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1() GARY S. BECKER
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INVESTMENT IN HUMAN CAPITAL: A THEORETICAL ANALYSIS 11
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12 GARY S. BECKER
Rn
-I
t n -I
Et as the sum of opportunitycosts and out-
v (3)
lays on training,(6) becomes
0 (I +i) t=o +
MP'+G=Wo+C. (7)
where n represents the number of
periods, and R, and E, depend on all The term G, the excess of future
other receipts and expenditures. The receiptsover futureoutlays,is a measure
equilibrium condition of equation (2) of the returnto the firmfromproviding
has been generalized, for if marginal training; and, therefore,the difference
productequals wages in each period,the betweenG and C measuresthe difference
present value of the marginal product betweenthe returnfrom,and the cost of,
streamwould have to equal the present training.Equation (7) shows that mar-
value of the wage stream. Obviously, ginal product would equal wages in the
however,the converseneed not hold. initial period only when the return
If trainingwere given only duringthe equals costs, or G = C; it would be
initial period, expenditures during the greateror less than wages as the return
initialperiodwould equal wages plus the was smalleror greaterthan costs. Those
outlay on training,expendituresduring familiarwith capital theorymightargue
other periods would equal wages alone, that this generalization of the simple
and receipts during all periods would equality between marginal product and
equal marginal products. Equation (3) wages is spurious because a full equi-
becomes libriumwould require equality between
n-i the returnfroman investment-in this
MRt
MPO+O +1 ( 1 _ -
t case, made on the job and costs. If this
+0Z implied that G = C, marginal product
(4) would equal wages in the initial period.
=WO + k+E t)tX
There is much to be said for the rele-
vance of a conditionequating the return
froman investmentwith costs, but such
wherek measuresthe outlay on training.
a conditiondoes not implythat G = C or
If a new termis defined,
that marginal product equals wages.
The followingdiscussion demonstrates
G= E M1-Wt (5) that great care is requiredin the applica-
t=__ (1 +iW
tion of this condition to on-the-job
equation (4) can be writtenas investment.
APo P+G=Wo+k. (6) 1. General. Our treatmentof on-the-
job trainingproduced some general re-
Since the termk onlymeasuresthe actual sults summarizedin equations (3) and
outlay on trainingit does not entirely (7) ofwide applicability,but morecon-
measure training costs, for excluded is crete results require more specific as-
the time that a person spends on this sumptions.In this and the followingsec-
training,time that could have been used tion two types of on-the-jobtrainingare
to produce currentoutput. The differ- discussed in turn: general and specific.
ence betweenwhat could have been pro- General trainingis usefulin many firms
duced, call this MPo and what is pro- in addition to the firmprovidingit, as a
duced, MPo, is the opportunitycost of machinisttrained in the army findshis
the time spentin training.If C is defined skills of value in steel and aircraftfirms,
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INVESTMENT IN HUMAN CAPITAL: A THEORETICAL ANALYSIS 13
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14 GARY S. BECKER
ilies" because as J. Mincer has shown(in a paper to "Educational Expendituresand theIncome Tax," in
be publishedin a National Bureau of Economic Re- Selma J. Mushkin[ed.],EconomicsofHigherEduca-
search conferencevolume on labor economics),the tion [Washington: United States Department of
labor-forceparticipationof wives is positivelycor- Health, Education, and Welfare (forthcoming)])
relatedwiththe difference betweenhusbands' long- that educated personsshould be permittedto sub-
run and current income. Participation of wives, tract fromincomea depreciationallowance on tui-
therefore, makes the correlationbetweena family's tion payments.Such an allowanceis apparentlynot
currentand a husband's long-runincome greater required for on-the-jobtrainingcosts; indeed, one
than thatbetweena husband'scurrentand long-run mightargue,on the contrary,that too much or too
income. rapid depreciationis permittedon such investment.
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INVESTMENT IN HUMAN CAPITAL: A THEORETICAL ANAILYSIS 15
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16 GARY S. BECKER
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INVESTMENT IN HUMAN CAPITAL: A THEORETICAL ANALYSIS 17
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18 GARY S. BECKER
search"), or the time employedin inter- that come underthe rubricof specificin-
viewing,testing,checkingreferences, and vestment. This set is now treated ab-
in bookkeepingdo not so obviouslyraise stractlyin order that a general formal
the knowledge of new employees, but analysis can be developed. Empirical
theytoo are a formof specificinvestment situations are brought in again after
in human capital, althoughnot training. several major implicationsof the formal
They are an investmentbecause outlays analysis have been developed.
over a short period create distributed If all trainingwerecompletelyspecific,
effectson productivity;they are specific the wage that an employee could get
because productivityis raised primarily elsewherewould be independent of the
in the firmsmakingthe outlays; theyare amount of traininghe had received. One
in human capital because theylose their might plausibly argue, then, that the
value wheneveremployeesleave. In the wage paid by firmswould also be inde-
restof this sectionI usually referonly to pendent of training. If so, firmswould
on-the-jobspecifictrainingeven though have to pay training costs, for no ra-
the analysis applies to all on-the-job tional employee would pay for training
specificinvestment. that did not benefithim. Firms would
Even after hiringcosts are incurred, collect the returnfromsuch trainingin
firmsusuallyknowonlya limitedamount the formof largerprofitsresultingfrom
about the ability and potential of new higherproductivity,and trainingwould
employees. They try to increase their be provided whenever the return-dis-
knowledge in various ways-testing, counted at an appropriate rate-was at
rotation among departments,trial and least as large as the cost. Long-run
error,etc.-for greater knowledge per- competitiveequilibriumrequiresthat the
mits a more efficient utilizationof man- present value of the return exactly
power.Expenditureson acquiringknowl- equals costs.
