Human Capital Theory and
Benefit-Cost Analysis in
Education
Emmanuel Jimenez, DECRG,
and Peter Moock, EASED
December, 1998
Outline
Basic Framework for Analyzing Investments
in Human Capital
 Relevance for project analysis...not

– Issues
– Modifying the approach
Human Capital Scale -- Weighing
Private Benefits and Costs
Benefits
Costs
The productivity chain
Education
Human capital
Wages
Welfare
Productivity
The productivity chain
Education
Human capital
Wages
Welfare
Productivity
Human Capital and Productivity
Human Capital
Working with Existing
Technology Better
Acquiring
New
Knowledge
Processing
Information
Developing
New Technology
Education raises wages for both men and women:
5
4.5
Primary
Secondary
Post-secondary
4
3.5
3
2.5
2
1.5
1
Slovenia
USA
Cote
d'Ivoire
Peru
0
Thailand
0.5
Indonesia
Wage relative to wage with no
schooling
Men
Returns over time
Wage ($)
S2
D1
S1
D2
W
S2
D1
D2
S1
G1
G2
Number of Graduates
Education raises wages for both men and women:
7
Primary
Secondary
Post-secondary
6
5
4
3
2
Slovenia
USA
Cote
d'Ivoire
Peru
0
Thailand
1
Indonesia
Wage relative to wage with no
schooling
Women
Education and productivity

Better educated farmers get a higher return
on their investments in agriculture:
– In Africa, farmers who have completed 4 years
of education (the minimum necessary for
literacy) produce, on average about 8-10
percent more than farmers who had not gone to
school (Moock, Jamison et al., Jamison & Moock)
– Technical and allocative efficiency (Welch, Timmer)
Education and productivity
(cont’d)

Production function may matter:
– In simple tasks or in settings where technology
slow to change, effect of education small
– In traditional farming, techniques passed from
generation to generation (T.W. Schultz)
– In piece-rate work in the Philippines, wage not
related to schooling after controlling for gender
and physical stature (Foster and Rosenzweig)
Human Capital and Wages
Education
Human capital
Wages
Welfare
Productivity
Education and productivity
(cont’d)
– But, if task involves new technology whether
there is a premium on learning and information
acquisition learning may be very important
– For example, large effect of education in Kenya
after introduction of new hybrid seed varieties
(Moock)
– In India, areas with relatively few educated
farmers at the onset of the green revolution
experienced less growth compared to other, high
schooling areas (Foster and Rosenzweig)
Human Capital Scale -- Weighing
Private Benefits and Costs
Benefits


Increased market productivity
Private non-market effects
(e.g., better personal
health, household productivity
effects)
Costs
Human Capital Scale -- Weighing
Private Benefits and Costs
Benefits


