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
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
- 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.
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
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
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