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The Adam Smith address: education, labor force quality, and the economy.

Education and other human capital are

important in promoting economic growth

and a strong position in international

markets. The U.S. needs to upgrade its average

labor force quality. This paper presents a

number of proposals to accomplish this goal

that would not require a lot of public

spending but would better prepare the U.S. for

a world emphasizing information and skills

as well as stiffer competition from other


TO MANY OF YOU, capital means a bank account, 100 shares of IBM, assembly lines, or steel plants in the Chicago area. These are all forms of capital in the sense that they yield income and other useful outputs over long periods of time. But I am going to talk about a different kind of capital. Schooling, a computer training course, expenditures on medical care, and lectures on the virtues of punctuality and honesty are capital too in the sense that they improve health, raise earnings, or even add to a person's appreciation of literature over much of his or her lifetime. Consequently, it is fully in keeping with the capital concept as traditionally defined to say that expenditures on education, training, medical care, etc., are investments in capital. However, these produce human, not physical or financial, capital because you cannot separate a person from his or her knowledge, skills, health, or values the way it is possible to move financial and physical assets while the owner stays put.

This embodiment of human capital in people is depressingly illustrated by the reactions of Hong Kong residents to the takeover of Hong Kong in 1997 by China. Many local people have been busy protecting themselves against China's policies by selling off some of their local financial and physical assets in order to invest in safer foreign securities and property. At the same time, however, computer experts, top management, and other skilled personnel are leaving Hong Kong in droves to seek citizenship elsewhere. They cannot reduce the risk to their human capital from China by investing only part of the human capital abroad; they must go where their capital goes.

The concept of human capital remains suspect within academic circles that organize their thinking about social problems around a belief in the exploitation of labor by capital. It is easy to appreciate the problems created for this view by the human capital concept. For if capital exploits labor, does human capital exploit labor too -- in other words, do some workers exploit other workers? And are skilled workers and unskilled workers pitted against each other in the alleged class conflict between labor and capital? If governments are to expropriate all capital to end such conflict, should they also expropriate human capital, so that governments would take over ownership of workers as well?

You can see why an idea developed to understand the economic and social world has been thrust into ideological discussions. Yet the concept of human capital has been popular in Communist countries. My book [1975] and those by others on human capital are extensively used in the Soviet Union, Eastern Europe, and China. Even before the recent reforms, economists and planners there had no trouble with the concept of investing capital in people.


Economists can readily explain why, throughout history, few countries experienced very long periods of persistent growth in incomes 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. More puzzling is the continuing growth in per capita incomes during the past 100 years and longer in the United States, Japan, and many European countries.

The evidence has become overwhelming that significant investments in human capital are essential for economic growth. For the expansion of scientific and technical knowledge raises the productivity of labor and other inputs in production. The systematic application of scientific knowledge to production of goods and services greatly increases the value of education, technical schooling, and on-the-job training as the growth of knowledge becomes embodied in people -- in scientists, scholars, technicians, business economists, managers, and other contributors to output. Adam Smith, whom this lecture honors, emphasized the importance of specialized knowledge to growth and the wealth of nations.

It is clear that all countries that manage persistent growth in incomes also have large increases in the education and training of their labor force. First elementary school education becomes universal, then high school education spreads rapidly, and finally children from middle income and poorer families begin going to college.

Economists have developed rather straightforward methods for determining how much of income growth is caused by growth in human capital. In an excellent study for the United States, Edward Denison [1985] finds that the increased schooling of the average worker between 1929 and 1982 explains about one-fourth of the rise in per capita income during this period. He is unable to explain much of the remaining growth. I believe that this is mainly because he cannot measure the effects on earnings of improvements over time in health, on-the-job training, and other kinds of human capital.

Rather compelling evidence on the link between education and economic progress comes from a comparison of the growth in incomes per capita of more than 100 countries since 1960. On average, poor countries grew about as fast as rich ones. But countries, whether rich or poor, that had a relatively well-educated labor force in 1960 advanced much faster than average.

