Part One Human Capital and Economic Growth
The purpose here is to outline economists’ understanding of the mechanisms by which human capital influences economic growth, the evidence at a broad macro-economic level for the importance of those influences, and historical and micro-economic evidence on how these mechanisms have operated in major developed economies.
Human capital has many dimensions, and is acquired through a variety of processes in different settings
In considering this evidence, several points need to be considered:
- Human capital is formed in a number of different settings, cumulatively over an individual’s life time. There are a wide variety of processes by which people acquire skills and capabilities.
- Human capital has many dimensions, which can influence productivity and hence growth in a variety of ways, both directly and indirectly.
- There are positive feedback loops connecting individual and societal outcomes. For instance, capabilities in one generation influence the acquisition of capabilities in the next. Higher productivity and earnings allow more resources to be devoted to human capital investments. In addition, human capital acquired early in life, makes it easier to acquire more human capital later on. Understanding these processes will be important for identifying where policies are likely to have the largest long-term impact.
Measures commonly used in empirical work, or for the purposes of policy evaluation, usually capture only a small part of this complexity. Government policies have more direct influence on some factors influencing human capital formation, than others. In sum, it is inherently exceedingly difficult to ascertain the true effects of human capital policies on individual and societal well-being.[7]
These points are illustrated in the following pages by Figures 1 and 2 from David (2001):
- Figure 1. Human capital: a taxonomy
- Source: David (2001)
- Individuals may not have the means to support themselves while they are undertaking education and training and may not be able to borrow for this purpose (with the intention of repaying loans through higher earnings later on).
- Human capital acquired by one individual may benefit many others (for instance through a lower probability of crime, or through enabling more productive technologies to be used). However individuals may mostly only consider the direct benefits to themselves (through earnings, job satisfaction, or social status for instance) in deciding how much and what type of human capital to acquire.
- In labour markets that are not fully competitive, employees may not get the full benefit of their skills in terms of earnings. Their employer will get a pecuniary benefit from their skills that employees do not take into account when making their education decisions[8].
- Figure 2. Human capital formation and growth: micro- to macro-level feed-backs
- Source: David (2001)
- It is difficult for individuals (students and education providers[9]) to tell what sorts of knowledge, skills and capabilities will be in high demand many years into the future. Likewise, firms investing in new technology may not know whether workers will have the skills needed to use it when it comes on stream. Firms, education providers and students might have different expectations about the future, leading to a mismatch between skills and technology. Unless they can co-ordinate their expectations, each might find it better to wait before making specific education and technology investments.
- Employers and workers may not be able to agree on the provision of workplace training, because authorities enforcing contracts might find it difficult to verify whether appropriate quality training has been provided. Workers might be unwilling to accept lower wages to reflect lower productivity during training, unless they are confident they will receive good quality training.
- Individuals may spend time and trouble to acquire qualifications, even when they do not thereby acquire much greater capability, because employers value qualifications as a sign that the holder has natural ability, and can be more readily trained[10]. (This may imply that the social value of education will be less than the private value.)
- [7]Some of the important issues that need to be considered in assessing the empirical evidence are set out in the Appendix.
- [8]This effect, and those covered in the next two bullet points apply to all investments, not just education.
- [9]Bureaucrats and politicians will face a similar difficulty in a publicly managed system.
- [10]Referred to as the “signalling” effect of education – see Part two.
Purely private decisions about human capital may not lead to the best outcomes for society
A further issue, highlighted by Figure 2 is that human capital formation is substantially shaped by the decisions of families, young people, education providers and firms. There are a number of reasons why private decisions by themselves may not lead to the best level and type of human capital formation for society as a whole. Some important instances are:
David and many other economists believe that these are among the reasons why government policies can lead to better outcomes for social well-being than if decisions were left up to private individuals alone, using their own resources. Of course, in practice, governments typically have a large involvement in funding, financing, regulating and providing education and training. The relevant policy question is not whether government should be involved, but what the nature and level of that involvement should be, and what changes to the status quo will lead to improvements in well-being. These issues will be explored further in the New Zealand context in Parts five and six.
