Transition Events in the Dynamics of Poverty. Human Capital Theory


Human capital theory is a theory of earnings, one of the major determinants of poverty. First developed by Becker and Mincer, this theory explains both individuals’ decisions to invest in human capital (education and training) and the pattern of individuals' lifetime earnings. Individuals’ different levels of investment in education and training are explained in terms of their expected returns from the investment. Investments in education and training entail costs both in the form of direct expenses (e.g., tuition) and foregone earnings during the investment period, so only those individuals who will be compensated by sufficiently higher lifetime earnings will choose to invest. People who expect to work less in the labor market and have fewer labor market opportunities, such as women or minorities, are less likely to invest in human capital. As a result, these women and minorities may have lower earnings and may be more likely to be in poverty.

Human capital theory also explains the pattern of individuals' lifetime earnings. In general, the pattern of individuals’ earnings are such that they start out low (when the individual is young) and increase with age (Becker 1975, p. 43), although earnings tend to fall somewhat as individuals near retirement. The human capital theory states that earnings start out low when people are young because younger people are more likely to invest in human capital and will have to forego earnings as they invest. Younger people are more likely to invest in human capital than older people because they have a longer remaining work life to benefit from their investment and their foregone wages—and so costs of investing are lower. Earnings then increase rapidly with age as new skills are acquired. Finally, as workers grow older, the pace of human capital investment and thus productivity slows, leading to slower earnings growth. At the end of a person’s working life, skills may have depreciated, as a result of lack of continuous human capital investment and the aging process. This depreciation contributes to the downturn in average earnings near retirement age (Ehrenberg and Smith 1991).

To the extent that poverty follows earnings, we might predict a similar relationship between age and poverty, with poverty more likely for the young and elderly. Consistent with this prediction, Bane and Ellwood (1986) find that a sizable portion of all poverty spells begin when a young man or woman moves out of a parent’s home—an event often associated with getting further education or training—and that these poverty spells are relatively short with an average duration of less than three years (p. 16-17). Also, our literature review indicates that persons age 65 and over are especially vulnerable to poverty because once they enter, they are less likely to exit.

While much empirical work tends to support the human capital theory,(6) it is a theory of human capital investment and labor market earnings, not poverty. As discussed below, earnings are only one of the main determinants of poverty. Non-earnings income and family composition are other important determinants that human capital theory does not shed light on. Thus human capital theory cannot be considered a complete theory of poverty. Are there other theories that shed light on these other aspects of poverty?

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