The outstanding economic records of Japan, Taiwan, and other Asian economies in recent decades dramatically illustrates the importance of human capital to growth. Lacking natural resources, e.g., they import practically all their sources of energy, and facing discrimination from the West, these so-called Asian tigers grew rapidly by relying on a well-trained, educated, hard-working, and conscientious labor force. It surely is no accident, for example, that Japan's system of lifetime employment at large companies originated after World War II when they began to upgrade their technology rapidly partly by investing heavily in the training of employees. The lifetime system is not explained just by the traditional Japanese culture that emphasizes loyalty toward groups, for job changes in Japan were frequent during the first half of this century (see Hashimoto and Raisian [1985]).

Further evidence on the link between human capital and technology comes from agriculture. Education is of little use in traditional agriculture because farming methods and knowledge are then readily passed on from parents to children. Farmers in countries with traditional economies are among the least educated members of the labor force. By contrast, modern farmers must deal with hybrids, breeding methods, fertilizers, complicated equipment, and intricate futures markets for commodities. Education is of great value because it helps farmers adapt quicker to new hybrids and other new technologies (see Welch [1970]). Therefore, it is no surprise that farmers are about as well-educated as industrial workers in modern economies.

Education and training are also helpful in coping with changing technologies and advancing productivity in the manufacturing and service sectors. Recent studies show that more rapidly progressing industries do attract better-educated workers and provide greater training on the job (see Mincer-Higuchi [1988]; Gill, [1989]).

The importance of human capital to an economy shows up clearly in the earnings advantages of greater education. Many studies have shown that high school and college education in the United States greatly raise a person's income, even after netting out direct and indirect costs of schooling, and after adjusting for the better family backgrounds and greater abilities of more educated people. Similar evidence is now available from over 100 countries with different cultures and economic systems. The earnings of more educated people are almost always well above average, although the gains are generally larger in less developed countries.

Consider the difference in average earnings between college and high school graduates in the United States during the past fifty years. After being reasonably stable at between 40 to 50 percent until the early 1960s, it rose during that decade and then fell rather sharply. This fall during the 1970s led some economists and the media to worry about "overeducated Americans" (see Freeman, [1976]). The concept of human capital itself fell into some disrepute.

But as several recent studies document (see, e.g., Murphy and Welch [1989]), the monetary gains from a college education rose sharply during the 1980s to the highest level during the past fifty years. The earnings advantage of high school graduates over high school dropouts also increased. Talk about overeducated Americans has vanished, and it has been replaced by concern once more about whether the United States provides adequate quality and quantity of education and other training. This growing premium to college education is found not only in the United States, but also in Great Britain, Germany, and several other European countries.

The fraction of high school graduates who enter college fell during the middle of the 1970s when benefits from a college education dropped, and it rose again in the early 1980s for whites -- it fell a bit for black males -- when the benefits greatly increased. The rise in enrollment rates caused an unexpected boom in college enrollments during the past few years, even though relatively few people have been reaching college age.

Many educators expected enrollments in the 1980s to decline not only for demographic reasons, but also because college tuition was rising rapidly. They were wrong, because they failed to appreciate that benefits from college rose even faster than costs, and that high school graduates responded to changes in both benefits and costs.


The 1980s also saw the development of considerable concern about the international competitive position of U.S. industry and services, concerns that were stimulated by tough economic competition from a renewed Europe, and from Japan, Korea and other Asian countries, sluggish rates of productivity advance in the United States during the past fifteen years, a large drop in SAT scores, and the dismal performance of American high school students on international tests in mathematics. Many people believe that the education and other human capital of American workers is much worse than that of the Japanese, Germans, and other competitors.

Yet this surprising conclusion is not correct, for there are many strengths as well as some glaring weaknesses in the quality of the American labor force. The United States has a superb university system and on the whole a good collection of colleges that offer a varied menu of programs. Many students come here from Japan and elsewhere for postgraduate studies, and a surprising number of foreign students are also enrolled as undergraduates.

