CHAPTER 11 Human Capital

Hayek (1945) did not emphasize an even more significant implication of his analysis, although he must have been aware of it. The specialized knowledge at the command of workers is not simply given, for the knowledge acquired depends on incentives. Centrally planned and other economies that do not make effective use of markets and prices raise coordination costs, and thereby reduce incentives for investments in specialized knowledge.

(Becker and Murphey 1993:306)

Introduction: Human Capital and the Nature of Knowledge

Market economies are characterized by complex capital structures, in which individual complementary capital goods combine, either directly or indirectly through the market process, to produce valued outputs. All production is essentially “team production.” We have noted, at various points, the role of knowledge in this process. Knowledge is necessary for action, and, indeed, motivates action. Multiperiod plans involving capital are informed in various ways by the knowledge of the planners. In this chapter we examine in more detail the importance and nature of knowledge in the production of valued outputs. We shall see that the human capital literature, which has developed in the last three or more decades, has much that is relevant to an understanding of capital in general, even more so when a disequilibrium framework is assumed.

We have seen that most production involves the flow of input services for the purpose of producing a flow of valued outputs (or services). (Simple “point input-point output” processes are quite rare.) This input flow is provided by the efforts of physical or human resources, traditionally referred to as labor and capital. Sometimes the identifying difference between labor and capital is the distinction between “original” and “produced” means of production.¹ When considering the role of knowledge in production, one comes quickly to realize, however, that there is little that is “original” in the type of labor effort that is typically provided in modern production processes. It is obvious, first, that human effort in production must be governed by certain types of very specific or general knowledge and that, second, much of this knowledge is intentionally acquired. One is faced, therefore, either with abandoning the distinction between original and produced means (for other reasons this distinction as applied to land is of dubious value), or of treating knowledge per se as a separate, produced input. This latter strategy is essentially what the human capital approach does. Knowledge conditions (determines) the type of service that gets “put in,” whether from labor or capital. So knowledge is “embodied” in both physical and human resources,² although there are some important distinctions in the way in which this happens. And knowledge takes time to acquire. Seen as the ability to produce or contribute (directly or indirectly) toward the production of some valued output, knowledge emerges as a special and very important type of capital. (Education considered as a pure consumption good can be accommodated in the above framework if one considers household production, as will become clear below.)

In some ways the term “human capital” is unfortunate. It originates probably from the fact that, in an essential way, knowledge must be embodied in the human mind. There is no human knowledge without a human knower. This aspect of knowledge suggests that it must be thought of as “subjective,” although information, from which it derives, is “objective.” Knowledge and information, though often used interchangeably, are distinct phenomena.³ It is knowledge that imbues information with value. Disembodied information, information without cognition, is valueless. In a sense, knowledge is information transformed into capital and, in fact, all capital has a similar knowledge dimension. In this sense, all capital is “human.” Capital is resources (information and other resources) plus meaning, the meaning that humans, by virtue of their purposes, impose on the resources at their disposal. Since knowledge must reside in the human mind, the enhancement in value that it occasions, when applied by humans to physical resources, is naturally referred to as human capital.

Knowledge, of course, in many ways defies characterization. While we may think of it as capital, knowledge as such is never traded, although information is. Knowledge is inevitably dispersed among individuals and can never be collected in a single place. It has aspects that are inexpressible even by the knower, aspects that are tacit (Polanyi 1958). This bears on the familiar implications for the impossibility of socialist planning made famous by Hayek (1945). In addition, as Karl Popper has shown, knowledge has an open-ended nature—he referred to knowledge—perhaps unfortunately, given our characterization of knowledge as “subjective”—as being “objective” in nature, meaning that, as we shall show, it has implications beyond the comprehension of any subjective mind (Popper 1972). So when we think of human beings as intentionally acquiring knowledge that is embodied completely within the human mind, we shall have to be a bit careful. Knowledge (or potential knowledge) exists outside of the human mind in the sense that certain machines, for example, embody the potential to produce certain outcomes only if used by someone who “knows how” to use it, but does not necessarily “know why,” in a more fundamental sense, certain results are produced. This latter type of knowledge is embodied within the machine. It was put there by someone who presumably knew how to make the machine so that it would work as intended.⁴ The question of where ultimately the knowledge actually resides would appear to be a metaphysical one, whose answer matters less for our purposes than the fact that knowledge is necessary for production, wherever we may visualize it residing. We need machines of certain physical configurations, embodying certain production potentials, and we need the know-how to operate them. Knowledge of some type, at some level, must always be available in any production plan. It is inconceivable that a production plan could exist without human knowledge. It is not simply another analogous type of capital in the same way as physical and human resources, which supply the energy and effort for its implementation. So a better term might have been “knowledge capital.” While bearing this in mind, for ease of reference and comparison we shall continue to use the term “human capital.”

In this chapter I will examine some important aspects of human capital that derive from the existing literature, especially from the work of T. W. Shultz and Gary Becker. We shall see that many of the valuable insights survive when considered outside of the neoclassical equilibrium world of fully consistent plans. More importantly, additional implications emerge as a result of this transplant. I then return, in the next chapter, to the inimitable nature of knowledge touched on above.

Human Capital and the Firm

Business organizations provide for the coordination of resources in production. These resources may be physical or human. In considering either of these types of resources, decision-makers face exactly the same type of decision. In particular, they are concerned about the capital value of any combination of resources, whether they be physical or human, and must take cognizance of the fact that the value of human resources may be enhanced by training and experience. Certainly there are important and significant differences between investments in human as compared to physical resources, but there are important similarities as well.

Knowledge, as we have seen (Chapter 3), comes in many forms. Some knowledge is helpful in all or many different production settings—we will call this general human capital. The ability to read and write, to follow instructions, to communicate instructions, etc., are examples. Some knowledge is of value in a limited number of (in the extreme, only one) production settings. We will call this specific human capital. Knowledge that relates uniquely to the procedures and routines of a particular firm or to particular production processes are examples. Some forms of general human capital are obtained through specialization in education, in other words, through the devoting of whole units of time (years of schooling) to the acquisition of certain kinds of knowledge. And some forms of general training are provided by firms. On the other hand, specific human capital is obtained mainly on the job, although full-time training courses in specialized subject areas are an exception to this. With both general and specific training, an important difference between human and physical capital is that the owner must be present at the investment stage and the implementation stage. Physical capital can be (and mostly is) produced and used away from its owner. But, at least in an economy without slavery, human capital is tied to its owner. This has some very important implications. It means, first, that firms cannot own human capital, they can only rent its services. As a corollary, it means also that any decision the firm might make with regard to training must be a joint decision taken together with the employee receiving the training. So, it is of some interest to ask when and under what circumstances a firm might pay for specific or general training (Becker 1993:ch. III).