edge of employee talents would be a These propositionscan be stated more
specific investment if the knowledge formallywith the equations developed
could be kept fromotherfirms,forthen earlier. Accordingto equations (5) and
productivitywould be raised morein the (7) the equilibriumof a firmproviding
firmsmakingthe expendituresthan else- trainingin competitivemarkets can be
where. writtenas
The effectof investmentin employees
on theirproductivityelsewheredepends
on market conditionsas well as on the + G[E =
0~ +0-t ( 11)
nature of the investment.Very strong = lvo+C
monopsonistsmightbe completelyinsu-
lated from competitionby other firms, whereC is the cost of traininggiven only
and practically all investmentsin their in the initial period, MPo is the oppor-
labor force would be specific. On the tunitymarginalproduct of trainees, Wo
other hand, firmsin extremelycompeti- is the wage paid to trainees, and Wt
tive labor marketswould face a constant and MPt are the wage and marginal
threat of raiding and would have fewer product in period t. If the analysis of
specificinvestmentsavailable. completelyspecifictraininggiven in the
These examples convey some of the preceding paragraph was correct, W
surprisinglylarge variety of situations would always equal the wage that could
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INVESTMENT IN HUMAN CAPITAL: A THEORETICAL ANALYSIS 19
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20 GARY S. BECKER
ing would suffera loss frombeinglaid off crease. Such trainingcan be looked upon
because he could not find an equally as the sum of two components,one com-
good job elsewhere. To bring turnover pletelygeneral,the othercompletelyspe-
into the analysis of specifictraining is cific, with the formerbeing relatively
not, therefore,a deus ex machine but is larger the greater the effecton wages
made necessary by the important link in other firmsrelative to the firmspro-
betweenthem. viding the training. Since firmsdo not
Firms paying for specific training pay any of completelygeneral costs and
might take account of turnovermerely onlypart of completelyspecificcosts,the
by obtaining a sufficiently large return fractionof costs paid by firmswould be
from those remaining to counterbal- negativelyrelated to the importanceof
ance the loss fromthoseleaving. (The re- the general component,or positivelyre-
turn on "successes"-those remaining- lated to the specificityof the training.
would, of course,overestimatethe aver- Our conclusionscan be stated formal-
age returnon all trainingexpenditures.) ly in terms of the equations developed
Firms could do even better,however,by earlier.If G is the presentvalue of the re-
recognizingthat the likelihoodof a quit turnfromtrainingcollectedby firms,the
is not fixedbut depends on wages. In- fundamentalequation is
stead of merely recouping on successes
MP' + G = W + C. (12)
what is lost on failures,they mightre-
duce the likelihood of failure itself by If G' measures the return collected by
offering higherwages aftertrainingthan employees,the total return,G", would
could be received elsewhere. In effect, be the sum of G and G'. In full equi-
they would offeremployeessome of the libriumthetotal returnwould equal total
returnfromtraining.Matters would be costs, or G" = C. Let a representthe
improvedin some respectsbut worsened fractionof the total returncollected by
in others, for the higher wage would firms.Since G = aG" and G" = C, equa-
make the supply of traineesgreaterthan tion (12) can be writtenas
the demand, and rationingwould be re-
quired. The final step would be to shift 14 Marshall was clearly aware of specifictalents
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INVESTMENT IN HUMAN CAPITAL: A THEORETICAL ANALYSIS 21
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22 GARY S. BECKER
output, the rest of the economy being trainingmight be lost forever. If spe-
unaffected. The marginal product of cificallytrained workers were not laid
employees without specific training- off, the firm would lose now because
such as untrained or generally trained marginal product would be less than
employees presumablyinitiallyequaled wages but would gain in the futureifthe
wages, and their employmentwould be decline in demand proved temporary.
reduced to prevent their marginal pro- There is an incentive,therefore,not to
ductivityfromfallingbelow wages. The lay off workers with specific training
marginal product of specificallytrained when their marginal product is only
employees initially would have been temporarilybelow wages, and the larger
greaterthan wages. A declinein demand a firm'sinvestmentthe greater the in-
would reduce these marginal products centivenot to lay offsuch workers.
too, but as long as theywere reducedby A workercollectingsome of the return
less thanthe initialdifference withwages, fromspecifictrainingwould have less in-
firmshave no incentive to lay offsuch centive to find a new job when tempo-
employees.For sunk costs are sunk,and rarilylaid offthan otherswould: he does
thereis no incentiveto lay offemployees not want to lose his investment.His be-
whose marginal product is greaterthan havior while laid offin turn affectshis
wages, no matter how unwise it was, in chances of being laid off,for if it were
retrospect,to invest in their training. known that he would not readily take
Thus workerswith specifictrainingseem another job, the firmcould lay him off
less likelyto be laid offas a consequence without much fear of losing its invest-
ofa declinein demandthan are untrained ment.