The top 60 percent of high schools also do a satisfactory job. True, they are generally far less demanding than the top half of schools in Japan, Korea, and many countries of Europe. But almost all graduates of these U.S. high schools go to college where they catch up to and often surpass students from other countries.

Another real strength of the United States, especially in comparison to Japan and even Germany, is the growing utilization of the human capital of women. Labor force participation of married women is low in both these countries, and women there do not readily advance to responsible positions.

Prior to the 1960s in the United States, women were more likely than men to graduate high school but less likely to continue on to college. Women avoided math, sciences, economics, and law, and gravitated toward teaching, home economics, foreign languages, and literature. Because relatively few married women continued to work for pay, they rationally chose an education that helped in household production and no doubt also in the marriage market.

All this has changed radically. The enormous increase in the participation of married women is the most important labor force change during the past twenty-five years. Many women now take little time off from their jobs even to have children. As a result, the value to women of market skills has increased enormously, and they are shunning traditional "women's fields" to enter accounting, law, medicine, engineering, and other subjects that pay well. Indeed, women now comprise one-third or more of enrollments in law, business, and medical schools, and many home economics departments have either shut down or are emphasizing the "new home economics," which is a true branch of economics.

The same trends in women's education are found in Great Britain, France, Scandinavia, Taiwan, Japan, Mexico, and other countries with large increases in the labor force participation of women, even when attitudes toward women differ greatly from those now prevalent in Europe and the United States. Whenever the labor force participation of married women has increased sharply, changes in the gains from work for pay have had a more powerful effect on the behavior of women than have traditional ideas about the proper role of women.

Job opportunities for women in the United States at first improved slowly as they started to move up in business and the professions during the past several decades. But the trend accelerated sharply after the late 1970s. The ratio of the earnings of full time working women and men increased more rapidly since 1979 than during any previous period in our history, and women are becoming much more prominent in many highly skilled jobs. Improvements in the economic position of black women have been especially rapid, and they now earn just about as much as white women.

What then is the United States' human capital problem? It is the lower 30 percent or so of high school students, who either do not finish school (about one-fifth), or are in the bottom quartile of high school graduates. Trends in the earnings of these groups provide good reason for concern about the preparation they are receiving. The trend has been disastrous for young high school dropouts, whose real wage rates fell by more than 30 percent since the early 1970s; the real wages of young persons in the bottom quartile of high school graduates also fell by a lot. Many young people without a college education are not being adequately prepared for work in modern economies.

Why has the bottom third of the United States' male labor force done so badly during the past 30 years? Part of the answer is the growing importance of world trade to the U.S. economy -- imports and exports relative to GNP more than doubled from about 5 percent in 1960 to over 11 percent in 1990, which is only a little smaller than the share of world trade in the Japanese economy. U.S. manufacturing industries that use less skilled labor -- textiles and simple electronic goods are examples -- cannot compete against China, Thailand, Brazil, Mexico, and other poorer countries. A few studies document that the growth in U.S. foreign trade contributed to the deterioration in the economic situation of less skilled males (see, e.g., Murphy and Welch [1989]).

Part of the explanation may also be the increasing relevance to modern economies of processing and utilizing information that raises the demand for workers who can handle information. Communist economies collapsed in good part, I believe, because they could not produce sophisticated commercially viable products.

Real spending per student in public schools trebled from $1500 in 1960 to near $4500 in 1990 -- how can we say that too little is spent on public education? Yet there is little question that the quality of the education available in large cities like Chicago and New York deteriorated greatly. Many schools in the inner city have come to resemble prisons with armed guards, search for weapons, and an overriding concern with maintaining order and a modicum of discipline.

Finally, but not least important in understanding the decline in the economic position of less skilled males, is the deterioration in family life. Almost half of all black children are raised by a single parent, while divorce and separation takes its toll on many white children as well. There is a small but growing body of evidence that divorce and being raised by one parent especially reduces the achievements of boys. I won't cite the many depressing statistics on trends in teen-age suicides, drug use, and alcohol abuse, and much other evidence of the decline in the quality of life of children.