We can examine this by considering the elements of the individual investment-in-training decision. The most important elements relate to earnings. The benefits of training come mainly from enhanced earnings in the post-training period, while the costs come mainly from reduced earnings during the training period. For simplicity we may, for the meantime, ignore the nonpecuniary aspects of training, that is, we ignore any direct satisfaction that the employee may derive from the training process or its results (satisfaction of curiosity, self-esteem, etc.)⁵ Also, we assume that the employer’s best estimate of the marginal value of the employee’s services is reflected in the wage rate paid. In this way, we shall see, both the employee’s and the employer’s valuation of the costs and benefits of the training are reflected in wages rates. We recall equation (6.1), the formula for the capital value of any prospective stream of returns from the perspective of point 0:

where

q_t = b_t - a_t are the net returns; benefits (b_t) minus costs (a_t)

and

R = (1 + r)

where r is the rate of discount (time preference). In order to calculate the internal rate of return (IRR) we put k₀ = 0.

In the case of investments in training, the costs and benefits have a special pattern. The costs of the investment will be captured by the (estimated) earnings profile that would have been earned in the absence of the training, and this must include any direct out-of-pocket costs. Using our previous notation, a_t = w_tα_t where w_t are the wage rates of the employee’s services, α_t, in the absence of training, and b_t = w’_tβ_t where w’_t are the wage rates of the employee’s services (adjusted for any out-of-pocket training costs), ß_t, with the benefit of training. Since α_t and ß_t refer to the services of the employee (before and after training), these are most conveniently expressed in terms of time units, that is number of hours of input of a particular type of employee service. Thus we may normalize by taking the basic unit to be one (hour, day, year, etc.), then (since α_t = β_t = 1) equation (11.1) becomes:

The projected gain from training consists of the prospective annual wage differentials each year over the working life (n years) of the employee. The internal rate of return (IRR) or perceived yield is obtained by putting k₀ = 0, or

Call this rate of return r*. Then the training will be undertaken whenever r* > r, where r is the best perceived alternative, due account being taken of risk, uncertainty, and other relevant factors, It is clear that r* depends not only on the perceived alternative earnings streams, but also on the perceived length of the payoff period, n. And this payoff period is influenced by the length of life and the degree of labor-force participation of the employee. (We shall consider later how human capital investments may increase the value of time more generally, that is, for time used in- and outside of the labor market.)

We may note at this point two other important differences between investment in human and physical capital. Again this is related to the fact that this human capital must be embodied in the human body.

1. Since human life and human working life is finite, it has an important effect on the perceived rate of return in investment in human capital, It is, in general, higher in younger people, and they are likely to predominate in training programs. The finiteness of the payoff period is an important reason for the existence of diminishing returns to investments in human capital. As years of training and schooling are added, the payoff period diminishes by an equal extent (unless the investment lengthens lifespan, as in the case of investments in health, but even then the degree of flexibility is very limited).

2. With each successive investment in human capital, the value of the employee’s time in the market is rising. So the value of earnings forgone tends to rise along with the benefits. For example, in the case of formal schooling, a graduate student forgoes more while in school than a high-school graduate.

Thus although, as we shall argue, significant complementarities exist between different types of human capital that are likely to raise the rate of return as investment proceeds, diminishing returns to marginal investments in individuals must eventually obtain, because of the two reasons just given. This is in marked contrast to investments in physical capital in general or in human capital from the economy-wide macro-level point of view, when investments across different individuals can be considered.

It should also be noted, however, that these differences can be overstated, especially in a rapidly changing economy, In a dynamic, rapidly changing world the relevant payoff period for any investment is, more often than not, not the physical life of the human or physical asset, but rather its (shorter) economic life. The scrapping or retooling of machines often comes not so much from the physical depreciation of the asset as from its technological obsolescence. And this is more and more true also of human capital, where individual skills lose their value not so much from physical deterioration or handicap, as from (unexpected, unplanned for) technological change. As the pace of change accelerates, the likelihood that the economic life of a skill is less than its physical life increases, and the need for midlife retraining (with a reduced payoff period) increases. We shall see this phenomenon in our discussion of specific training below. Capital losses (and gains) occur with both physical and human capital in categorically identical ways.⁶

Perfectly General Training

We may now consider the question of who is likely to pay for training. In the case of perfectly general training, it should be clear that the firm is less likely to pay than the employee. The reason is that general human capital is perfectly portable. The training increases (and is known to increase) the value of the employee’s services as much in other (competitive) firms as it does in the one providing the training.⁷ Since firms cannot own human capital, they cannot capitalize the value created by buying it, as is the case with physical capital. So the moral hazard problem cannot be solved by “internalizing” the investment process. It is possible for firms to provide the training if they can be insured against the likelihood that the employee will quit and take his skills elsewhere. For these purposes contracts are sometimes fashioned, an example being the armed forces,⁸ but enforcement costs can be prohibitive. An easier solution is for the employee to pay. The inalienable property right that the employee has in his skills is the source of his incentive to invest in training by taking a temporary “cut” in earnings.

Thus for firms providing general training with the employee paying, the employee’s earnings during the training period would be reduced by the cost of training. Employees pay for general training by receiving wages below what they could receive elsewhere. In this way, current earnings (negatively) include capital investment items. So, unlike formal educational courses (schooling), expenditure for training on the job is “automatically” deducted from earnings. All costs then appear as the value of forgone earnings to workers receiving general on-the-job training and an estimate of their value depends on expectations of future post-training earnings.

Perfectly Specific Training

Specific training illustrates an aspect of the heterogeneity of human capital. As with physical capital, heterogeneity implies complementarity. Specific human capital is valuable in specific combinations of general and specific human capital and physical capital.

Perfectly specific training increases the expected earnings of the employee only in the firm providing the training. In this case, the employee has a substantially reduced incentive to pay for the training. On the other hand, since the skills obtained are not portable, the firm has a substantially increased incentive to pay for its acquisition. Since the employee’s post-training skills are more highly valued in the firm that has provided the training than in the “market,” they have a much reduced incentive to quit. Quitting would necessitate taking a pay cut. If the firm could be confident that the employee would not quit in spite of this reduced incentive, it would be prepared to pay the full cost for this training. Since, however, no such absolute assurance could be obtained, the training costs are likely to be shared, even in the case of perfectly specific training.

