Human Capital Research Paper

This analogy between investment in physical capital and investment in human capital was recognized by several eighteenth and nineteenth-century economists, but not fully developed until the 1960s when US economists such as Schultz and Becker published a series of influential works, notably Investment in Human Capital (Schultz 1961) and Human Capital (Becker 1964), which explored the idea and implications of investment in human capital by attempting to measure, for the first time, the rate of return to investment in education and training. This new emphasis on empirical analysis of human capital, described by another US economist, MaryJean Bowman (1966), as ‘the human investment revolution in economic thought’ proved to be a powerful influence, not only giving rise to a whole new branch of economics—the economics of education— but also affecting education policy in both industrialized and developing countries in a number of ways. This contribution summarizes research and literature on educational aspects of human capital, discusses ways in which estimates of rates of return and the links between education, employment, and economic growth have influenced education policy, particularly on the financing of education, and examines a number of criticisms of the concept of human capital, including the idea that education often represents a ‘screening device,’ rather than a genuinely productive form of investment, and the more recently developed concept of ‘social capital,’ which challenges narrow definitions of human capital.

1. Measuring The Rate Of Return To Investment In Education

The notion that education is investment in human capital represents more than a simple analogy between education and investment in physical capital. It implies that it is possible to measure the returns to investment in education, and to apply cost–benefit analysis to decisions about education expenditure, in the same way as rates of return are used to analyze the profitability of investment in conventional physical capital. Cost–benefit analysis is designed to express the costs and benefits of a project in monetary terms, and to calculate its expected profitability, or rate of return, by comparing all future benefits with the total costs of the investment. As noted above, there were several early references to the idea of human capital in eighteenth and nineteenth-century economic literature, but the first serious attempts to measure the economic costs and benefits of education, and compute rates of return, were in the USA in the 1960s. (Schultz 1961, Becker 1964). These were followed quickly by estimates of the rate of return to education in many other countries. Psacharopoulos (1973) presented international comparisons of rates of return to education, both as a social and as a private investment, in 32 countries, and subsequently published several attempts to update and summarize estimates of rates of return around the world, including more than 50 industrialized and developing countries (see, for example, Psacharopoulos and Woodhall 1985, Psacharopoulos 1994).

Such estimates of the rate of return to educational investment for the individual (the private rate of return) or to society as a whole (the social rate of return) rest on several crucial assumptions. Cost–benefit analysis of education assumes that the economic benefits of education can be measured in monetary terms by using the average earnings differentials between more and less educated workers as a measure of their superior productivity. Workers with higher levels of education have better employment opportunities, and therefore higher average lifetime earnings, than those with less education, and these additional earnings, after various statistical adjustments, are used by economists as a proxy measure of the direct economic benefits of education, and compared with the private and social costs of education (including costs of tuition and earnings forgone by students in school or university). Most rate of return estimates concentrate on these direct monetary benefits, and either ignore or sidestep the problem of measuring the indirect benefits to society (sometimes called ‘spillover’ benefits or ‘externalities’) of investing in education. More attention has been paid recently to indirect benefits, but most rate of return estimates still rely mainly on the direct monetary benefits of investment in human capital.

International comparisons of rates of return to education (for example Psacharopoulos and Woodhall 1985) reveal certain general patterns:

(a) Social returns are consistently lower than the private rate of return.

(b) Social and private rates of return to primary education tend to be higher than rates of return to secondary or higher education.

(c) The rate of return to education is higher in developing countries than in developed countries.

(d) The rate of return to investment in education is higher than the average rate of return to physical capital in developing countries, though not necessarily in developed countries.