or even generallytrainedworkers.'7 The conclusion here can be briefly
If the decline in demand were suf- summarized. When one firmalone ex-
ficientlygreat so that even the marginal periences an unexpected decline in de-
product of specificallytrained workers mand, relativelyfew workerswith spe-
was pushed below wages, would the firm cific trainingwould be laid off,if only
just proceed to lay them off until the because their marginal product were
marginal product was brought into initiallygreaterthantheirwage. If thede-
equalitywithwages? To show the danger cline were permanent,all workerswould
here,assume that all the cost and return be laid offwhen theirmarginal product
fromspecifictrainingwas paid and col- became less than theirwage and all those
lected by the firm.Any workerlaid off laid off would have to find jobs else-
would tryto finda new job, sincenothing where. If the decline were temporary,
would bind him to the old one.'8 The specificallytrainedworkersmightnot be
firmmight be hurt if a new job was laid off even though their marginal
found, for the firm'sinvestmentin his product were less than their wage be-
cause the firmwould sufferif they took
A verysimilarargumentis developedby Wal- otherjobs. The likelihoodof theirtaking
17
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INVESTMENT IN HUMAN CAPITAL: A THEORETICAL ANALYSIS 23
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24 GARY S. BECKER
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INVESTMENT IN HUMAN CAPITAL: A THEORETICAL ANALYSIS 25
ing to the United States, for he would offerstraining in conjunction with the
have to invest in learning English and productionof goods. Some schools, like
Americanlaw and procedures.25 those forbarbers,specialize in one skill,
In extremetypes of monopsony, ex- while others, like universities,offera
emplifiedby an isolated company town, large and diverse set. Schools and firms
job alternativesforboth trainedand un- are oftensubstitutesourcesof particular
trainedworkersare nil, and all training, skills. The shiftthat has occurred over
no matter what the nature, would be time in both law and engineeringis a
specificto the firm. Monopsony com- measure of this substitution.In acquir-
bined with control of a product or an ing legal skills the shifthas been from
occupation (due, say, to anti-pirating apprenticeships in law firms to law
agreements)convertstrainingspecificto schools, and in engineeringskills from
that product or occupation into firm- on-the-job experience to engineering
specifictraining.These kinds of monop- schools.27
sony increase the importanceof specific Some types of knowledge can be
trainingand thus the inventiveto invest masteredbetterifsimultaneouslyrelated
in employees.26The effecton trainingof to a practical problem; others require
less extreme monopsony positions is prolonged specialization. That is, there
more difficultto assess. Consider the are complementaritiesbetween learning
monopsonistwho pays his workersthe and workand betweenlearningand time.
best wage available elsewhere.I see no Most trainingin the constructionindus-
reason why training should have a try is apparentlystill best given on the
systematically differenteffect on the job, while the trainingof physicistsre-
foregoneearningsof his employeesthan quires a long period of specialized effort.
of those in competitivefirmsand, there- The development of certain skills re-
fore, no reason why specific training quires both specializationand experience
should be more (or less) important to and can be had partly fromfirmsand
him. But monopsonypower as a whole, partly from schools. Physicians receive
including the more extrememanifesta- apprenticeshiptraining as interns and
tions, would appear to increase the im- residentsafter several years of concen-
portance of specifictrainingand the in- trated instructionin medical schools. Or
centive for firms to invest in human to take an example closerto home, a re-
capital. search economistnot only spends many
yearsin schoolbut also a ratherextensive
B. SCHOOLING
apprenticeshipin masteringthe "art" of
A school can be definedas an institu- empirical and theoreticalresearch. The
tion specializing in the production of complementaritywith firmsand schools
training,as distinct from a firm that dependsin part on the amount offormal-
25 Ofcourse,personswhohave notyetinvestedin ized
knowledge available- price theory
themselveswouldhave an incentiveto migrate,and can be formallypresented in a course,
this partly explains why young persons migrate whilea formalstatementofthe principles
morethan older ones. For a furtherexplanationsee
my discussionon p. 38; also see the paper in this 27 State occupationallicensing often
requirements
Supplementby L. Sjaastad. permit on-the-job training to be substituted for
betweenmarginal school training(see S. Rottenberg,"The Economics
26 A relativelylarge difference
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26 GARY S. BECKER
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INVESTMENT IN HUMAN CAPITAL: A THEORETICAL ANALYSIS 27
about the prices charged by different that the direct costs of search, like the
sellerswould enable a personto buy from direct costs of schooling, are usually
the cheapest, thereby raising his com- added to consumptionrather than de-
mand over resources, or information ducted fromearnings.If firmspaid costs
about the wages offeredby different and collected the return,search would
firmswould enable him to work forthe have the same implicationsas on-the-job
firm paying the highest (see Stigler's specifictraining.
paper in this Supplement,pp. 94-105). Whether workers or firms pay for
In both examples informationabout the search depends on the effectof a job
economic system, of consumption and change on alternatives: the larger the
production possibilities,is increased as number of alternatives made available
distinctfromknowledge of a particular by a change,the larger,not the smaller,
skill. Informationabout the political or the fractionof costs that have to be paid
social system-the effect of different by workers. Consider a few examples.
