Human Capital Approach

The human capital approach to economic evaluation places a monetary value on loss of health as the lost value of economic productivity due to ill health, disability, or premature mortality. More specifically, the human capital approach uses the present value of expected future earnings, often adjusted for nonmarket productivity, to estimate the potential loss to society if an individual dies or becomes permanently disabled. It is commonly employed in cost-of-illness (COI) analyses that distinguish between direct costs, chiefly medical care, and the indirect costs of lost productivity. It is also employed in certain cost-effectiveness and cost-benefit analyses, particularly in older publications.

The idea that a human life can be valued by capitalizing the value of future earnings goes back to Sir William Petty in England in the late 1600s. The application of human capital to economic evaluation of health interventions can be traced to Burton Weisbrod in the 1960s. Under this approach, productivity is calculated as the present value of the sum of expected labor market earnings in future years, adjusted for life table survival probabilities and discounting. It is standard practice to take the current pattern of average earnings stratified by age and sex and assume that an individual's earnings trajectory will trace the same pattern, adjusted for expected increases in future labor productivity and inflation-adjusted earnings. For example, in the United States, it is conventional to assume that future labor productivity will increase at 1% per year. If one combines this with a 3% discount rate as is recommended in the United States, one gets estimates roughly equivalent to use of a 2% discount rate without assuming future productivity increases.

It is standard in health economic evaluations to include the imputed value of household production as well as paid earnings in human capital estimates, although cost-benefit analyses in environmental policy typically do not do so. The inclusion of household productivity is particularly important for older people and women, who tend to have high values of household productivity relative to paid compensation. Time spent in household production can be valued using either the individual's own wage or imputed wage (opportunity cost method) or the average wage paid to workers performing similar services (replacement cost method); the latter is more commonly employed. The original justification for the inclusion of household services was to reduce the lower valuation placed on women's lives because of lower labor force participation. Although in principle one could put a monetary value on other uses of time, such as volunteer service and leisure, this is rarely done.

Earnings are typically calculated as gross earnings, including payroll taxes and employee benefits, and are intended to capture the full cost of employee compensation. The rationale for the human capital approach is that the marginal productivity of labor is equal to the compensation paid to the average employee and that the withdrawal of that individual's labor due to premature death or permanent disability would result in a loss to society of that individual's future production. In most applications, average earnings are estimated for everyone within a given age-group, stratified only by gender. This avoids the ethical problems that can result from using different earnings for individuals of different socioeconomic or ethnic groups, which can have the effect of causing diseases affecting disadvantaged groups to appear less costly. The same argument can be applied to the use of sex-specific earnings estimates, given that in almost all countries average earnings are lower for women than for men, even after taking household services into account.

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