1. Economics 324: Labor Economics Please read Chapter 7, Human Capital. Reminder: You must take the 2nd oral exam by Thanksgiving break (don’t assume I can make time at the last minute) Workshops begin Thursday (Margaret, Doug, Nabil) … only 25 minutes each!

2. Human Capital Theory “Give a man a fish and you feed him for one day. Teach a man to fish and you feed him for a lifetime.” – Chinese proverb Theory of Compensating Wage Differentials suggests that wages differ among people because jobs are different. Wages also differ because people are different. A person’s human capital is their unique set of knowledge, skills, experience, and ability. Human capital can also be thought of as one’s accumulated investments in education, job training, and migration while Non-human capital is society’s stock of natural resources, building, machines, etc. (64% avg) Three types of investment in human capital: 1. education and training 2. migration 3. job search

3. Optimal Acquisition of Human Capital Comparison of benefits and costs Costs Benefits Present value of a stream of benefits/costs Relevant comparison PV(B) > PV(C) –Assume utility maximization –Assume lifetime perspective taken Two methods 1. Present value method specify r & compare 2. Internal rate of return method solves for r Assume MC of another unit of HC is constant MB declining because another year of school creates shorter time horizon $ Human Capital MC’ MC PV(MB) HC*HC’ $ Human Capital MC PV(MB) HC*HC’ PV(MB’)

4. Present Value method example An unskilled laborer earns $20,000 per year. Suppose that by taking courses at UNC Tech for a year, the person can qualify for a job paying $23,000/year, lasting 10 years. Tuition/books for the year cost $2,000. r = 6% Is this a good investment? Internal Rate of Return method example A worker is offered a salary bonus of $2,000 per year for 2 years if he or she enrolls in a job training program this year. Total cost is $3,500 (including forgone earnings) (a) what is the internal rate of return for this investment? 9.38% (b) Is it a good investment for someone with a discount rate of 6%? (c) What is the highest discount rate a person can have and still find this investment attractive? Why might people have higher discount rates? (d) Why are older workers less likely to seek out or be offered “on-the-job” training? Optimal Acquisition of Human Capital

5. Demand for College Education Let’s measure the demand for college education by the % of graduating HS seniors who matriculate (this abstracts from finances or grades/SAT) Gender197019801990 199319962001 Men55.2%46.757.859.760.159.7 Women48.5%51.062.065.469.763.3 Avg increase 0.3% 1.0% 1.0% Consumption or Investment? Choice is broadly between two lifetime income streams Predictions of our theory: 1. r 2. T 3. C 4. B Expectations are important in # 4  Could have cobwebs in college attendance

6. Age-Earnings Profiles Age-earnings profiles display four main patterns: 1. Average earnings (for full-timers) tend to rise with level of education 2. Concavity Murphy & Welch (1990), JoLE: 2 / 3 of career wage growth occurs in first 10 years of work. 3. Higher educated individuals have steeper profiles (“fanning out”) 4. Female profiles are less concave and fan out less than male Reasons?

7. Age-earnings profiles

9. Returns to Education Is additional education a good investment? Studies of the monetary costs and benefits estimate a real internal rate of return to education at 5 - 15 %, about 9% in the 1990s. So educational investments are comparable to financial investments Caveats: 1. Upward bias 2. Downward bias 3. Selection bias Estimating the Rate of Return to Schooling –Twins (3 or 15%) –Vietnam Draft lottery (7%)

10. Selection Bias Example Doug is adept at “blue-collar work” (no training required) & Wendy at “white-collar” work (requiring another year of schooling) WorkerEarnings in Blue-Collar job Earnings in White-Collar job Doug$20,000$40,000 Wendy 15,000 41,000 With 10% discount rate, and people living for only 2 periods, WorkerPV if no more school PV if go to school Doug$38,181 $36,363 Wendy 28,636 37,273 We observe $38,181 and $37,273 in the actual data Did Wendy make a big mistake? –No! This is comparing apples to oranges because workers sort themselves into occupations. Doug & Wendy both made the right choice for them. Comparative advantage is important factor in making choices about schooling & occupations.

11. Is Education a Good Social Investment? Empirical studies seem to indicate education is a good individual investment Is education primarily a signaling device in the labor market? If education doesn’t improve one’s skills, but only helps firms identify those with the highest innate ability, higher education may be socially unnecessary! Example For education to be an effective signal, cost of acquiring signal must be strongly & inversely related to worker’s productivity PV ($100K) 16 12 Education (years) 12 1620 0 8 4 C low-prod C high-prod

12. Is Education a Good Social Investment? Would 18 years be an effective signal? 14 years? Evidence on whether education is primarily a signal or whether it actually increases a worker’s productivity is inconclusive. –Signaling proponents argue: “higher rate of return for college graduate compared to a college dropout means the piece of paper is just a signal.” –Productivity proponents argue: “the dropouts get a lower return because they overestimated their ability and quit.” Worker and firm perspectives