parties or social arrangements-could Immigrantsto the United States usually
raise real incomes.29
also significantly found many firmsthat could use their
Let us considerin more detail invest- talents,and thesefirmsshould have been
ment in informationabout employment reluctantto pay the large cost of trans-
opportunities. A better job might be portingworkersto the United States. In
found by spending money on employ- fact, immigrantsalmost always had to
ment agencies and situation-wantedads, pay theirown way. Even the system of
using one's time to examine want ads, contractlabor, which we have seen is a
talkingto friendsand visitingfirms,or in means of protectingfirmsagainst turn-
Stigler'slanguage by "search." When the over, was singularlyunsuccessfulin the
newjob requiresgeographicalmovement, United States and has been infrequently
additional time and resourceswould be used.3" Firms that are relatively insu-
spent in moving.30These expenditures lated from competition in the labor
constitutean investmentin information markethave an incentiveto pay thecosts
about job opportunitiesthat would yield of workerscomingfromelsewheresince
a returnin the formof higherearnings they have little to worry about in the
thanwould otherwisehave been received. way of competingneighboringfirms.In
If workerspaid costs and collected the addition,firmswould be willingpartlyto
return,an investmentin search would pay forsearchwithina geographicalarea
have the same implicationsabout age- because some costs-such as an employ-
earningsprofiles,depreciation,and the ment agency's fee-would be specificto
like as general on-the-job trainingand the firmdoingthe hiringsince theymust
schooling, although it must be noted be repeated at each job change.
29 The role of political knowledgeis systemati-
D. PRODUCTIVE WAGE INCREASES
cally discussedin A. Downs, An EconomicTheoryof
Democracy(New York: Harper & Bros., 1957), and One way to invest in human capital
morebrieflyin my "Competitionand Democracy,"
Journalof Law and Economics,Vol. I (Fall, 1958). is to improve emotional and physical
30 Studiesof largegeographicalmoves-those re- health. In Westerncountriestoday earn-
quiringbotha changein employmentand consump-
tion-have tendedto emphasizethejob changemore 31 For a carefuldiscussionof the contract-labor
than the consumptionchange. Presumablymoney systemsee C. Erickson,AmericanIndustryand the
wagesare consideredto be moredispersedgeographi- EuropeanImmigrant, 1860-1885(Cambridge,Mass.:
cally than prices. Harvard UniversityPress, 1957).
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28 GARY S. BECKER
ings are much more closely geared to ductive, some on-the-job investments
knowledge than to strength,but in an would not be undertaken even though
earlierday, and elsewherestill, strength theywereveryproductiveby "absolute"
had a significantinfluenceon earnings. standards.
Moreover,emotionalhealth increasingly Before I proceed further,one point
is consideredan importantdeterminant needs to be made. The amount invested
of earnings in all parts of the world. outside the job would be related to cur-
Health, like knowledge,can be improved rent earningsonly if the capital market
in manyways. A declinein the death rate was very imperfect,for otherwise any
at working ages may improve earning amount of "outside" investmentcould
prospectsby extendingthe periodduring be financed with borrowed funds. The
whichearningsare received;a betterdiet analysis assumes, therefore,that the
adds strength and stamina, and thus capital market is extremelyimperfect,
earning capacity; or an improvementin earnings and other income being a
workingconditions-higherwages, coffee major source of funds.32
breaks, and so on-might affectmorale A firmwould be willingto pay forin-
and productivity. vestmentin human capital made by em-
Firms can invest in the health of em- ployees outside the firmif it could bene-
ployees through medical examinations, fitfromthe resultingincreasein produc-
luncheons,or steeringthem away from tivity. The only way to pay, however,
activities with high accident and death would be to offerhigher wages during
rates. An investmentin health that in- the investmentperiod than would have
creased productivityto the same extent been offeredsince directloans to employ-
in many firmswould be a general in- ees are prohibitedby assumption.When
vestmentand would have the same effect a firmgives a productivewage increase-
as general training,while an investment that is, an increasethat raises productiv-
in health that increased productivity ity-"outside" investments are, as it
more in the firmsmakingthemwould be were, converted into on-the-job invest-
a specific investment and would have ments. Indeed, such a conversion is a
the same effectas specifictraining. Of natural way to circumventimperfections
course,most investmentsin healthin the in the capital market and the resultant
United States are made outside firms, dependence of the amount invested in
in households, hospitals, and medical human capital on the level of wages.
offices.A full analysis of the effecton The discussion can be stated more
earningsof such "outside" investmentin formally.Let W representwages in the
health is beyond the scope of this paper, absence of any investment,and let a
but I would like to discuss a relationbe- productive wage increase costing an
tween on-the-joband "outside" human amount C be the only on-the-jobinvest-
investmentsthat has receivedmuch at- ment. Total costs to the firmwould be
tentionin recentyears. 7r= W + C, and since the investment
When on-the-jobinvestmentsare paid cost is received by employees as higher
by reducingearningsduringthe invest- wages, 7rwould also measuretotal wages.
ment period, less is available forinvest- The cost of on-the-job training is not
ments outside the job in health, better
32Imperfections in the capital market with re-
diet,schooling,and otherfactors.If these spect to investmentin human capital are discussed
"outside" investmentswere more pro- in Sec. IV, D.
