Comparison and implications of human capital theory at the individual, organization, and country levels.

Author:Bae, Seong-O.
 
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INTRODUCTION

According to human capital theory, education level is positively correlated with income. It specifies a particular mechanism by which education increases skills; in turn, acquired skills increase productivity, resulting in higher productivity being rewarded through higher earnings (Becker, 1993). It shows a positive correlation between age and earnings whereby older workers earn more because they have more on-the-job experience or training. Education and on-the-job training are said to make workers more productive and they are paid more because of their increased productivity. On-the-job training can provide general human capital (i.e., skills and knowledge transferable to other firm settings) or specific human capital (i.e., skills and knowledge only useful in the particular firm) (Becker 1993).

The notion of human capital theory provides us with important insight about the relationship between education and earnings and the factors related to education and earnings (e.g., age, type of training, costs, labor markets, etc.). Based on these insights, we can classify three implications of human capital theory at the individual, organization, and country levels. At the individual level, human capital theory explains basically a supply-side theory, which analyzes individual data consisting of the supply-side of the labor market. At the organization level, demand-side theory takes into account the analysis of firm related phenomena (e.g., productivity, investment, turnover, etc.). There is a comprehensive perspective at the country level, where both supply- and demand-side theory should be equally considered in national policy making.

With respect to individuals, understanding of human capital theory can increase their investment motivation and decrease failure in the labor market. For human resource development professionals, a more economic view of training and development is required to apply investment activities and gain benefits with a minimal investment risk. With regards to government policy makers, implementing human capital theory provides a wider scope for considering the extent to which policies, such as education reform, government training policy, equal employment opportunity legislation, affirmative action, and pay equity arrangements, can provide a more efficient and equitable use of human resources.

The purpose of this paper is to present human resource development professionals with information about significant factors related to human capital investment. It will help human resource development professionals understand what considerations they should make before investing in human capital. Based on a perspective of the individual, organization, or country, human resource development professionals may react differently in human capital investment. This paper will present the differences between three perspectives in human capital investment that are necessary to make good investment decisions. To achieve this purpose, the paper includes two challenges to human capital theory. First, it will theorize the basic frameworks of human capital to provide a theoretical foundation for further analysis in human capital investment. Secondly, it will identify considerable factors in human capital investment related to three levels of perspective--individual, organization, and country. At the same time, it will present how human capital theory can be applied in an investment decision for the three respective levels.

THEORETICAL FRAMEWORKS OF HUMAN CAPITAL THEORY

Becker (1962) introduced the basic notion of human capital. He states that the theory of human capital can be defined as skills acquisition, and that skills acquisition can be achieved through education and training. Education is the most important way to obtain human capital, and training is another important method to invest in human capital. For example, individuals invest in human capital by spending their money (e.g., tuition, books, supplies, etc.) and time (e.g., opportunity costs) for schooling and companies invest in human capital by providing training programs for individual workers. After investing in human capital, individuals acquire higher level of skills and are rewarded with higher wages and salaries in return for their improved productivity. The companies benefit both from the workers' improved performance and from higher productivity. Many labor economists have explored empirical data and built useful theoretical analyses to explain phenomena of human capital, which are as follows.

Production Function Model

Jorgenson and Grilichres (1967) presented the production function model that includes all contributions to output:

Y = f (K, L, T, Q)

It represents that the degree of output (Y) is produced by the physical capital (K), labor services (L), technical progress (T), and human capital (i.e., labor quality) (Q) in addition to labor services. Individuals will seek either to maximize their present value of future earnings or to maximize the internal rate of return. Holding the technical progress (T) factor and other factors constant, human capital (i.e., labor quality) (Q) is another factor of production (i.e., a second type of capital). Each factor has a price based on marginal productivity, so that human capital (i.e., labor quality) (Q) will have a price that equates the value of the marginal contribution to the cost of labor quality. The production function implies that there can be an optimal level of investment in human capital for firms and individuals, and they should optimize their accumulation of human capital to avoid any over- or under-investment.

General Training vs. Specific Training

Becker (1993) distinguished general training from specific training with perfect labor markets: (1) General training increases the marginal productivity of trainees by exactly the same amount in the firms providing the training as in other firms, and (2) Specific training has no effect on the productivity of trainees that would be useful to other firms. The concept of training is concerned with the cost of training (i.e., training finance), and who (i.e., firms or individual workers) bears the cost of training. In terms of general training, firms will provide training only if they do not have to pay any of the training costs. Trainees receiving general training are willing to pay these costs because training will raise their future earnings. Individual workers bear the costs of general training and also receive the profit from the return. However, in the case of specific training, workers cannot transport acquired skills across firms because the acquired skills are only useful in the specific firm or workers are effectively immobile between firms for other reasons. Trainees do not have the benefit of moving between firms. Also, the firm will acquire benefit from the specific training and bear the training costs equal to the returns from training. Individual workers may also invest in specific training if it decreases the probability of layoff. Firms paying for specific training will suffer when trained workers leave, because equally trained new workers cannot be obtained without additional training costs.

However, firms within non-competitive labor markets may pay for general training. Labor market frictions and institutions shape the wage structure, so that they may have an important impact on the financing and amount of human capital investments and account for some international differences in training practices (Acemoglu & Pischke 1999b). Moreover, specific and general training are incentive complements from the firm's point of view. Specific training not only renders the provision of general training viable for a firm, but also the reverse also holds: the higher the level of a worker's general human capital, the larger are the firm's incentives to train him in specific skills. As a consequence, firms may be willing to sponsor general training, even in competitive labor markets, where outside wages fully reflect a worker's marginal product from his general human capital (Kessler & Lulfesmann 2006).

Two Period Labor Market

Becker (1975), Hashimoto (1981), Hashimoto and Yu (1980), and Azariadis (1988) provide a job training analysis based on a two-period model. Labor market entrants encounter a two-period time horizon. In the first period, workers choose between training and job search, and, in the second period, trained workers take up a skilled occupation. This two-period model assumes that there are two levels of occupations, skilled and unskilled, and that entry into the skilled occupation requires a certain level of training.

In the two-period model, the supply of trainees depends on the distribution of discount rates. For example, a lower discount rate occurs when the difference between the skilled and unskilled wage in the second period is greater than that between the unskilled and trainee wage in the first period. Each individual has different discount rates, so the training decisions among individuals vary depending on the individual's discount rate. Individuals with a low discount rate will decide to train in the first period, because these individuals know that the skilled wage, compared to the unskilled wage, is high enough to bear the lowest trainee wage. But individuals with a high discount rate will not get training and search for jobs in both periods, because there may be no significant wage difference between skilled and unskilled workers or a trainee's wage rate is too low during training; consequently, individuals are better off not to get training. In this analysis, it is clear that the individual wage will become higher after training, and that the lowest wage, lower than that of an unskilled job, will be given during the training period.

The issues about job rationing and training subsidy are related to the supply of skilled labor. Training investment may occur with unemployment issues in skilled labor,...

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