The Theory of Human Capital: Egypt and the USA examined.

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Spring

1216

The Human Capital Theory

Presented to Dr. N. Al Iskandarani                                   By Nathalie Alphonse

     

08

Fall


Table of Contents

The United States’ Investments in Education        

Expected Returns from Human Capital Investments in the United States        

The Human Capital Theory        

Investments on Education in Egypt        

Reasons for the Low Return on Education in Egypt        

Other Non-Financial Motivations for Human Capital Investments        

Implications for the Human Capital Theory        

Indices        

Annex        

References        


The United States’ Investments in Education

Business leaders in the United States targeted a $3.5 Billion investment in education and training in 2011. In 2012, the education budget in the United States reached 68.1 Billion and the department of education is seeking a 2.5% increase in the budget for 2013.

Expected Returns from Human Capital Investments in the United States

These tremendous amounts of investments are made in order to receive expected returns on those investments. Returns include global competitiveness. For instance, “a recent report by McKinsey & Company estimates that bringing lower-performing states up to the national average between 1983 and 1998 would have added $425 billion to $710 billion to our [their] 2008 GDP.” Another research shows that “closing the international achievement gap between 1983 and 1998 would have added $1.3 trillion to $2.3 trillion to our [their] 2008 GDP.” Another form of return is economic returns; if half the students that had dropped out of high school in 2012 had graduated, they would have added $7.6 Billion in earnings per year, $5.6 Billion in spending and $2 Billion in investing. Moreover, investing in education leads to cost savings. Estimates show that “taxpayers are spared up to $13 for every $1 invested in quality early education”. High graduation rates reduce the incarceration rates and poverty levels, which leads to costs savings. Another form of return is restoring the middle class. Jobs acquired by the middle class require the attainment of an education or training beyond the secondary school. Another societal benefit is the political awareness; in Andrew Delbanco's new book "College: What It Was, Is, And Should Be", he emphasizes the importance of education in a democratic system, he says that “We cannot have a political system that works if we don't have a population that say knows the difference between a dogmatic opinion or a demagogic speaker and somebody who makes arguments based on evidence”. He also stated some private returns such as higher lifetime income and higher chances of being employed. He mentioned that college graduates have an unemployment rate that is almost half the nation’s jobless rate. Moreover, he also stated some non-financial benefits such as happier marriages and better health.

The Human Capital Theory

This somewhat conforms to the theory of human capital. According to the theory. Investments in education will be made if the present value of the future returns on the investment is bigger than the present value of the costs of the investment. So a person will decide to go to college if the present value of the incremental earnings that he will receive is bigger than the present value of the direct and indirect costs of attending college. The theory can also be applied for employers’ decisions to invest in their employees. Obviously, the employers would only invest in the employees’ human capital if the present value of their returns of the investment is bigger than the present value of the cost of the investment. In this paper, I intend to examine human capital investment decisions in Egypt. By using Internet based and field-based research, I shall investigate the factors that affect human capital investment decisions and test for the validity of the theory against the results of the research.

Investments on Education in Egypt

According to Nancy Birdsall and Lesley O'Connell, the investments on education in Egypt are pretty significant, providing free pre-college education. For a more detailed illustration of the numbers, please refer to figure 4. The highest Egypt has invested in education was seen in the year 2002 with around 1,200 Billion Egyptian Pounds with a budget of 5 Billion Dollars. Although it’s not nearly close to the United States’ 68 Billion Dollars, it’s still considered significant as a percentage of total expenditures and as a percentage of the GDP compared to other developing countries. Gross enrollment in schools has greatly increased for both boys and girls, 80% of school-age students are enrolled in primary school and 68% are enrolled in secondary school. Also adult literacy has increased from 25% in 1960 to 51% in 1995. The mean number of years of schooling for children that are 10 years and older has increased from 1.6 in 1960 to at least 5 in 1996.

The phrase “education is a matter of national security” is commonly used among Egyptian politicians which expresses their belief in that education is the way to economic growth, productivity and self sufficiency. Former minister of education emphasized that education affects the citizens’ productivity, which is what differentiates one nation from another. This shows that on a societal level, investments in education are made in expectations for future returns in the form of higher productivity and economic growth.