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INVESTMENT IN HUMAN CAPITAL: A THEORETICAL ANALYSIS 29
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30 GARY S. BECKER
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INVESTMENT IN HUMAN CAPITAL: A THEORETICAL ANALYSIS 31
another more concrete term is used to providing a net earning stream of X0,
indicate that any kind of investmentin X1, . . . Xn,witha presentvalue of V(X),
human capital is permitted,not just on- the presentvalue of the gain fromchoos-
the-job trainingbut also schooling,in- ing Y would be given by
formation,health,and morale. By "net"
d= V(Y) - V(X)
earningsI continueto mean that tuition
costs duringany period have been sub- E _ X_
_ (19)
tracted and returns added to "gross" i=o ( 1 +i)i0
earningsduringthe same period (see dis-
cussion in Sec. II). "Real" earningsare Equation (19) can be reformulatedto
the sum of monetary earnings and the bringout explicitlythe relationbetween
monetaryequivalent ofpsychicearnings. costs and returns.The cost of investing
Since many persons appear to believe in human capital equals the net earnings
that the term "investment in human foregoneby choosing to invest rather
capital" must be restrictedto monetary than choosing an activity requiringno
costs and returns,let me emphasize that investment.If activity Y requiresan in-
essentiallyall my analysis applies inde- vestmentonly in the initialperiod and if
pendentlyof the division of real earn- X does not require any, the cost of
ings into monetary and psychic com- choosing Y ratherthan X is simply the
ponents. Thus the analysis applies to differencebetween their net earningsin
health, an activity with a large psychic the initial period, and the total return
component, as well as to on-the-job would be the presentvalue of the differ-
training,an activity with a large mone- ences between net earnings in later
tary component. When psychic compo- periods. If C= Xo- Yo, k= Yj-
nents dominate,the language associated Xj, j = 1,... n, and if R measures the
with consumerdurable goods might be total return,the gain from Y could be
consideredmore appropriate than that writtenas
associated withinvestmentgoods, but to
n
simplifythe presentation,I use invest- k
d-C=R-C.
(1i)i (20)
ment language throughout. (I
The presentvalue of the net earnings
streamin Y would be The relationbetweencosts and returns
can be derivedin a different and, forour
V( ) = (18) purposes, preferableway by definingthe
(I Oi)+'
internalrate of return,40whichis simply
a rate of discount equating the present
where i is the market discount rate, as-
value of returnsto the present value of
sumed for simplicityto be the same in
costs. In other words, the internalrate,
each period. If X were another activity
r, is definedimplicitlyby the equation
39Our discussionassumes discreteincome flows
40 A substantialliteraturehas developed on the
and compounding,even though a mathematically
more elegant formulationwould have continuous difference betweenthe incomegain and internalre-
variables,withsums replaced by integralsand dis- turn approaches. See, for example, Friedrichand
count rates by continuouscompounding.The dis- Vera Lutz, The Theoryof Investmentof the Firm
creteapproach is, however,easier to followand yet (Princeton,N.J.: PrincetonUniversityPress, 1951),
yieldsthe same kindofresultsas the continuousap- chap. ii, and the articlesin The Managementof Cor-
proach. Extensions to the continuous case are porateCapital,ed. Ezra Solomon (Glencoe,Ill.: Free
straightforward. Press, 1959).
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32 GARY S. BECKER
= d=o , and
= k I1- (?rI + r ) 711,--ff
In
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INVESTMENT IN HUMAN CAPITAL: A THEORETICAL ANALYSIS 33
ment in period 1 would be the total age of the rates of returnon the indi-
earnings foregone,or the differencebe- vidual investments. Any sequence of
tween what could have been received internalrates or investmentcosts is per-
and what is received. The difference mitted, no matter what the pattern of
between X1 and Y1 could greatly rises and declines, nor what form the
underestimate true costs; indeed, Yj investmentstake, be they a college edu-
mightbe greaterthan X1 even thougha cation, an apprenticeship, ballet les-
large investmentwas made in period 1.43 sons, or a medical examination. Differ-
In general, therefore,the amount in- ent investment programs would have
vested in any period would be deter- the same ultimate effect on earnings
mined not only fromnet earningsin the wheneverthe average rate of returnand
same periodbut also fromnet earningsin the sum of investment costs were the
earlierperiods. same.45
If the cost of an investmentis con- Equation (25) can be given an inter-
sistently defined as the earnings fore- estinginterpretationifall rates of return
gone, quite differentestimates of total were the same. The termk r would then
costs emerge. Although superficiallya be the value at the beginningof the mth
less natural and straightforwardap- period of all succeedingnet earningdif-
proach, the generalizationfroma single ferentialsbetween Y and X discounted
period to distributed investment is
actually greatly simplified.So let Cj be Y1is greaterthan XI if
4
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34 GARY S. BECKER
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INVESTMENT IN HUMAN CAPITAL: A THEORETICAL ANALYSIS 35
j-1 definitionis the same: investmentoccurs
Cj=Xj-Yj+r E Ck, allj, (28) in Y wheneverearningsthere are below
0
the sum of those in X and the incomeac-
and total costs by cruingon priorinvestments.If costswere
co found to be greater than zero before
C = 1Cj3. (29) some period m and equal to zero there-
0 after,the firstm periods would be the
empirically derived investment period.
