Recent Theoretical Contributions To The Growth Literature Emphasize Economics Essay

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This paper analyzes the interaction between the distribution of human capital and economic growth. It argues that the composition of human capital is an important factor in the determination of the pattern of economic development.

It seems appropriate to discuss some terminological aspects before proceeding.

As we know that there are different kinds of capital:

Physical Capital

Human Capital

Technical Progress

The most important type of capital is human capital for any nation because no matter how much a physical capital a country possesses it is not of any beneficial use without human capital.

Human capital is a complex theoretical concept that is not defined in a uniform manner. In its most general form, it refers to the resources in people. It has been defined by the OECD as:

"The knowledge, skills, competences and other attributes embodied in individuals that are relevant to economic activity".

This is a broad definition because it is not restricted to education but encompasses all investments in humans which are made to improve their skills. These can include schooling and parental education as well as on-the-job training and learning-by-doing (i.e., acquiring skills through work experience) or other activities that help a person put his or her skills to productive use. In addition, just like physical capital, human capital may depreciate (as people forget what they have learned and as certain abilities deteriorate with age, for example) or become obsolete.

An important distinction which should be made is between human capital and abstract technological knowledge. Although human capital involves the acquisition of knowledge, it differs in one respect from abstract knowledge such as an invention or a design. Human capital is a private good in that it is tied to a person and is therefore rival and excludable.

Issues affecting Human Capital:

Two issues arise in considering the effect of human capital on economic growth:

How any relationship should is specified?

How should human capital be measured?

Main Objective of the Study:

The main objectives of this study is to estimate and analyze the effects of human capital as a flow variable on economic growth. The objective of the study is only limited to estimate the effect of human role in Pakistan. The advantage of this study is:

A more careful and in-depth examination of institutional and historical characteristics of Pakistan

The use of data set comprised of the most appropriate and highest quality measures unconstrained by the need for measurement consistency in Pakistan

A more detailed exposition of the dynamic evolution of the economy.

Moreover, a lot of work has been done for developed countries; a very little attention has been given to developing nations. Therefore, the following study adopts an alternative empirical strategy to investigate the importance of human capital on economic growth by focusing on developing country i.e., Pakistan.

Therefore; the main objective of this study is to estimate and analyze the effects of human capital as a flow variable on economic growth.

Economic Theory:

The 'new growth theory' has been highly influential in explaining the differences in the economic performance of developing countries. Economic backwardness is highly linked to low labor efficiency and training, deficient supplies of entrepreneurship and slow growth in knowledge. The countries that have surged ahead, on the other hand, are characterized by high level of human capital accumulation where the educated labor force has raised the level of output and the rate of growth over a sustained period of time. The new growth theory differs from the traditional neo-classical growth theory because it takes growth as an endogenous outcome of the economic system itself and not as a result of forces from outside the system. The new growth theory does not necessarily assume that capital has diminishing rates of return. There can be, for instance, externalities to capital and/or human capital that give capital constant (or increasing) rates of return.

Literature Review:

The idea that human capital plays an important role in explaining income differences have been present in economists' thinking for a long time. By some accounts, it can even be traced to the work of Adam Smith and Alfred Marshall, although it was not until the middle of the 20th century that Gary Becker and others developed a theory of human capital. This theory, according to which a person's level of education and experience determine his or her (labor) income, was originally envisaged in a microeconomic context, but has subsequently been applied to macroeconomics. Growth accountants such as Denison and Jorgenson/Guilloches examined to what extent changes in the quality of the workforce could explain the "residual" total factor productivity (TFP) unaccounted for by increases in labor and capital inputs.

