsake the opportunity in one location in order to exploit One forsake the opportunity in one location in order to exploit

those in anotherthose in another– Having children and raising them in certain waysHaving children and raising them in certain ways

• Provide economic security in old ageProvide economic security in old age

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Human Capital and the Human Capital and the Labor MktLabor Mkt

• A A major reason of HKImajor reason of HKI through schooling through schooling – To augment their income in the future and so to To augment their income in the future and so to

increase their total wealthincrease their total wealth

• Recall the Human capital TheoryRecall the Human capital Theory– After choosing what kind of investment After choosing what kind of investment

• Physical capital (e.g. a new car) vs. financial capital Physical capital (e.g. a new car) vs. financial capital (e.g. stocks, bonds) vs. human capital(e.g. stocks, bonds) vs. human capital

– If formal schooling initially has the higher rate of If formal schooling initially has the higher rate of return, one will maximize his/her wealth by return, one will maximize his/her wealth by continuing to invest in schooling until the rate of continuing to invest in schooling until the rate of return on schooling has been driven down to the return on schooling has been driven down to the market rate of interestmarket rate of interest

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The Rate of Return on The Rate of Return on EducationEducation

• It’s the interest rate that equates the It’s the interest rate that equates the cost of the investment with the cost of the investment with the present value of the stream of future present value of the stream of future benefits from the investmentbenefits from the investment

• An illustration to explain the rate of An illustration to explain the rate of return to the investment (i.e. the return to the investment (i.e. the internal rate of return)internal rate of return)

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The Rate of Return on The Rate of Return on EducationEducation …cont…cont

• E.g. Bob is contemplating a bachelor degree in E.g. Bob is contemplating a bachelor degree in UPM at the age of 20 and expects to retire at 56. UPM at the age of 20 and expects to retire at 56.

• In yr In yr t t the annual earningthe annual earning– w/o the added yr of school ~ Ew/o the added yr of school ~ Ett – with the added yr of school ~ E’with the added yr of school ~ E’tt – E’E’tt > E> Ett

• The cost of added yr in school ~ MC consist of:The cost of added yr in school ~ MC consist of:– Forgone earnings ~ EForgone earnings ~ E00 – Out of pocket costs ~ COut of pocket costs ~ C

• So, MC So, MC = = EE00 + C + C

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• The benefit from added yr of schooling is the difference The benefit from added yr of schooling is the difference between the future stream of annual earning between the future stream of annual earning – with the added yr of school ~ E’with the added yr of school ~ E’tt AND AND– w/o the added yr of school ~ Ew/o the added yr of school ~ Ett

• The interest rate The interest rate i i equates the Present Value (PV) of equates the Present Value (PV) of the expected stream of benefit fr added school with the expected stream of benefit fr added school with the cost of additional yr of schthe cost of additional yr of sch– ∑ ∑ (E’(E’tt - E- Ett)/(1+)/(1+ii) ) tt = MC = MC = = EE00 + C + C -- at n=56 and -- at n=56 and tt =1 =1

• If If ii > the mkt int rate on financial investment ( > the mkt int rate on financial investment (rr) ~ Bob ) ~ Bob will increase his wealth by getting the added yr of will increase his wealth by getting the added yr of schoolingschooling

• If If ii = = rr Bob will be indifferent between investing in Bob will be indifferent between investing in financial capital or human capitalfinancial capital or human capital

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• Why the rate of return to schooling will decline with Why the rate of return to schooling will decline with each added yr of schooleach added yr of school

1.1. MC increasesMC increases• The opportunity cost, EThe opportunity cost, E00 increases because the wage rate increases because the wage rate

employers are prepared to pay increases with educationemployers are prepared to pay increases with education

2.2. MB decreasesMB decreases• Each additional yr of schooling reduces the remaining yrs Each additional yr of schooling reduces the remaining yrs

during which an indiv works , shortening the expected during which an indiv works , shortening the expected streams of benefits of added schooling and reducing the streams of benefits of added schooling and reducing the MBMB

3.3. Law of Diminishing Marginal ProductivityLaw of Diminishing Marginal Productivity• As the no of additional schooling rise, the rate of return As the no of additional schooling rise, the rate of return

to additional education falls (i.e. increasing at a to additional education falls (i.e. increasing at a decreasing rate)decreasing rate)

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Signaling/Screening TheorySignaling/Screening Theory

• An alternative theory of investment in An alternative theory of investment in educationeducation

• Says:Says:– It could be rational to invest in costly It could be rational to invest in costly

education even if education adds nothing education even if education adds nothing directly to a worker’s marginal productdirectly to a worker’s marginal product

• Assumes:Assumes:– People are born with different innate ability – People are born with different innate ability –

i.e. some are good at most things, others are i.e. some are good at most things, others are less smart and on average less productive less smart and on average less productive

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Signaling/Screening Theory Signaling/Screening Theory … … contcont

• Suppose higher education contributes Suppose higher education contributes nothing to productivity. Before making this nothing to productivity. Before making this costly investment how can school leavers costly investment how can school leavers be assured that their future earning will be assured that their future earning will offset the initial cost?offset the initial cost?