Where the firm pays all or part of the costs of training, wages during the training period are likely to be more than the “full worth” of the marginal value to the firm of the employee’s services and to be less than this “full worth” in the post-training period (where such values can be estimated). This will most likely manifest in the employee earning more than the “market” for his current skills will pay during the training period. And since his skill is specific to the firm, he will earn more than the “market” in the post-training period as well.⁹

Multiple Specificity in Training

In reality, training is seldom likely to be perfectly specific to a particular firm. Rather, the training may have a greater or lesser degree of specificity and this may vary across space and (importantly) across time. A firm that is technologically innovative and pioneers a particular process or product, might, for example, have to provide all of a particular type of training itself and would be prepared to do so since the training was of use only to it. As time passed, however, and the benefits of the new process or product became diffused through the economy and imitated by competitors, the training would become more general in nature. This is a risk of which innovative firms are well aware and may be a reason for endeavoring to shift some of the training costs onto the employee. As a general rule the fraction of the training costs paid by firms would be inversely related to the perceived importance of the general component of the training and positively related to the perceived enduring specificity of the training. Firms pay generally trained employees the same wage and specifically trained employees a higher wage than they would get elsewhere.

An important implication of this consideration of specific training is that turnover depends on the wage rate and the degree of specificity. Firms are concerned about the turnover of workers with specific training and would therefore be prepared to offer a premium to prevent it. By the same token, employees are concerned about the possibility of being laid off (or fired). Quits and layoffs in turn affect the expected returns to firms and workers respectively of investments in training. Employees with specific training have less incentive to quit and firms have less incentive to fire them. Accordingly, the quit and layoff rates are inversely related to the amount of specific training possessed, other things constant.

Thus, an unexpected (and isolated) decline in demand could be expected to affect generally trained workers more than those with specific training. Generally trained workers would be laid off before specifically trained ones for two reasons. First, firms have sunk investments costs in specifically trained employees that may be partially recouped in the event that the decline in demand is temporary. Second, if it is indeed temporary, newly hired workers would have to be retrained in the specifics possessed by existing employees, were the latter to be let go. In this sense, labor can be seen as a “quasi-fixed factor of production” (see Oi 1961; Becker 1993:46). Specific training thus implies the existence of a bond between employee and employer which provides a measure of security of service to the firm and job security to the employee. It is, however, a double-edged sword. For the firm, investing in specific training represents a risk in the event that, as noted above, the specificity does not endure. For the employee, investing in specific training is risky to the extent that it ties the employee to a specific employer and its fate. To the extent that a specific product or process loses out in the marketplace and suffers bankruptcy or downsizing, the loss to specifically trained employees is greater than to generally trained ones.

Furthermore, both parties (employees and employers) are subject to the threats of opportunism and holdups noted above in Chapter 9 (Rosen 1991). Shared investment costs require sharing later returns and can lead to problems relating to opportunistic behavior—shirking (thus preventing the collection of the returns) and/or threatening to hold up production. As with specific physical capital, it should be clear that holdup threats can occur on both sides of the market. The firm can hold out the threat of termination of a specifically trained employee in an effort to secure “post-contract” reductions in earnings, and the employee could threaten to quit and take a valuable skill with him in an effort to secure higher earnings. In this regard the situation represents a bilateral monopoly.¹⁰

Pension plans that incorporate gradual vesting provide a type of insurance to firms against premature quitting of specifically trained workers. Consequently, specifically trained workers would find such plans more valuable than generally trained ones. Similarly, firms are more likely to pay the moving expenses of employees who are or will be specifically trained. Migration is a form of human capital investment, and migration costs are likely to be shared in proportion to the degree of specificity of the employee’s skills. Similar considerations attach to the firm’s contemplation of investments in the health of its employees. Finally, to the extent that different types of organizational arrangements affect the motivation and performance of employees, this must be seen as a type of (knowledge) capital. Thus, for example, where the conditions are right, firms may be expected to take an interest in and subsidize the consumption of its employees. In less developed countries “an increase in consumption [may have] a greater effect on productivity . . . and a productivity advance [may raise] profits more there” than in more developed countries (Becker 1993:57).

Human Capital and the Individual

The investment approach to human capital outlined above thus provides many insights to the type of decisions that firms and employees together face in the production process. This approach can also be used to investigate aspects of individual behavior more generally. Individuals face human capital decisions not only in, or in relation to, the workplace, although traditionally and logically this is the place to start in any investigation. The opportunities available to individuals in the workplace condition and constrain them in the other aspects of their lives. We must begin this more general discussion by visualizing the relationship between individual workers and their earnings over time.

Age–Earnings Profiles

As noted, the “human” aspect of human capital is responsible for important differences between investments in physical and human assets. Both involve considerations of time—intertemporal planning and the evaluation of earnings at different points in time. For investment in individual human capital, however, the elapse of time necessarily suggests aging that cannot be reversed. The tracking of earnings over time is thus often referred to as an age–earnings profile.

Typically, age–earnings profiles (with earnings on the vertical and age on the horizontal axes) are concave to the horizontal axis, suggesting that earnings rise over time at a decreasing rate. This shape suggests that “experience” has value as a form of on-the-job training even in the absence of formal (conscious) training, as earnings increase with tenure and job experience. The fact that the increase tapers off suggests the influence of finite life. The typical shape of the age–earnings profile is a very robust observation, found widely where statistics exist (Becker 1993:12). However, the height and rate of change of the profile varies with circumstances. From a human capital perspective, certain implications emerge.

The age–earnings profiles of less trained workers are likely to be flatter (rise more slowly) than those of trained workers. This is because the age–earnings profile includes the returns to training. The profiles of generally trained workers are likely (other things constant) to be steeper than the profiles of specifically trained workers. With specifically trained workers the firm pays for all or part of the training, thus paying the worker more than their opportunity cost during the training period and less than their opportunity cost after training, thus flattening out the profile. Age–earnings profiles and investments in human capital go a long way towards explaining the personal distribution of earnings (Becker 1993:109ff; Mincer 1974; more below).

Full-time schooling is often a form of investment in general human capital (although there are degrees of specificity that attach to it, the degree of specificity rising usually with the level of education). Thus schooling may be expected to steepen age–earnings profiles. Typically, for example, the age–earnings profiles of college graduates start later and below those of high school graduates, rise much more steeply and rapidly overtake the latter. The same pattern is observed by comparing graduate and college degree earnings profiles. This suggests a phenomenon that we shall examine more closely below, namely that human capital investments are likely to be (sequentially) complementary in nature. College graduates, though sacrificing some earnings growth while in college and thus having to start at a wage below that of their more experienced coworkers who entered the work force right after high school, are able to catch up rapidly as a result of the knowledge that they have accumulated.¹¹

Investments and the Allocation of Time over Time

The human capital approach to age–earnings profiles shows that an individual’s earnings are not simply given to him as an exogenous constraint. Rather, it is a result of their actions over time with regard to the time he devotes to investing in human capital and other activities. In this way, the human capital approach integrates many aspects of individual behavior.

The amount of time an individual spends investing in human capital would tend to decline with age for two reasons that we have already discussed.

1. The number of remaining periods, and thus the present value of future returns, would decline with age.

2. The cost of investing would tend to rise with age as human capital accumulation proceeded because the forgone earnings of the individual would rise.

