VII. Education

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Capital is a stock of wealth used to produce goods and services. Most often, by capital people mean physical capital: buildings, machines, technical equipment, stocks of raw materials and goods. But "human capital"—people’s abilities, knowledge, and skills—is at least as important for production, and at least as valuable to people who have it. The importance of the “human factor” in modern production is reflected in the distribution of income among people who own physical capital and people who “own” knowledge and skills. For example, in the United States in the 1980s the income received on knowledge and skills (through wages and salaries) was about 14 times that received on physical capital (through dividends and undistributed corporate profits). This phenomenon led economists to acknowledge the existence of human capital.

Next, in the 1990s, came the recognition of a new stage in global economic development: the “knowledge economy,” knowledge-based and knowledge-driven¹. This recognition stemmed from the fact that the countries that invested most actively in knowledge creation and adaptation (through investing in research and development activities, R&D) as well as in knowledge dissemination (through investing in education as well as in information and communication technologies, ICT) tended to become most successful in solving their development problems (see Data Table 2). Moreover, it is now widely believed that even poor countries, with insufficient resources to invest in creating new knowledge, can “leapfrog” in their development provided that they succeed in absorbing advanced global knowledge and adapting it for the needs of their developing economies. A well-educated and adaptive population is seen as central to this task.

Education and Human Capital

Most human capital is built up through education or training that increases a person’s economic productivity—that is, enables him or her to produce more or more valuable goods and services and thus to earn a higher income. Governments, workers, and employers invest in human capital by devoting money and time to education and training (to accumulating knowledge and skills). Like any other investment, these investments in human capital require sacrifices. People agree to make these sacrifices if they expect to be rewarded with additional income in the future.

Governments spend public funds on education because they believe that a better-educated population will contribute to faster and more sustainable development. Employers pay for employee training because they expect to cover their costs and gain additional profits from increased productivity. And individuals are often prepared to spend time and money to get education and training, since in most countries people with better education and skills earn more. Educated and skilled people are usually able to deliver more output or output that is more valuable in the marketplace, and their employers tend to recognize that fact with higher wages.

Economic returns to education are not always the same, however. Returns to education may be lower if:

• The quality of education is low or knowledge and skills acquired at school do not match market demand. In this case investments in human capital were not efficient enough, resulting in less human capital and lower returns to individuals and society.
• There is insufficient demand for human capital because of slow economic growth. In this case workers’ human capital may be underused and underrewarded.
• Workers with lower and higher education and skills are deliberately paid similar wages to preserve a relative equality of earnings—as used to happen in centrally planned economies. These distortions in relative wages are being eliminated as part of these countries’ transition to market economies.

The national stock of human capital and its rate of increase are critical to a country’s level and rate of economic development, primarily because these are important determinants of a country’s ability to produce and adopt technological innovations. But investing in human capital, although extremely important, is not sufficient for rapid economic growth. Such investment must be accompanied by the right development strategy.

Consider the Philippines and Vietnam. In both countries adult literacy is higher than in most other Southeast Asian countries (see Data Table 2). Nevertheless, until recently both countries were growing relatively slowly, largely because of development strategies that prevented them from taking full advantage of their stock of human capital. In Vietnam central planning stood in the way, and in the Philippines economic isolation from the global market was to blame. In recent years, however, both countries have realized a return on their investments in human capital—Vietnam by adopting a more market-based approach to development and radically improving its growth rate, and the Philippines by “exporting” many of its educated workers and “importing” their foreign exchange earnings

Most governments are playing an increasingly active role in providing education (see Map 7.1 and Data Table 2). Differences in public spending on education (relative to GDP) across countries reflect differences in government efforts to increase national stocks of human capital. Governments of developing countries devote a larger share of their GDP to education today than they did in 1980. But this share is still smaller than that in developed countries: 3.3 percent of GDP in low-income countries and 4.8 percent in middle-income counties compared with 5.4 percent in high-income countries. Using Data Tables 1 and 2, you can calculate the absolute gap between per capita public spending on education in developed and developing countries. This gap is an important manifestation of the vicious circle of poverty described in Chapter 6: low per capita income inhibits investment in human (as well as physical) capital, slows productivity growth, and so prevents per capita income from increasing significantly.

Data on public education spending do not, however, paint a complete picture of investment in human capital because in many countries private spending on education is considerable. Around the world, the difference between public and private spending on education varies enormously and does not seem to be correlated with a country’s average income. Among low-income countries, for example, the share of private spending on education ranges from about 20 percent in Sri Lanka to 60 percent in Uganda and Vietnam, while among high-income countries it ranges from 5 percent in Austria to 50 percent in Switzerland.

There are, however, certain patterns in the balance between public and private spending on different levels of education. Most governments are committed to providing free primary and often secondary education because it is believed that not just individuals but the entire country benefits significantly when most of its citizens can read, write, and fully participate in social and economic life. At the same time, tertiary education institutions, both private and public, usually charge tuition, because more of the benefits from this level of education are believed to accrue to graduates (in the form of much higher future earnings) rather than to society at large.

In vocational education, employers often play an important role in providing on-the-job training for employees and in financing training in vocational schools. Governments try to encourage employers’ involvement in order to save public funds and to link vocational education to the needs of the labor market. Specific work skills are best developed through training during employment, especially in jobs involving substantial technological change.

Public financing of vocational training is generally considered justified when employer training capacity is weak (as in small and medium-size firms) or absent (as with retraining for unemployed workers). High-quality general pre-employment education is the best guarantee of an individual’s ability to learn new skills throughout a career and of employers’ willingness to invest in that individual’s professional training. Most importantly, employees must be able to communicate clearly in writing and to use mathematics and science skills to diagnose and solve problems.

Continued: Please see Page 2

¹ These terms are relatively new and are not yet strictly defined, although many researchers and journalists use them, often interchangeably.