Human Capital and Poverty

The main purpose of economics is to understand and to help alleviate poverty, and there is an intimate and transparent relation between investments in human capital and the alleviation of poverty. That is the theme of my presentation.

The term human capital may not be familiar to all of you. Human capital refers to the skills, education, health, and training of individuals. It is capital because these skills or education are an integral part of us that is long-lasting, in the way a machine, plant, or factory lasts.

Prior to the nineteenth century, systematic investment in human capital was not important in any country. Expenditures on schooling, on-the-job training, and other forms of investment were quite small. This began to change radically during that century with the application of science to the development of new goods and more efficient methods of production, first in Great Britain, and then gradually spreading to other countries.

During this century, education, skills, and other knowledge have become crucial determinants of a person’s and a nation’s productivity. One can even call the twentieth century the Age of Human Capital in the sense that the primary determinant of a country’s standard of living is how well it succeeds in developing and utilizing the skills, knowledge, health, and habits of its population.

It has been estimated that human capital–education, on-the-job and other training, and health–comprises about 80 percent of the capital or wealth in the United States and other advanced countries. Even if such estimates are somewhat exaggerated–and if there is any exaggeration, it is not large–these estimates clearly indicate that human capital can be neglected only at a country’s peril.

Human Capital and Economic Growth

The importance of human capital to growth is perhaps excessively illustrated by the outstanding records of Japan, Taiwan, Hong Kong, South Korea, and other fast-growing Asian economies. But they are obvious examples because they lack natural resources–which typically is overstated greatly as a determinant of economic performance–and face discrimination against their exports in the West. Nevertheless, they have managed to grow extremely rapidly in significant part because they have had a well-trained, well-educated, and hard-working labor force, and dedicated parents.

If you look at Korea, for example, all the coal is in North, not South, Korea. Prior to the Korean War, the north was the richer part of Korea. Today North Korea is an economic disaster while South Korea is a very prosperous, democratic nation. South Korea prospered, I believe, mainly because it was able to utilize and promote the talents of its population effectively. All the Asian Tigers are highly educated and literate. On-the-job and other training, as well as good work habits and values, support these hardworking people.

Every culture has the capacity to produce a successfully developing nation, be it Asia or Latin America, where we see examples in Chile and possibly Argentina and Brazil. It is not the culture that has prevented Africa from growing but the policies governments have inflicted on their people. With good policies, there is nothing in African culture to prevent these nations from joining in increasing numbers the economically advanced nations of the world.

Many economists have examined the growth of more than one hundred nations since 1950. They have asked, “Why are some nations that started out poor, such as Korea and Taiwan, now fairly wealthy? Why have nations that started out poor, such as Nigeria and other nations in Africa, remained economically stagnant or even regressed? And why has a nation such as Argentina, once one of the richest nations in the world, fallen back over a sixty-year period?” Almost every one of these studies shows that the utilization of education and health–life expectancy is a measure of health–are important determinants.

I am not saying that machinery and physical capital are of negligible importance in a modern economy. Of course, you need good machinery, equipment, and factories. But you also need skilled workers and managers, and innovative entrepreneurs to utilize this machinery effectively. There are many examples of nations that have imported the best possible machinery and have had dismal results. You cannot grow without a strong human capital base. Success depends on how well a nation utilizes its people. If it treats them badly, leads them to underinvest in themselves, or neglects a significant fraction of them, it will fail in the modern world, no matter how much machinery it utilizes.

One might think that the value of having an educated and trained population would have fallen over time because there are so many more educated people in the world. A simple supply/demand analysis would say that, as there is more supply, price goes down. Although the supply of educated people has increased, technology has been shifting rapidly and significantly in favor of the better trained, more educated people. So, despite the sizable increase in supply of educated people in the United States, in most European nations and in some of the developing nations there has also been tremendous growth in the advantages of getting additional education and training.

From about 1930 to 1970, the typical college graduate in the United States earned about 40 percent more than the typical high school graduate, while the typical high school graduate earned some 40 percent more than the typical high school dropout. These premiums have doubled to between 70 percent and 80 percent. The reasons are not completely clear. Economic studies are fairly convincing that it is not just because this is an increasingly competitive world with low-skilled jobs being exported to Asia and other poorer countries. Although that is happening, the major determinant seems to be technology. Computers are one example. Computer literacy is just a sample of what is going on in every area: The ability to harness and utilize knowledge effectively determines a nation’s success. Knowledge is power in the modern world.

The same general trends that I indicated for the United States are found in Western Europe. Lack of human capital development tends to show up more in Europe in increasing unemployment. In 1980, United States unemployment was much above that in Germany, France, Sweden, and many other Western European countries. There has been a complete reversal since then. Unemployment in France now is 11 percent; West Germany is about 9 percent; Britain is 8.5 percent; Sweden is 13 percent; Spain is 23 percent. Similar numbers apply in most of the Netherlands and Belgium.

Most of these unemployed people are less-educated young people without job experience or on-the-job investment.

Education and training not only promote growth and efficiency, but they can reduce inequality and the impact of disadvantaged backgrounds. Education is the most effective way for able young people of poor backgrounds to rise in the economic hierarchy, because human capital is the main asset of 90 percent of the population. This is why income inequality in a nation is greater when inequality in education is greater. Indeed, income inequality is more generally related to inequality in all types of human capital: in training and health, as well as in schooling.

It is not surprising, therefore, that the increased inequality in incomes in the United States since the mid-seventies has been caused in good part by larger returns to schooling and other training, and that many countries, like Mexico and Brazil, have major pockets of poverty related to regional disparities in opportunities for education.