The internalrate could be determinedin But costs and returnscan be estimated
the usual way fromthe equality between fromequation (28) even whenthereis no
presentvalues in X and Y, costs in each simpleinvestmentperiod.
periodfromequation (28) and total costs A common objection to an earlier
fromequation (29). draftofthispaper is that the generaland
The definitionof costs presentedhere rather formal definition of costs ad-
simplyextends to all periods the defini- vanced here is all rightwhen applied to
tion advanced earlierforthe investment on-the-jobtraining,schooling,and other
period.49The rationale for the general recognizedinvestments,but goes too far
49 Therefore,sincethe value ofthe firstmn
earning
by also including as investment costs
differentials
has been shownto equal many effects that should be treated
m-1
otherwise.For example,the protestruns,
ECj suppose that learningwas essentiallyun-
() avoidable in an activityZ, so that earn-
ings "automatically" growsrapidlywith
at period m (see n. 47), total costs could be esti-
matedfromthe value ofall differentialsat the end of experience. Since earnings in Z would
the earningperiod.That is, tend to be lower than those in X at
00 00 younger ages and higher later on, my
C= E Cj =E (xi- Yj) C-1-i. approach would say that investmentoc-
0 0 curs in Z. Criticshave argued that there
reallyis no investmentin Z since the rise
Thus the value of all differentialswould equal zero
at thebeginningofthe earningperiod-by definition in earningsresultsfromunavoidablelearn-
oftheinternalrate-and C at the end. The apparent ing ratherthan froman attempt to im-
paradox resultsfromthe infinitehorizon,as can be prove skills, knowledge, or health. Al-
seen fromthe followingequation relatingthe value
of the first differentials
at the beginningof the gth though the argument is superficially
periodto costs: plausible I am convincedit is as reason-
able to say that investmentin human
f_1
V( f, g) A (Xj-
capital occursin Z as in activitiesrequir-
= Yj)(1 + r)o-1-i
i=0 ing trainingor schooling.Indeed, an im-
portant virtue ratherthan defectin my
f-1
= + r)-f-
concept of human capital is that learn-
YCj(l
i=0 ing-both on and offthe job-is included
along with trainingand schooling.
Whenf = co and g = 0, V = 0,but wheneverf= g,
If Z were preferredto X the higher
f-1 earnings at later ages presumably out-
V= Ec weigh the earnings foregone initially.
0
Similarly,a person enteringan activity
In particular,iff = g =CO) V = C. requiringmuch educationis said to value
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36 GARY S. BECKER
the stream of future higher earnings that the total investmentin any activity
more than the net earnings foregone can be determined?
initially. If the lower earnings due to The statement"nothingis investedin
education are called investment costs, an activity" means only nothingwould
the higherearningsinvestmentreturns, be invested afterthe age when informa-
and if costs are related to returnsby an tion on earningsfirstbecame available;
internal rate of return,logical consist- investment can have occurred before
ency and economic sense would require that age. If, forexample, the data begin
that similar concepts apply to learning. at age eighteen, some investment in
Thus the lower initial earningsof high- schooling,health, or informationsurely
school graduates who enter occupations must have occurredat youngerages. The
"with a future"have as much rightto be earning stream of persons who do not
considered investment,both from the invest afterage eighteenwould have to
social and private viewpoints,as do the be considered,at least in part,as a return
lower net earnings of those enrolled in on the investmentbefore eighteen. In-
college. In general,since the private and deed, in the developmentalapproach to
social rankingof differenteconomic ac- child-rearing(discussed in Selma Mush-
tivitiesdepend only on theirnet earning kin's paper), mostifnot all ofthese earn-
streams,if one activity was said to re- ings would be so considered.
quire a given investmentand to yield a The earning stream in an activity
given return,another activity with the with no investmentbeyond the initial
same net earningstreammust be said to age (activityX) would be flat if the de-
require the same investmentand yield velopmentalapproach was followedand
the same return,no matter how they earningswere said to resultentirelyfrom
differin otherrespects. earlier investment." The minimum in-
So much in defenseof our approach. vestmentcould then be determinedif an
To estimate costs empiricallystill has assumption was made about its rate to
requireda prioriknowledgethat nothing return.My discussionof the shape of the
is invested in activity X. Without such earningstream in X is, however,highly
knowledge,only the difference between conjectural,52and furtherinvestigation
the amounts invested in any two activi- may well indicate that anotherapproach
ties with known net earning streams is preferable.
could be estimated fromthe definitions Our assumption that lifetimes are
in equation (28). Were this done for all infinite,although descriptivelyunreal-
available streamsthe investmentin any istic,is oftena veryclose approximation.
activitybeyond that in the activitywith For example, I have shown elsewhere
the smallest investmentcould be deter- that the average rate of returnon college
mined.50The observed minimuminvest- education in the United States could
ment would not be zero, however,if the
51If C measuredthe cost ofinvestmentbeforethe
rate of returnon some initialinvestment
initial age and r its rate of return,k = rC would
was sufficientlyhighto attracteveryone. measurethe returnper period. If earningswere at-
A relevantquestion is, therefore:can the tributedentirelyto this investment,Xi = k = rC,
shape of the streamin an activityhaving whereXi representsearningsat the ith period past
the initialage.
zero investmentbe specifieda priori so
52 But note that empiricalevidenceindicatesthat
50The techniqueis applied and furtherdeveloped age-earningprofilesin unskilledoccupationsare very
by Mincerin his paper in this Supplement. flat.
