Lecture 5 - Human Capital

What is human capital?

1. Qualities of people that are productive (i.e. useful in producing more output)

-Health

-Education

-…

1. Qualities of people that are produced through investment

2. Earns a return to the worker if he/she works (cf. physical capital)

3. Depreciates over time

Overview within the lecture:

Possible drivers of income differences considered in previous lectures:

-Physical capital

-Population (quantity of labor)

Now: differences in the quality of labor or human capital as an explanation for income differences among countries

Heigh is a good indicator of malnutrition (exp. in first years of life)

-> In the US little correlation between height and wages

-> In Brazil, where malnutrition is extensive, high correlation between height and wages

Health and income:

How health interacts with income:

-> The intersection of the two curves determines the equilibrium levels of income and health

Consider a change in income that is unrelated to health (e.g. an exogenous improvement in productive technology. For every level of health, we have a higher level of income): for each level of h, higher y

Impact on equilibrium levels of health and income:

-Workers of any given health level can now produce more output

-The initial increase in output will in turn improve health

-The improved health will in turn increase output

-> Multiplier effect

Question: What is the primary source of differences in health and income between countries?

The Health view: all differences between countries have their roots in the countries’ health environments - that is, in things other than income that also affect health (geography, climate, diseases, etc.)

The Income view: all differences between countries have their roots in aspects of production that are unrelated to health (e.g. physical capital accumulation or technology)

In advanced economies, cognitive ability is far more important than physical ability in determining a person’s wage

Investment in education is a key form of investment in human capital

Direct costs: Like investments in physical capital, investment in human capital through education is costly (6,2% of US GDP)

Opportunity costs: Foregone income while in school - Almost as large as direct costs (12,4% of US GDP, same as investment in physical capital)

Physical capital earns a return - firms or workers are willing to pay to use a piece of physical capital

-> Measuring productivity of physical capital by looking at the rent it commands in the market

-> Measuring productivity of human capital is not as obvious

A person’s wage consists of two parts:

1. Raw labor (The person without human capital)

2. Human Capital

Physical capital’s share of GDP: 1/3

2/3 of GDP paid to labor

Decompose payment to labor in two parts:

1. Payment to raw labor

2. Payment to human capital

Share of human capital in wages:

Share of human capital in GDP:

Big differences in levels of human capital across countries

-> To what extent can income difference be accounted for by human capital?

h = amount of labor input per worker (human capital)

Production function depending on the quality of labor:

Change in capital:

Steady-state levels:

-> Variation in education explains some, but not all of the variation in income per worker among countries

-> Quality of education matters as well

In this version: human capital is constant over time

-> What if we consider the variation of human capital over time?

Capital per effective unit of labor:

Multiplying both sides by kj:

Human capital per effective unit of labor:

Multiplying both sides by hj:

Cobb-Douglas production function of country j:

Output per effective unit of labor:

Accumulation of capital and human capital:

They consider:

Does the data support the Solow’s model predictions?

MRW first estimate equation (IV) without the human capital term for the cross-sectional sample of non-oil producing countries