Barro (1990) and Mankiw et al. (1992) investigates the impact of the human capital level on subsequent economic growth using cross-country analysis. Barro finds that primary school enrolment rates have significant explanatory power in the (per capita) output regression, but the same enrolment measures for 1950 or 1970 have no predictive value. Mankiw et al. find a significant role of human capital measured by the secondary school enrolment rates, but find production to exhibit diminishing returns to physical and human capital inputs. The large proportion of empirical evidence on the effect of human capital on growth are studies that use data on cross-section of countries and try to link some initial level of human capital with subsequent real output growth. In general, the results from the existing theoretical models suggest a positive impact of human capital on real growth. However, the individual empirical studies, though they provide numerous intriguing findings, differ substantially on their predictions, there is no consensus on the overall implications of the results.

Uzawa (1965) and Rosen (1976) also stress the importance of human capital in driving economic growth.

Nelson and Phelps (1966) said that the ability of nation to adopt and implement new technology from abroad is function of its domestic human capital stock.

Recent models of economic growth such as Romer (1986) and Lucas (1998) emphasize that investment in human capital an important factor contribution to economic growth. These models generate persistent growth endogenously from the actions of the individuals in the economy. An additional role for human capital may as engine for attracting other factors such as physical investment, which also contribute measurably to per capita income growth. Recent experience with attempts to accumulate physical capital at a rapid rate in poor counties bears out the necessity of due attention to human capital because it has become evident that the effective use of physical capital itself dependent on human capital. If there is underinvestment in human capital, the rate at which additional physical capital can be productively utilized is limited since technical, professional, and administrative people are needed for the effective use of physical capital.

Levine and Renelt (1992), recommend a reasonable degree of skepticism about inferences from empirical studies linking human capital to growth.

In the simplest formulation, growth rates are affected by ideas and invention, which in turn are related to the stock of human capital either through research and development

(R&D) activities or through adoption behavior. These formulations indicate not only why the level of output is higher when a country has more human capital but also why the growth rate is higher.

Previous investigations of growth have concentrated on various measures of formal schooling activities as proxies for relevant human capital. The most frequently employed measure is either the primary- or secondary-school enrollment rate, used, for instance, in Romer (1990), Robert J. Barro (1990), and N. Gregory Mankiw et al. (1992) and highlighted in the influential sensitivity studies of Ross Levine and David Renelt (1992) and Levine and Sara J. Zervos (1993). These schooling flow variables, however, will not accurately represent either the relevant stock of human capital of the labor force or even changes in the stock during periods of educational and demographic transition. To deal with these problems, Barro and Jong-Wha Lee (1993) pioneered the development of better schooling stock variables through the use of individual country survey and census data.

Stern (2001) argues that Education takes center stage in any discussion of development strategy for two reasons. First, the quantity and quality of education influences strongly the labor force, governance and the workings of most institutions. Thus it is a key determinant of the investment climate. Firms, both domestic and foreign, are more eager to invest when they know that they will be able to draw on a skilled workforce to make that investment productive. Second, universal access to basic education is essential for ensuring that all segments of society will benefit from macroeconomic growth.

According to Fagerberg the main conclusion from the vast field of catch-up and growth studies is that catching up to leader countries is not an easy task, and only countries with appropriate economic, social, and institutional characteristics will succeed in it. One could add that the level of human capital is of major importance.

All in all, human capital seems to play a decisive role in the performance of an economy both, 'cross sectionally' and over time. These empirical results motivate a closer look at the growth theories in order to find out what their emphasis on the subject is.

Framework of the Study:

As the objective stated is to estimate the role of human capital in economic growth in the developing country i.e. Pakistan.

We have considered growth accounting with human capital as a factor of production, so we employ the standard growth accounting methodology with human capital specifies an aggregate production function in which Gross Domestic Product (GDP) Yt is the dependent variable, three input factors i.e., employment Lt, physical capital Kt, and human capital Ht are the independent variables.

Model Specification:

The growth model used is:

Yt = At Ktα Ltβ Htγ et (1)

Where,

Yt= Gross Domestic Product

At = Exogenous level of technology.

Kt = Gross domestic investment (a proxy variable for physical capital).

Lt = Employment.

