Human capital

The previous two chapters have argued that – in contrast to mainstream neoclassical models – population growth and the accumulation of physical capital are largely endogenous to economic growth. This chapter turns to an important driver of income that is exogenous at least over a 10 to 15-year horizon: human capital. Investment in education usually precedes the pay-out period by many years. Individuals tend to first go to school and then earn higher income. As a result, an increase in a country's level of human capital occurs mostly because young people entering the labor force are better educated than old people leaving the labor force.

Preferences and educational policies determine how many children complete a certain level of education. History shows that these decisions do not depend much on current income levels. Support for the view that education is exogenous comes from Stevens and Weale (2004), who note that the “spread of formal school seems to have preceded the beginning of modern economic growth.”

Today's decision to raise a country's level of human capital will have its biggest impact in 15 years or even later when the better-educated young enter the labor force. Any resulting rise in GDP will be spread out over many years. While potentially frustrating for policy-makers, this slow and gradual movement of human capital can be very informative for a long-run forecasting model.