Human Capital and Its Structure.

Author:Burns, Scott
 
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"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. "

--Carl Menger ([1871] 1981, p. 76)

"Finally, the productive structure as a whole, encompassing the capital structure (narrowly understood) and the institutional structure (including the financial structure), must also be seen to include the value of human capital. In fact the human capital structure is arguably the most essential (and the most difficult to replicate) ingredient of the entire productive structure. Human knowledge has value. It is an asset. The human capital structure is, however, indescribably complex and unfathomable."

--Peter Lewin (1999, p. 215)

  1. Introduction

    Economists dating back to Adam Smith have discussed the parallels between the entrepreneur's decision to invest in physical capital and an individual's decision to invest in education and other productivity-enhancing skills, or human capital (Kiker 1966). Yet explicit discussion of human capital only moved to the mainstream of the profession in the mid-twentieth century, with the pioneering work of Gary Becker, T. W. Shultz, and Jacob Mincer. In labor economics, human capital theory has been used to explain what factors influence an individual's (and firm's) decision to invest in labor-augmenting skills such as education and job training. It has also been used in growth economics to explain why some nations experience more rapid economic growth than others. (1)

    In this paper, I discuss how insights from Austrian capital theory can be extended to human capital to explain not only growth but also cyclical phenomena. In particular, I argue that viewing human capital not as a homogeneous stock but as a heterogeneous structure helps to explain how central bank credit expansion and various labor and education policies can distort market price signals, disrupt the coordination of human capital investments with underlying market conditions, and lead to a cluster of malinvestments in human capital, with adverse effects on postrecession recovery and economic growth. It may also offer insights into some of the most pertinent questions in macroeconomics, such as the growing prevalence of "jobless recoveries" (Bernanke 2003; Schweitzer 2003; Aronowitz 2005) and the perceived skills gap and underemployment problems that many economists fear are stunting growth (Faberman and Mazumder 2012; Fadda and Tridico 2013; Mutikani 2016).

  2. Human Capital in the History of Economic Thought

    Generally speaking, human capital refers to investments that workers or firms make in any skills (through education or job training, for example) that might enhance their productivity (Becker 1962, p. 9). In quantitative terms, we can think of the value of a person's human capital as the present value of the higher expected future stream of income they can reap from the higher output they can produce thanks to these investments. Thus, human capital can be estimated much in the same way that the value of a piece of physical capital can be as the present discounted value of its future productivity.

    Although the term "human capital" wasn't formally employed until the turn of the twentieth century with the work of Irving Fisher (1897) and A. C. Pigou (1928), the concept has a long tradition in economic thought (Kiker 1966). Classical economists ranging from Adam Smith, Jean Baptiste Say, and J. S. Mill to Walter Bagehot, Henry Sidgwick, Jeremy Bentham, and Frederick List all noted the close parallels between investments in physical and human skills. Smith ([1776] 2008, p. 11.1.17) famously included the "acquired and useful abilities" of workers in his four categories of a nation's fixed capital. (2) The "improved dexterity" of workers, he concluded, "may be considered in the same light as a machine ... which facilitates and abridges labour." Others, such as J. R. McCulloch, Nassau Senior, Leon Walras, and Irving Fisher, went even further to argue that there was little practical need to distinguish human and physical capital; both were vital components of a nation's capital stock (Kiker 1966, pp. 485-87). Overall, although these writers recognized the differences between human and physical capital--most notably, that human capital is inalienable and so cannot be bought and sold separately from the person who possesses it--most agreed that useful analogies could be drawn between the two. As Alfred Marshall ([1890] 1920, p. 468) argued in his landmark textbook, "The most valuable of all capital is that invested in human beings."