2. Implications Of Rates Of Return For Education Policy

Analysis of costs, benefits, and rates of return on investment in human capital raises important implications for both economic and education policies. The idea that education contributes to economic growth by developing and disseminating knowledge, and by improving the quality and productivity of the labor force, is now widely acknowledged and has influenced the economic strategies and educational planning of many individual governments, as well as international agencies and multilateral agencies such as the World Bank. For example, a study for the World Bank (Psacharopoulos and Woodhall 1985, p. 3) notes that:

Education, like other forms of investment in human capital, can contribute to economic development and raise the incomes of the poor just as much as investments in physical capital, such as transport, communications, power, or irrigation. The World Bank … has long recognized the importance of investment in education and has been active in this field since 1962. When the Bank was first established in 1944, however, education was not counted among the productive purposes for which it was authorized to provide investment capital. This attitude prevailed right through the 1950s, when official statements of Bank policy took the view that the Bank should concentrate its lending on projects designed to make a direct contribution to the productive capacity of its members, rather than finance projects such as the construction and equipment of schools, colleges and universities. Even though such projects were considered essential to the development of a country, the Bank’s proper role, as a bank, was said to be confined to providing loans for the more directly productive sectors of the economy. Gradually, this attitude changed, however, both within the World Bank and in the world at large.

More recently, the 1998–9 World Development Report (World Bank 1999), devoted to Knowledge for Development, emphasized that ‘knowledge is crucial for development,’ arguing that education as a form of investment in human capital was a ‘key ingredient’ in the economic growth and success of East Asian economies such as Hong Kong (China) the Republic of Korea and Singapore (sometimes called the East Asian Miracle economies).

Policies determining investment by governments, lending by agencies such as the World Bank, and aid policies of bilateral and multilateral agencies have been influenced not only by the assumed and often demonstrated relationship between education and economic growth, but also by the consistent finding that the rate of return to primary education is the highest among all educational levels, particularly in developing countries. Studies of the economic benefits of primary education were influential in building support for the World Conference on Education for All at Jomtien in 1990, and for the subsequent emphasis on achieving universal primary education as an economic as well as an educational goal (see Colclough and Lewin 1993).

Rate of return estimates also have important implications for policies on education finance. The fact that private rates of return to educational investment are higher than the social rate of return, particularly for higher education, has been used to justify the introduction of tuition fees or student loans at the university level in several countries. For example, when the UK government first announced the introduction of student loans in 1988, the Department for Education and Science (1988, p. 10) presented estimates of social and private rates of return and argued that:

the return on the individual graduate’s personal investment in higher education … in recent years has been in the region of 25 percent, taking all subjects together. The same analysis shows that the return to society on its investment in the graduate’s higher education has been much lower: between 5 percent and 8 percent. The individual graduate benefits more than the community as a whole from the latter’s investment in the former’s higher education. The division of costs, on the other hand, goes the other way. That is why there is scope for the individual student to bear more of the cost of the investment.

Critics argue that such arguments ignore, or at least tend to underestimate, the indirect benefits of education, which accrue to society as a whole as much as (or even more than) the individual. These include the inter-relationships between education, family health, fertility and child mortality, which are now recognized as crucial components of the benefits of education for girls and women in developing countries. An early attempt to analyze differences between rates of return for males and females, (Woodhall 1973) emphasized that ‘human capital’ should not be interpreted as ‘investment in man,’ being just as relevant to women as to men, but there was little progress in developing measures of social or indirect economic benefits of education until the 1990s, when a study of Women’s Education in De eloping Countries (King and Hill 1993) included estimates of the returns to women’s education which demonstrated clearly the importance of social as well as monetary returns to education for women and girls. This led Larry Summers, then chief economist of the World Bank, to declare, in a Foreword to his book ‘I have become convinced that once all the benefits are recognized, investment in the education of girls may well be the highest return investment available in the developing world.’ (Summers 1993, p. v). This has crucial implications for policies to improve equity by reducing barriers to female participation in education.

3. Objections To Human Capital Theories: Education As A ‘Screening Device’

Although the concept of human capital has a long history in economic theory it remains a controversial idea, when applied to education, and there have been many objections and criticisms to the notion of measuring the rate of return to educational investment. The earliest discussions of human capital suggested that education or training raised the productivity of workers, and hence increased their lifetime earnings, by imparting useful knowledge and skills. However, this assumption was challenged by critics who argued that the earnings of educated workers reflected their superior ability, rather than the specific knowledge and skills acquired during their education. Moreover, critics argued that highly educated workers were more likely to come from higher social or income groups, to work in favored occupations and in urban rather than rural areas. Many estimates of rates of return to education now adjust the observed earnings differentials of educated people to allow for the observed influence of other factors, such as ability or social class background, on earnings, or in the absence of suitable data, they simply assume that 60 percent, rather than the full 100 percent of observed earnings differentials, are due to education, rather than ability or other factors (an adjustment that is often called the ‘alpha coefficient’ in the literature on the economics of education).

