Chapter Two: Human Capital: Education and Health in Economic

Development
2.1. Introduction: Basic Concepts of Human Capital
 Capital is a stock of wealth used to produce goods and services. Most often, by capital
people mean physical capital: buildings, machines, technical equipment, stocks of raw
materials and goods.
 How are physical capital and human capital similar? How are they different?
- The above definition stands for physical capital.
- Physical capital consists of man-made goods that assist in the production
process.
 Human capital is people’s abilities, knowledge, and a skill which is at least as important
for production, and at least as valuable to people who have it.
 The formation of both human capital and physical capital needs investment; and both
human capital and physical capital are used to produce good and service.
 Human capital formation is thus associated with investment in man and his development as
a creative and productive resource.
 Theodore W. Schultz (1964) introduced the magnitude of human investment. According
to Schultz, there are five ways of developing human resources:
- Health facilities and services, broadly conceived to include all expenditures that
affect the life expectancy strength and stamina, and the vigour and vitality of the
people.
- On-the-job training, including old type apprenticeships organized by firms.
- Formally organized education at the elementary, secondary, and higher levels.
 Education can add to the value of production in the economy and also to the
income of the person who has been educated. But even with the same level of
income, a person may benefit from education—in reading, communicating,
arguing, in being able to choose in a more informed way, in being taken more
seriously by others and so on (Nobel laureate Amartya Sen, Development as
Freedom, 1999).
- Study programmes for adults that are not organised by firms, including
extension programmes notably in agriculture.
- Migration of individuals and families to adjust to changing job opportunities.
 Job search and migration are activities that increase the value of one’s human
capital by increasing the price (wage) received for a given stock of skills.
- To this list may be added the import of technical assistance, expertise, and
consultants.
 As you have seen the dimension of human capital in the above, the dimension of human
capital is wide. In this chapter, we focus on two important dimensions of human-capital such
as education and health.
 Health and education are both components of human capital and contributors to human
welfare.
2.2. Human Capital and Economic Development
 Economic analysis has no trouble explaining why, throughout history, few countries have
experienced very long periods of persistent growth in income per person. For if per capita
income growth is caused by the growth of land and physical capital per worker, diminishing
returns from additional capital and land eventually eliminate further growth.
- The puzzle, therefore, is not the lack of growth, but the fact that the United States,
Japan, and many European countries have had continuing growth in per capita
income during the past one hundred years and longer.
 Presumably, the answer lies in the expansion of scientific and technical knowledge that
raises the productivity of labor and other inputs in production.
 Human capital thus constitutes an intangible asset with the capacity to enhance
or support productivity, innovation, and employability.
 Human capital increases the productivity of workers.
 Human capital may directly affect economic development and growth or
indirectly, in particular through the generation of technology.
 Governments in virtually all developing countries are attempting to increase levels of
schooling and to improve levels of health.
- These goals are also very important to households and other major social units.
 The systematic application of scientific knowledge to production of goods has greatly
increased the value of education, technical schooling, and on-the-job training as the growth
of knowledge has become embodied in people-in scientists, scholars, technicians, managers,
and other contributors to output.
- Education and health are basic objectives of development; they are important ends in
themselves.
- Health is central to well-being, and education is essential for a satisfying and rewarding
life; both are fundamental to the broader notion of expanded human capabilities that lie
at the heart of the meaning of development.
- Education plays a key role in the ability of a developing country to absorb modern
technology and to develop the capacity for self-sustaining growth and development.
 Individuals with the highest talents may contribute to technological progress by
the use of their human capital if they have the necessary access to educational
facilities.
 A better educated work force is more skilled, more adaptable, and more
entrepreneurial.
 The value of education is not limited to any particular sector of the economy:
better educated farmers appear more responsive to new technical possibilities, and
 better educated women seem more effective at allocating resources within the
home, including those that enhance child survival.
- Moreover, health is a prerequisite for increases in productivity, and successful education
relies on adequate health as well.
- Thus both health and education can also be seen as vital components of growth and
development as inputs to the aggregate production function.
- Their dual role as both inputs and outputs gives health and education their central
importance in economic development.
- Improvements in the health status of the population have a positive impact on economic
performance through different mechanisms widely following:
 Productive efficiency: Education and health is a conditioning factor of an
individual’s productivity and efficiency. Healthier workers have more physical
and mental energy, being more creative and productive. Health also affects labor
supply since health problems cause many times absenteeism at work.
 Life expectancy: one important outcome of health status improvements is the
raise of life expectancy, which has consequences on education and
investment/saving decisions. It makes investment in education more attractive and
at the same time it is an incentive to save more for retirement since individuals
expect to live longer. Therefore an increase of life expectancy should raise
schooling qualifications and saving rates. An increase of life expectancy has also
effects on the demographic structure of the population. By reducing infant
mortality, a higher life expectancy will be reflected on a raise of the proportion of
working age population. However, in the long term it is expectable that a decrease
in the fertility rate will have the opposite effect, so the final result will depend on
the predominance of these two forces.
 Learning capacity: improvement on health status and nutrition are responsible
for better cognitive capacities and educational outcomes. It is expected that
healthier people have higher learning capacity explained not only by showing less
absenteeism at school or at work but also for being more capable to assimilate and
accumulate more knowledge.
 Creativity: health improvements induce better educational achievements, which
are likely to have additional effects on the country’s creativity and innovation
 activity. Educational improvement speeds technological diffusion since educated
individuals are likely to become good innovators and to be more flexible to
technological changes. In this context, it is assumed that healthier workers are
more able to have positive reactions to change, which is a determining factor for a
successful change implementation. Healthier and more educated workers will be
more receptive to technological change and innovation processes.
 Inequality: investment on human capital qualification is one important
explaining factor of wage differentials. Having this in mind, promoting health can
be seen as a vehicle to reduce income inequalities, since health policies will affect
more the less favored population. Investing in the health sector is a way to reduce
income inequalities, to increase labor productivity and therefore growth.
 Schultz (1961) argued that human capital is important to economic growth. It is impossible to
realize modern agricultural as well as industrial economic growth without considering human
capital.
 Linkages between Investments in Health and Education
Health and education are investments made in the same individual.
Greater health capital may raise the return on investment in education for several reasons:
- Health is an important factor in school attendance.
- Healthier children are more successful in school and learn more efficiently.
- Deaths of school-age children also increase the cost of education per worker.
- Longer life spans raise the return to investments in education.
- Healthier individuals are more able to productively use education at any point in
life.
Greater education capital may raise the return to investment in health in the following
ways:
- Many health programs rely on skills learned in school (including literacy and
numeracy).
- Schools teach basic personal hygiene and sanitation.
- Education is needed for the formation and training of health personnel.
- Education leads to delayed childbearing, which improves health.
 Improvements in productive efficiency from investment in education raise the return
on a lifesaving investment in health.
In addition to their intrinsic value as elements of human welfare, improved health and
education contribute to improved economic performance.