    By the twentieth century, most economists scoffed at equating individuals with physical commodities (Schultz 1961). This dismissive attitude was most prevalent in the burgeoning field of labor economics led by institutionalist scholars such as Richard T. Ely and John R. Commons. These early labor economists dismissed many core aspects of neoclassical theory, including the marginal productivity theories of wage determination and the neoclassical theory of the firm; they instead focused their scholarly attention on advocating for labor reforms along progressive lines (White 2016, pp. 10-12). So, although some advances in the neoclassical theory of labor and wage determination were made during this period by William Hutt, John R. Hicks, Paul H. Douglas, A. C. Pigou, and others, these advances were relegated to the background of the field (White 2012).

    The topic of human capital experienced a renaissance in the mid-twentieth century with the work of Gary Becker, T. W. Shultz, Jacob Mincer, and George Stigler. (3) As Becker (1962, pp. 9-10) pointed out, although ample work had been done up to that point in estimating the economic return to various types of physical assets, there had been "few, if any, attempts to treat the process of investing in people from a general viewpoint or to work out a broad set of empirical implications." Applying rational choice theory to explain individuals' decisions to invest in their "human capital," Becker argued, provided a much more "unified explanation of a wide range of empirical phenomena" such as the time structure of earnings, the migration patterns of skilled vs. unskilled labor, and the optimal time workers should invest in training, education, and job search.

    In the years since this revival, research on human capital has concentrated heavily on two areas within the economics literature. The first has been in the more microeconomic realms of labor economics and industrial organization. Following the work of Becker, Schultz, and Mincer, economists have continued to analyze what factors influence an individual's (or firm's) decision to invest in their human capital as a means of production. The second has been in the more macroeconomic realm of growth economics. Over the past few decades, more economists have argued that a nation's human capital is a key ingredient for explaining why some nations enjoy higher labor productivity rates and hence more sustained economic growth than others. (4)

    Despite its continuing relevance in these two areas, the topic of human capital has remained conspicuously absent from the modern literature on business cycles. With the disappearance of capital theory from macroeconomics following the Keynesian revolution, economists have paid little attention to how investments in human capital interact with and complement an economy's physical capital structure, and how the two might be thrown into disarray during the business cycle. Standard models conceive of human capital in one-dimensional terms. (5) Such an approach neglects the dispersed nature of knowledge in society and the importance of capital's heterogeneity. (6) When instead we view human capital as a structure, not a simple aggregate, we can better appreciate how monetary and fiscal disturbances can distort market price signals and can cause entrepreneurs to malinvest in certain types of human (and physical) capital.

  3. Human Capital and Its Structure

    Before the Keynesian revolution, Austrian scholars from Carl Menger and Eugen von Bohm-Bawerk to Ludwig von Mises and F. A. Hayek made vital contributions to economic thought. They made efforts to erect from the micro-level principles of purposive human action and simple price theory a macro-level theory of how intertemporal coordination leads to sustained growth and what factors might disrupt it. Their emphasis on intertemporal coordination placed the economy's "time structure of production," or capital structure, at the heart of their macroeconomic analysis. (7)

    1. Austrian Capital Theory and Capital-Based Macroeconomics In this capital-based approach, savings play a pivotal role; they make possible not only the accumulation of more capital, but also the use of more "roundabout" and capital-intensive production processes with longer time to build and payback periods that ultimately yield greater output per unit of factor input (Bohm-Bawerk 1959). From an Austrian perspective, capital or "higher order" goods (defined as an economy's nonlabor means of production (8)) occupy a critical role in the capitalist economy because they are the means through which advanced material production takes place (Menger [1871] 1981). The enhanced productivity of these more roundabout production methods--made possible by the public's prior savings and the movement toward a greater division of capital that it promotes--lies at the heart of the Austrian theory of sustainable growth (Garrison 2001; Manish and Powell 2014).

      The greater steady-state output of these more time- and capital-intensive production methods, however, comes at a cost in addition to longer waiting--namely, the higher risk of embarking on projects that might turn out to be inconsistent with future consumer preferences. The immense difficulty of predicting a future that is, as Lachmann put it, "unknowable but not unimaginable," led Austrians to stress two...

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