The role of education in economic growth: theory, history and current returns

Background

This paper was prepared to address the issue of whether current levels of public expenditures on education are cost-effective in countries with widely differing average levels of education.

Purpose

The paper examines the role of education in economic growth from a theoretical and historic perspective, addresses why education has been the limiting factor determining growth, discusses why certain countries have provided education to the masses and others have not, provides estimates of the quantitative importance of the direct and the indirect effects of education on the economy, calculates the marginal national return on investment for 60 countries, and examines the implications of these results for government policy.

Methodology

The paper presents the results from other studies and estimates the marginal product of human capital and of physical capital and the relative importance of post-secondary education in 2005 using cross-country estimates of national income and the stocks of human capital and physical capital. The estimates of the stocks of human capital were developed from historic rates of public and private investment in schooling, the cost of capital during schooling, and students’ foregone earnings.

Results

The paper presents evidence that education has direct and indirect effects on national output. Educated workers raise national income directly because schooling raises their marginal productivity. They raise national income indirectly by increasing the marginal productivity of physical capital and of other workers. In highly educated countries the spillover effect on other workers is minimal, but in less-educated countries the spillover effect appears to be much larger. In all countries, the positive effect of rising human capital on the productivity of physical capital is required to offset the diminishing returns to investment in physical capital and make rising investment in physical capital financially viable in the growth process. The empirical results indicate that investment in schooling is subject to diminishing returns but that the marginal return at the national level is still considerable in highly educated countries, over 10% in 2005. In the least educated countries, the marginal return is much larger, in excess of 50%, but since most of this effect is indirect, its magnitude is not generally appreciated. Achievement of these returns requires public investment in education because the direct return to the educated individual is insufficient to overcome the high cost of private financing. The results also indicate that investment in post-secondary education does not provide any additional effect on national income beyond the effect of investment in education generally. The implication is that governments may allocate their limited funds to primary and secondary schooling of the poor without suffering a loss in GDP growth.

Conclusions

These very high macro-marginal returns to education make it possible for poor countries to grow very rapidly if they make a major public commitment to raising the average level of schooling of the masses.

Keywords:

• education
• schooling
• world
• financial returns
• investment
• history

Notes

1. China is not included in the data set, but if it were, it would be in the group of countries with relatively little human capital.

2. I estimated these stocks using the standard OECD (2001) methodology, which sums each nation’s cumulative investment in each type of capital and then depreciates this investment over its expected useful life. For physical capital, the investment period is 1960 to 2004, while for human capital the period is 1960 to 2000. Physical capital has an assumed geometric depreciation rate of 6%. Human capital has an assumed linear depreciation rate of 2.5%. Physical capital investment rates and income data were obtained from the series ci and rgdpch in PWT 6.3. Human capital investment rates in public schooling were obtained from UNESCO data. The detailed methodology for the calculation of the human capital stock is presented in Breton (2013).

3. The schooling data are from Morrisson and Murtin (2009). The GDP/capita data are from Maddisson (2003), but the units were converted from 1996 US$ to 2005$ using data from PWT 6.3.

4. The increase in GDP/capita with increases in schooling at higher levels of income may be due in part to the effect of income on the demand for schooling.

5. The data for GDP/adult are from PWT 6.3, but they include my estimate of students’ foregone earnings. Since students did not receive these earnings, they are not included in GDP statistics, but these earnings are the value of the time that students have invested in their education, so in theory they should be included in GDP.

6. Breton (2013) investigates whether estimates of the effect of human capital on income in the Mankiw, Romer, and Weil model are sensitive to the inclusion of other variables in the model. He shows that these estimates are robust, which indicates that the levels of physical capital and human capital are the proximate causes of economic output and that other national characteristics affect income through their influence on the levels of capital.

7. The curves in Figures 5 and 6 are fitted with a power function, which is consistent conceptually with the form of the Cobb–Douglas function in Equation (1).

8. The first stage regressions are:Log(H/Y) = 0.66 + 0.05 log(ProtSh) + 0.65 ProtSh R ² = 0.40(0.16) (0.03) (0.25)PostSecSh = 0.28 + 0.023 log(ProtSh) − 0.01 ProtSh R ² = 0.27(0.04) (0.007) (0.05)