Chapter 2 Human Capital
Chapter 2 Human Capital
Chapter 2 Human Capital
Education and health are basic objectives of development: they are important ends in themselves.
Health is central to well-being and education is essential for a satisfying and rewarding life; both are
fundamental to improve a human capability which is the heart of development.
At the same time education plays a key role in the ability of a developing country to absorb modern
technology and to develop the capacity for self sustaining growth and development.
Moreover, health is a pre-requisite for increases in productivity, while successful education relies on
adequate health as well.
Health and education is investment in human capital to improve lobar productivity.
Thus, both health and education can also be seen as vital components of growth and development as
inputs to the aggregate production function.
Education and Health as Joint Investments for Development
Greater health capital may improve the returns to investments in education
Greater education capital may improve the returns to investments in health
Increasing Incomes only Is Not Sufficient: So development policy need to focuses on income, health
and education simultaneously.
2.2. Investing in Education and Health: The Human Capital Approach
Human capitalis the term economists often use for education, health, and other human capacities that
can raise productivity when increased.
Initial investment in health and education lead to a stream of higher future income. The human capital
approach focuses on the contribution of well-being of health and education by increasing income.
This higher future income gains from education must be compared with the total costs incurred to
understand the value of human capital as an investment.
The income gains can be written as follows, where E is income with extra education, N is income
without extra education, t is year, i is the discount rate, and the summation is over expected years of
working life.
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Lecture note: Development Economics II 2022
Figure above provides a typical schematic representation of the trade-offs involved in the decision to
continue in school. This is taken to be 66 years. Two earnings profiles are presented for workers with
primary school but no secondary education and for those with a full secondary (but no higher) education.
Primary graduates are assumed to begin work at age 13, secondary graduates at age 17. For an individual
in a developing country deciding whether to go on from primary to secondary education, four years of
income are forgone. This is the indirect cost, as labeled in the diagram. The child may work part time, a
possibility ignored here for simplicity, but if so, only part of the indirect-cost area applies.
There is also a direct cost, such as fees, school uniforms, books, and other expenditures that would not
have been made if the individual had left school at the end of the primary grades. Over the rest of the
person’s life, he or she makes more money each year than would have been earned with only a primary
education. This differential is labeled “Benefits” in the diagram. Before comparing costs with benefits,
note that a dollar today is worth more to an individual than a dollar in the future, so those future income
gains must be discounted accordingly, as is done in the above Equation.
After the end of secondary grades, earnings with secondary graduates are higher than earnings with
primary graduates-the differential is labeled as "benefits”. Before comparing cost with benefit –first-
go to Present value criteria:
The rate of return of investment in secondary education will be higher whenever the discount rate is
lower, the direct or indirect costs are lower, or the benefits are higher.
Factors affecting economic returns to education:
Quality of education
The match between knowledge and skills acquired at schools and market demand
Demand for human capital: in sufficient demand for human capital because of slow economic
growth
Wage difference for worker with higher and lower education and skills.
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Lecture note: Development Economics II 2022
1. Student’s desire for more income through future modern-sector employment (the family's private
benefits of education) and
The amount of education demanded is thus in reality a derived demand for high-wage
employment opportunities in the modern sector
Derived demand: Demand for a good that emerges indirectly from demand for another good.
2. The educational costs, both direct and indirect, that a student or family must bear.
Supply side:the quantity of school places at the primary, secondary, and university levels is determined
largely by political processes, often unrelated to economic criteria.These are in turn influenced by the
level of aggregate private demand for education.Because it is the amount of education that is demanded
that largely determines the supply, let us look more closely at the economic determinants of this derived
demand.
The amount of schooling demanded sufficient to qualify an individual for modern sector jobs appears to
be determined by the combined influence of the following four variables:
1. The wage or income differential
2. The probability of success in finding modern-sector employment.
3. The direct private costs of education.
4. The indirect or opportunity costs of education.
For each year the childcontinues his education, he in effect foregoes the money income he
couldexpect to earn or the output he could produce for the family farm.
2.3.2. Social versus Private Benefits and Costs
In developing countries, the social costs of education (costs borne by the public) increase rapidly as
students climb the educational ladder. The private costs of education (those borne by students themselves)
increase more slowly or may even decline.
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Lecture note: Development Economics II 2022
As a student completes more and more years of schooling, expected private returns grow at a much
faster rate than private costs, for reasons :
The anticipated private benefits of more schooling is larger than less schooling
The direct and indirect private educational costs are relatively low since it is subsidized.
The social benefits curve rises sharply at first, reflecting the improved levels of productivityand the
self-employed that result from receipt of a basic education and the attainment of literacy, arithmetic
skills, and elementary vocational skills.
After that, the marginal social benefit of additional years of schooling rises more slowly, and the
social returns curve begins to level off.
By contrast, the social cost curve shows a slow rate of growth for early years of schooling (basic
education) and then a much more rapid growth for higher levels of education.
This rapid increase in the marginal social costs of post primary education is the result both of the
much more expensive capital and recurrent costs of higher education (buildings and equipment)
and the fact that much post primary education in developing countries is heavily subsidized.
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Lecture note: Development Economics II 2022
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Lecture note: Development Economics II 2022
It has long been understood that some developing countries’ health systems were far more effective
than others in achieving health goals with low level of per capital income as compared to developed
nation.
Health and productivity:
Poor health condition harms the productivity of adults. Studies show that healthier people earn higher
wages.
A healthy population is per request for successful development.
2.5. The Gender Gap: Discrimination in Education and Health
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Lecture note: Development Economics II 2022
2.6. Policies for Health, Education, and Income Generation: Classified in to external and internal policies:
External policies include:
A. Adjusting imbalance, Signals, and Incentives
Policies that tend to remedy major economic imbalances and incentive distortions (e.g., in income
and wage differentials) and
Alleviate social and political constraints multiple beneficial effects of increasing job
opportunities, slowing the rate of rural-urban migration, and facilitating development-related
modifications of educational systems.
B. Modifying Job Rationing by Educational Certification
To break the vicious cycle in which overstated job specifications make over-educationnecessary
for employment, policies are needed that will induce or require publicand private employers to
seek realistic qualifications.
C. Curbing the Brain Drain
Controlling or taxing the international migration of indigenously trained high-level a professional
is a very sensitive area.
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Lecture note: Development Economics II 2022