The human capital model

The human capital model forms the basis for several explanations of individuals earnings. This theory assumes that individuals invest in human capital (which includes education, training, health care and migration) in the expectation of participating in both labour and non-labour market activities. The type and quantity of the investment determines an individual's wage (including reservation wage for non-workers). The individual is assumed to maximise lifetime earnings given the costs and benefits associated with the investment in human capital.

12 13

Smith, A.,(1776), pi 16-117. See Rosen, S.,(1981)

The model is derived from papers of Ben-Porath (1967), Mincer (1974) and Becker (1975). Following Mincer and Polachek (1974), the human capital earnings function may be stated as

(1) Et = rCtl

where Et is the gross earnings in period t, Ct_i is the dollar amount of investment in period t-1 and r is the average rate of return to an individuals human capital. Rewriting (1) (2) E, = £ „ + r § J- E ,-, Re-writing (2) (3) E, = E,.i + E, . i r k,.i = E,,(1+ r k j

where kt. \ is the ratio of investment expenditure to gross earnings in period t-1. Following a simple expansion of (3), and assuming that r is a constant 14, and noting Et=Eo(l+rk0)(l+rki)....(l+rkt_i), may be approximated by the logarithmic statement In (1+rk) ~rk, then

t - i

(4) £, = £„ + r 5 > ,

School and post school experience may be separated as follows (5) £ , = £ 1 + r X k 1 + r ^

i=0 i=s

where kj and kj are investment ratios during and after school respectively. Imposing the assumption that the investment ratio in school equals one, the earnings function becomes

t —1 (6) Et = E0 + rs + r ^ JkJ

j = s

We may now estimate this equation as (7) Wi = X'ß + e

where is the hourly wage rate for individual i, and X represents a vector of endowments which include educational attainment (which may be either years of schooling or, as is done in this paper, dummy variables for each classification allowing for different returns to each level of education), experience is labour force experience (using the Mincer approximation of age in years - age left school)15, as well as occupational, demographic and other human capital terms. As returns to experience are not thought to be constant over an individuals lifetime, a quadratic experience term is also included in the specification of the earnings function.

Productivity improving investment in human capital may take two forms- formal education and on-the-job training. In the case of formal schooling, individuals pay the direct costs of tuition and forgo current earnings in order to raise their future productivity which in turn leads to higher wages than they would be otherwise able to achieve. For on-the-job training 16 Becker (1975) identified two types of training - general and specific. He argued

[g]eneral training is useful in many firms besides those providing it..[and]..[e]mployees pay for general on-the-job training by receiving wages below what they would receive elsewhere 17

Contrasted to this is

A discussion of this specification of the experience term is conducted in Chapter 5. Additional regressions which attempt to demonstrate the sensitivity of other regressors to the specification o f the experience term is undertaken in Appendices F and G.

Arrow (1962) proposed that " technical change in general may be ascribed to experience, that is the very activity of production which gives rise to problems for which favourable responses are selected over time". That is, Arrow argues increases in total labour productivity may arise from factors other than physical capital investment changes.

[completely specific training [which] can be defined as training that has no effect on the productivity of trainees that would be useful to other firms18

For specific training, the costs and benefits are shared between the employer and employee.

The shares of each depend on the relations between quit rates and wages, layoff rates and profits, and on other factors....such as the cost of funds, attitudes toward risk and desires for liquidity19

Training may not be completely specific nor completely general. Becker argued that both type of training have a similar effect on productivity.

The predictions of the model with respect to the investment in human capital for full- and part-time employment suggest that individuals who intend to work in part-time work rather than full-time work will invest in lower levels of human capital if the rate of return to effort are the same for both groups. This results from an individual evaluating the lifetime returns to human capital investment. Since costs, unlike benefits, of education are not dependent upon the intensity of labour force participation20, the number of years of workforce experience required for an individual to break-even regarding their investment in human capital is longer for individuals working part-time rather than full-time. Thus, in cost-benefit terms, part-time workers would be expected to undertake lower level of education than full-time workers21.

Also, individuals who treat part-time work as a short-term proposition before or after undertaking full-time work (such as the young, old and those with young dependants) will be more closely related to full­ time workers than those not in the labour force with respect to their human

Becker, G.S.,(1975),p26

Becker, G.S.,(1975),p30. An extension of this single period model to a two period model is analysed in Hashimoto (1981).

For a discussion of recent changes to student fees in Australian higher education see Chapman, B.J., Chia, T.T.,(1992)

capital endowments. Part-time work may also be viewed as a means to lower the rate of human capital depreciation which would be observed if the individual withdrew completely from employment.

In summary, the simple predictions from the human capital model with respect to part-time workers may be summarised into three. Firstly, part-time workers are predicted to have less education than full-time workers since their expected labour force commitment is lower. Additionally, the education part-time workers obtain will depreciate a higher rates than full-time workers due to reduced workforce exposure. Secondly, since part-time workers has a smaller hours schedule than full­ time workers, employers are less likely to provide training for part-time workers, and hence their productivity is predicted to be lower than that observed for full-time workers. Thirdly, by its very nature, part-time workers will obtain less workforce experience than full-time workers.