A Life-cycle model of human capital formation and educational choices in developing economies

In impoverished societies a shock to the household's resources often results in a decision to reduce the contemporaneous investment on children's education. Although such shocks may be transitory in nature they could lead to permanent long run effects in terms of reduced human capital for future generations thus further enhancing a state of deprivation. This paper models the long-run effects of productivity shocks using a micro-economic founded life-cycle model where investment uncertainty faced by heterogeneous households plays a crucial role with regards to optimal educational choices for their primary school age children. The dynamics in the structural model provide the basis for identification and estimation of endogenous human capital formation allowing for household's heterogeneity, a concept often missing from empirically implemented macro-models of growth. The empirical section illustrates the modelling strategy and estimation procedure using data from Tanzania (The Kagera Health and Development Survey, 1991-1994). The results suggest that primary school age orphans that attend school regularly can experience gains in human capital (i.e., productive capacity within the household) that are 6.2% higher than similar orphans in a non-schooling regime. Howerver, when one or both parents are present to bring up the children, the gains that result from attending school are small when we compared these to the human capital gains that result from intergenerational transfers,i.e., gains purely from knowledge transfers between generations.