An unfortunate aspect of these effects on children is that differences grow over time with age and schooling because children learn easier when they are better prepared. Therefore, even small differences among children in the preparation provided by their families are frequently multiplied over time into large differences when they are teenagers. This is why the labor market cannot do much for school dropouts who can hardly read and never developed good work habits, and why it is so difficult to devise policies to help these groups.

Families divide their total spending on children between number of children and the amount spent per child. The number of children and spending per child tend to be negatively related. The reason is simple. An increased number of children raises the effective cost of adding to the spending on each child because an additional dollar or hour of time spent on each child then means a larger total addition to spending. Similarly, an increase in the dollars or time spent on each child raises the cost of having an additional child.

This negative relation at the family level between number of children and spending per child implies a close and also usually negative relation at the aggregate level between population growth and investments in human capital. Differences among ethnic groups in the United States are fascinating. Groups with small families generally spend a lot on each child's education and training, while those with big families spend much less. Japanese, Chinese, Jews, and Cubans families have few children who become well-educated, while Mexicans, Puerto Ricans, and blacks have big families and the education of children suffers. (I should add that the Mormons are an interesting exception, for they have both very large families and high levels of achievement.) It should come as no surprise that children from the ethnic groups with small families and large investments in human capital typically rise faster and further in the United States' income-operation hierarchy than do children from other groups.


I would like to spend a little time considering what can be done to help workers at the lower end of the skill distribution compete more effectively. Obviously, it is not possible to change drastically the high divorce rates and other trends in family structure. And it would be unwise to try to punish developing countries for their success at producing more cheaply than the United States can blouses, television sets, and other products that use lower skilled labor.

Yet several steps can increase the quality at the lower end of the labor force without requiring much additional public spending. The easiest action conceptually, although not politically, would be to reorient immigration policy to admit many more younger, skilled workers. Such newcomers can help alleviate shortages in engineering, nursing, computer programming, and many other fields. Because they would have above-average incomes, they would pay above-average taxes and make few demands on welfare, medicaid, and other transfer programs. The evidence indicates that especially skilled immigrants pay considerably more in taxes than they receive in subsidies.

The economy can use many more well-trained workers, yet almost all current immigrants have few skills. They are either unskilled illegal entrants or beneficiaries of the preferential treatment given to parents, children, and other close relatives of current residents. In 1988, fewer than 4 percent of the 640,000 legal immigrants were admitted on the basis of their skills.

It is bizarre to have a policy that one way or another gives preference to unskilled entrants. Australia and Canada admit much larger fractions of their immigrants under special priorities for skilled workers. A new U.S. law takes a step in the right direction by expanding to about 150,000 the number of skilled workers admitted each year. But many more skilled immigrants should be accepted.

Millions of workers all over the world are eager to come to America. To me, it is disgraceful that the United States hasn't accepted the hundreds of thousands of skilled Hong Kong residents who want to leave before China takes over in 1997. And close to a million Jews and other Soviet citizens -- many of whom are quite skilled -- have requested exit visas. Yet the U.S. has revoked their political-refugee status and is sharply limiting the number accepted. Countless other skilled workers from Eastern Europe, Ireland, South America, Africa, and elsewhere would jump at the opportunity to move here.

There is no magic bullet to improve automatically the education received by inner city blacks and other disadvantaged groups. But greater competition for students from private schools would be a big help. This is why I support a system that would provide each student, especially each poorer student, with a voucher equal to the per capita expenditure by public schools. Students would be allowed to use their vouchers at private as well as public elementary and high schools. Including religious-sponsored and other private schools in the program would help break the monopoly of teachers' unions and public school bureaucrats. The average Catholic high school provides a much better education than the typical public school at about two-thirds the cost.

The main beneficiaries of a voucher system would be the poor families who cannot easily "vote with their feet" against inferior public schools in their neighborhoods. For this reason the experimental voucher program in Milwaukee that includes private schools is limited to poor students from the inner city. Naturally, this experiment is being fought in the courts by the teachers' unions and the bureaucrats entrenched in the present system.

