Wednesday, June 6, 2012

The Human Capital Theory in Education: Principles, critiques and current thinking

 Godfrey Mulongo

Institute of Education, University of London

Without education, people can be subject to abuses by the most powerful. …….Without education, people may be constrained to find menial jobs that do not fulfill them… Without education, those who are marginalized or oppressed may not have the resources to denounce the injustices they suffer from and to claim their rights. Unterhalter in Deneulin and shahani (2009 pp.201)

This essay is a critical reflection on the Human Capital Theory (HTC), focusing on its principles, critiques and current thinking. According to Psacharopoulos et al. (2004a), the HTC has roots in the works of classical authors such as Adams Smith (1776) and Alfred Marshall (1890). The former concluded that ‘a man educated at the expense of much labour and time may be compared to one of those expensive machines… and the work he learns to perform should replace to him the whole expense of his education’. The latter referred to industrial training as ‘a national investment’. Much later authors such as Mincer (1958), Schultz (1961) and Backer (1975) gave ‘meat’ to this theory when they affirmed that time and money spent on education builds human capital hence one should be able to estimate the rate of return (RoR) on such investment, in a way similar to investment in physical capital. In short, the HTC states that a person’s education is an investment (involves costs, in terms of direct spending on education and the opportunity costs of student time) in her/his human capital (akin to investment by a firm in physical capital), which makes the individual more productive and accrue him/her a future stream of benefits (superior productivity, higher wages and other non-monetary benefits to the individual and the society).  

The Human Capital Theory; Principles, Critiques and Current Thinking
The significance of education and human capital has been brought out in many studies and arguments of economic growth and development.  This can be classified into the micro and macro levels.

 Micro level

At the micro level, the theory postulates that an individual bears the costs (direct costs such as fees paid and indirect costs such as opportunity cost on student time) of education because s/he expect that this investment will create a future stream of benefits to h/her (higher productivity and thus higher wages). There’s a significant bulk of literature and research to underscore this fact: For instance, Psacharopoulos and Patrinos study “Human capital and rates of return” (2004) conclude that educational quality, (measured by cognitive skills) has a strong impact on individual earnings, moreover educational quality has a strong and robust influence on economic growth with “truly causal relationships”. McIntosh and Vignoles (2001) studied wages in the United Kingdom and found strong returns to this investment while Finnie and Meng (2002) and Green and Riddell (2003) established the same fact in Canada. Nickell (2004) considered how differences in the distribution of incomes across countries were affected by the distribution of skill and concluded that “the bulk of the variation in earnings dispersion was generated by skill dispersion. Other studies have also concluded that skills have an increasing impact on the distribution of income and that the income distribution becomes more dispersed in reflection of growing rewards to individual skills (Juhn, Murphy and Pierce 1993, Levy and Murnane (1992). Psacharopoulos (2004) concludes more schooling is associated with higher individual earnings.

 Table 1 below shows the relationship between income levels and educational attainment in the US.

Table 1: Mean Earnings by Highest Degree Earned, $: 2009 (SAUS[1], table 232 cited by Strauss S[2].)

 Basically, the higher the education level, the higher the income. For example, people with professional degrees earned 6x as much as people who did not graduate from high school (in 2009: $128,000 vs. $20,000). Therefore, more “educated” people tend to earn higher wages and have better jobs than the less “educated” ones (UNDP, 2010)
However, education is not just an income effect. Table 2 demonstrates that unemployment rates and educational attainment are also strongly related.

Table 2: Mean un-employment rate by education qualification (SAUS, table 233 cited by Strauss S.)

In other words, the better educated the group, the lower the unemployment rate i.e. at the extremes, unemployment rate for those with less than a high school education was 7%,  and the highest reaching 15%, a four-year college degree and at least some graduate school had unemployment rates of 4.5%, compared to an overall rate of 9%.
Also according to the theory, other benefits of education may be realised in terms of greater productivity and less need to incur costs. An example of educational benefit that improves production possibilities is the greater labour market productivity of those with additional schooling. And the lesser dependency on subsidies in educated communities is an example of benefit that reduces costs for tax-payers (Vila, 2000). In addition, a large body of literature in macroeconomics has underscored that productivity spillovers are important determinants of economic growth and that an increase in aggregate human capital will have an effect on aggregate productivity[3] which is as a results of an increase in an individual’s education on productivity (Moretti, 2005).

The HTC also recognises the non-monetary benefits that accrue to the individual as a result of the investment in education. Vila (2000) encapsulates;

The economic benefits that education bestows are not limited to higher expected production or lower production costs. They could also consist in direct additions to welfare possibilities in terms of longer life expectancy, less criminal behaviour, stronger social cohesion or greater political participation” p.p 21-22
Being educated empowers people to advance their interests and resist exploitation (Eyben, 2004).  Educated people are more aware of how to avoid health risks[4] and to live longer, have smaller families[5], exhibit better consumption/savings habits[6] and more comfortable lives (Bassel 2008a, 2008b).  

The UNDP’s Human Development Report (2010) asserts that it is a basic fact that levels of income and levels of health and education are positively and significantly correlated as depicted in the figure below.

i.e. the relationship between the income and non-income dimensions of human development has shifted up since the 1970s.

Theory predicts that increases in the overall level of education can benefit society in ways that are not fully reflected in the ‘private returns’ of educated workers, what is otherwise referred to as the ‘externalities of education’. For instance, social groups, communities or countries where the average schooling is higher offer, as a rule, better living conditions, both material and non-material, than those where the population is less educated (Vila, 2000)[7].