2.3. Why Human Capital difference among countries?

 Human capital varies greatly across countries.
 Compared with developed countries, much of the developing world has lagged in its
average levels of nutrition, health (as measured, for example, by life expectancy or
undernourishment), and education (measured by literacy).
 What is crucial to determine the difference of human capital across countries?
- Difference in social settings in which it is created and used: schools, organizations,
labor markets, communities, national institutions, and cultures influences human
capital formation and creates human capital across countries.
- Schultz (1961) and Becker (1962) argued the difference in human capital investment
creates the difference in stock of human capital among countries.
- Schultz noted that the tax laws, professional associations, governmental bodies,
imperfect capital laws for funding investment on human capital such as lack of long-
term private as well as public loan to students, discrimination such as racial, religious
and others, lack of modern sectors for internal migration from farm work to off-farm
work, lack of employment opportunity to the educated adults and low earning of
educated adults are detrimental to investment on human capital and, as result creates
variation in stock of human capital among countries.
- Lim (2003) shown that human capital formation is significantly influenced by the
following policy variables.
 Ratio of government consumption expenditure to GDP: It is noticed that the
country with higher government consumption expenditure has the lower stock of
human capital.
 Ratio of government expenditure on education to GDP : it is found that a
government with more education expenditure has the larger stock of human
capital.
 Political instability:
 The degree of democracy-political right and civil liberties
 And the mortality rates are significantly related with the difference of human
capital formation across countries.
 In addition, it can be argued that collecting more tax to maintain large public
consumption can discourage the investment in human capital.
2.4. Investment in Education and Health: The Human Capital Approach
 The analysis of investments in health and education is unified in the human capital
approach.
- Human capital is the term economists often use for education, health, and other
human capacities that can raise productivity when increased.
- Investment in human capital takes place over the course of people’s lives in a wide
range of settings – including in the family, at school and at work.
- The quantity of human capital investment can most readily be measured through two
resources devoted to learning and health: money and time.
 The amount of money spent by individuals, companies and governments on
training and education, health and the time spent by participants in courses of
study, serve as useful approximations of human capital formation.
- Initial investments in health or education lead to a stream of higher future income.
 Human capital investment confers benefits on individuals, enterprises, and
societies. These benefits may be economic in nature and accrue in the form of
additional earnings, productivity, or economic growth.
- As a result, a rate of return can be deduced and compared with returns to other
investments.
- This is done by estimating the present discounted value of the increased income
stream made possible by these investments and then comparing it with their direct
and indirect costs.
 Discount rate: in present value calculations, the annual rate at which future
values are decreased to make them comparable to values in the present.
 In deploying finite resources, it is needed to know which forms of investment
produce the best value for money. This calculation has to take account of the
postponement of returns, often over long periods after the investment has been
made.
 To calculate the economic return, the cost of investments should be examined
alongside the value of future benefits – “discounted” to take account of their
postponement.
 To compare alternative investments, this information can be combined to
produce in each case an annual “rate of return”.
- The difference between what could have been and what is earned (including any value
placed on foregone leisure) is an important indirect cost of schooling. Tuition, fees,
books, supplies, and unusual transportation and lodging expenses are other, more
direct, costs.
- Calculating Rates of Return
 The income gains can be written as follows, where E is income with extra
education, N is income without extra education, t is year, i is the discount rate,
and the summation is over expected years of working life:
Et −N t
∑ (1+i)
t
  Investment in additional schooling is attractive if the present value of future
benefits exceeds costs:
B1 B2 BT
+ 2
+…+ >C
1+ r (1+ r) ( 1+r )T
 Net earnings can be defined as the difference between actual earnings and
direct school costs. In symbols,
W = MP – k
Where W is wage, MP is actual marginal product (assumed equal to earnings)
and k is direct costs. Where C is the sum of direct and indirect costs and
where net earnings are the difference between potential earnings and total
costs.
- Private returns to education are high, and may be higher than social returns, especially at
higher educational levels.
Table 1: Sample Rates of Return to Investment in Education by Level of Education,
Country, Type, and Region

