Economics distinguishes in addition to physical
capital another form of capital that is no less critical as a means of production –
human capital. With investments in human capital, such as education, three major economic effects can be expected: •
increased expenses as the accumulation of human capital requires investments just as physical capital does, •
increased productivity as people gain characteristics that enable them to produce more output and hence •
return on investment in the form of higher
incomes.
Investment costs Investments in human capital entail an investment cost, just as any investment does. Typically in
European countries, most education expenditure takes the form of
government consumption, although some costs are also borne by individuals. These investments can be rather costly.
EU governments spent between 3% and 8% of
GDP on education in 2005, the average being 5%. However, measuring the spending this way alone greatly underestimates the costs because a more subtle form of costs is completely overlooked: the
opportunity cost of forgone wages as students cannot work while they study. It has been estimated that the total costs, including opportunity costs, of education are as much as double the direct costs. Including opportunity costs investments in education can be estimated to have been around 10% of GDP in the EU countries in 2005. In comparison, investments in physical capital were 20% of GDP. Thus, the two are of similar magnitude. K-12 public education in the United States is primarily funded by state and local governments, while the federal government provides a smaller percentage of funding through grant programs for at-risk youth. In 2018, the US spent approximately 5% of its GDP on K-12 public education, placing the US as the 7th highest spender per student compared to other
OECD nations. Schools in the US spend approximately $17,000 per student, but public education spending varies significantly at the state level. Over the past decade, the cost of in-state tuition for a 4-year education increased by one-third, with tuition inflation rates decreasing in the recent decade. A 2014 study by economists Jaison Abel and Richard Deitz found that the opportunity cost of attending college amounts to $120,000 due to forgone wages, with the total cost of college amounting to an estimated $150,000 when also factoring in out-of-pocket expenses.
Returns on investment Human capital in the form of education shares many characteristics with physical capital. Both require an investment to create and, once created, both have
economic value. Physical capital earns a return because people are willing to pay to use a piece of physical capital in work as it allows them to produce more output. To measure the productive value of physical capital, we can simply measure how much of a return it commands in the market. In the case of human capital calculating returns is more complicated – after all, we cannot separate education from the person to see how much it rents for. To get around this problem, the returns to human capital are generally inferred from differences in wages among people with different levels of education. Hall and Jones have calculated from international data that on average the returns on education are 13.4% per year for first four years of schooling (grades 1–4), 10.1% per year for the next four years (grades 5–8) and 6.8% for each year beyond eight years. Thus someone with 12 years of schooling can be expected to earn, on average, 1.1344 × 1.1014 × 1.0684 = 3.161 times as much as someone with no schooling at all. Higher levels of educational attainment can increase lifetime earnings, impacting the return on investment (ROI) of education. In the US at the college and university level, each level of degree attainment significantly increases lifetime earnings as more education is achieved. Lifetime ROI is significantly higher at lower levels of educational attainment than at higher levels (1,200.8% for an Associate's degree vs. 287.7% for a Bachelor's degree). College degrees with the highest ROI are in engineering, medicine, business, and other sciences. While nearly 40% of degree programs do not deliver a financial return, a bachelor's degree can also have social benefits that can increase ROI, which is often not accounted for in typical ROI calculations.
Effects on productivity Economy-wide, the effect of human capital on incomes has been estimated to be rather significant: 65% of
wages paid in
developed countries is payments to human capital and only 35% to raw
labor. Children in the
1962 Perry Preschool program and matched controls have been followed for decades since. The Perry Preschool participants had substantially fewer teenage pregnancies, fewer high school dropouts, less crime and higher incomes on average as adults. And the results have been intergenerational: The children of the Perry Preschool children have similarly had fewer school suspensions, higher levels of education and employment, and lower levels of participation in crime, compared with the children of those in the control group. To distinguish the part of GDP explained with education from other causes, Weil Positive externalities from human capital are one explanation for why governments are involved in education. If people were left on their own, they would not take into account the full social benefit of education – in other words, the rise in the output and wages of others – so the amount they would choose to obtain would be lower than the social optimum. == Demand for education ==