Planning Decisions, Inc.

THE BOTTOM LINE FROM CHUCK LAWTON

Human Capital and Public Policy

Published Sunday April 6, 2008

The improved dexterity of a workman
may be considered in the same light
as a machine … which facilitates and abridges labour,
and which, though it costs a certain expense,
repays that expense with a profit.
~Adam Smith

One of the most fundamental insights of economics is the concept of investment—spending more money today for the purpose of gaining even more tomorrow. The concept is readily understood for machinery—we spend more today for solar panels or windmills with the expectation of paying less for electricity over the life of the machinery. And enough less to more than offset the higher immediate cost of replacing our old generators with the newer, less oil dependent versions. Whether these investments ultimately pay off depends on the future prices of oil, natural gas and coal. In short, investment is a bet that a new way of doing something will, over some future time span, prove superior to the current way.

The same concept can readily be applied to education and training—investment not in machinery but in human capital. A high school graduate foregoes four years of working at one job, pays four years worth of tuition, room, board, books and living expenses, obtains a degree and hopes, over his/her working life, to earn enough more than would have been possible in a non-college career to justify the educational “investment.” In an article recently published in the Journal of Student Financial Aid that analyzes Census education and earnings data, Mark Kantrowitz shows that, for the U.S. as a whole, the lifetime return on that investment is $1.2 million. According to these data, the average high school graduate can expect to earn $1.5 million over her/his working lifetime. The average college graduate can expect to earn $2.7 million over a working lifetime. Discounting these two future income flows to a present value and subtracting the cost of the college investment (both the actual costs paid and the income not earned while going to school) yields a return on investment of 27 percent. Higher education looks like a pretty good bet.

From a public policy perspective, however, the bet is complicated by the issue of labor mobility. If I put up a windmill or install solar panels, I can be sure I’ll get the benefit of their cost savings because I own the home or factory where they operate. If I pay for my education, I “own” the knowledge and skills I obtain, so I can get the benefits they provide. If I’m a Maine taxpayer, however, I can’t be so sure. Every time a high school graduate leaves Maine for a job out of state, she is taking well over $100,000 in taxpayer “investment” in her education with her. If she pursues her career in Massachusetts or California or North Carolina, the “return” on our investment goes to the taxpayers in those states. Unless we can offset that loss by attracting educated immigrants from away, we end up subsidizing the rest of the country. And the same risk applies to our public investment in higher education.
As investors evaluating their education investments, Maine taxpayers are forever faced with the chicken-or-egg question of “Do we invest in educating people and hope to get jobs, or do we invest in jobs and hope to get educated people?” Bill Gates got to be the richest man in the world even though 99 percent of his “capital” walks out the door every night because he had an iron clad claim to the intellectual property that human capital created. States don’t have that control over the human capital they help create. From the national perspective, investment in education is a no-brainer. From the perspective of a single state, however, the question is more complicated. It is particularly complicated in a state whose population is growing very slowly and whose young people tend to be leaving in great numbers.

All of this brings me to a substantially “safer” form of investment in human capital—on-the-job training. Nationally, Columbia University economist Jacob Mincer has estimated that the value of on-the-job training exceeds $100 billion annually. No employer, not even Bill Gates, can insure that a worker trained at company expense won’t leave for a better job elsewhere, thus giving someone else the return from the company’s investment. But it seems clear that a trained worker’s tie to the employer who trained him will be greater than to the state where he went to school. Ultimately, Maine’s economic prosperity depends on the productivity of the people who work here. As a matter of public policy, we can attempt to achieve that prosperity by educating people and hoping they find jobs here or by increasing the skills of those already employed here and hoping they stay. To my mind, we do far too little of the latter, not because such investments aren’t productive but because they require greater adjustments on the part of both our educational institutions and our employers. In sum, the appropriate public policy question for investment in human capital is not “How much?”—no amount will ever be enough—but rather, “How?”

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