Figure 1: Financial Trade-Offs in the Decision to Continue in School

  Note that the higher rates of return for developing countries reflect that the
income differential between those with more and less schooling is greater on
average than for the developed countries.
2.5. The Gender Gap: Discrimination in Education and Health
- Young females receive less education than young males in nearly every low and lower-
middle income developing country.
- Large majorities of illiterate people and those who have been unable to attend school
around the developing world are female.
- The educational gender gap is especially great in the least developed countries in Africa.
- Educational gender gap is the male-female differences in school access and completion.
- Closing the educational gender gap is important because:
 The social rate of return on women’s education is higher than that of men in
developing countries.
 Education for women increases productivity, lowers fertility – Educated
mothers have a multiplier impact on future generations.
 Education can break the vicious cycle of poverty and inadequate schooling for
women.
- Good news: Millennium Development Goals on parity being approached, progress in
every developing region.
2.6. Child Labor
 Child labor is a widespread problem in developing countries.
 When children under age 15 work, their labor time disrupts their schooling and in a
majority of cases prevents them from attending school altogether.
- The health of child workers is significantly worse, even accounting for their poverty
status, than that of children who do not work; physical stunting among child laborers is
very common.
 - In addition, many laboring children are subject to especially cruel and exploitative
working conditions.
 Approaches to child labor policy
- The International Labor Office (ILO), a UN body that has played a leading role
on the child labor issue.
- Get more children into school (as in Millennium Development Goals), e.g. new
village schools; and conditional cash transfer incentives to induce parents to send
their children to school.
- Recognizing child labor as an expression of poverty and recommends an
emphasis on eliminating poverty rather than directly addressing child labor (a
traditional World Bank approach).
- Considering child labor inevitable, at least in the short run, and stresses palliative
measures such as regulating it to prevent abuse and to provide support services for
working children.
- Ban child labor; or if impossible, ban child labor in its most abusive forms (ILO
strategy; “Worst Forms of Child Labor Convention”).
- Activist approach: trade sanctions. Concerns: could backfire when children shift
to informal sector; and if export sector growth slows.
2.7. Educational Systems and Development
The Political Economy of Educational Supply and Demand: The Relationship between
Employment Opportunities and Educational Demands.
- As employment opportunities diminish (for given level of education) demand for
higher education increases putting pressure on government to expand educational
facilities at the higher level.
 The amount of education demanded is thus in reality a derived demand for high-
wage employment opportunities in the modern sector.
 Derived demand: demand for a good that emerges indirectly from demand for
another good.
- On the supply side, the quantity of school places at the primary, secondary, and
university levels is determined largely by political processes, often unrelated to
economic criteria.
Social versus Private Benefits and Costs
- Social costs of education: costs borne by both the individual and society from private
education decisions, including government education subsidies.
- Private costs: the costs that accrue to an individual economic unit.
 -
Social benefits of education: benefits of the schooling of individuals, including those
that accrue to others or even to the entire society, such as the benefits of a more
literate workforce and citizenry.
 Not all benefits of investment in human capital can be captured in terms of direct
economic impact. The creation of knowledge, skills, competences, and aptitudes
relevant to economic activity affect not only performance at work but also social
behavior
 . “Spin-off” benefits may affect public health, crime, the environment, parenting,
political and community participation and social cohesion, which in turn feed back
into economic well-being.
- Private benefit of education: the benefits that accrue to an individual economic unit.
For example, private benefits of education are those that directly accrue to a student
and his or her family.
- Educational attainment is positively related to individual performance in the labour
market. Those with higher levels of education are more likely to participate in the labor
market, face lower risks of unemployment, and receive on average higher earnings.
Figure 2: Costs and benefits of human capital investment (Education)

