Chapter 6
Copyright © 2009 Pearson Education, Inc. Publishing as Pearson Addison-Wesley
Human capital
So far, “labor” is the OTHER factor of production
(other than K)
Yet not all workers are of equal “quality”
• Healthy and unhealthy
• Educated and not educated
The human input to production may be seen as a type
of capital (HUMAN CAPITAL)
“Human capital” – HK – comes in two main types:
health and education
Human capital is “capital”
HK shares many features of physical capital
• Human capital may be productive
• Human capital is itself produced through the process of
education and training
– Not a natural resource
• Human capital earns a rate of return, which motivates its
– Educated or healthier worker earns higher wage
– Good-looking workers earn 12% higher wage than less goodlooking workers
• Human capital also wears out
Human capital is positively correlated
with Gdp per capita
1. Nutrition versus GDP per Capita
Human capital is positively correlated with Gdp
per capita
2. Life Expectancy Versus GDP per Capita
Human capital is positively correlated with Gdp per
3. Average Years of Schooling Versus GDP per
HK and per-capita Gdp: what is
causing what?
Is economic development (that is: higher per-capita
Gdp) that feeds into higher health and education
Or rather are well-fed and well-educated workers to be
more productive and raise per-capita Gdp?
Human capital
Per-capita Gdp
Who knows? Problem solved with statistical methods
The rate of return to education
Problem in computing economic return to education:
HK is “embodied” in each person
• Educated people typically earn a higher market wage
compared to people with no education
• Premium varies with amount and quality of
• Take total number of schooling years as a proxy
– Doesn’t account for different quality of schooling
Returns to schooling are diminishing -13.4% on primary education – 10.1% on low
secondary – 6.8% for higher secondary and tertiary
These are average values for rich and poor countries
How to compute the rate of return
(r.o.r) to education
What is the r.o.r. to the first year of schooling?
• 13.4%, that is a person who has gone to school for one
year will earn 1.134 times the salary of a person with no
How about two years of schooling (with respect to noschooling)?
• W2 = 1.1342 W0 = 1.29 W0
How about five years of schooling (wrt no-schooling)?
• W5 = (1.1344 x 1.101) W0 = 1.82 W0
• The educational premium to 5 years of schooling is 82%
Ratio of Tertiary Wages to HighSchool Wages
In the U.S. the educational premium has gone up a lot over
time. This is true for the rest of the world as well
How much of the cross-country income
gaps is explained by education?
We have pinpointed big differences in countries’
levels of HK
Now want to understand the extent to which such
differences translate into differences in income
per capita across countries
We just focus on schooling (and not on training or
other informal ways of accumulating HK)
Quantitative implications of
Y = Akα(hL)1-α = (h1-αA) KαL1-α
Formula (6.1) answers the question: What would it be
the income gap between country “i” and “j” when the
two countries exhibit identical A, n and δ?
Problem: In country j number of years of schooling
is two; in country i it is 12.
Compute the income gap in the steady state
• hj = 1.1342 x h0 = 1.29 x h0
• hi = 1.1344 x 1.1014 x1.0684 x h0 = 3.16 x h0
yiss/yjss = hi/h j = 3.16 / 1.29 = 2.47
More systematically: predicted versus
Actual GDP per Worker using
schooling years
Copyright © 2009 Pearson Education, Inc. Publishing as Pearson Addison-Wesley
What is left out of our model
Quality of schooling

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