Taking Stock
Human capital differences are a major proximate cause of cross-country differences in economic performance. In addition, human capital accumulation may play an important role in the process of economic growth and economic development.
These considerations justify a detailed analysis of human capital. This chapter has presented a number of models of human capital investments that have emphasized how human capital investments respond to future rewards and how they evolve over time (with schooling as well as on-the-job training).Four sets of related but distinct issues arise in connection with the role of human capital in economic growth. First, if some part of the earnings of labor we observe are rewards to accumulated human capital, then the effect of policies (and perhaps technology) on income per capita could be larger, because these would affect not only physical capital accumulation but also human accumulation. The neoclassical economy with physical and human capital studied in Section 10.4 models and quantifies this effect. It also provides a tractable framework in which physical and human capital investments can be studied simultaneously. Nevertheless, any effect of human capital differences resulting from differences in distortions or policies across countries should have shown up in the measurements in Chapter 3. The findings there suggest that human capital differences, though important, can only explain a small fraction of cross-country income differences (unless there is a significant mismeasurement of the impact of human capital on productivity).
The second important issue related to the role of human capital relates to the measurement of the contribution of education and skills to productivity. A possible source of mismeasurement of these effects is the presence of human capital externalities. There are many compelling reasons why there might exist significant pecuniary or technological human capital externalities.
Section 10.6 illustrated how capital-skill complementarities in imperfect labor markets can lead to pecuniary externalities. Nevertheless, existing evidence suggests that the extent of human capital externalities is rather limited—with the important caveat that there might be global externalities that remain unmeasured. A particular channel through which global externalities may arise is R&D and technological progress, which are the topics of the next part of the book. An alternative source of mismeasurement of the contribution of human capital is differences in human capital quality. There are significant differences in school and teacher quality even within a narrow geographical area, so we may expect much 411larger differences across countries. In addition, most available empirical approaches measure human capital differences across countries by using differences in formal schooling. However, the Ben-Porath model, analyzed in Section 10.3, suggests that human capital continues to be accumulated even after individuals complete their formal schooling. When human capital is highly rewarded, we expect both higher levels of formal schooling and greater levels of on-the-job investments. Consequently, the Ben-Porath model suggests that there might be higher quality of human capital (or greater amount of unmeasured human capital) in economies where the levels of formal schooling are higher. If this is the case, the empirical measurements reported in Chapter 3 may understate the contribution of human capital to productivity. Whether or not this is so is an interesting area for future research.
The third set of novel issues raised by the modeling of human capital is the possibility of an imbalance between physical and human capital. Empirical evidence suggests that physical and human capital are complementary. This implies that productivity will be high when the correct balance is achieved between physical and human capital. Could equilibrium incentives lead to an imbalance, whereby too much or too little physical capital is accumulated relative to human capital? We saw that such imbalances are unlikely or rather short lived in models with competitive labor markets.
However, our analysis in Section 10.6 shows that they become a distinct possibility when factor prices do not necessarily reflect marginal products, as in labor markets with frictions. The presence of such imbalances might increase the impact of human capital on aggregate productivity.The final issue relates to the role of human capital. In Section 10.8, we discussed the Nelson-Phelps view of human capital, which emphasizes the role of skills in facilitating the adoption and implementation of new technologies. While this perspective is likely to be important in a range of situations, it seems that, in the absence of significant external effects, this particular role of human capital should not lead to a major mismeasurement of the contribution of human capital to aggregate productivity either, especially, in the types of exercises reported in Chapter 3.
This chapter has also contributed to our quest towards understanding the sources of economic growth and cross-country income differences. We now have arrived to a relatively simple and useful framework for understanding both physical and human capital accumulation decisions. Our next task is to develop models for the other major proximate source of economic growth and income differences; technology. Before doing this, however, we will have our first look at models of sustained long-run growth.
10.10.