Macro level
At the macro level[8], Robert (1991) developed a human capital model which shows that education and the creation of human capital is responsible for both the differences in labour productivity and the differences in overall levels of technology that we observe in the world today. This, according to him, explains the spectacular growth in East Asia that has given education and human capital their current popularity in the field of economic growth and development. Countries such as Hong Kong, Korea, Singapore, and Taiwan have achieved unprecedented rates of economic growth while making large investments in education. This correlation between education, national and international development can be traced to the Solow growth model, way back in the mid-1950s. This theoretical model asserts that the economic growth of a country depends on its endowments of labour (population size) and of physical capital (machinery, infrastructure), and on technological change. In 1962, Edward Denison used the Solow growth accounting framework to examine the factors that contributed to economic growth in the US over the period 1910 to 1960.  Denison established that increases in the quantity of labour and of physical capital during that period did not explain the increase in national income and the huge unexplained growth residual but concluded that as much as 23% of the annual growth rate of GNP could be explained by increases in the level of education of the workforce. In other words, education was an important determinant of economic growth. Much later, Denison (1985) found that the increase in schooling of the average worker between 1929 and 1982 explained about one fourth of the rise in per capita income during this period. Even in African countries such as Kenya, education contributed to much to economic development, particularly in the phase up to the mid-1970s during which the economy grew at a comparable rate to the economies of East Asia and when agricultural improvements benefited from educational advance (Green A., 2007). But detailed investigations on rates of return from education to families and national economies were undertaken by George Psacharopoulos in the 1970s and 1980s who like those before him, concluded that indeed education played a significant role in the social-economic development of a country.


According to Fitzsimons (cited in the Encyclopedia of Philosophy of Education, 1999 – available at, accessed on 28/05/12), there are two main critiques of the HTC: methodological and another fronted by economic sociology which challenges the first assumption by arguing that the society and culture cannot be arbitrarily split from the economy.  i.e.  methodological foundations of neo-classical economics obscure the social, cultural, and political determinants of economic action. A similar critique has been leveled against the work of Psacharopoulos who pundits argue that he made some unsafe inferences from his data. Other critics point out that the HTC “framework assumes that labour markets work rationally and efficiently and that, once schooling has developed certain aspects of human capital, the labour market will allocate people to occupations that are appropriate for their level of skills. … The framework tends to view schooling as something like a machine, which children enter and exit with their human capital appropriately topped up (Unterhalter E, in Deneulin & Shahani, 2009, pp. 211).

Perhaps the most damning critique is the one fronted by screening hypothesis[9]. This theory says that schools produce just diplomas or sheepskins helping the holder to get a privately well paid job, although the social payoff of the human investment he has undertaken might be minimal (Arrow 1973)

This discussion has presented a critical reflection on the Human Capital Theory (HTC), by looking at its historical background, the arguments that underpin it, its principles, current applications and its critiques. This has been done through citing evidence for and against the theory. However, though the HTC faces severe criticism, a huge school of thought agrees that education is one of those investments that will surely pay a dividend, both at the private, social and national arenas. In the next section, we look at the application of the HTC in informing policy in education.


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[1] Statistical Abstract of the United States published by the US Census Bureau.
[2] The Connection between Education, Income Inequality, and Unemployment. Available at: Accessed on 23/05/2012)

[3] Using a unique firm-worker matched dataset, obtained by combining the Census of Manufacturers with the Census of Population, Moretti (2005) assessed the magnitude of productivity spillovers from education in U.S. cities by estimating plant-level production functions. The study (Social Returns to Human Capital-available at Accessed on 23/05/2012) found that the output of plants located in cities that experience large increases in the share of college graduates rises more than the output of similar plants located in cities that experience small increases in the share of college graduates. Furthermore, the study established that aggregate human capital in the high-tech sector of the city matters more for high-tech plants than aggregate human capital in the low-tech sector of the city
[4] The links between education and may be found in Sander (1998, 1999), Hartog and Oosterbeck (1998), Nayga (1998), Grossman and Kaestner (1997), Kenkel (1991), and Berger and Leigh (1989).
[5] Educational advance is associated with declining fertility rates because it reduces infant mortality and unwanted pregnancy of teenagers, raises the age of marriage and may influence attitudes towards contraception. Since high fertility rates and poverty are related, education also reduces fertility by reducing poverty.5 Discussion and evidence on the links between education and fertility can be found in Klepinger et al. (1998), Doyle and Weale (1994), Brien and Lillard (1994), Rosenzweig and Schultz (1989), and Psacharoupoulos and Woodhall (1985)
[6] Education may influence individual and aggregate consumption patterns in several ways. First, more education directly increases the demand for some manufactured goods (e.g. books, paper, writing instruments, computers) and complementary services (transport, meals, housing, information) related to the acquisition of knowledge. Second, education influences personal preferences that guide choice of expenditure, leading to more efficient household management. Some economists think that educated people are likely to save higher share of their income and to obtain higher rates of return from their savings (Attanasio (1998), Arrow (1997), Lemennicier (1978), Solmon (1975), and Michael (1972).
[7] Vila (2000) defines Non-monetary benefits of education (NMBs) as those educational outcomes whose full economic impacts escape pecuniary measurement. He also asserts that NMBs are sometimes very difficult to identify and even more difficult to measure, but these effects add to the monetary returns and must be considered in the rational analysis of educational investment and planning
[8] Macro level can be categorized into growth that is realized within a country and the cross-country growth
[9] Under the screening hypothesis, acquiring education is still privately profitable since education level can be used to signal ability and thereby earn higher wages, but education does not increase a person’s productivity and it is not a socially profitable activity and the rationale for public subsidy to education no longer exists.