378.744 W55 141 RESEARCH MEMORANDUM SERIES Library Waite Economics Dept. of Applied University of Minnesota ClaOff 1994 Buford Ave - 232 55108-6040 USA St Paul MN WILLIAMS COLLEGE WILLIAMSTOWN MASSACHUSETTS 7im 378.744 W55 141 RESEARCH MEMORANDUM SERIES ft5 Library Waite Economics Dept. of Applied University of Minnesota Buford Ave - 232 ClaOff 1994 USA St. Paul MN 55108-6040 THE RETURNS TO ENDOGENOUS HUMAN CAPITAL IN PAKISTAN'S RURAL WAGE LABOR MARKET mm171.1' by Harold Alderman, Jere R. Behrman, t771 David R. Ross and Richard Sabot RM-14 November, 1994 1994-(Harold Alderman, Jere R. Behrman, David R and Richard Sabot) , WILLIAMS COLLEGE ,, , WILLIAMSTOWN ,, MASSACHUSETTS CA ii Research Memorandum No. 141 Center for Development Economics Fernald House Williams College Williamstown, Massachusetts 01267 THE RETURNS TO ENDOGENOUS HUMAN CAPITAL IN PAKISTAN'S RURAL WAGE LABOR MARKET by Harold Alderman, Jere R. Behrman, David R. Ross and Richard Sabot RM-141 November, 1994 (c) 1994-(Harold Alderman, Jere R. Behrman, David R. Ross and Richard Sabot) Note: This paper is intended for private circulation and should not be quoted or referred to in publication without the permission of the authors. THE RETURNS TO ENDOGENOUS HUMAN CAPITAL IN PAKISTAN'S RURAL WAGE LABOR MARKET by ••• Harold Alderman, Jere R. Behrman, David R. Ross, and Richard Sabot* November 1994 Abstract This paper estimates the private returns to human capital in Pakistani rural labor markets using particularly rich data that permit inclusion of a number of dimensions of human capital and controlfor the endogeneity resulting from investment in human capital. The results suggest that without data on the determinants of investments in human capital it would not be possible to disentangle the separate effect of each dimension of human capital on wage differentials and, in particular, to distinguish human capital explanationsfor wage differentialsfrom signalling and credentialist models. With controlfor endogeneity of human capital and selectivity into wage employment, cognitive skills, but not schooling attainment separate from cognitive achievement nor long-run health status, affects wage differentials in rural Pakistan. *Alderman, World Bank; Behrman, University of Pennsylvania; Ross, Bryn Mawr College; Sabot, Williams College. The paper was prepared for the Human Capital Accumulation in Post Green Revolution Pakistan Project of the International Food Policy Research Institute. We are grateful to the World Bank and USAID for financial support; to Mary Bailey and Emily Mellott for able research assistance. The views presented here are those of the authors and should not be interpreted as reflecting the views of IFPRI, the World Bank or USAID. 1 Developing countries spend over $60 billion a year on education, health, and other human capital investments. Thus it is important to determine whether resources devoted to human resources have a high payoff.. Aggregate cross-country estimates and micro studies suggest that the productivity effects of human capital investments in the developing world often are considerable.' Most of these studies focus on schooling, but some of them indicate that the returns to investment in health and nutrition are large, and possibly larger than for schooling investments, in poor populations.' Most of the literature on the returns to school, however, primarily or exclusively considers urban labor markets even though the majority of the population in developing countries lives in rural areas, in which in many cases the returns to human capital investments reputedly have increased substantially recently due to new technological and market developments.' Most studies that focus on education also fail to identify whether observed schooling associations with wages and other outcomes measure the contribution of cognitive achievement, credentialism, or ability signals. Almost all of the literature on the impact of schooling, labor force experience, and the longer-run indicators of health and nutrition (though not shorter-run indicators of nutrition) on wages and other 'Recent aggregate estimates are presented, for example, in Barro (1991), Birdsall and Sabot (1994), and Lau, Jamison and Louat (1991). Recent surveys of the micro evidence include Behrman (1990a,b 1993a) and Schultz (1988). We are aware of no studies that focus on wage determinants for post-green revolution rural Pakistan, which is the context of our empirical analysis. Studies of urban labor markets in Pakistan include Khan and Irfan (1985), Kozel and Alderman (1990), and Shabbir (1993). Previous studies of schooling in rural labor markets elsewhere in South Asia include Behrman, Birdsall and Deolalikar (1994), Behrman and Deolalikar (1989), Deolalikar (1988) and • Walker and Ryan (1990) on India and Sahn and Alderman (1988) on Sri Lanka. We are not aware of any previous studies of the impact of health and nutrition on rural wages in Pakistan, though Behrman and Deolalikar (1989), Deolalikar (1988), and Sahn and Alderman (1988) present evidence for other parts of South Asia. 