Introduction

According to human capital theory, we can in general almost always earn more than we do. The difference between actual and potential earnings corresponds to the sacrifice we incur by learning on-the-job so as to ensure future earnings growth. The fact that we receive an earnings increment in any year is taken to be the return to on-the-job learning costs. Assuming the earnings increment represents a permanent addition, its present value is a measure of the size of on-the-job learning costs.

However, post-school investment in training – the gap between actual and potential earnings – is not constant each year. It ordinarily diminishes over the life cycle. If the link between earnings growth and past human capital investments is accepted, lower earnings growth must imply lower investments. Thus the old generally invest less than the young.

This chapter deals with the incorporation of post-school investment into an empirical framework so that earnings functions can be estimated, and the plausibility of the hypothesis that individuals rationally plan over their life cycles can be considered. The next section of the chapter derives a statistical formulation based on the work of Jacob Mincer (1974) which, when applied to real world data, can be used to test the validity of life-cycle models.