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INVESTMENT IN HUMAN CAPITAL: A THEORETICAL ANALYSIS 37
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38 GARY S. BECKER
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INVESTMENT IN HUMAN CAPITAL: A THEORETICAL ANALYSIS 39
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40 GARY S. BECKER
an absolute narrowingof wage ratios. show both an average annual declineof 0.8 per cent
In the United States duringmuch of of variationof wages and an aver-
in the coefficient
age annual rise of 1.2 per cent in the real standard
the last eightyyears,a narrowingofwage deviation.The declinein the coefficient of variation
ratios has gone hand in hand with an in- was shown in his study (op. cit); I computed the
creasing relative supply of skill, an as- change in the real standard deviation from data
made available to me by Keat.
sociation that is usually said to result 63 For those believing that the evidence over-
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INVESTMENT IN HUMAN CAPITAL: A THEORETICAL ANALYSIS 41
The actual returnon human capital than a generationelapses betweenthe choiceby par-
varies around the expected return be- ents of a skilledtrade forone of theirchildren,and
his reapingthefullresultsoftheirchoice.And mean-
cause of uncertaintyabout several fac- while the characterof the trade may have been al-
tors.There always has been considerable most revolutionizedby changes, on which some
uncertaintyabout the lengthof life,one probably threw long shadows before them, but
otherswere such as could not have been foreseen
important determinant of the return. even by the shrewdestpersons and those best ac-
People are also uncertain about their quainted with the circumstancesof the trade" (op.
ability, especially youngerpersons who cit., p. 571), and "the circumstancesby which
the earningsare determinedare less capable ofbeing
do most of the investing. In addition, foreseen[thanthose formachinery]"(ibid.).
thereis uncertaintyabout the returnto 65 Note that our argumenton p. 38 implied that
a personof given age and abilitybecause investorsin human capital would be younger.
66 Smithsaid: "The contemptof riskand thepre-
of numerousevents that are not predict-
sumptuoushope of success, are in no period of life
able. The long time required to collect moreactive than at the age at whichyoungpeople
the returnon an investmentin human choose theirprofessions"(op. cit.,p. 109). Marshall
capital reduces the knowledgeavailable, said that "youngmen ofan adventurousdisposition
are moreattractedby the prospectsof a great suc-
for requiredis knowledgeabout the en- cess than they are deterredby the fear of failure"
vironmentwhen the returnis to be re- (op. cit.,p. 554).
ceived,and the longerthe average period 67 See M. Friedmanand L. J. Savage, "The Util-
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42 GARY S. BECKER
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INVESTMENT IN HUMAN CAPITAL: A THEORETICAL ANALYSIS 43
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44 GARY S. BECKER
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INVESTiMENT IN HUMAN CAPITAL: A THEORETICAL ANALYSIS 45
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46 GARY S. BECKER
well as directlydepend on C, and thereforethe dis- At least ever since the time of Pigou
tributionof abilitywould depend on the amount of economists have tried to reconcile the
human capital. Some persons might rank high in strong skewness in the distributionof
earningsand thus high in ability if everyonewere
unskilled,and quite low ifeducationand othertrain- earnings and other income with a pre-
ing werewidespread. sumed symmetricaldistributionof abili-
79 In addition,theywould findit easier to invest ties.84Pigou's own solution, that prop-
if the marginalreturnand the resourcesof parents erty income is not symmetricallydis-
and otherrelativeswerepositivelycorrelated.
tributed,does not directlyhelp explain
80 Accordingto a well-knownformula the skewnessin earnings.Subsequent at-
r = ral+
( +11 tempts have largely concentrated on
developing ad hoc random and other
whererm is the marginalrateofreturn,ratheaverage probabilisticmechanismsthat have little
rate, and ea the elasticityof the average rate with 82 The firstis frequentlyalleged (see, forexample,
respectto the amountinvested.The ratesrmand ra
Marshall,op. cit.,pp. 199,684). Evidence on the sec-
would be positivelycorrelatedunless ra and l/ea
ond is discussed in my forthcomingstudy for the
were sufficientlynegativelycorrelated.
National Bureau of Economic Research.
81 This kind of argumentis not new; Marshall
83 See my "An EconomicAnalysisof Fertility"in
argued that business ability and the ownershipof
Demographicand Economic Change in Developed
physical capital would be positively correlated: Countries (Princeton, N.J.: Princeton University
"[economic]forces. . . bring about the result that
Press, 1960).
thereis a farmoreclose correspondence betweenthe
84 See A. C. Pigou, The EconomicsofWelfare(4th
abilityofbusinessmenand the size ofthe businesses
which they own than at firstsight would appear ed.; London: Macmillan & Co., 1950), Part IV,
probable" (op. cit.,p. 312). chap. ii.
