Economic Growth: The Role of Human Capital

On November 10, Christopher Pissarides, Nobel Prize laureate in Economics and Professor at the London School of Economics, spoke at HSE ICEF. His lecture on human capital and its impact on economic growth commemorated the 20^th anniversary of ICEF.

Professor Pissarides is a renowned expert in labour economics, macroeconomic policy, growth economics and structural change. Human capital undoubtedly impacts the development of the labour market and the economy as a whole, but, as Prof. Pissarides demonstrated, it is difficult to accurately measure its contribution. Furthermore, the impact of human capital isn’t always positive, depending largely upon how the population puts it skills and knowledge to use.

How is human capital defined?

Human capital is defined by the Organization for Economic Co-operation and Development (OECD) as the knowledge, skills, competencies and attributes embodied in individuals. It is acquired through formal learning, substantiated by school and university certificates, as well as through non-certified means (such as accumulation of knowledge through work experience).

The consensus is that both kinds of human capital, that is, education and training, contribute to growth, in particular by means of productivity gains. But this effect is very difficult to measure. According to Prof. Pissarides, ‘countless macro empirical studies have failed to establish a precise and robust relationship between human capital and GDP growth’. Estimates at the aggregate level suggest a considerable range of impact: if, on average, the stock of education is increased by one year of schooling, per capita GDP grows by 3-15%.

Why does this happen? What’s important is not only human capital itself, but the way it is used by humans. Its contribution to the economy depends on the incentives that the person has to use it productively, and these incentives vary.

How is human capital used?

Incentives to use human capital to contribute to productivity are largely determined by the institutional structure of the economy. However, institutions vary widely between countries, so it cannot be measured easily.

Some institutions might offer incentives for ‘rent seeking’, whereby many individuals are involved in redistribution without new production, instead of productivity enhancement.  For example, corruption in the public sector, complex taxation laws and lack of intellectual property protection are incentives for highly trained people to enter the public sector to extract bribes or to become lawyers to make profit from endless court disputes, rather than to contribute to productivity.

Excess market monopolization promotes similar behavior. This can be observed in the oil and gas sector, however suppression of competition is also common among non-manufacturing businesses in market economies. Prof. Pissarides gave the example of the transportation technology company, Uber. In some areas where Uber operates, local authorities are earning huge money selling licenses to a small number of taxi drivers. In this way, Uber is being forced out of many European and American cities.

Such institutional ‘tension’ usually limits the contribution of human capital to GDP growth, but not its contribution to the growth of private revenues. Such cases occur, where an increase in personal wealth doesn’t lead to the growth of public wealth.

Since education systems and economy levels vary from country to country, the return on investment in human capital also varies. Empirical studies have shown that countries lagging behind the technological frontier, such as many of the African nations, grow by applying simple technologies learned from other countries. Based on this approach, development of elementary education would be their most effective strategy for economic growth. Populations in middle income countries acquire more sophisticated technologies; hence, investment in higher education by these countries would be most effective. In frontier countries, university education is most beneficial for economic growth.

When does human capital become firm capital?

For a given macro environment, human capital is most productive when a firm provides the right incentives to operate in productivity-enhancing activities. The firms that succeed in organizing their internal structure in such a way so as to ensure maximum efficiency of their employees will experience the most growth. This can be referred to as ‘organizational capital’; the effectiveness of which is related to ‘managerial capital’, or the ability of the company managers to administer the company properly.

A successful firm can be considered a monopolist in what it does, not as a result of barriers it creates for others, but as a result of its way of organizing itself in order to gain an implicit competitive advantage. Prof. Pissarides compared firms to football teams. Many teams have talented players. But not all of them are able (and the role of the manager, or coach, is vital here) to find a place on the field as part of the configuration which will lead to a win for the team.

Is it possible to imitate the winning strategies of other ‘teams’ (firms)? Yes, but only to a certain extent. Human capital is at its most effective when it exploits the unique characteristics of each individual, and not when it copies the characteristics of others. The ability of individuals to work together and to exchange ideas and concepts is transformed into social capital. The sum of individual human capital, social capital and the organizational capital of firms equals the intellectual capital of firms, and, ultimately, countries.