We note now that the rise in the value of the individuals time applies with equal force to the time spent within the household and generally outside of the workplace. Assuming that work was not an end in itself, an increase in the amount of time spent working or investing in human capital would raise the marginal value of “consumption” time to the individual. The age–earnings profile implies an age investment profile. Generally an individual’s investment time will rise with age at a decreasing rate, mirroring the path of earnings, but would most likely peak before the peak in earnings. (For a more precise discussion see Becker 1993:70–85.) During time periods when an individual’s value of time was rising most, they would tend to economize on other uses of their time. This implies, in addition to forgoing work time and the earnings that come with it, forgoing “leisure” or “consumption” time. Leisure time appears most expensive when one could be buying large increases in “career advancement” with it. As increases in earnings potential taper off, the tradeoff against leisure time becomes less attractive, and eventually the pendulum swings in the other direction with more time being devoted to consumption and leisure at higher ages. The capital theoretic decision is thus seen to apply to this margin of time as well.

The Illiquidity of Human Capital

The above discussion suggests that the investment approach to human capital resources is a powerful and simple tool for explaining a wide range of phenomena. It is predicated on little more than the basic logic of capital value and individual rationality (in the Misesian sense of internal consistency between means and ends). It requires that the individual weigh, in a consistent manner, the costs and benefits of alternative decisions as they see them. Of course, all decisions are taken within a social framework and we have implicitly assumed that these imagined and projected costs and benefits correspond closely to materialized reality. To be sure, investments in human capital, like all investments, may have outcomes that differ to a greater or lesser extent from the planned outcomes on which they were based. As with all actions, they are based, to some extent, on disparate plans and are thus, in part, bound to fail. We shall examine some implications of this below. There are, in addition, some special considerations that attach to human capital, of which we take note at this point.

“Since human capital is a very illiquid asset—it cannot be sold and is rather poor collateral on loans—a positive liquidity premium, perhaps a sizable one, would be associated with such capital” (Becker 1993:91). This is a consequence of the inalienability of human capital and the finiteness of human life. Loans to finance investments can be obtained with greater or lesser ease (on better or worse terms) depending on the degree of confidence that the financiers have in the investment and on the degree to which the alternative value of the investment assets themselves provide some safeguard against the failure of the investment. Assets of a failed business can be separated from the business and sold (redeployed) to help offset the loss. In the case of human capital, however, the asset is inseparable. Furthermore, loans for investment in assets depend on the reputation of the investor. A young investor, anxious to start his own business, must convince the financier that he is creditworthy. If necessary he can postpone the investment a while in order to accumulate a track record and some personal capital. Human capital investments cannot be so easily postponed (Becker 1993:94). Relevant to this is the fact that for investment in human capital the individual must of necessity use his own time (in addition to any other resources and other people’s time that may be necessary) in a rather rigid manner in order to accomplish the investment. In other words, there is no substitute for “being there” for a minimum amount of time.¹² In the case of physical capital, a project previously postponed can often be expedited later by increasing the rate of application of inputs.

For these reasons human capital is likely to be much more illiquid and less easily financed. Like other investments there is a greater or lesser degree of uncertainty, depending on the situation. Some of the elements that contribute to uncertainty in the case of human capital have been analyzed.

There has always been considerable uncertainty about the length of life, one important determinant of the return. People are uncertain about their ability, especially younger persons who do most of the investing. In addition, there is uncertainty about the return to a person of given age and ability because of numerous events that are not predictable. The long time required to collect the return on an investment in human capital reduces the knowledge available, for the knowledge required is about the environment when the return is to be received, and the longer the average period between investment and return, the less such knowledge is available.

(Becker 1993:91–92, italics added)¹³

These remarks suggest that financial markets cannot be relied on as readily with human as with physical capital. The relative illiquidity of human capital also explains aspects of the personal distribution of earnings.

Human Capital and the Personal Distribution of Earnings

Comparison of different age–earnings profiles suggests that different people invest different amounts in human capital. It is clear also that different people invest in different types of human capital. If people were identical in their abilities and opportunities (reflected in an accurate assessment of the returns), we would expect to see everyone investing in the same way and earning the same returns. An explanation of differences in earnings (from work) naturally, therefore, should turn to an examination of differences in abilities and opportunities (including “luck”). This is the approach taken by Becker in a seminal lecture (the Wyotinsky lecture, reprinted in Becker 1993:109ff).

In this approach differences in the amounts invested by different people in human capital are related to differences in the rates of return available from investing and in the opportunities to finance such investments. Becker calls the former, the differences in rates of return available, differences in ability. It should be clear that “ability” here does not necessarily mean differences in innate capacities, like cognitive ability or IQ, although these may play some part.¹⁴ Rather, it refers to the differential capacities that individuals have for learning and for turning that learning into economically advantageous outcomes, which is obviously a much more complex set of phenomena than ability as measured by any one-dimensional criterion.¹⁵

Consider, then, a situation in which all individuals had the same opportunity to invest. Differences in the amounts invested and in earnings from human capital would then be explained solely by differences in perceived rates of return. Indeed, for the same amount invested, more “able” individuals would earn more. But more able individuals would be inclined to invest more (their demand curves for human capital would be higher). Thus, if the marginal cost of investing in human capital were rising (an upward-sloping supply curve) then more able investors would be observed to earn a higher rate of return and would invest more. And the more elastic the supply of human capital (or the supply of financing for human capital), the greater will be the variance in earnings and human capital investment.

If, on the other hand, everyone was equal in ability—investing the same would bring the same rate of return—then differences in earnings and rate of return would be explained by differences in opportunities. This view goes back at least to Adam Smith:

The difference of natural talents in different men is, in reality, much less than we are aware of; and the very different genius which appears to distinguish men of different professions, when grown up to maturity, is not upon many occasions so much the cause, as the effect of the division of labor. The difference between a philosopher and a common street porter, for example, seems to arise not so much from nature, as from habit, custom, and education.

(Smith 1982:28–29)

Smith quotes David Hume as follows: “Consider how nearly equal all men are in their body force, and even in their mental powers and faculties, ere cultivated by education” (ibid.:28, quoting David Hume). Opportunities to invest in human capital will be determined by access to financial markets and by socioeconomic background. Because human capital is rather poor collateral, much human capital investment is financed by parents and other family members. Thus people with the same ability but a superior (more affluent) background would tend to accumulate more human capital. Conversely, scholarships based on need would work in the other direction.¹⁶

In reality, both abilities and opportunities differ across individuals. Abler persons tend to invest more than others and the distribution of earnings would be very skewed to the right even if ability were symmetrically distributed and people had “equal” access to finance. In fact, abilities and opportunities may even be positively correlated, in that more able people are more likely to have access to loans and other types of financial assistance. This would tend to reinforce the explanation of why earnings distributions are positively skewed.

