Human capital acquisition, financial constraints, and international migration

Roman Zakharenko

State University – Higher School of Economics

Moscow, Russia

Most of modern labor and development economics literature views human capital as an analog of physical capital. The analogy is so close that in the 1950s and 1960s, when the concept of human capital just emerged, it was accepted with hostility by the public, because of direct comparison of humans to machines (Becker 1992). The process of human capital accumulation, again by analogy with physical capital accumulation, is associated with utilization of some inputs, usually the time of a student spent on education. Starting with the classic work of Schultz (1960), all inputs other than the time of the student are viewed as secondary. For example, the article on returns to schooling (Card 2008) in the Palgrave Dictionary of Economics does not even mention other inputs.

At the same time, there is an obvious difference between the process of physical capital and human capital accumulation: the latter requires, in most cases, a personal interaction with a person already possessing human capital. As Robert Lucas in his seminal 1988 paper emphasized,

“Human capital accumulation is a social activity, involving groups of people in a way that has no counterpart in the accumulation of physical capital.”

To become a jet pilot, one must interact closely with experienced jet pilots; there is no alternative way of acquiring the skill. For the one who desires to become an expert in the theory of human capital, learning from Gary Becker personally is strictly better than reading Becker's books: personal communication with the author is interactive, while books are mute. Even skills that are labeled by economists as “low” such as taxi driving or hunting in a rainforest requires frequent personal interaction with people already possessing such skills.

Moreover, in post-industrial world learning through personal interaction becomes part of worker's job description throughout most of their careers. For example, software industry changes so rapidly that only those who are very social and who learn permanently may survive. Scientists personally attend conferences on a regular basis, despite unprecedented improvements in communication technologies. Also, in the past several decades Western economies have had an expansion of the service sector; I argue that acquisition of skills in the service sector is different from that in the industrial sector. The latter requires knowledge of math, physics, chemistry, and other well-formulated theories which can be uniformly taught and applied across the globe. Provision of services requires knowledge of consumer psychology which may differ from market to market, and which is hard to standardize in a textbook; learning in the service sector is associated with intense interaction with a live teacher. This matches up with the finding of Buera Kaboski 2009 that the share of teaching services in the educational sector rose from 73% in 1950 to 83% in 2000: teachers are becoming more important, relative to other inputs of the educational process, than they were before. Also, the classic assumption that the input of educational process is the opportunity cost of a student originates from half-century old findings of Schultz (1960); since then, the skill premium (difference between wages of high-skilled and low-skilled) has increased from 1.25 in 1950 to 2.0 in 2000 (Buera Kaboski 2009), which has obviously reduced the opportunity cost of education as measured in high-skilled wages.

In this paper, I propose a simple model of knowledge acquisition. I assume there are two types of individuals, low-skilled (also referred to as students) and high-skilled (teachers). I will define (current) product of labor as the amount of goods and services that a person can produce without being engaged in teaching or learning.

My model of learning is based on the following formal assumptions:

Students can acquire knowledge only through personal communication with teachers.
Given localized nature of interaction between students and teachers, the former may compensate the latter for receiving education.

The last assumption implies that students earn less than their current product of labor, and those who teach earn more. While the former effect is a very well-known phenomenon in the on-the-job learning literature (see for example Heckman Lochner 1998), the latter effect is novel to my knowledge. The existing literature on human capital accumulation, that assumes student's time as the main input of human capital production and neglects the role of teachers, does not capture this effect.

But this effect is not the end of the story: given that students (low-skilled) earn below their current product of labor and teachers (high-skilled) earn above, the difference in wages is higher than the difference in productivities, which induces students to study even more, and increases the student-teacher wage gap even further. This may lead to formation of a learning bubble: as the cost of education rises to infinity, the demand for education does not necessarily decrease to zero. The reason is simple: the cost of education for students is also the income from education for teachers; rising cost of education means rising income of teachers (that is, high-skilled individuals), which means increased willingness of students to acquire skill, which can only be acquired through personal interaction with the existing teachers. Moreover, students' expectations about increasing skill premium in the future will make them study (interact with existing high-skilled) more intensively today, which will increase current income of existing high-skilled people. Thus, expectations about skill premium may be self-fulfilling in this simple model, which makes skill acquisition process a learning bubble.

