The effect of education on economic institutions

ABSTRACT

This research is the first to use the Heritage Foundation economic freedom index as a measure of economic institutions in order to examine the relationship between education and economic institutions. It presents a variety of empirical evidence to show that education predicts economic institutions whereas the inverse is not true. It uses 2SLS, with the level of education in 1950 as the instrument for the level of education in 2015, and finds that the effect of education on economic institutions is positive and statistically significant. Also, this paper uses fixed effects in order to control for country-level omitted variables that may affect both economic institutions and the instrument. Finally, it uses difference GMM, and system GMM. These regressions exploit both the cross sectional and the time series variation in the data, address endogeneity, and confirm that the effect of education on economic institutions is positive and statistically significant.

KEYWORDS:

• Education
• economic institutions
• economic freedom
• 2SLS
• GMM

JEL CLASSIFICATION:

• I25
• O43
• O50

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

¹ The role of education has been emphasized by many researchers but in most cases the channels through which education affects economic outcomes are different. For example, Mankiw, Romer, and Weil (1992), examine the effect of education as a factor of production, and Nelson and Phelps (1966) argue that education is important mainly because it increases the rate of technological change.

² Almond and Verba (1989) argue that the level of education determines what kind of political actor an individual is. Milligan, Moretti, and Oreopoulos (2004), and Dee (2004) show that the level of education has a positive and causal effect on political participation. Similarly, Ansolabehere and Iyengar (1996) show that less educated individuals are affected more by political advertising. The assumption that education increases civic participation has been used extensively in theoretical papers. For example, Bourguignon and Verdier (2000), assume that only the educated individuals actively participate in the political process. Glaeser et al. (2007) present a theoretical model, which explains why higher levels of education lead to more democratic regimes. These studies provide theoretical support and motivate the empirical exercises presented in this paper.

³ This paper’s findings have important policy implications. They show that education causes economic development and it is not just its byproduct. Therefore, supply side (cost reduction) policies that increase the level of education are important. Examples of such policies are direct subsidies to education, tax incentives, health insurance subsidies for students, and every policy that makes education more affordable.

⁴ See Doucouliagos and Ulubasoglu (2008). Also, education affects other economic variables that significantly affect the level of development. For example, Alshubiri (2021) shows that education affects FDI in the OECD economies.

⁵ The choice of the specific years was made in order to have the same years for the two sets of regressions and the maximum possible period. The economic freedom data are available until 2023, but the education data end at 2015. Also, the education data go back to 1950 but the economic freedom data start in 1995. Therefore 1995–2015 is the longest period for which data for all the variables are available.

⁶ The negative coefficients of economic freedom in columns (1) and (2) and of years of schooling in columns (3) and (4) are explained in the literature as mean reversion caused by measurement errors (see for example Glaeser et al. (2004)).

⁷ We use education data from 1950 because this is the earliest year with available education data in Barro and Lee (2015).

⁸ Difference GMM developed by Arellano and Bond (1991) and system GMM developed by Arellano and Bover (1995) and Blundell and Bond (1998).