Running head: INVESTMENT IN HUMAN CAPITAL

Investment in Human Capital Renuka Kumar University of Maryland University College

INVESTMENT IN HUMAN CAPITAL Investment in Human Capital

The main contention of the article, Investment in Human Capital, by Theodore Schultz is that investment in human capital accounts for most of the impressive rise in the real earnings per worker (Schultz, 1961, p. 1). Schultz (1961) recognized that investing in human capital in the form of education, training, and health among other activities raises the productivity of individuals and as a result increases the lifetime earnings of the worker. This essay will define Human Capital Theory (HCT) and look at the strengths and weaknesses of the HCT. Discussion The Human Capital Theory Most people do not think of skills and knowledge as a form of capital. They also do not realize that governments are deliberately investing in this capital, nor do they realize the size of this investment (Schultz, 1961). In fact, most people are offended by the thought of treating human beings as wealth and looking at human beings as capital. Because of the worlds history with slavery and indentured workers our value system and beliefs make it difficult for us to relate to human beings as capital goods (Schultz, 1961). The Human Capital Theory, however, categorizes skills and knowledge as capital. HCT argues that knowledge and skill are a result of investment and it is this investment in human capital that has led to greater economic success in the developed countries. The basis of the HCT is that education leads to productivity which leads to increased income. In other words, educated people earn more because they are more productive. The HCT provides us with ways to measure human capital and the rate of return (RORE) on investments in human capital to the individual and to the economy as a whole.

INVESTMENT IN HUMAN CAPITAL Strength of Human Capital Theory

The connection between education and productivity provides governments with motive to invest in human capital. Schultz (1961) recognized that investment in human capital was an important factor in the national economic growth of a country. In fact, many studies have shown that the economy as a whole benefits from increased productivity and that investment in human capital is essential for sustained economic growth over time. Not only does the individual have more earnings with the HCT, but the increased earnings of the individuals result in greater tax revenues for the government (Schultz, 1961). The government, therefore, has an incentive to invest in human capital. Schultz (1961) acknowledges the difficulty in exactly measuring human investment; however, there are some activities that improve human capabilities, such as the investment in education, training and health services. The investment in health facilities and services has far reaching consequences. Not only does it provide benefits to the individual, it also affects the communities. Better health affects the life expectancy and the improvement in health for the population (Schultz, 1961). In underdeveloped countries investment in health can take the form of additional food and better shelter (Schultz, 1961). Schultz (1961) argues that investment in education by government has risen dramatically and this investment by itself may well account for a substantial part of the otherwise unexplained rise in earnings (p.10). On an individual level HCT measures the rate of return on an individuals expense in education including the loss of income while getting an education. On an economic level HCT measures the increased economic output against the public expense of investing in education. Schultz (1961) states that in spite of the rise in the cost of education the

INVESTMENT IN HUMAN CAPITAL returns on education is better that the investment in nonhuman capital. Government, therefore, invests in health and education because of the returns in the form of higher tax revenues and the growth of the economy. As a result many individuals who otherwise would not have access to health and education are able to benefit from these investments. Employers also prefer high-productive individuals to maximize profits to their

organization. An investment in education can also lead to the potential of upward mobility of the worker in the internal labor market. Another benefit of an investment in education is that it can help with job-seeking and employable opportunities (Kwon, 2009). Additional forms of investment outlined by Schultz (1961) are on-the-job training, elementary, secondary and high school education, study programs for adults, and migration of families to areas with job opportunities. All these investments provided by the government benefit not only individuals but communities at large. Weakness of Human Capital Theory Schultz (1961) acknowledges that there are perils with discussing the social implications of human capital. He states that racial and religious discrimination exist and these can affect an individuals opportunities in the labor market. An individuals race, sex, age or social background can affect the earnings potential of an individual. As an example, men and women with the same educational background continue to have inequalities in wage earnings (Tierney, 2002). Schultz (1961) also points to the failure of the government, in the past, to invest in the health and education of certain classes of people such as Negroes, indigenous migratory farm workers and older workers. This is evidenced by the lower earnings of these workers. He