Much like financial bubbles, learning bubbles are only possible if the costs of transactions are low. In the education industry, transaction costs are manifested in the form of financial constraints: students, which have low skill and low income, have to pay teachers for education; the ability of students to pay depends greatly on their access to credit. Thus, a learning bubble, when the cost of education rises to very high levels, is only possible when students are able to borrow large amounts of money.

Within this framework, we can offer another explanation of the increased skill premium in the past five decades. With improved access of the low-skilled people to credit, they bid more for the same amount of education, which increases the cost of education and consequently incomes of teachers/high-skilled people, which further increases the willingness to study. Thus, with a modest improvement in the access to credit and unchanged current product of labor, the skill premium may considerably increase.

An important result of this modeling framework -- that cross-country differences in the access to credit may lead to differences in skill premium -- lead us to new insights in the theory of international migration. Suppose there are two countries: “North” with good and “South” with poor financial institutions; then, skill premium is higher in the North. That induces high-skilled people from the South emigrate to the North, because of lack of access to credit of low-skilled people. The existing literature, to my knowledge, explains international migration of labor by cross-country differences in productivities, or differences in purchasing power of national and foreign currencies, or simply different psychic costs of living at home and abroad. In my theory, differences in the quality of financial institutions are sufficient for international migration to emerge.

Suppose that Southern financial institutions can be improved at some cost; then, I show, payoffs of such improvement increase as the South becomes more open to international migration. Indeed, in a closed economy poor institutions do not prevent human capital accumulation: high-skilled people offer teaching services for free or for a low fee. In an open economy, poor financial institutions cause brain drain; in other words, lowered migration barriers “discipline” governments and induce them to improve access to credit. This result is analogous to an observation that lowered barriers to international trade discipline manufacturers and induce them to increase productivity.

In this paper, I also study the effects of a sudden improvement of the Southern institutions. The long-run effects are trivial, but the study of transition dynamics offers some new insights. An improvement in financial institutions increases the demand for education and thus creates a lack of teachers. High-skilled emigrants return; but if the improvement was sufficiently large, the return of foreign diaspora is not sufficient to cover the deficit of teachers. Assuming that Northerners never migrate to the South (which is not far from reality), there emerges a brain circulation: low-skilled Southerners travel to the North to get education, and return once the education has been acquired.

References

Becker, Gary, “The Economic Way of Looking at Life: Nobel Prize Lecture,” 1992.

Buera, Francisco and Joseph Kaboski, “The rise of the service economy,” NBER working paper 14822, 2009.

Card, David, “Returns to schooling,” The New Palgrave Dictionary of Economics, 2008, 2nd edition.

Chand, Satish and Michael Clemens, “Skilled emigration and skill creation: A quasi-experiment," Crawford School of Economics and Government working papers, 2008.

Heckman, James and Lance Lochner, “Explaining Rising Wage Inequality," Review of Economic Dynamics, 1998, pp. 1-58.

Kamihigashi, Takashi, “Transversality conditions and dynamic economic behaviour," The New Palgrave Dictionary of Economics, 2008, 2nd edition.

Mayr, Karin and Giovanni Peri, “Return Migration as a Channel of Brain Gain," NBER working paper 14039, 2008.

Santos, Manon Domingues Dos and Fabien Postel-Vinay, “Migration as a source of growth: the perspective of a developing country," Journal of Population Economics, 2003, 16, 161-175.

Schultz, Theodore W., “Capital formation by education," Journal of Political Economy, 1960, 6, 571-583.

Stark, Oded, Christian Helmenstein, and Alexia Prskawetz, “A brain gain with a brain drain," Economic Letters, 1997, 55, 227-234.

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Human capital acquisition, financial constraints, and international migration