Saturday, April 13, 2013

13/4/2013: Human Capital & Economic Development - a fascinating study

A fascinating paper, published in The Quarterly Journal of Economics (2013), 105–164, titled "Human Capital and Regional Development" by Nicola Gennaioli, Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer (see also NBER Working Paper No. 17158, September 2011 or in final version at looked at "the determinants of regional development" across "1569 sub-national regions from 110 countries covering 74 percent of the world’s surface and 96 percent of its GDP."

The authors "combine the cross-regional analysis of geographic, institutional, cultural, and human capital determinants of regional development with an examination of productivity in several thousand establishments located in these regions." In addition, the study also extends a standard model of regional development to include a "model of the allocation of talent between entrepreneurship and work", and a "model of human capital externalities".

Top line conclusion: "The evidence points to the paramount importance of human capital in accounting for regional differences in development, but also suggests from model estimation and calibration that entrepreneurial inputs and human capital externalities are essential for understanding the data."

More specifically:

  • In the paper, human capital as measured by education attainment "emerges as the most consistently important determinant of both regional income and productivity of regional establishments.
  • "…Some of the key channels through which human capital operates, includ[e] education of workers, education of entrepreneurs/managers, and externalities." 
  • The authors omit other forms of human capital (e.g. creative capacity, innovation capacity, various measures of aptitude, etc), which implies that the results of the study error on cautious side when it comes to determining the full extent of the effects of human capital on economic development.
  • The authors also omit from consideration "the role of human capital in shaping the adoption of new technologies. Starting with Nelson and Phelps (1966), economists have argued that human capital accelerates the adoption of new technologies." This once more implies that the numerical estimates provided by the authors error on the side of underestimating the true effects of human capital on economic development.
  • The authors "do not find that culture, as measured by ethnic heterogeneity or trust, explains regional differences."
  • The paper shows no effect of "institutions as measured by survey assessments of the business environment in the Enterprise Surveys" on helping to "account for cross-regional differences within a country."  
  • The two points above are important for us in Ireland - and indeed in all Small Open Economies within the EU27 - because, given the extent of labour mobility and markets integration within the EU27, we are closer, on a comparative basis, to being a regional economy, rather than a separate country-level economy.
  • "In contrast, differences in educational attainment account for a large share of the regional income differences within a country. The within country R2 in the univariate regression of the log of per capita income on the log of education is about 25 percent; this R2 is not higher than 8 percent for any other variable."
  • Acemoglu, D, & M. Dell (2010) paper “Productivity Differences Between & Within Countries” (published in American Economic Journal, 2(1):169-188) examined "sub-national data from North and South America to disentangle the roles of education and institutions in accounting for development. The authors find that about half of the within-country variation in levels of income is accounted for by education." 
  • The study also shows that "focusing [in the analysis of the role human capital plays in economic development] on worker education alone [absent separate consideration of entrepreneurial human capital] substantially underestimates both private and social returns to education. Private returns are very high but to a substantial extent are earned by entrepreneurs, and hence might appear as profits rather than wages…  …the evidence points to a large influence of entrepreneurial human capital, and perhaps of human capital externalities, on productivity."
  • Key numerical finding is that "education explains 58% of between country variation of per capita income, and 38% of within country variation of per capita income."
  • "Turning to institutions, some of the variables, such as access to finance or the number of days it takes to file a tax return, explain a considerable share of cross-country variation, …but none explains more than 2 percent of within country variation of per capita incomes. Indicators of infrastructure or other public good provision do slightly better: on their own many explain a large share of between country variation, while density of power lines and travel time account for up to 7% of within country variation. These variables are obviously highly endogenous, and still do much worse than education."
  • The last two points summarised in the table below:

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