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INVESTMENT IN HUMAN CAPITAL: A THEORETICAL ANALYSIS 47
relation to the mainstreamof economic capable, therefore, ofreconcilinga strong
thought.85 The approach presentedhere, positive skewnessin earningswith a pre-
however, offersan explanation that is sumed symmetricaldistributionof abili-
not onlyconsistentwith economicanaly- ties.
sis but actually relies on one of its Variations in X help explain an im-
fundamental tenets; namely, that the portant difference among skill categories
amountinvestedis a functionof the rate in the degree of skewness. The smaller
of returnexpected. In conjunctionwith the fractionof total earnings resulting
the effectof human capital on earnings
86Jacob Mincer ("Investmentin Human Capital
thistenetcan explain severalwell-known
and Personal Income Distribution,"JournalofPo-
propertiesof earningsdistributions. litical Economy,Vol. LXVI [August, 1958]) con-
By definition,the distributionof earn- cludedthata symmetricaldistributionofinvestment
ingswould be exactlythe same as the dis- in education impliesa skewed distributionof earn-
ings because he defineseducational investmentby
tributionof ability if everyoneinvested school years ratherthan costs. If we followMincer
the same amount in human capital; in in assuming that everyonewas equally able, that
particular,if ability were symmetrically schoolingwas the onlyinvestment,and that the cost
of the nth year of schoolingequaled the earningsof
distributed, earnings would also be. personswith n - 1 years of schooling,then,say, a
Equation (32) shows that the distribu- normaldistributionofschoolingcan be shownto im-
tion of earnings would be exactly the ply a log-normaldistributionof school costs, and
thus a log-normaldistributionof earnings.
same as the distributionof investmentif The difference between the earningsof persons
all persons were equally able; again, if withn - 1 and n years of schoolingwould be kA=
investment were symmetrically dis- Y- Yn,- = rnCn. Since r, is assumed to equal r for
all n, and Cn = Y.-l, this equation becomes Y, =
tributed, earnings would also be.86 If (1 + r) Yn.4 and therefore
ability and investment both varied,
Cl = Yo
earningswould tend to be skewed even
when ability and investmentwere not, C2= Y,= Yo(1+r)
but the skewness would be small as
long as the amount invested was sta- C3 = Y2 = Yj(1 + r) = YO(1 + r)2
tisticallyindependentof ability.87 Q = Yn-1 = Yo(1 + r)n 1 ,
Our analysishas shown,however,that
or the cost of each additional year of schoolingin-
abler personswould tend to invest more creasesat a constantrate. Since total costs have the
than others, so ability and investment same distributionas (1 + r)n, a symmetrical,say a
would be positively correlated,perhaps normal,distributionofschoolyears,n, impliesa log-
normaldistributionofcosts and henceby eq. (32) a
quite strongly.Now the product of two log-normaldistributionofearnings.I am indebtedto
symmetricaldistributionsis more posi- Mincer for a helpfuldiscussionof the comparison
tively skewed the higher the positive and especially for the stimulationprovided by his
work. Incidentally,his article and the
correlationbetween them,and mightbe pioneering
dissertationon which it is based cover a much
quite skewed.88The economic incentive broaderarea than has been indicatedhere.
given abler persons to invest relatively 87 For example, C. C. Craig has shown that the
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48 GARY S. BECKER
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INVESTMENT IN HUMAN CAPITAL: A THEORETICAL ANALYSIS 49
of earnings could be very unequal and employmentamongunskilledthanskilled
even skewed, even though "ability" workersmay resultfromthe latter hav-
weresymmetrically and not too unequal- ing morespecificcapital; or incompletely
ly distributed.To take anotherexample, vested pension plans may be a means of
learning,both on and offthe job, and insuring firms against a loss on their
other activities appear to have exactly specificinvestments.
the same effectson observed earningsas This paper has concentrated on de-
do education, training,and other tradi- veloping a theoryof investmentin hu-
tional investmentsin human capital. We man capital, withan emphasison empiri-
argue that a relevant concept should cal implications rather than on formal
cover all activities with identical effects generalization.Of course, empiricaluse-
and show that the total amount in- fulnessis the only justificationfor any
vested in a generalizedconceptofhuman theory,and although I did not try to
capital and its rate of returncan be esti- bringin even the quite limited evidence
mated from information on earnings on the role of human capital, the em-
alone. pirical workreportedin this volume,my
Some investmentsin human capital do own work,and that of many otherssup-
not affectearningsbecause costs are paid port the view that investmentin human
and returnsare collected by the firms, capital is a pervasive phenomenonand a
industries,or countriesusing the capital. valuable concept. The next few years
These "specific"investmentsrange from should provide much strongerevidence
hiringcosts to executivetrainingand are on whetherthe recent emphasis placed
more importantthan is commonly be- on this concept is just another fad or a
lieved. To take a couple of examples,we development of great and lasting im-
showed that the well-knowngreaterun- portance.
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