2.8. Problems of developing country education and health systems

 Some problems of developing country education systems
- Children learn much less in school than the curriculum states they should learn. Lack of
needed logistics for effective teaching and learning (most basic equipment and school
supplies such as textbooks, blackboards, desks, classrooms).
- Grade repetition and leaving school at an early age (dropout) are common.
 - Teacher quality and availability is a common problem: Most teachers are not trained
and teacher shortages are high, resulting in very high student-teacher ratios.
- Teachers often have weak incentives: This results in low morale and does not
encourage teachers to “give off their best”.
- Teacher absenteeism is high. Beyond absence, many “present” teachers do not actually
do effective teaching most of the time.
- Quality of education has deteriorated because expansion in educational investment and
infrastructure has lagged behind growth in the population of school going age: There is
congestion affecting quality.
 Some problems of developing country health systems

- Fewer health facilities compared to developed countries, and facilities often in very
poor state.

- There are high patient-doctor and high patient-nurse ratios as a result of inadequacy
of health personnel.

- Per capita public expenditures on health care are also much smaller in developing
than in developed countries.

- Private health facilities are few and mainly located in urban areas and are generally
afforded by the wealthy.

- There are also a number of indigenous (traditional) medical practitioners

(particularly, herbalists) of various kinds in developing countries.

- Health services are unevenly distributed among the population: rural areas usually
lack the availability of health centers and personnel.

- There is often a lot of congestion at health facilities, particularly public facilities,

because of the fewness of the facilities relative to the size of the population.
2.9. Human Capital Investment: Policy Issues
 Governments can influence the development of human capital in many ways even though
their influence is one of many, and must be exercised in partnership with other interested
parties.
 Evidence clear that health and education are joint investments.
 Need for integrated policy approach; some policy issues:
 Adequate levels of human capital investment
- A range of policy options are available to encourage investment in human capital.
- Options to be explored include, e.g. re-examining taxation systems in order to give
further incentives to individuals and enterprises to invest in human capital.
- No single sector has a monopoly on human capital investment. The investments made
by individuals, families, enterprises and public authorities all contribute to the total
stock of human capital.
- The incentives for enterprises and workers to invest in human capital could also be
improved by enabling workers “to alternate between work and extended periods of
off-the-job training over their working life – e.g. through reductions in working time
that are compensated by increases in training time.
Appropriate sharing of investment costs
- Better measurement of returns could inform decisions about the most appropriate
sharing of costs and responsibilities.
- Calculations of public and private rates of return can help clarify whether existing
patterns of cost-sharing are appropriate. In areas such as tertiary education for young
people where investments are primarily public but large private gains accrue, it is
legitimate to ask whether cost-sharing should be adjusted.
- Investments such as enterprise-based training that are currently financed primarily by
the private sector, public gains from increased tax revenues or spin-off effects arising
from economic growth need to be recognized.
Optimal allocation of scarce resources in relation to the costs and benefits of
alternative investments
- It is also important to look carefully at both the costs and benefits.
- Market failure” may lead to under-investment by companies in work-based
training.
An equitable distribution of investment
- Greater equity of access and use of skills constitutes a major policy challenge.
Monitoring, measuring and accounting
- Better accounting for human capital as an investment can provide better signals to
governments, businesses, and individuals.
References
- Michael P. Todaro, Stephen C. Smith (2011). Economic Development, 11th Edition (The
Pearson Series in Economics)
- M.L. Jhingan (2014). The Economics of Development and Planning, 40th Edition.
- R. Nurkse, Problems of Capital Formation in Underdeveloped Countries, 1951.
- Human Capital Investment an International Comparison (1998). Centre for Educational
Research and Innovation.
- Becker, Gary S. 1962. "Investment in Human Capital: A Theoretical Analsis." Journal of
Political Economy 70 (5): 9-49.
- Schultz, Theodore W. 1961. "Investment in Human Capital." The American Economic
Review Vol. 51 (1): pp. 1-17.
- Poças, Ana (2014). Human capital dimensions – Education and health – And economic
growth. Research Unit for Inland Development (UDI) and Polytechnic Institute of
Guarda (IPG), Portugal.
- Appleton S. and Teal F. (1998).’Human Capital and Economic Development’, Economic
Research Paper, No. 39.

“End of Chapter Two”