Human Capital Accumulation
Should I quit my job?
I recently met up with a friend who is in an important crossroad in his life. In some sense, the problem he is facing quite a common one among my peers these days. Maybe it’s quarter life crisis, but the problem is essentially as such:
He is unhappy with his job. He wants to build his own start-up. He thinks he should quit his job to build his own start-up.
This particular friend is also quite logical and he uses a very systematic framework to make his decision. This framework has 3 steps:
Calculate his runway if he is unemployed
Conduct cost-benefit analysis
Consider worst-case scenario
Unemployment runway
This he does by calculating (i) how much money he has in savings and (ii) his monthly expenditure. By dividing (i) with (ii), he concludes that he can afford to be unemployed for 2 years.
Cost-benefit analysis
His cost benefit analysis is as such:
The above framework shows that overall, he would potentially lose IDR 400 million, but would feel significantly happier. Sounds like a pretty solid green light.
Worst-case scenario
He asks himself: what would happen if his attempt to build a start-up fails after 2 years?
His answer:
I can always go back to a day-job
That’s actually not a very bad worst-case scenario, right?
At the end of the day, I will still have all the skills and knowledge, which means I will still be extremely highly valued in the job market. Because the data shows that a person’s rate of human capital accumulation is the highest at the point they graduate from university. When you are in the workforce, you don’t actually learn much anymore.
I stopped him right then, right there. Could you repeat that?
And he went:
Because the data shows that a person’s rate of human capital accumulation is the highest at the point they graduate from university. When you are in the workforce, you don’t actually learn much anymore.
Why no one told me this? Data is showing something different
I went on to say the exact opposite of what he just said.
I contend that human capital accumulation occurs significantly during the early- to mid-career period, as reflected by wages (exhibit A).
In fact, if you question why women generally earn less than men (exhibit B), it is not that women are less capable than men. As one of my compulsory readings in labor economics class, a paper shows: women tend to drop out of the labor force during the crucial period when human capital accumulation occurs at the fastest rate, because of family/children reasons. As a result, they lack behind in work experience and human capital accumulation, which translates into lower wages later in life.
My friend had a few reactions:
Wow, this is different from my prior belief
Why has nobody ever told me this?
Given this new information, I might reconsider my decision to quit
If my friend was struck by what I said, I was equally struck by his reaction. True enough, why did no one from Academia ever feel bothered to communicate these findings to the people for whom these insights matter the most? Academics may sometimes talk to policymakers to help them implement policies that correct the inefficiencies and problems in society. But why not talk to the individuals so that they can make better decisions and prevent these inefficiencies/problem in the first place?
I was even more struck by the fact that with this new information, my friend was willing to reconsider his decision. Prior to presenting him with this evidence, I tried to convince him using more emotional and anecdotal arguments, which didn’t sway him the least.
And so I decided to do what I feel has not been done much by people in my profession. We have done a lot in creating and advancing knowledge, but we have not done much in sharing this knowledge. So here is my humble attempt to share a little bit about human capital accumulation.
Context: What is human capital accumulation?
What is human capital accumulation?
You can think about this as the process in which you build your skills and knowledge. The more human capital you have, you are usually considered smarter, better at your job, more capable, {insert_other_praises}, which makes you more valued in the workforce.
How does human capital accumulation happen?
In the field of labor economics, there are two main ways to think about the link between working and human capital accumulation.
The first is that the more you work, the less time you have to build your human capital. The second is that you accumulate more human capital as you work (learning by doing).
It seems that both factors are equally right, but they work in different context.
The current evidence seems to suggest that the first applies more to younger people. That is why we see people with more education generally tend to have better skills and therefore, have better jobs and higher wages. (Of course, there are always exceptions. You can quote Bill Gates and Steve Jobs; closer to home, we have people like Susi Pudjiastuti and Eka Tjipta Widjaja.)
But if we believe in this view religiously, how can we explain the fact that people’s salary increases the longer they spend working in a company? If people don’t accumulate human capital during work, then we expect them to not get any better, and this should not be reflected in the salary they receive. So human capital accumulation definitely happens during work as well.
Evidence #1: wage growth as a proxy for human capital accumulation
The most objective and standardised way to measure a person’s human capital, especially an adult’s, is through his/her wages.
Now you might say that wages is not a reflection of a person’s ability, which is true. We are all probably more used to the idea of measuring a person’s ability using a standardised test/examination. But the problem with using tests is that it depends on what test you are administering. If you administer math, english, physics, or history tests, you are examining a person’s ability on these specific subjects. This may not necessarily reflect the kind of value one brings to one’s job.
Now let’s go back to the idea of wages. In economics, wages are defined as the marginal product of labor. In human language: a worker’s salary is equivalent to how much additional profit/value that worker can bring to a company.
At this point, my friend made a very useful remark. He says: but that’s not how a worker’s salary is determined in a company. You don’t see management deciding to give you X amount in salary after assessing how capable you are. Company’s management usually have a position and attaches a salary to it, before advertising and recruiting — so the salary is already pre-determined prior to the hiring and selection process.
I agree fully with this remark. Here’s what I have to add: that company’s management must have opened that position and attaches a salary to it based on the value that the person is expected to bring to the company.