• Signaling theory says:Signaling theory says:– In going on education, smart people are In going on education, smart people are sending sending

a signala signal to employer that they are highly to employer that they are highly productive (prospective) employeeproductive (prospective) employee

– Higher education is Higher education is screening outscreening out the smart high the smart high productivity workersproductivity workers

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• Thus, firm can be assured that they are Thus, firm can be assured that they are the high-ability workersthe high-ability workers

• In short:In short:– Signaling theory says that education is used as Signaling theory says that education is used as

a signal/screening that the person is a signal/screening that the person is productiveproductive• i.e. formal education don’t teach you anything but i.e. formal education don’t teach you anything but

signaling that you are productivesignaling that you are productive

• Thus, to be effective, the screening Thus, to be effective, the screening process must indeed separate the high-process must indeed separate the high-ability workers from the othersability workers from the others

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• But, why don’t lower-ability workers go to But, why don’t lower-ability workers go to university and fool firms into offering them university and fool firms into offering them high wages?high wages?

1.1. They do not expect to passThey do not expect to pass

2.2. They may feel that in order to scrape through they They may feel that in order to scrape through they will have to work enormously and unpleasantly hardwill have to work enormously and unpleasantly hard

• Since most people know their own ability, Since most people know their own ability, firms may take it on trust that people who firms may take it on trust that people who have stuck it out till their final year at have stuck it out till their final year at university believe themselves to be at the university believe themselves to be at the higher end of the ability rangehigher end of the ability range

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• In short, the signal used (e.g. college education) In short, the signal used (e.g. college education) should be the signal that not everybody has itshould be the signal that not everybody has it

• Caution about signaling theory:Caution about signaling theory:– Relates to discrimination ( more productive will Relates to discrimination ( more productive will

be paid more)be paid more)– One may choose to manipulate signals (e.g. One may choose to manipulate signals (e.g.

education) – e.g. if you want to get more wage, education) – e.g. if you want to get more wage, get more educationget more education

– But, some signals are not manipulative – e.g. But, some signals are not manipulative – e.g. race and genderrace and gender• Thus, it’s a Thus, it’s a DISCRIMINATIONDISCRIMINATION – e.g. use race as a signal to – e.g. use race as a signal to

determine whether he’s productive or notdetermine whether he’s productive or not

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• Points to ponder:Points to ponder:– The distinction between individual vs social benefitThe distinction between individual vs social benefit

• Individual benefit – invest in human capital to earn moreIndividual benefit – invest in human capital to earn more• Social benefit – If education raises productivitySocial benefit – If education raises productivity

• Suppose the only function of higher education Suppose the only function of higher education was to signal which were the higher-ability was to signal which were the higher-ability workers workers – it make sense to an indiv to go to univ but, does it it make sense to an indiv to go to univ but, does it

make any sense to the society as a whole?make any sense to the society as a whole?– Perhaps it’s should be replaced by cheaper method of Perhaps it’s should be replaced by cheaper method of

signaling – i.e. conducting a national IQ test adjusted signaling – i.e. conducting a national IQ test adjusted for disadvantages and previous opportunity to learnfor disadvantages and previous opportunity to learn

WHAT DO YOU THINK???WHAT DO YOU THINK???

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Human Capital as a HH Human Capital as a HH ActivityActivity

• Recall Recall the division of time:the division of time:– Mkt work vs. hh prod vs. leisureMkt work vs. hh prod vs. leisure– The decision of time allocation is based on,The decision of time allocation is based on,

• The real wage rate that the employer wld be willing to payThe real wage rate that the employer wld be willing to pay• Individual productivity in the hh productionIndividual productivity in the hh production• Individual relative preference for leisure vs good (i.e. Individual relative preference for leisure vs good (i.e.

purchased vs homemade)purchased vs homemade)

– In SR, individual have no control over real wage In SR, individual have no control over real wage rate and productivity in the hh productionrate and productivity in the hh production

– In LR, individual considerably control their In LR, individual considerably control their productivity and hence income trough devoting productivity and hence income trough devoting time and resource to human capital formationtime and resource to human capital formation

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Human Capital as a HH Human Capital as a HH Activity Activity ……contcont

• Actually time allocation consisted of 4 Actually time allocation consisted of 4 activitiesactivities

– Market work; HH production; Leisure Market work; HH production; Leisure ANDAND– Human capital formation – Human capital formation – why?why?

