Investment in Human Capital: Individuals

Education, higher education in particular, indeed, may be considered an investment, but is it not also, at least in part, a "consumption" good? Probably, in the sense that it is acquired to enhance one's current, not just future, utility, and thus well-being. Some people just seem to delight in learning, engaging or developing their mind, being around knowledge, knowledgeable people, ideas, or academic institutions. Because there may be some "psychic" payoff, many such "consumers" are willing to pay the expense (in terms of both money and time).

If we treat the investment in human capital as a decision similar to investing in physical capital, then we can subject it to net present value analysis. Since the payoff accumulates only gradually, it may take many years for the initial investment to pay "dividends."

In order for an investment in education or training to be rational, the net payoff must be positive over the life of the investment, which, in this case is the expected duration of your working life (until retirement). To project the net present (life-time, discounted) value of the initial investment, one need only be given the total costs of the investment, added earnings per year, discount rate and number of years expected to be in the labor force. At some year in the future, the additional stream of income each year breaks even with and then surpasses the (substantial) initial cost, after which you will realize it was worthwhile and rational.

In the case of higher education, studies find that the private rate of return to a college education is in the range of 10 percent, give or take a few percentage points. Indeed, every additional year of higher education, on its own, contributes a positive return, at least on the average.

Thoughts to Ponder

Do you think this increasing premium is encouraging or discouraging high school students to attend college? To what extent does the answer depend on opportunities in the labor market without a college degree? To what extent does it depend on the number of individuals who go to and/or complete college, and increase the supply of college educated workers hunting for jobs at the same time?

Reference: Campbell McConnell, Stanley Brue, David Macpherson, Contemporary Labor Economics, 10th edition, McGraw-Hill, 2013