investment, development-economicsI know that theoretically, the inability to collateralize human capital would raise interest rates on educational above the rate at which would maximize aggregate utility. (Please tell me if this is a misconception.)
Has this notion been empirically investigated in the developing world and if so, is human capital underinvested and what are the costs of this underinvestment?
I realize truly rigorous studies cannot be conducted on such a question so studies involving macroeconomic regressions will do just fine.
First, I think it is worth re-considering Schultz’s famous AER paper “Investment in Human Capital” where we all learned that it is often difficult to sort out what is an investment in human capital and what is consumption. Many potential “human capital” investments can be both investments and consumption. Further, human capital investments can include non-educational expenses, most notably health-related expenditures.
With that caveat in mind, let’s consider the return to education while clearly acknowledging that we are assuming away other human capital investments that might be complements and/or substitutes.
We tend to talk about under-investment in relative terms. For example, whether we are sub-optimally investing in education depends on its return relative to that of physical capital. So, we can simplify the question into something more easily answerable and ask: what is the return to education relative to the return to capital? For example, from one of the more widely cited (but now a bit dated) papers on the subject by Psachropoulous (1994):
The lowest social rate of return average referring to higher education in OECD countries (8.7%) is close to the (long-term) opportunity cost of capital. This means that the profitability of human and physical capital, at the margin, has reached virtual equilibrium.
The author found much higher rates of social return to education in Sub-Saharan Africa (~24% primary, 11.2% higher ed) and private rates of return that were even higher. This is a clear signal that education is probably underinvested relative to capital.
However, as you point out, we are (implicitly) ignoring the fact that in some cases, as Ljungqvist (1993, p.220) put it “future labor earnings cannot serve as collateral on a loan.” As is common in development economics, whenever we see (especially private) returns to an activity or factor that are not in-line with returns to other activities/factors, we begin to think about missing or incomplete markets. Here, we find that developing country credit markets are, for many people, missing (absent physical capital) hence the differential returns to education between high- and low-income countries.
Perhaps the largest gap in human capital in the developing world is related to the undereducation of women.
Women take care of most issues related to “home and hearth.” So deficiencies in their education create deficiencies in home life. On the other hand, better educated women have fewer children, take better care of them, provide more nourishing meals, and in general, are better practitioners of “home economics.”
The inability to collateralize human capital stems from a lack of disposable income.
I disagree with the premise that:
the inability to collateralize human capital would raise interest rates.
The inability to collateralize human capital prevents loans from being issued in the first place. The only solution is an alternate occupation that has disposable income. Manufacturing and mining are commonly the industries that provide the first opportunities for disposable income. Once there is disposable income, human capital may be used as collateral.
I don’t know how to measure “maximum aggregate utility.” However, once there is disposable income, any underinvestment in human capital quickly corrects itself. For example: the large number of graduates from Chinese Universities… only a few decades since manufacturing entered the Middle Kingdom.
All content is licensed under CC BY-SA 3.0.