Human capital investments serve partially as inheritances.

Inheritances appear to be received by only a small and select part of the population because small inheritances are invested in human capital and therefore are not reported in inheritance statistics. As the amount inherited by any person increased, a larger and larger fraction would be invested in physical capital. This can explain the sizable inequality in reported inheritances and can contribute to the large inequality in physical capital and property income.

(Becker 1993:148)

Age–earnings profiles together with the above considerations explain also why earnings inequality appears to increase with age. Abler and more fortunate people who invest more (and for a longer time) in human capital take longer to reach their peak earnings. The absolute gap (though not necessarily the proportional gap) between people with different amounts invested in human capital rises with age.

Conclusion

This common framework helps explain many aspects of individual human behavior and their outcomes.¹⁷ We have yet to consider the full implications of rapid change for human capital investment decisions. Before we do, however, we should take note of the role of human capital in the economy as a whole.

Human Capital and the Economy

When we shift our view from the individual to the economy, we must take account of the way in which the knowledge possessed by different individuals is combined in joint and related projects. One is drawn naturally to the concept of the division of labor.

Recognition of the phenomenon of human capital and its role in the economy is clear in Adam Smith’s treatment of the division of labor in the Wealth of Nations. He gives the following as (two out of the three) reasons that the division of labor leads to an increase in output (increasing returns): that the specialized individual worker both improves in dexterity over time and may be expected often to discover improved methods of production (Smith 1982:17–18). We have already seen an example of this in our discussion of the firm and of the connection between the division of labor and the acquisition of knowledge (human capital) by the worker and also in our discussion of Lachmann’s capital theory and his reinterpretation of Böhm-Bawerk’s notion of increasing roundaboutness. The division of labor appears to be involved, implicitly or explicitly, in many aspects of capital theory. In addition, as Carl Menger has pointed out, “Adam Smith has made the progressive division of labor the central factor in the economic progress of mankind” (Menger 1976:72).

Menger goes on, however, to criticize Smith. He points out that even in primitive societies labor is efficiently specialized, yet the improvement in production is not such as is typical of technologically progressive societies.¹⁸ Production may be efficient within the given state of the arts; progress consists in breaking out of the existing framework, in visualizing and implementing new methods of production. To be fair, it seems to me that Smith does indeed imply this in his third reason for the importance of the division of labor (“the inventions of common workmen,” etc. (Smith 1982:19–22)). Be that as it may, the point is that the division of labor occurs within a given, known way of doing things and it is primarily through changes in the latter that progress occurs.

The quantities of consumption goods at human disposal are limited only by the extent of human knowledge of the causal connections between things, and by the extent of human control over these things. Increasing understanding of the causal connections between things and human welfare, and increasing control of the less proximate conditions responsible for human welfare, have led mankind, therefore, from a state of barbarism and the deepest misery to its present stage of civilization and wellbeing, and have changed vast regions inhabited by a few miserable, excessively poor, men into densely populated civilized countries. Nothing is more certain than that, the degree of economic progress of mankind will still, in future epochs, be commensurate with the degree of progress of human knowledge.

(Menger 1976:74, italics added)

What, presumably, Smith would argue is that advances in knowledge (human capital accumulation) and the division of labor are intricately connected.

This is the theme of some recent work (Becker and Murphey, reprinted in Becker 1993) integrating human capital, coordination of team production, and economic progress. Becker and Murphey argue that the degree of the division of labor is governed not only by the extent of the market, as Smith would have it, but also by “the costs of combining specialized workers.” We have already discussed problems of team production that manifest in principal-agent difficulties, free riding, communication difficulties, and the like. Becker and Murphey suggest that these considerations “imply that the costs of coordinating a group of complementary specialized workers grows as the number of specialists increases” (ibid.:300). More specifically:

The productivity of specialists at particular tasks depends on how much knowledge they have. The dependence of specialization on knowledge available ties the division of labor to economic progress since economic progress depends on growth in human capital and technologies.

(ibid.:300)

As societies progress, they become more complex in the sense that tasks become more specialized. This echoes the views of Lachmann and Böhm-Bawerk. It is in this sense that progress implies a greater degree of roundaboutness. We see this in the specialization of the professions (for example, in physicians with their specializations and subspecializations) and in the way in which new industries develop. Much of this increased specialization “has been due to an extraordinary growth in knowledge” (ibid.:307). This knowledge embodied in the human capital of specialized workers not only raises the average product of each worker, but also raises the marginal product of the larger team. Teams may be within or between firms. Specialized members of a team who are employed by the same firm get coordinated by the rules and routines of the firm. Specialists who are employed by different firms have their activities coordinated by contracts and other agreements across firms.

The modern market economy, as Hayek (1945) has pointed out, facilitates the coordination of larger, more complex teams than would be possible in other types of economy. And larger and more complex teams facilitate economic progress.¹⁹ So teams get larger and workers become more specialized and expert over a smaller range of skills as human capital and technology grow. While, in Smith, causation goes from the division of labor to greater knowledge, in Becker and Murphey it also goes from greater general knowledge to a more extensive division of labor and greater task-specific knowledge.

There are important complementarities between different types of human capital.²⁰ In particular, general knowledge is usually complementary with investments in task-specific knowledge (adding another dimension to the distinction between specific and general human capital discussed earlier). Thus, increasing general knowledge increases the demand for specific knowledge. By the same token, increases in general scientific and other knowledge, together with the decline in coordination costs that a mature market system brings, raise the benefits from greater specialization. Declining transportation costs, raising the effective size of the market, are seen by Becker and Murphey as an alternative and additional explanation, but this may be equally seen as a particular aspect of the growth of knowledge and a decrease in coordination (communication) costs.

It is important to emphasize that the incentive to invest in knowledge depends partly on the degree of specialization. In this way the essential and vital complementarities between different types of knowledge is brought out. At the economy level, investments in knowledge are not subject to diminishing returns in the usual way that investments in physical capital are thought to be (but remember our discussion on growth theory above in Chapter 5). Greater knowledge raises the productivity of further investment in knowledge (ibid.:312). Greater specialization enables workers to absorb knowledge more easily, which tends to offset the tendency toward diminishing returns. Thus, complementarities obviously exist within as well as between individual workers. One has to learn how to learn and, having done so, can learn more easily and productively (we will return to this below).

According to Becker and Murphey, the increasing returns associated with the division of labor and the accompanying accumulation of knowledge are garnered by increasingly more “roundabout” production of human capital. All people who help produce human capital are called “teachers.” The human capital of the economy is “produced” over many succeeding generations. “The human capital of workers in later periods is produced with more ‘roundabout’ methods, and hence longer lineages, than the human capital of workers in earlier periods” (ibid.:316). So the effects of human capital accumulation on the degree of specialization implies that members of more roundabout sectors tend to specialize in a narrower range of tasks. This provides some insight into the “evolution” of human capital. All surviving human capital is of relatively old vintage-lineage.