Many critics go further, however, and suggest that education does not improve productivity by imparting knowledge and skills, but simply acts as a ‘screening device,’ which enables employers to identify individuals of high innate ability or with certain personal characteristics, attitudes, or motivation, which employers value and which they therefore reward by means of higher earnings. This objection to theories of human capital, often called the ‘screening hypothesis,’ has attracted considerable controversy. Dore for example, in The Diploma Disease, an influential critique of the effects of education in developing countries, (Dore 1997, p. 93), presents many criticisms of what he calls the ‘rate of return argument,’ culminating in the assertion:

We observe people who have certain kinds of education subsequently (on average) getting higher levels of income than other people with less education. But how do we know that this enhanced earning power is because of their education (implying on a broader scale, that more education in a society would make that society more productive)? Is the ‘investment’ metaphor genuinely justified? Is it true that the education changes a man, enhances his capacity to work and in this way alters the price at which he can sell his labours?

Dore gives numerous examples of educational qualifications being used as a ‘screening device’ or ‘filter’ in selecting job applicants—an aspect of what he calls the ‘diploma disease’—and contrasts the ‘screening hypothesis’ with ‘traditional ‘‘human capital theorists’’ who persist in believing that people earn more because their education has changed them and that the ‘‘investment’’ assumptions of their rate of return analysis are correct’ concluding that ‘different institutional practices, different social structures, different educational traditions and degrees of equality of opportunity make the intervening mechanisms between schooling and earnings levels very different in different countries.’ (Dore 1997, pp. 94–5)

Such criticism was challenged, however, on the grounds that while a ‘weak’ version of the screening hypothesis is undoubtedly true, since employers may well use educational qualifications as a proxy for other characteristics when selecting their work force, there is no evidence to support the ‘strong’ version of the hypothesis, that education has no direct effect on productivity. The fact that employers continue to pay educated workers more than the uneducated throughout their working lives refutes this.

Even so, the idea of education as a screen or filter has been important in influencing theories of human capital. Blaug (1976, p. 850) in a review which he describes as a ‘slightly jaundiced survey of the empirical status of human capital theory’ predicts that:

in time, the screening hypothesis will be seen to have marked a turning point in the ‘human investment revolution in economic thought,’ a turning point to a richer, still more comprehensive view of the sequential life cycle choices of individuals.

4. Concepts Of Social And Cultural Capital

Just as economists now recognize that the concept of human capital must be enlarged to take account of the effect of education on individual attitudes and motivation, as well as knowledge and skills, and that the indirect benefits (externalities) of education may be even more important than the direct economic and monetary benefits, sociologists and scholars from other disciplines now emphasize the complementarities between human capital, social capital and other forms of investment. Bourdieu (1986) argued that ‘capital can present itself in three fundamental guises: as economic capital, which is immediately and directly convertible into money and may be institutionalized in the form of property rights; as cultural capital which is convertible, on certain conditions, into economic capital and may be institutionalized in the form of educational qualifications, and as social capital.’ (Bourdieu 1986, p. 47). At about the same time Coleman (1988, pp. 14–15) argued that analysis of the purely economic effects of human capital is deficient and needs to take into account social structures and relationships in the family and community as well as effects of investment on the individual: ‘norms, interpersonal trust, social networks, and social organization are important in the functioning not only of society but also of the economy.’ (Coleman 1988, reprinted in Dasgupta and Serageldin 2000, p. 14).

More recently the concept of ‘social capital’ has attracted considerable attention, including a new study for the World Bank (Dasgupta and Serageldin 2000) that emphasizes the complementarities between human capital and social capital, and between concepts from sociology, anthropology, and political science as well as economics, in analysis of the effects of investment and social action. The overwhelming conclusion of this review is that educational aspects of human capital must also be included in such a ‘multifaceted perspective.’

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