Ht= Schooling enrolment rate at secondary level of education (a proxy of human capital)

et = Error term. Yt = At Ktα Ltβ Htγ et

Assumption regarding specification of the model:

In this analysis it is assumed that rates of return on investment in human capital rise rather than decline as stock of human capital increases, at least until the stock becomes large. So there are constant return to scale in three reproducible physical, labor and human capital stocks (i.e., α + β + γ = 1 or > 1), the model generate perpetual growths.

Data Collection:

The major source of this data is the Economic Survey of Pakistan (2005-06). There are certain limitations about the data that are given as:

Many theoretical models of economic growth have used the schooling enrolment rates (SERs) as proxy variables for human capital. In this paper we also use the schooling enrolment rates. Schooling enrolment ratios have several deficiencies as measure of stock of human capital. First, the current enrolment ratios measures the flows of schooling, the accumulation of these flows creates the future stocks of human capital. Because the educational process takes many years, the lag between flows and stock is very long. If the approximate lag is considered, then the construction of human capital stocks still requires an estimate of initial stocks. Errors are introduced because of mortality and migration and because the net enrolment ratios are unavailable for developing countries. The gross enrolment ratio introduces errors related to repetition of grades and dropouts, phenomena that are typically high in developing countries.

"Over short time periods, there is little change in a nation's true mean schooling level, so the transitory component of measurement error in schooling would be large relative to variability in the true change. Over longer periods, true education levels are more likely to change, increasing the signal relative to the noise in measured changes."

An additional source of upward bias may be that the data refer to the registered number of students at the beginning of each school year. The actual number of children that attend the school during the year can be substantially lower. The error is particularly serious for developing countries in which government punishes parents that do not register their children at primary schools.

Methodology:

To estimate the growth model the methodology that is used, is OLS method. The above stated model is stated as exponential model written as:

Yt = At Ktα Ltβ Htγ et (1)

Which may be expressed alternatively as:

Taking natural log of (1), the relationship for growth can be expressed as

ln Yt = log At + α ln Kt + β ln Lt + γ Log Ht + ln et (2)

ln Yt = a + α ln Kt + β ln Lt+ γ ln Ht + et (3)

Where,

ln At = α

ln et = et

Because of data constraints, so proxy variables are used relevant to growth accounting by those, which are directly observable. For example:

Proxy variable for physical capital: Gross domestic investment rates used as a proxy variable for physical capital.

Proxy variable for human capital: Schooling enrolment rates at secondary level used as proxy for human capital.

Our method of analysis is consisted of two parts:

Firstly, we consider separate impacts of human capital and labor force on GDP: ln Yt = a + α ln Kt + β ln Lt+ γ ln Ht + et

Secondly, we combine a human capital measure and employment to create effective labor input. Because human capital embodied labor performs better than traditional employment in estimating potential output growth.

So aggregate production function of (1) can be written in the following form:

Yt = At Ktα (LtHt)β et (4)

Taking natural log of (4), we get:

ln Yt = ln At + α ln Kt + β (ln Lt + ln Ht) + ln et

ln Yt = a + α ln Kt + β (ln Lt + ln Ht) + et

Hypotheses of Study:

The growth accounting with human as a factor of production, we will estimate the standard growth accounting model. In the literature human capital is considered as the engine of growth. For example, Romer (1990) found that countries with greater initial stock of human capital experience a more rapid rate of introduction of goods and thereby to grow faster. Becker, Murphy, and Tamura (1990), assume that the rate of return on human capital increases over some range, an effect that could arise because of the spillover benefits from human capital that Lucas (1988) stresses. As an example, the return to kind of ability, such as talent in communications is higher if other people are more able. In this setting, increase in the quantity of human capital per person leads to higher rate of investment in human capital and hence to higher per capita growth. Therefore, we hypothesize those proxies for human capital will effect positively to the growth of Pakistan.