Reasons for the Low Return on Education in Egypt

Despite the increased enrollment and literacy, those investments are not realizing any form of quantifiable returns. The rate of return on primary, secondary and higher education in Egypt is respectively 4.7%, 7.7% and 14.2%, all lower than global and regional averages. This poor outcome was due to many factors. One factor is the poor quality of education; even though the quantity has been mounting, the quality has been diminishing. That is due to the demographic pressure on the limited resources. The poor quality led to drop out ratios that reached up to 30%. As for the students who finished their years of schooling, their education was so poor that it had no real economic value and it didn’t translate into incremental earnings, private returns or economic growth. A very interesting finding by Fergany shows that incremental earnings for the people attending primary or intermediate school compared to those that didn’t finish them or didn’t attend in the first place are actually negative. This could mean that the motivation and entrepreneurial skills of those with more years of schooling is actually lower than those with lower or no years of schooling. This shows how bad the quality of education had really become.  We need to relate this finding with the theory of Human Capital. The theory claims that the higher the years of education, the higher the earnings. But the above findings show that sometimes, the educated can’t earn as much as the uneducated. This goes against the theory as it proves quite the opposite of what the theory says. Interviews conducted with the children of a doorman confirm the above findings, his daughter rarely attends school and depends on costly private lessons in order to get by. Moreover, his eldest son had decided to drop out of school when he was fourteen, then has worked as a wall painter ever since, he doesn’t regret that he left school as he is doing quite well in his current job. On the other hand, his younger son chose to finish school and college, he graduated with a law degree a year ago and has not found a job ever since. We can try to relate these findings with the interviews I conducted. Samir who was working at Kheir Zaman and Mohsen who worked at Family Market both seemed satisfied with their education. They mentioned that they benefited either from the social skills they gained or the technical skills. This could mean that the higher college education in Egypt is better than the primary and secondary education. But maybe it was the poor quality of the high school education was the reason for their low scores in Thanaweyya Amma as they mentioned. Another factor is that expenditures on education are not equally distributed. Also, “public spending on education is poorly allocated and ineffective, that the poor and the middle class will fall behind in education, setting the stage for a future society that is more segmented and with higher income inequality.” The poor quality of public education pushes the poor to take private lessons making the “free” education not really for free anymore – as illustrated with the doorman’s daughter’s situation above. Between the years 1980 and 1990, the costs of education for the poor have increased 7 times in urban areas and 10 times in rural areas. Hence, education reinforced the transmission of poverty and poor standards of living across the generations. The above 2 factors are the reason for the poor economic returns on investments in human capital. This can be observed in a study made by Fergany, which saw no link between the GDP growth and the education in Egypt. This in turn can be the result of the low private returns that individuals experience on their years of schooling relative to other developing countries. “Private returns to primary, secondary and higher education for males (measured as the increase in wages for each year of schooling) are 8.3, 31.7, 62.1 percent, respectively”. Fore more details on the annual earnings in Egypt, please refer to figure 2. Both interviewees expressed their satisfaction with their income levels and they both stated that their jobs more than covered the costs of education that were very low. Samir did mention that the more the years of the education, the higher the position and the higher the pay for employees at Family Market. This supports the theory of Human Capital. However, this does not necessarily mean that the returns on education are the highest they could be. We should note something interesting: it is easier to cover the investments on education on an individual level but when it comes to the societal level, covering the investments on education is not that easy. This could be the result of the high subsidies that the government provides for education. Another factor that prevents the investment in education from showing positive results on the economy is the mismatch between the demand for and the supply of labor. This little demand can be the result of deficiencies in overall economic policy and also onerous labor legislations that increase the cost of labor for the employers. We should note though that there’s a difference between what the laws say what how they are actually applied in Egypt. 80% of the workers in the private are classified in the informal economy where “they can be laid off any time, they have no provisions for retirement or disability, and they have no legal recourse in disputes against their employers”. The fact that the supply of graduates (who are poorly qualified because of their weak education) is bigger than the demand for labor leads to keeping the wages at low levels, hence, the low private returns on investments in education. Another reason for the mismatch between the supply and demand is the lingering effect of the Employment Guarantee Scheme established in the 1960s. This scheme guaranteed public-sector employment for all graduates of secondary and post-secondary institutions, which led to an increase in enrollment and in the number of graduates. The large private informal sector could not afford the skills of those graduates, the public sector was unable to respond to all the supply and the private formal sector was too small to contain all those graduates and was unwilling to hire poorly educated workers. This mismatch between the demand and the supply might have been the reason why Samir would have had to use nepotism and connections in order to work in communications – the field which he studied. Another factor that we can examine is the regional segmentation of labor. Because of the lack of labor demand in certain regions, the lack of development and production resources, the earnings differ greatly among the regions. The limited mobility of labor forces the workers to endure the low levels of earnings. Earnings in Rural Lower Egypt, Rural Upper Egypt, Urban Lower Egypt, and Urban Upper Egypt are respectively 11.5%, 28%, 18%, and 27% less than Greater Cairo. This is reflected in the lower returns on education in other regions than Greater Cairo. For more details, please review Figure 1. Another reason is the mismatch between the skills required by the labor market and the skills provided by education. “Enterprise surveys in Egypt indicate that the school to work transition is complex and firms report that worker skills and education are among the top five constraints in the business climate”. This again relates to the quality of the education that is failing to supply the students with the adequate needed skills. Samir did mention that he never used any of the technicalities that he learned in college or at school and he added that Kheir Zaman does not look for technical skills as much as they look for general ones. In contrast, Mohsen, the manager of Family Market mentioned that they looked for specific skills in accountants and agricultural engineers which they can’t easily find! Another important factor is the increasing household cost of education. Even though the education is supposedly free, parents do incur costs such as private lessons, uniforms, transportation, textbooks, stationary and more importantly the opportunity cost of the jobs that those students could get. One of the reasons the eldest son of the doorman decided to drop out of school was that he saw an opportunity and he didn’t want to wait while his father struggled to provide for the family. That’s why he took the job, “the job is going well thanks to God, I wouldn’t have made that much money had I attended college,” he told me.

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Other Non-Financial Motivations for Human Capital Investments

On a more private level, realizing positive financial returns on education does not seem to be the only motive for investing on education. Education motives could very much be non-financial. One particularly interesting research showed that “female education plays a significant role in having a marriage with better characteristics. Women can increase their chances of a better marriage through three ways: higher status men would prefer to marry educated women, educated women can find higher status men easier because of their interactions in the education environment, and education would increase a ...

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