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Saturday, November 20, 2010

Theodore W. Schultz publishes Investment in Human Capital

This year (1961), Theodore W. Schultz publishes an article in the American Economic Review entitled "Investment in Human Capital." The previous year, Schultz had presented this article as his Presidential Address at the seventy-third annual meeting of the American Economic Association.
In this article, Schultz introduces his theory of Human Capital. He argues that both knowledge and skill are a form of capital, and that this capital is a product of "deliberate investment." Schultz highlights Western countries, and explains their increase in national output as a result of investment in human capital. He also makes a direct link between an increase in investment in human capital, and the overall increase in workers earnings.
The first section of the article deals with 'Shying Away from Investment in Man'. It argues that economists have been afraid to relate to human beings as capital. Schultz believes that the concept of human capital has negative connotations that arise from the American experience of slavery, and that society is hypersensitive towards anything that serves as a reminder of that system. For Schultz, however, the concept of human capital implies an investment in people. He argues that education, training, and investments in health open up opportunities and choices that otherwise would be unavailable to many individuals. Schultz compares the acquisition of knowledge and skills to acquiring the "means of production." Workers no longer have to be at the mercy of others; instead they can be in control of increasing their own productivity and earnings.
The second section of the article deals with Economic Growth from Human Capital. Schultz argues that the difference in earnings between people relates to the differences in access to education and health. For example, when farm folk move to the city, or when African-American kids look to find work, they experience a barrier that arises from their lack of human capital (i.e., appropriate knowledge and skill). Schultz also argues that in many underdeveloped countries, food and shelter are of primary concern, and thus there are short-term investments made to deal with these crises. In societies whose main concern is not basic needs, there is the opportunity for long-term investment in education, health, and migration (i.e., helping people adjust by finding them jobs and offering them the opportunity to learn/improve their skills). In the long-term these investments will strengthen the economy and raise the standard of living.
The third section deals with the 'Scope and Substance of These Investments'. Schultz argues that investment in human capital must focus on supporting individuals in acquiring an education, since it is skill and knowledge that affect one's ability to do productive work. He believes that an investment to enhance these capabilities leads to an increase in human productivity, which in turn leads to a positive rate of return. Schultz criticizes those who see investment in human capital as a cost. He argues that while in the short-term there may be a cost (i.e., cost of facility, loss of earnings for workers while in school, etc), in the long-term the yield from the investment will far outweigh the cost.
Finally, the fourth section deals with 'A Concluding Note on Policy'. Here, Schultz discusses social implications and policy of his theory. This can be summarized in nine main points:
1.      Existing tax laws (i.e., in 1961) discriminate against the investment in human capital.
2.      Unemployment (i.e., sitting idly) causes human capital to deteriorate.
3.      There are hindrances to free choices of professions.
4.      There is a need to provide funds for investment in human capital, and thus, long-term public and private loans should be made available to students.
5.      There should be investments made in migration (i.e., in helping people settle and find education).
6.      There has been a failure to adequately invest in those who sit on the periphery of society (i.e., African-Americans, Puerto-Ricans, Mexican Nationals, etc.).
7.      There has been an under-investment in human beings in general (beyond just those on the margins).
8.      The return on public investment in human capital should not be returned directly to each individual. The individual will see a return in the form of wages, and will benefit from a strong economy.
9.      As a society, we must assist underdeveloped countries to achieve economic growth, and to begin investing in human capital.
Since this article first appeared, there has been much praise (in 1979 Schultz received the Nobel Prize in Economic Sciences) and much criticism for human capital theory. Today, many still believe that society needs to invest in people for the sake of a stronger, more productive economy, and also to increase the opportunities and choices open to the individual. At the same time, however, many criticize the Human Capital Theory as serving the needs of those in power (i.e., government and business), and not the individual.

Paul Bouchard, in his article entitled "Training and Work; Myths about Human Capital" challenges seven basic assumptions contained in Schultz' theory. Briefly, they are as follows:

Assumption 1: Human Capital is in investment in the future.
-It is impossible to accurately predict future labour market needs. All the forecasting tools we have are problematic.
Assumption 2: More training leads to better work skills.
-Organizations value particular skills and what these are often change over time. There are not necessarily 'better' skills, just ones that fit what serve the needs of the organization at the time.
Assumption 3: Educational institutions play a central role in the development of human capital.

-Today our traditional educational institutions are not as relevant or effective as they could be. Things change so fast that people tend to learn more on the job.

Assumption 4: Employees need to improve their skills.
-Work has not become more complex, in fact, with technology things have become 'easier'. The need to improve one's skills comes from having to compete in a job market with people who are in many cases over-qualified.
Assumption 5: Training enhances employability.
-Many individuals do not have access to training and thus access to jobs, while others may have access to training, but not to mobility within the organization.

Assumption 6: Training can compensate for skill shortages.
-Bouchard argues there are not skill shortages, rather there is a skill-mismatch. In other words, for various reasons, individuals with appropriate skills do not find work. Three potential reasons for this are: labour market dynamics, structural discrimination, and employee self-selection.
Assumption 7: Employment and unemployment are economic concepts.
-The labour market is NOT a market like any other. There are social forces present that keep people from having equal access to employment regardless of their skill and experience.

A major issue with Schultz' theory is that it places the onus on the individual for becoming 'educated', finding employment, and becoming a productive member of society. The theory implies that if an individual does not succeed it is their fault (i.e., they are too lazy, not bright enough, etc.), as opposed to a bias in the system. This is a tremendous burden because for many their inability to find work is due to factors beyond their control (i.e., socio-economic status, ethnicity, gender, etc), and not necessarily to their unwillingness or inability. Finally, knowledge and skill gained through education is not necessarily what is important to employers. As Bowles and Gintis (1976) and many others have pointed out, the characteristics that an individual who has been through the formal educational system possesses (i.e., obedience, responsibility, etc), are in many cases more attractive to employers than their knowledge and skill.
Bouchard, P (1998). "Training and Work: Myths about Human Capital". In Scott S., Spencer B., and Thomas A. (Eds.), Learning for Life: Canadian Readings in Adult Education, Toronto: Thompson Educational Publishing, Inc.
Bowles, S. and Gintis, H. (1976). Schooling in capitalist America: Educational reform and contradictions of economic life. New York: Basic Books.
Rubenson, K (1992). "Human Resource Development: A Historical Perspective". In L.E. Burton, In Developing Resourceful Humans: Adult Education Within the Economic Context, New York: Routledge.
Schultz, T. W. (1961). Investment in Human Capital. The American Economic Review 1(2), 1-17
Prepared by Tamar Kagan (OISE/UT) August 2000
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