For instance, a car dealer may want to hire a salesperson who is expected to sell at least 5 cars a month, bringing the company IDR 50 million in gross profit. Then it only makes sense for the company to offer a salary that is below IDR 50 million, say IDR 20 million, so that the company can still earn a net profit of IDR 30 million. Suppose the company hires 2 people, Adi and Budi, who are both paid IDR 20 million monthly.
Adi is not a very good salesperson. He can only sell 1 car per month on average, earning his company IDR 10 million in gross profit. The value he brings to his company is lower than his wage, so his company fires him after 3 months.
Budi is a fantastic salesperson. His monthly sales is 20 on average, generating IDR 200 million in gross profit for his company. After 3 months, he is promoted to manager and his salary grows to IDR 100 million. See how Budi can generate a lot of value to his company, and therefore he gets rewarded through his wage?
I would say that wage is quite a fair way to measure a person’s human capital, as it measures how much value you can bring to your company. Although in the past years we have seen quite a lot of wage distortion and inefficient wage-setting in the labor market.
Case in point is start-ups that receive a whole lot of easy money from venture capitals (I can attest that Recompound is not one such start-up). Suddenly with lots of money in their bank account, these start-ups have to prove that they are “growing”. One way to generate an impression of growth (which I like to call pseudo-growth) is by hiring a few hundred workers, each being paid salary that is far above the value that they bring to the company. Imagine this: if you pay workers IDR 20 million when they only generate IDR 10 million gross profit, you are essentially paving your way to bankruptcy. So when the venture capital money runs out, these start-ups end up laying off many of their workers. I greatly empathise with workers who are laid off as a result of this imprudent hiring and growth practise. But rather than wallowing in sadness and blaming those companies, I would encourage people to adopt the following principles:
Work in a company that creates value for people. This ensures the existence of revenue
Work in a company with proper management. This ensures revenue > cost → positive profit → the company will exist for a long time
Obsess with generating value for your company. In other words, make sure you are constantly building your human capital and translating this into your work. This ensures 2 things:
The value you bring to your company > your salary → you will not be fired
The value you bring to your company is high → your salary is high
I apologise for digressing, but I hope you see the link between your human capital, value-creation, and salary.
Evidence #2: human capital explains gender wage gap
The research that I referred to earlier is a paper about gender wage gap. Essentially, the question that the researcher asks is:
Why is it that women earn less than men throughout their entire life-cycle?
The author considers the fact that both workers and employers play a role in driving this gender wage gap.
Worker-side factors:
Human capital: Women spend more time in non-employment (due to marriage and fertility reasons) → accumulate less human capital than men on the job → progress more slowly in their career
Job preference: Women choose jobs with lower wages but more flexibility and family-friendly amenities
Employer-side factors:
Statistical discrimination: Employers anticipate that women have more likelihood to quit due to family- and child-related reasons, therefore
Assign them different jobs
Offer different wages for the same job
Both
The figure below shows the gender wage gap of individuals with master’s degrees (equivalent to US bachelor’s degree) in Finland. We can just focus on the black line, which captures the general gender wage gap across years (panel A) and year before/after the birth of first child (panel B). There is growing wage gap between men and women in the early years of individuals’ career as well as starting child birth.
Now the question is, what is driving this gender wage gap? Is it because of the human capital, job preference, or statistical discrimination? The figure below summarises the results of the paper. In the early years of one’s career, most of the wage gap is driven by statistical discrimination. However, progressing into later years of one’s career, the gender wage gap is increasingly driven by women having accumulated shortage of human capital compared to men, driven by maternity leave and exiting from the labor force. In fact, 20 years in to the labor force, 75% of the wage difference between men and women is due to lower human capital accumulated.
The takeaway for workers
Disclaimer: you shouldn’t not marry or not have children
Results from the gender wage gap research above are by no means a call for women to not marry or not have children. In fact, we don’t have to think about gender wage gap as necessarily a bad thing at all. Ultimately, money is not the be-all and end-all. Women may forgo some income for the joy of raising children and caring for their families. I personally thank my mother who has been a hero, allowing me to accumulate human capital and write this article.
Rather, understanding the causes behind the gender wage gap can help women make better life decisions. For instance, if a woman who just gives birth stop working temporarily and would like to go back to work, one way to ensure that she remains competitive in the workforce is to complement with at-home learning to enhance her human capital despite being out of work for a short period of time.
Furthermore, this can also be a call for employers to realise that they could be advertently / inadvertently discriminate against young women and therefore correct their hiring practise.
The spirit of learning
I myself am a nerd. I love studying for exams, for fun, for writing this kind of blog posts.
Even if you are not weird like me, this blog post can perhaps be a logical persuasion for you to continuously learn and become better. Accumulating human capital is not restricted to intellectual knowledge, but is very generic. It could be becoming better communicators, better salesperson, better coder; becoming more discipline, less distracted; it can be anything that makes you a more valuable person for yourself, your family, your job, your society.
And going back to the workforce, I hope this blog can help us have a little mindset shift. Instead of always thinking about wanting to extract more, take more, earn more; why not focus on becoming better, creating value, and giving more. Also be wise in choosing the kind of company you want to work at. The monetary rewards will follow naturally.
 | A guest post by
|