Becker and Murphey’s vision complements the endogenous growth literature (see Chapter 5) in explaining the absence of any tendency toward diminishing returns in expanding economies and in explaining why human capital tends to migrate toward them rather that toward less developed and more slowly expanding economies. Rates of return on investment in knowledge depend on the costs of coordinating specialized workers.

Countries with lower coordination costs due to stabler and more efficient laws, or other reasons, not only have larger outputs, but they also tend to grow faster because lower costs stimulate investments in knowledge by raising the advantages of a more extensive division of labor.

(ibid. :314)

In sum, “An analysis of the forces determining the division of labor provides crucial insights not only into the growth of nations, but also into the organization of product and labor markets, industries and firms” (ibid.:318).

Human Capital and the Family

Introduction

Among the changes that have occurred in the twentieth century, perhaps none is more profound than the changes that have occurred in the nature and role of the family in the economy and in society as a whole.

The family in the Western world has been radically altered—some claim almost destroyed—by events of the last three decades. The rapid growth in divorce rates has greatly increased the number of households headed by women and the number of children growing up in households with only one parent. The large increase in labor force participation of married women has reduced the contact between children and their mothers and contributed to the conflict between the sexes in employment as well as in marriage. The rapid decline in birth rates has reduced family size and helped cause the increased rates of divorce and labor force participation of married women. Conversely, expanded divorce and labor force participation have reduced the desire to have large families.

(Becker 1991:1)

Among those women who were married for the first time in the 1950s, less than 15 percent have been divorced, whereas the comparable number for those first married in the 1980s is around 60 percent. The average household size has declined by one-third since the end of the nineteenth century. Female-headed households increased from 15 to 31 percent of all households (in the United States) between 1950 and 1987. Labor force participation rates of women, especially married women, rose precipitously in all of the advanced economies of the world in the postwar period (see Becker 1991 and the references therein).

Economists have generally not shown much interest in the family, and where they have it has been primarily from the point of view of population growth. Changes in fertility are a major determinant of changes in population growth and these affect not only the size of the population at any given point in time but also the age composition of the population through time. In this regard the most famous contribution is that of Malthus. Even here, however, subsequent to the discrediting of the dire predictions of Malthusian theory, economists paid very little attention to the determinants of population growth and simply took it to be “exogenously given,” as, for example, in growth economics. The human capital “revolution” introduced a new and richer perspective on population questions. The human capital approach in fact began with this new look at population. In a very influential article Jacob Mincer (1962) argued persuasively that the labor force participation of married women was determined not only by their earnings but also by the earnings of their husbands, the number of children they have, and other aspects of the family. In this way it was seen that population influences the economy not only by its size and composition but in a more detailed way by the degree and type of participation of the elements of the population in work and other activities. And these, in turn, are the results of “endogenous” forces: basic economic decisions involving intertemporal planning.

While economists are used to analyzing the decisions of economic agents with regard to their consumption patterns, hours of work, investment prospects, and the like, they have tended to ignore those decisions relating to marriage, children, health, and other “personal” matters. But this dichotomy between “personal” and “economic” matters is surely an artificial one that can be maintained only at the risk of ignoring important aspects of both. People, after all, do not make such decisions in isolation one from the other. Rather, they make and change lifetime plans involving jointly work, marriage, leisure, children, and retirement. Each of these decisions influences and is influenced by the others in ways on which economic reasoning can throw considerable light. This is the project of the “family economics” that Gary Becker deals with in much of his work and most particularly in his A Treatise on the Family (1991, second enlarged edition).

Children

The unprecedented rise in labor market opportunities available for women in this century (as caused, for example, the rapid expansion of the service sector), manifesting in an increase in the relative wage rate earned, has changed the value of time spent in the home by both husband and wife. This is the major cause of the increased participation of married women in the labor force. The traditional division of labor between husband and wife has become less advantageous or “more expensive.” More families have decided that they cannot afford for the wife not to work and forgo the second source of income. This increase in the opportunity cost of the wife’s time has meant that all those things that are produced in the household that intensively use her time have become “more expensive.” This includes children.

Childcare is a very time-intensive activity, especially involving the time of the mother when the child is still young. Thus the decline in fertility, according to this perspective, is simply a reflection of a decline in the demand for children. It is a reflection also of a shift, with urbanization, of the changing role of children in the family. Whereas in traditional societies children are an important source of wealth, both in the form of labor and as a form of social security, in modern urbanized societies this is no longer true. Children are desired more exclusively as ends in themselves and can no longer be relied on as sources of wealth. This reinforces the effect of an increasing cost of time in making them more expensive.²¹

The decline in the average size of the family has been accompanied by an increase (both absolutely and relatively) in the amount spent on (invested in) the smaller number of children. There has been a shift away from “quantity” to “quality” (Becker 1991:ch. 5). In important respects this development stands the Malthusian model on its head. It is true that, other things constant, an increase in incomes leads generally to an increase in the demand for children and therefore to an increase in family size, which reduces income per capita. What Malthus neglects are the implications of an increase in the value of time. Other things are not constant when incomes rise as a result of an increase in earnings from work (as contrasted, for example, with an increase in property or inherited income). A rise in the earnings rate of a family member increases the cost of using that member’s time in household activities, and when this applies to women, the implication is a substitution effect away from children toward other types of expenditure that (if it is strong enough) will outweigh the Malthusian income effect. In addition, with rising incomes and the changing role of children, there is a tendency to “want more for one’s children,” that is, an increase in the demand for “child quality.”

We saw earlier that differences in earnings among people could be explained by the interaction of “abilities” and “opportunities.” We can see now that these “abilities” are most likely largely determined by the kinds of family decisions that we are discussing. The quality and quantity of human capital invested in children is profoundly influenced by parents’ lifetime decisions concerning family size, labor force participation and the division of labor in the home, investments in physical and financial assets, and the success or failure of marriages.

The Family and the Division of Labor

Considering the family as a productive unit, one gains insights into the type and extent of the division of labor within it. As expected, at any point of time, the division of household tasks for the accomplishment of mutually beneficial outputs is determined by the perceived comparative advantages of the various family members. We abstract here from the question of how, and by whom, decisions within the family are made, although clearly this is a relevant determinant of the allocation of tasks. Given a particular decision-making regime, the perception of comparative advantages will be important. The same principles that govern the identification of the gains from trade in an international trade context (or in any market context) operate as well within organizations in general and within the family in particular. And just as has been recently emphasized in the international trade literature (Krugman 1991), so with the family, the degree and type of specialization is, at least in part, endogenously determined over time by the investment decisions of the traders. Resources are not simply given.