1.1. Human capital is a separate HH activity when it Human capital is a separate HH activity when it takes place via formal schoolingtakes place via formal schooling

2.2. Human capital formation occurs in mkt work Human capital formation occurs in mkt work when the investment takes the form of mkt when the investment takes the form of mkt work experiencework experience

3.3. HKI also takes place in the in conjunction with HKI also takes place in the in conjunction with HH prod when the formation takes the form of HH prod when the formation takes the form of hh prod experiencehh prod experience

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Study time, part-time work Study time, part-time work and academic performanceand academic performance

• StudyingStudying vs vs part time workpart time work – A trade-off between A trade-off between academic performanceacademic performance and and

future consumptionfuture consumption

1.1. An increase 1hr/wk of PT reduces GPA by 0.09An increase 1hr/wk of PT reduces GPA by 0.09• Why? A std who does more PT work must reduce the Why? A std who does more PT work must reduce the

no of credit taken or because the std obtain lower no of credit taken or because the std obtain lower gradegrade

2.2. Student loan do increases academic Student loan do increases academic performanceperformance in that student use the money to in that student use the money to reduce PT, buy study time, and increase GPAreduce PT, buy study time, and increase GPA• An added USD$1000 of student loan translates to an An added USD$1000 of student loan translates to an

avg of 0.5 GPAavg of 0.5 GPA

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Expectation and the sex Expectation and the sex typing of HKItyping of HKI

• Generalization of MB ≥ MCGeneralization of MB ≥ MC– MB -- Is actually the contemplated MB of HKIMB -- Is actually the contemplated MB of HKI

• Sex typing of HKISex typing of HKI– HKI occur when individuals expectation or those HKI occur when individuals expectation or those

of their parents, about their future activities of their parents, about their future activities depend upon genderdepend upon gender

– Historically –females were expected to spend Historically –females were expected to spend majority of their live in HH and leisure activities majority of their live in HH and leisure activities • Thus, MB to labor specific HKI by or on behalf of Thus, MB to labor specific HKI by or on behalf of

females were lower than those malesfemales were lower than those males• Hence, reducing the amt of such investment made by Hence, reducing the amt of such investment made by

females or by society and parents on their behalffemales or by society and parents on their behalf

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Expectation and the sex Expectation and the sex typing of HKItyping of HKI …cont…cont

• Another area of HKI sex typing – Another area of HKI sex typing – HH HH ProdProd

– What is the expectation?What is the expectation?– Consequently:Consequently:

• training related to household chorestraining related to household chores

– Check:Check:• Participation of boys and girls in household Participation of boys and girls in household

choreschores• Time allocation and division of labor in the HH Time allocation and division of labor in the HH

between men and womenbetween men and women

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Health as a Human Capital Health as a Human Capital InvestmentInvestment

• Decision to invest in one’s health – MB ≥ Decision to invest in one’s health – MB ≥ MCMC

• What make health different fr other type What make health different fr other type of HKI?of HKI?

– Increase yr of schooling will not increase Increase yr of schooling will not increase one’s expected life span, but investing in one’s expected life span, but investing in health willhealth will

– Learning-by-doing will not prevent sickness Learning-by-doing will not prevent sickness from reducing the number of days of from reducing the number of days of activities per year, proper nutrition and other activities per year, proper nutrition and other preventive health measure willpreventive health measure will

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Health as a Human Capital Health as a Human Capital InvestmentInvestment …cont…cont

• Investing in health reduces the no of Investing in health reduces the no of absentees due to medical reason per year.absentees due to medical reason per year.

– Consequently it increase one’s productivity and Consequently it increase one’s productivity and time usetime use

• What affect one’s current health statusWhat affect one’s current health status– Individual’s age; Own and spouse’s education; Individual’s age; Own and spouse’s education;

Past health statusPast health status• These areThese are factors affecting individual’s “demand for factors affecting individual’s “demand for

health” – i.e. the demand arising from both the future health” – i.e. the demand arising from both the future benefit of investing in one’s health today as well as benefit of investing in one’s health today as well as the consumption benefits of enjoying being healthy the consumption benefits of enjoying being healthy currentlycurrently

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Health as a Human Capital Health as a Human Capital InvestmentInvestment …cont…cont

• Interesting link between education Interesting link between education and HKI in healthand HKI in health

– HKI in education -- (+) -- HKI in healthHKI in education -- (+) -- HKI in health– Health -- (+) -- intellectual development Health -- (+) -- intellectual development

of childrenof children• In short, healthy children accomplish more in In short, healthy children accomplish more in

school. Better educated people are healthierschool. Better educated people are healthier

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Human Capital, Marriage Human Capital, Marriage and Divorce Investmentand Divorce Investment

• HK formation, especially one gained through HK formation, especially one gained through experience in HH activities, takes place in experience in HH activities, takes place in the context of a HH, the context of a HH,

– Thus, the type of HH affect return of HKI, Thus, the type of HH affect return of HKI, hence the amt and type of HK formationhence the amt and type of HK formation• Single – cannot exploit specialization of Single – cannot exploit specialization of

function and economics of scale in hh prod function and economics of scale in hh prod activities, single do less chores thus HH prod activities, single do less chores thus HH prod experienceexperience

• Married couple with many children accumulate Married couple with many children accumulate more child-specific HK via experience than more child-specific HK via experience than unmarried, males and couples with no childrenunmarried, males and couples with no children

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FEM 4204 HUMAN CAPITAL: INVESTING IN ONESELF AND ONE’S FAMILY

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