'See the survey in Behrman (1993a) for a review of micro studies and Behrman, Foster and Rosenzweig (1994) for a more recent study for Pakistan. Behrman (1993b) presents cross-country aggregate estimates that suggest that aggregate health and nutrition indicators for 1965 (controlling for initial per capita income) better predictaggregate per capita growth rates over the next quarter century than do aggregate school investments (also controlling for per capita income). 'With new technology and greater integration of markets, Schultz (1975), Sabot (1992) and others claim that better human resources have had advantages in permitting better adjustment to new and changing opportunities. Jamison and Lau (1982) and Pitt and Sumodiningrat (1991) present some of the more systematic cross-sectional micro studies on this topic and give references to other studies as well. Longitudinal studies would be preferable for the investigation of such a dynamic response, but we are aware only of the recent study of the Indian experience by Foster and Rosenzweig (1994b). 2 indicators of productivity in developing countries, moreover, ignores the fact that these human resources reflect choices that have been made in light of unobserved individual characteristics such as ability and inherent robustness, and thus may be subject to simultaneous or omitted variable biases that make interpretation very difficult.' That is, in terms of the human resources that are emphasized in such wage studies, the child truly may be "father to the man." We investigate the impact of different dimensions of human capital -- cognitive achievement produced partly through schooling, labor force experience, and health, as measured by nutritional status -- on wages for males in rural Pakistan. The rural Pakistan context is of interest because of the relatively low level of human resources and because of the apparent expansion of that labor market in part due to the widespread adoption of new agricultural technology and the increased demand for a number of supportive activities.' Because of special characteristics of our data -- particularly information on cognitive achievement, ability, wage work experience, anthropometrics, and childhood determinants of these human capital variables -- we are able to go beyond the previous literature on wage determinants by 1) including a wider range of human capital variables and 2) using the information on the determinants of childhood investments in human capital to control for their endogeneity in addition to controlling for selectivity regarding who reports wages. We address a number of questions about the private returns to human capita in Pakistani rural labor markets: How do human capital investments affect wages in the emerging rural markets? Urban wage labor markets have been extensively studied in low income countries. Do the models of the determinants of wage differentials used for studies of urban labor markets hold up in relatively sparse rural wage labor markets? Are the private returns to schooling primarily a function of gaining access to the market as in credentialist and signalling models? Or do the cognitive skills acquired through schooling directly affect wages as in human capital models? Are there productivity and wage returns to workers' health? If so, how do the returns to health compare with those to schooling? Are 'We are unaware of an exception to this statement regarding schooling and wage market experience in studies for developing countries. Haddad and Bouis (1991), Schultz and Tansel (1993), and Strauss and Thomas (1992) are exceptions with regard to some anthropometric or self-reported morbidity indicators of health and nutrition status in studies for developing countries. 'Behrman and Schneider (1993) present comparisons of human resources in Pakistan with the international experience. For a similar context in India Behrman, Rosenzweig and Vashishtha (1995) find that the new agricultural technologies induced expanded private and governmental rural labor market demands. 3 there important returns to work experience? If so, are the returns to actual wage work experience different from those to general maturity or total work experience? ,Our results suggest that models of wage differentials used for studies of urban labor markets hold up even in a relatively sparse rural wage labor market. However, unless researchers make the effort to gather data on the determinants of investments in human capital