The rising wage rates of married women has meant an increase in the cost of their home time and an economizing of it within the family. This has implied a reduced division of labor within the household, a greater sharing of traditionally specialized tasks. This has, as we have seen, also implied a decline in the size of families; a reduction in the number of children per family. These developments have, in effect, reduced the gain from marriage and increased the likelihood of divorce. And an increase in the likelihood of divorce has, in turn, reduced the advantages of specialization within the family.

The incentive to invest in human capital specific to a particular activity is positively related to the time that one anticipates will be spent on that activity. The traditional division of labor between men and women, with men specializing in the accomplishment of market-oriented tasks and women specializing in the accomplishment of household-oriented tasks, is predicated on the assumption that men would spend a sizeable proportion of their time in the labor market and, more importantly, that women would spend the bulk of their time in the home. As a result, men tended to invest primarily in market-specific human capital and women in household-specific human capital. Thus the traditional division of labor may not be the result of (large) intrinsic differences between people in general, or between the sexes in particular, but, rather, are the path-dependent result of decisions to specialize. Because of complementarities in learning and between different types of specific human capital, investments in specialized human capital produce increasing returns and thereby provide a strong incentive for the division of labor even among basically identical people. Initially small differences between people become, over time, transformed into large observed ones (Becker 1991:57ff.).

Divorce

As the amount of time that women anticipate spending in the home has gone down, their incentive to invest in household-specific human capital has diminished and this has reinforced the move away from the traditional division of labor. In addition, as the probability of divorce has risen, the incentive of women to invest in “marriage-specific” human capital has likewise diminished. To some extent the acquisition of market skills by women is a type of “divorce insurance,” as it is they who are most likely to obtain custody of any children and to have to provide for them (the degree of contributions by divorced fathers being notoriously low). Expectations of divorce are, in this way, partly self-fulfilling—the perception of reduced gains from marriage has led to a reduced commitment to marriage.

There is an element of paradox in this. It is almost as if, to some extent, people marry in the expectation of getting divorced. Yet, fundamentally, divorce is a result of plan failure; it is an indication that the marriage has failed. It is, in this sense, an indicator of disequilibrium in the “marriage market.” Another way of looking at it is to see the gains from marriage as having become more uncertain, inviting the provision of more contingency planning. Just as rapidly changing technologies have implied the expectation of a reduced tenure within firms, the disappearance of the career track, so these same changes have implied a “reduced tenure” of marriage. Women are more economically mobile, more committed to market production, and less able to rely on the contributions of their potential spouses. They therefore invest less in marriage and get divorced much more often. And, while it is true that men are investing more in household- and marriage-specific human capital than they used to, this is much too weak to offset the much larger change in the status and role of women. (See Horwitz and Lewin (2008) for a more extensive discussion.)

Conclusion: The Evolution of the Family

The momentous changes in the family—in fertility, divorce, and the division of labor—can thus be seen as a response (to some extent an unconscious one) to the rapid changes of our technologically advanced society and the uncertainty that it implies.

Traditional societies have enormous problems coping with uncertainty and changes in knowledge (Becker 1991:ch. 11). Societies exemplified by traditional farming and hunting (fishing) economies do not experience rapid and cumulative changes in techniques. In such societies, the family, or more accurately the kinship group or extended family, is very important in protecting members against uncertainty. The family serves as both a social and a productive unit. The characteristics of the members of the group are well known and their behavior is easily (inexpensively) monitored since they live together or close by. Elders are venerated because of their knowledge, the value of their specific human capital. This knowledge is particularly valuable in stationary societies where it can be passed down to younger generations through the family, mainly via the cultural inheritance of children, nephews, and other young relatives. In such societies occupational tracks across generations coincide with families. Families can be considered as small, specialized schools that train graduates for particular occupations and accept responsibilities for attesting to qualifications and suitability for certain tasks, especially where such is not easily ascertained (ibid.:344).

In dynamic economic environments, where technologies, incomes, and opportunities change rapidly, the knowledge accumulated by older members of society is much less useful, especially to younger members. The young face a different and continually changing environment. General human capital (acquired in large schools) becomes much more valuable. The ability to adapt becomes crucial. The importance of kinship thus declines. Market insurance replaces reliance on the family. Market contracts replace informal family contracts. Members of the kin scatter. Individualism replaces group identity.

There is some indication that the above trends in fertility, divorce, and the division of labor may be slowing down and even partially reversing, perhaps with a renewed appreciation or reappraisal of the costs they have entailed. In particular, as Becker has argued, families tend to be held together by altruism, by sharing of concerns across family members, and those families that behave more altruistically tend to be more socially and economically successful. Altruism is in this way “selected.”

[A]ltruistic parents tend both to have larger families and to spend more on each child than selfish parents with equal resources. . . . If children “inherit” culturally or biologically a tendency to be like their parents, families with greater altruism would become relatively more numerous over time.

(Becker 1991:8–9)

It remains to be seen what this implies for the nature of the family in the future.

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¹See the discussion in Chapter 7.

²See Baetjer (1998); Lewin and Baetjer (2011).

³“We shall use the words information and knowledge respectively to mean the tradable material embodiment of a flow of messages, and a compound of thoughts an individual is able to call upon in preparing and planning action at a given point in time. Our distinction between the two terms thus rests in part . . . on that between a socially objective entity and a private and subjective compound of thoughts” (Lachmann 1986:49; see also Lewin 1994:235–236). Also: “Whether applied to comprehensive or noncomprehensive planning, the knowledge problem argument crucially depends on the view that knowledge is not the same as data, that is, given pieces of explicit information” (Lavoie 1985b:57).

⁴See Baetjer (1998).

⁵This can be easily accommodated by adding the net nonpecuniary gains to the value of the investment. Adam Smith recognized that differences in nonpecuniary aspects of different jobs would be reflected in market wages. This remains true for jobs that require training. Thus, rates of return from observed wages do not always tell the whole story, not only because outcomes will differ from expectations, but also because wage differences must be adjusted for preferences for and against different kinds of jobs, if the returns are to be taken to imply a net gain to the investor. Still, considering large groups across different occupations does yield important insights.

⁶Lachmann asserts:

The fundamental difference between labor and capital as “factors of production” is of course that in a free society only the services of labor can be hired while as regards capital we usually have a choice of hiring services or buying their source, either outright or embodied in titles to control. The chief justification of a theory of capital of the type presented here lies in the fact that in the buying and selling of capital resources there arise certain economic problems like capital gains and losses.

(Lachmann 1978:87n.)

The distinction that Lachmann makes here is surely without substance. The fact that human capital cannot be transferred does not prevent it from being valued in the market by its owners and by its renters. The capital value will vary directly with the rental rate (earnings). Most important, exactly the same considerations that apply to the theory of capital and make it interesting in Lachmann s view apply to human capital. Capital gains and losses most definitely attach to human capital in an uncertain world and are part of the market process of continual re-evaluation of production plans. We shall return to this below.