Human Capital and the Family

Where does human capital come from? What constitutes a successful investment in human capital, either at the individual or national level? One has to start with the family. It is the foundation of a good society and of economic success. Families have differed over time, but they are still very important in the modern economy. To understand human capital, you have to go back to the family, because it is families that are concerned about their children and try, with whatever resources they have, to promote their children’s education and values. Families are the major promoters of values in any free society and even in not-so-free societies.

Families make a variety of decisions. One is whether to have many children or to have fewer children and to try to do more for each child. As countries develop, the trend shifts very strongly toward the latter. Every nation that has developed has done that, some in remarkably short periods of time. Taiwan, for example, has a birth rate lower than the United States. Declining birth rates also characterize Hong Kong, Mexico, and Poland.

Greater education of parents, perhaps of mothers, tends to improve the treatment of children, especially of daughters. The gap between the education of sons and daughters is smaller when parents are more educated.

More educated men and women tend to invest more in their own health and the health of their children. Indeed, education may be the single most important personal determinant of a person’s health and life expectancy. I will only mention a few examples of the considerable evidence on the link between education and health.

Educated persons in the United States and other rich nations are the least likely to smoke. Smoking in the United States is now found in significant numbers only among those with no college education, and is especially common among high school dropouts.

Education of the poor helps improve their food intake not only by raising their incomes and spending on food but also by inducing them to make better, healthier, choices. All the studies from different nations I have seen indicate that educated persons tend to consume a healthier diet even when the total amount spent on food is held constant.

Of course, the relation between education and better health and life expectancy involves causation in both directions, for greater health and lower mortality also induces larger investments in education and other human capital since rates of return on these investments are greater when the expected amount of working time is greater.

I do not want to create the impression that simply educating the population provides a magic wand to economic prosperity. Communist nations such as Cuba and North Korea did pretty well, at least on paper, in terms of the education levels of their populations. Years of schooling and literacy were high, and yet these countries had very poor economic performance. The Soviet Union was a third-world economy. Even East Germany, which was the pride and joy of communism, would be at an income level below that of South Korea if it had not received about $500 billion of help from West Germany.

Why did they do so badly even with educated populations? Because human capital is not enough. You also need the right economic environment. Systems that failed even though they had educated populations did so because they did not have the complementary aspects of a well-functioning economy: free markets, a flexible price system, and individual choice as to what type of education people want and what they are going to do.

You need a system where people who work harder get paid more. Why get an education or work hard if you are not going to be paid more than anyone else? I visited a few factories in China in 1981, when it was just beginning to open up its economy. When I walked through a room, the people started acting busy, but when I looked away, they stopped working. I asked why and discovered everybody was getting paid more or less the same. Equality of income produces a very low level of productivity. Everybody loses as a result.

In studies of countries, hundreds of variables have been tried. People have had all kinds of ideas of what determines economic success. Is it culture or society? Is it population growth or density? The two general variables that turn out to be important are human capital and the type of economic system. Does a country give the thousands of people it is investing in an incentive to work hard, to innovate, to develop good work habits, and to teach their children that it does pay to come to work on time and to work hard?

Human Capital and Education Policy

The significant role of human capital in the economy means that policies toward education, health, and other investments are important partly for their implications about economic prosperity, economic growth, and income inequality. I would like to make a few points on education policy before closing.

Education through secondary school in most nations tends to be dominated by public schools that charge no tuition; for example, 90 percent of students in the United States are in public elementary or high schools. Persons generally go to school in the neighborhoods where they live or in larger geographic units. Curricula and other programs are determined politically. There is no need for schools to compete for students by offering better programs or through tuition charges since the supply of students to a school is largely given.

This system works reasonably well for upper- and middle-class students, for their parents exercise considerable control over the schooling of their children. When these parents are dissatisfied with public schools, they may have means to enroll their children in private schools. Or they can move to communities with public schools more to their liking. Indeed, suburban communities in many developed countries compete for residents partly through the quality of their public schools. So to speak, residents vote with their feet if they do not like the public schools in their neighborhood.

But this system does not do justice to the schooling demands of poorer families who need good schools to overcome weak family training and learning. Disadvantaged families cannot afford private-school tuition and can seldom move to communities with better public schools. Usually they must accept whatever public schools are available to them, no matter how poor.

To remedy these defects, a proposal that is growing in popularity is to give vouchers to students they can use to help pay their tuition at any school, private or public, that accepts them. Versions of this system have been partially implemented in Sweden, Denmark, Chile, and on a small scale in the United States.

The World Bank studied private and public schools in Colombia and Tanzania. But the most detailed studies compare public and private high school education in the United States. Private schools here, especially Catholic ones, spend much less per student than big-city public high schools, yet they are more successful in raising the performance and cutting the dropout rates of pupils. The reasons are not clear, although these schools are less subject to political interference that limits disciplinary procedures, and they manage to get parents and the neighborhood community closely involved in their programs.

Two recent studies conducted in Chicago show that Catholic schools in the United States raise earnings and other performance measures even after detailed efforts to implement selectivity corrections for the unobserved characteristics of students who attend private schools. What is especially important for this talk and the proposal to have vouchers for poor families is the evidence from these studies that students from disadvantaged backgrounds tend to gain the most from attending private schools. This is not surprising in light of the more extensive choices available to middle class and rich students.

I have discussed some evidence that relates investments in education and other human capital to employment and earnings, health and mortality, fertility and family size, and discrimination against girls in education, diet, and other ways. Overall, I believe the case is overwhelming that investments in human capital are one of the most effective ways to raise the poor to decent levels of income and health.