INVESTMENT IN HUMAN CAPITAL stresses the importance of not repeating this mistake in the future. In order to capitalize on the

HCT all individuals must be valued equally and the same opportunities need to be available to all members of society regardless of different classes, race and gender. In addition, Schultz (1961) acknowledges that existing tax laws discriminate against human capital in favor of nonhuman capital. He also recognizes that in addition to changing tax laws, banking practices need to change to allow more loans to students so that they may invest in education. While there are many statistical findings that relate higher earnings with more education there is no conclusive evidence that more education necessarily leads to higher earnings. It has been argued that individuals with more education do well in the labor market not because of their education but because of other abilities such as ability, self-discipline and motivation (Human Capital, 2014). In addition, unemployment can lead to the loss of skills of workers because they are not these skills and as a result can lead to a deterioration of human capital (Schultz (1961). A criticism of the HCT comes from the Screening Theory which questions whether the knowledge and skills learned from education lead to increased productivity. Instead Wolf (2002) argues that education today is a socially acceptable way of ranking people which most employers would find hard to do without (p. 29). Wolf states that the number of years one stays in school is a reflection of an individuals motivation and perseverance. Employers assume that graduates are smarter and will be more productive and keep the better paying jobs for them (Wolf, 2002). Wolf (2002) also argues that the link between education and national economic growth is not clear cut. Could it be that growth causes education, rather than education causing growth?

INVESTMENT IN HUMAN CAPITAL (Wolf, 2002, p. 45). Education increases productivity and as a result people have higher earnings. The now prosperous parents will want their children to get an education especially since more people are earning degrees and education is being used as a selecting tool by prospective employers. While this investment in education is certainly beneficial to the

individual, Wolf (2002) states that it is not clear if the extra education is benefitting the economy and whether public money should be spent on it. Critics also point to the difficulty in measuring worker productivity and future income and whether all investments in education guarantee a positive rate of return (Human Capital, 2014). As more and more individuals receive higher education will the education credentials lose value? The argument of the positional goods theory is that if supply and demand do not rise hand-in-hand and if the value of education is not upheld in the labor market then more education will not necessarily justify the investment in higher education (Marginson, 1993). Conclusion According to Schultz (1961) investment in human capital is a major feature of our economic system. He argues that many of the unexplained rises in earnings of workers are explained by the returns to the investment in human capital of the workers. Without this investment there would only be hard, manual work and poverty except for those who have income from property (Schultz, 1961, p. 16). The HCT has been criticized by the screening theory as well as the positional goods argument among others. However, in spite of the criticisms one cannot ignore the benefits of the Human Capital Theory to individuals in the form of higher earnings and to society as a result of investments in higher education, health and wellness.

INVESTMENT IN HUMAN CAPITAL References Human Capital. (2014). Retrieved from Encyclopedia of Business: http://www.referenceforbusiness.com/encyclopedia/Gov-Inc/Human-Capital.html Kwon, D. (2009). Human Capital and Its Measurement. The 3rd OECD World Forum on Statistics, Knowledge and Policy. Retrieved from http://www.oecd.org/site/progresskorea/44109779.pdf Marginson, S., & Melbourne Univ. (Australia). Centre for the Study of Higher, E. n. (1993).

Educational Credentials in Australia: Average Positional Value in Decline. Centre for the Study of Higher Education Research Working Papers, 93.4. Schultz. T. (1961). Investment in human capital. The American Economic Review, 51(1). 1-17. Tierney, H. (2002). Human Capital Theory. Women's Studies Encyclopedia. Greenwood Press, Retrieved from http://gem.greenwood.com/wse/wsePrint.jsp?id=id317 Wolf, A. (2002). Elixir or snake oil? Can education really deliver growth? In A. Wolf (Ed.), Does education matter? Myths about education and economic growth (pp. 13- 55). London: Penguin books.