⁷One does not require a situation of equilibrium here. Irrespective of whether plans exactly match outcomes or not, perfectly general training, like literacy, benefits the individual in a general way, that is, in a variety of situations, to the same extent. Even though the precise benefit may be uncertain, the differential benefit, as between one work situation and another, is zero.

⁸Where the military pays for general training, for example for pilots, and does not pay the market wage for graduate trainees, there is a problem of re-enlistment and losses in favor of businesses in the private sector, like the private airlines (Becker 1993:39).

⁹As Becker notes, Marshall was clearly aware of the difference between general and specific training.

Thus the head clerk in a business has an acquaintance with men and things, the use of which he could in some cases sell at a high price to rival firms. But in other cases it is of a kind to be of no value save to the business in which he already is; and then his departure would perhaps injure it by several times the value of his salary, while he could not get half that salary elsewhere.

(Marshall 1949:626, quoted in Becker 1993:44n.)

¹⁰This is really just another aspect of the general imputation problem attaching to team production. “Perfectly efficient” imputation would facilitate “perfect learning” of production processes and would thus facilitate perfect coordination and enforcement over time in competitive markets.

¹¹We do not consider here alternative explanations, like the “screening” hypothesis that formal education serves merely to “weed out” already existing abilities. For a convincing (to me) rejection of these types of explanations, see Becker (1993:8).

¹²The necessity of the individual’s own time in the investment process prompted Becker to liken the process to the Austrian period of production model. His model is said to be “almost identical to those used in the ‘Austrian’ theory of capital to explain optimal aging of trees or wine. Indeed the main relevance of the Austrian approach in modern economies is to the study of investment in human capital” (Becker 1993:113n.). One may appreciate the point being made here, namely, that in a consideration of investments of human capital one comes to appreciate the importance of time in the investment process and, also, that there is very little scope for substitution when it comes to individual “time.” One can learn more or less intensively, but “crash courses” are less effective (productive) than more leisurely ones. Nevertheless, as with the Austrian period of production approach, it can be fundamentally misleading. Time, as such, is never “put in” to anything. Time is not a substance or a resource. Rather it is what happens over time that is important. Sometimes, as with the aging of wine, it happens almost incidentally. Mostly it is a matter of conscious effort or a by-product of such effort, as in the case of the acquisition of tacit skills or “experience.”

¹³Becker refers here again to Marshall:

Not much less than a generation elapses between the choice by parents of a skilled trade for one of their children and his reaping the full results of their choice. And meanwhile the character of the trade may have been almost revolutionized by changes, on which some probably threw long shadows before them, but others were such as could not have been foreseen even by the shrewdest persons and those best aquainted with the circumstances of the trade . . . the circumstances by which the earnings are determined are less capable of being foreseen [than are those for machinery].

(Marshall 1949:571; Becker 1993:92)

¹⁴Recent research into the connection between traditional measures of intelligence and economic success have cast doubt on any simple connection. See, for example, Goleman (1995:ch. 3).

¹⁵It is possible, of course, that differences in amounts invested in human capital and in type of human capital reflect differences in preferences (however caused). The analysis in the text abstracts from this, in effect assuming that such differences in preferences are less important than differences in abilities and opportunities. Certainly both forces are at work, affecting the demand for human capital. There is very little that one can say systematically about differences in preferences. One suspects that the larger the population under discussion, the less likely that systematic differences in preferences will explain differences in (average) earnings. It is also important to note that differences in rates of return (and therefore earnings) that are observed for individuals who invest the same amounts in the same type of human capital cannot be explained by differences in preferences.

¹⁶The presence of state subsidies for education and other human capital investment would normally set up compensating variations in private investments. For example, parents might be inclined to spend less of their after-tax dollars on human capital investment in the presence of subsidies to their children. As we have discussed, human capital is poor collateral. Therefore investments are unlikely to be financed to the full extent desired by poorer parents (were they better collateral) in the absence of state assistance. Thus, state assistance is likely to result in more (of certain types) of human capital (at the expense of other types of expenditure) than would be accumulated otherwise.

¹⁷The work of Gary Becker and his collaborators has extended this approach to the search for explanations of observed outcomes relating to intergenerational individual and family mobility and aspects of family economics in general. We shall have an opportunity to visit some of this below.

¹⁸“We may assume that the tasks in the collecting economy of an Australian tribe are, for the most part, divided in the most efficient way among the various members of the tribe. Some are hunters; others are fishermen; and still others are occupied exclusively with collecting wild vegetable foods. . . . We may imagine the division of labor of the tribe to be carried still further, so that each distinct task comes to be performed by a particular specialized member of the tribe. [The improvement in allocation and the increase in production that results from this] is very different from that which we can observe in actual cases of economically progressive peoples” (Menger 1976:72–73). Essentially the same point was made at length by T. W Schultz (1964).

¹⁹“It is the extensive cooperation among highly specialized workers that enables advanced economies to utilize a vast amount of knowledge. This is why Hayek’s emphasis on the role of prices and markets in combining efficiently the specialized knowledge of different workers is so important in appreciating the performance of rich and complex economies” (Becker and Murphey 1993:308).

²⁰Although he often does not seem to see the significance of this and, indeed, sometimes claims to assume exactly the opposite, Becker (and his collaborators in this work) clearly see human capital as a heterogeneous structure, much in the same way as Lachmann thinks of physical capital structures, that is in which the elements are crucially complementary. Another example: “An important function of entrepreneurship is to coordinate different types of labor and capital” (ibid.:305, italics added). Perhaps surprisingly, this is clearly recognized by the founder of the concept of human capital, T. W. Schultz, who states:

I have argued . . . that while a strong case can be made for using a rigorous definition of human capital, it will be subject to the same ambiguities that continue to plague capital theory in general, and the concept of economic growth models in particular. [Particularly problematic] is the assumption, underlying capital theory and the aggregation of capital in growth models, that capital is homogeneous. Each form of capital has specific properties: a building, a tractor, a specific type of fertilizer, a tube well, and many other forms not only in agriculture but also in all other production activities. As Hicks has taught us, this capital homogeneity assumption is the disaster of capital theory. It is demonstrably inappropriate in analyzing the dynamics of economic growth . . . whether capital aggregation is in terms of factor costs or in terms of the discounted value of the lifetime services of its many parts. . . . One of the essential parts of economic growth is thus concealed by such capital aggregation.

(Schultz 1981:10–11)

It does not seem as though this insight has permeated the human capital literature in general.

²¹An explanation in terms of the advances in the technology of birth control has been investigated and found wanting. There is historical evidence to suggest that effective forms of birth control have always been readily (cheaply) available (Becker 1991).