Increased market productivity
Private non-market effects
Costs
Direct costs
Foregone
production or
earnings
Graph on Rate of Return Estimation for
University-level Education
Post-tax earnings
University
graduates
Age
22
65
Graph on Rate of Return Estimation for
University-level Education
University
graduates
Returns
Secondary
school leavers
Indirect costs
(foregone
earnings)
Age
18
22
Cost
years
65
Benefit
years
43
Time (years)
Graph on Rate of Return Estimation for
University-level Education
Returns
University
graduates
Secondary
school leavers
Indirect costs
(foregone
earnings)
Age
Direct costs (out-ofpocket expenses)
Graph on Rate of Return Estimation for
University-level Education
University
graduates
+
----Costs - - -----
Benefits
+++++++
+ + + + + + + + + + + + Secondary
+ + + + + + + + + + + + + school leavers
++
+ +++
Age
Human Capital Scale -- Weighing
Private Benefits and Costs
Benefits
Costs
Graph on Rate of Return Estimation for
University-level Education
University
graduates
+
Benefits
+++++++
+ + + + + + + + + + + + Secondary
+ + + + + + + + + + + + + school leavers
++
+ +++
----Costs - - -----
age 18,
t=0
Age
age 22,
t=4
age 65,
t = 47
Time Value of Money
Now
Later
Inflation plus real rate of interest
Discounting
Now
Later
Interest Rate (Discount Rate)
FV = PV(1+r)t
PV = FV/(1+r)t
Interest Rate (Discount Rate)
Future Value ($ in t
years)
Life of investment
FV = PV(1+r)t
Principal ($
invested)
Interest rate
PV = FV/(1+r)t
Present Value of
FV paid t years
from now
Discount rate
Weighing Private Benefits and Costs -Without Discounting
Costs
Benefits
Internal Rate of Return
Benefits
Costs
The discount rate that equates benefits and costs
Returns to Investment in Education by
Level (%) -- Private Rates of Return
Country/Yr.
Bolivia
Brazil
Greece
Israel
Japan
Mexico
Paraguay
Taiwan
Venezuela
1989
1989
1977
1958
1976
1984
1990
1972
1989
Source: Psacharopoulos (1994).
Private
Prim. Sec.
Higher
9.8
36.6
20.0
27.0
13.4
21.6
23.7
50.0
36.3
8.1
5.1
6.0
6.9
10.4
15.1
14.6
12.7
14.6
16.4
28.2
5.5
8.0
8.8
21.7
13.7
15.8
11.0
Social Benefits
•Private benefits
•Increased market productivity
•Private non-market effects
•Plus ...
•Additional social benefits
•Taxes on higher earnings
•Externalities
•Spillover effects (my education increases your
productivity)
•Technical innovation
• Community non-market effects (e.g., lower crime)
Marginal Gains in Per Capita GDP
Growth per 10% Increase in
Enrollment Rate, 1960-1985
0.8
0.6
0.4
0.2
0
% Gain in -0.2
growth -0.4
-0.6
-0.8
-1
-1.2
-1.4
LowMiddleHighincome
income
income
countries countries countries
Source: Mingat and Tan, 1996.
Primary enrollment rate
Secondary enrollment rate
Tertiary enrollment rate
Child mortality and education
100
Percent
80
60
40
20
0
1-3 years
4-6 years
7+ years
Mother's educational level
Total fertility rate (%)
Fertility and education
7
6
5
4
3
2
1
0
No schooling
4-6 years
7+ years
Mother's educational level
Human Capital Scale -- Weighing
Private Benefits and Costs
P
R
I
V
A
T
E
Benefits


Increase market productivity
Private non-market effects
P
R
I
V
A
Direct costs
T
Foregone production or E
Costs
earnings
S
O
C
I
A
L




Spillover effects
Technical innovation
Community non-market effects
Reduced fertility/child mortality
Public subsidy
S
O
C
I
A
L
Measurement
Can we measure externalities?
 Can we measure monetary value of
reduced fertility and reduced mortality?
 Can we measure returns to equality?

Full (“Social”) Rates of Return
P
R
I
V
A
T  Increased market productivity
E  Private non-market effects
Benefits
P
R
I
V
A
Out-of-pocket expenses T
E
Foregone production/
Costs
earnings
S
O  Taxes on higher earnings
C
I
A
L
Public subsidy
S
O
C
I
A
L
Estimated Full Rates of Return by
Level of Education and Country
Group (%)
Level of education
Primary
Secondary
Higher
Low-income Middle-income
group
group
(74 countries) (19 countries)
47
8
<0
Source: Mingat and Tan, 1996.
39
52
<0
High-income
group
(20 countries)
-<0
20
Studies of rates of return
to sector investment
Relevant to the economic
analysis of projects?
Relevant to economic analysis
of projects?
externalities
marginal
returns vs. average returns
projects more delimited
Using economic sector work
to diagnose sector issues and
design appropriate
interventions
Cote d’Ivoire: Distribution of
Education Subsidies
Annual
subsidy
per capita
14000
12000
10000
8000
6000
4000
2000
0
Poorest
2
3
4
Quintile
Richest
All
Primary
Secondary
Tertiary
Ratio of Private to Public
Spending
Nicaragua
Primary
Secondary
Kenya
Primary
Secondary
1.25
2.57
2.22
0.62
Some of the right questions
What is the full cost of the project?
What are the alternatives to the project?
What are the benefits -- to the project?
More students -- what will be the impact of the
project on their future productivity?
 More efficient education system -- what are the cost
savings?

More of the right questions
What is the appropriate role of government?
 Try and estimate externalities
 How large would externalities have to be?
What are the incentives (and the disincentives)
to reform?
 Who benefits from the intervention?
 Who loses?
Human Capital Theory and
Benefit-Cost Analysis in
Education
Questions from Participants?