Vouchers would encourage more poorer students to finish high school, but no doubt many would continue to drop out. This is not to be lamented if other reforms help dropouts acquire skills that make them productive members of the labor force. Germany has a successful program that combines on-the-job training with classroom activities for over two-thirds of their students between ages sixteen and nineteen. Vouchers that would have gone to students if they continued in school can be well spent on a program that would give to dropouts computing and other skills valued by the modern American economy.

Of course, not all dropouts would benefit from such an on-the-job training-apprentice program. Still, this would help raise the productivity of the sector of the labor force most in need of aid.

I already indicated that the enormous changes in family structure during the past quarter of a century cannot be radically reversed. But the harmful effects on children can be reduced. The United States is wisely moving toward policies that force divorced fathers to make good on their child support obligations, and welfare eligibility should not be contingent on the father being absent.

Under present laws, welfare payments closely depend on the number of children and not at all on their quality. This should be altered to make the number of children less important. Instead, parents should receive larger grants if they enroll their children in head-start programs, if the children do well in school, if they are taken for health check-ups, and for other contributions to the quality of their children.

Finally, I believe it is not wise to discriminate against women who stay home to care for their children. It is questionable whether child care facilities should be subsidized at all, but surely any subsidies should not only be available to working women. Programs that favor working parents create artificial incentives for parents to work rather than stay home to care for their young children.

It is easy but futile to offer suggestions to improve the quality of the labor force that require large expansions of public spending. Fortunately, my suggested changes require little net increase in public spending, and may decrease spending. A large expansion in the number of young skilled immigrants would add more to tax revenue than to government spending. Greater competition among schools would improve school efficiency, which would permit better education at a lower cost. A shift in family assistance programs toward grants that reward parents for better performance of their children might also cut spending by reducing the subsidies to larger families.

An on-the-job training-apprenticeship program for high school dropouts and some high school graduates would add to spending. However, the additional spending is unlikely to be much greater than the savings from the other proposals. Moreover, a program to help dropouts, in effect, reallocates the monies they would have received if they had gone on to complete high school.


The main arguments can be briefly summarized.

Education and other human capital are important in promoting economic growth and a strong position in international markets for goods and services. The United States has real strengths in achieving these goals: its colleges and universities, its growing utilization of working women, and as a mecca for ambitious and skilled immigrants.

But the United States needs to upgrade its average labor force quality. This can be accomplished through a large increase in the number of younger skilled immigrants; a voucher plan that includes private schools, which would pay for elementary and high school education, especially of poorer students; an extensive on-the-job training program for high school dropouts and other less well-educated youths; and a reorientation of family aid programs to improve the health and other human capital of children.

These proposals do not require a lot of public spending; indeed, they are probably cheaper than the present inefficient programs. But they would help better prepare this country for the modern economic world with its emphasis on information and skills, and the stiffer competition from other countries.


Becker, Gary S., Human Capital, New York, NY: Columbia University Press, 1975. Denison, Edward F., Trends in American Economic Growth, 1929-1982, Washington, DC.: The Brookings Institution, 1985. Freeman, Richard, The Overeducated American, New York: Academic Press, 1976. Gill, Indermit, "Technological Change, Education and Obsolescence of Human Capital: Some Evidence for the U.S.," University of Chicago, 1989. Hashimoto, Masanori and John Raisian, "Employment Tenure and Earnings Profiles in Japan and the United States," American Economic Review 75 (1985): 721-35. Mincer, Jacob and Yoshio Higuchi, "Wage Structures and Labor Turnover in the U.S. and Japan," Journal of the Japanese and International Economies (1988): 297-331. Murphy, Kevin M. and Finis Welch, "Wage Premiums for College Graduates: Recent Growth and Possible Explanations," Educational Researcher 18 (1989): 17-27. Welch, Finis, "Education in Production," Journal of Political Economy 78 (1970): 35-59.

Gary S. Becker is a Professor of Economics and Sociology, University of Chicago, IL.
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Author:Becker, Gary S.
Publication:Business Economics
Article Type:Transcript
Date:Jan 1, 1992
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