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Human capital investment, and the inefficiency of compensation based on marginal productivity: the static case

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  • Bruce D. Smith

Abstract

A simple extension of the traditional analysis of human capital accumulation is considered in a general equilibrium context. When real wages are equated to marginal products in the presence of human capital investment, resulting equilibria are almost never efficient even by very weak criteria. This is true even though labor is not a quasi-fixed factor, and informational asymmetries are excluded from the model. It is shown that human capital investment generates externalities, and has associated with it a “free-rider problem.” This, in turn, explains the common practice of employers requiring minimum levels of human capital accumulation for some employees, and refusing to hire “overqualified” workers for other positions.

Suggested Citation

  • Bruce D. Smith, 1982. "Human capital investment, and the inefficiency of compensation based on marginal productivity: the static case," Working Papers 205, Federal Reserve Bank of Minneapolis.
  • Handle: RePEc:fip:fedmwp:205
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    References listed on IDEAS

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    1. Lazear, Edward P, 1981. "Agency, Earnings Profiles, Productivity, and Hours Restrictions," American Economic Review, American Economic Association, vol. 71(4), pages 606-620, September.
    2. Riley, John G., 1975. "Competitive signalling," Journal of Economic Theory, Elsevier, vol. 10(2), pages 174-186, April.
    3. M. J. Piore, 1972. "Notes for a Theory of Labor Market Stratification," Working papers 95, Massachusetts Institute of Technology (MIT), Department of Economics.
    4. Riley, John G, 1976. "Information, Screening and Human Capital," American Economic Review, American Economic Association, vol. 66(2), pages 254-260, May.
    5. Spence, Michael, 1974. "Competitive and optimal responses to signals: An analysis of efficiency and distribution," Journal of Economic Theory, Elsevier, vol. 7(3), pages 296-332, March.
    6. Weiss, Yoram, 1971. "Learning by doing and occupational specialization," Journal of Economic Theory, Elsevier, vol. 3(2), pages 189-198, June.
    7. Diamond, Peter A & Mirrlees, James A, 1971. "Optimal Taxation and Public Production: I--Production Efficiency," American Economic Review, American Economic Association, vol. 61(1), pages 8-27, March.
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