Empirical Analysis of Impact of Human Capital on Economic Growth:

The empirical estimates presented below provide insights into the relationship between measures of physical and human capital and growth. However, this regression should not be misinterpreted as causality tests: in particular, acknowledge a substantial feedback effect from output toward the input, as emphasized in the endogenous growth literature. These estimates are not simple correlations because the input measures directly impact the production process so that the measures are related directly. Rather, view the evidence as indicating whether our human capital proxies improve upon traditional growth measurement. Now the empirical results of empirical analysis are discussed below.

Effects of Human Capital on Economic Growth as Measured by School Enrolment Rates at Secondary Level:

First of all we will estimate the equation that is:

ln Yt = a + α ln Kt + β ln Lt+ γ ln Ht + et

Where,

ln Yt= ln (Gross Domestic Product)

ln At = ln (Exogenous level of technology)

ln Kt = ln (Gross domestic investment)

ln Lt = ln (Employment)

ln Ht= ln (Schooling enrolment rate at secondary level of education)

ln At = α

ln et = et

In this equation schooling enrolment rate at primary level of education (SERP) is used as a proxy variable for human capital. And regression is estimated by using the Ordinary Least Squares (OLS) method.

By applying the OLS method the following regression line is obtained:

ln Yt = -1.954 + 0.475 ln Kt + 0.121 ln Lt+ 0.401 ln Ht

The above estimated regression line shows the effect of Gross Domestic Investment(GDI),Employed Labor Fprce and the Enrollments at the Secondary Education Level on the economic growth of Pakistan.

First analyzing the effect of GDI on the growth of Pakistan. We have analyzed its effect by keeping all the other factors i.e. Employed labor Force and the Enrollments at the Secondary Education level as constant. The above estimated regression line reveals that the coefficient of GDI is positive and significant. It means that increase in GDI leads to increase in economic growth.

Secondly, the coefficient of the Employed Labor Force also shows that it has a significant and positive impact on the growth of GDP i.e. increase in labor force which is used as indicator of human capital leads to increase in GDP.

Finally, analyzing the effect of the number of Enrollments. This also reveals the positive and significant impact on economic growth.

Regarding the assumption of the model it is notable that for Pakistan there are constant returns to scale (i.e.α+β+γ=1) which implies that the model generates perpetual growth.

The above results have proved that the country's subsequent growth is positively related to the measures of human capital.

Effects of Human Capital on Economic Growth as Proxied by Effective Labor:

Secondly we would estimate the equation as:

ln Yt = a + α ln Kt + β (ln Lt + ln Ht) + et

In the above equation as mentioned earlier we combine a human capital measure and employment to create effective labor input.

By applying the OLS method the following line is obtained:

ln Yt = -2.181+ 0.479 ln Kt + 0.508(ln Lt + ln Ht)

The second part of the analysis we have combined employed labor force and the number of enrollments at the secondary level of education to create effective labor input. As it is obvious that human capital embodied labor performs better than raw labor. The results reveal that there is a significant improvement in share of effective labor for estimating the human capital.

All the above results indicate that GDI, employed labor force and the enrollment at the secondary level of education has a positive impact on the growth of the economy of Pakistan. As we know that Pakistan is a developing country but with the advancement in the world economy the people of Pakistan are becoming aware of the present needs for the development of the economy.GDI in the country is increasing with the pace of time and thus increasing the employment opportunities. Education also plays an important role in the development of the economy so the people are becoming aware of the importance of education. Parents compel their children to gain more knowledge and even the government is working for the progress of this sector. Progress in this sector would lead in the generation of more skilled labor force thus enhancing the growth of the economy. Moreover, treating human capital as a factor of production implies that in growth accounting regressions, human capital affects positively and significantly to GDI and education level to the growth rate.

Conclusion:

In this paper, an attempt is made to determine empirically the role of human capital on economic growth. Economists use different analysis of the growth process where growth is an endogenous process bought by human capital accumulation. In the analysis of this paper the impact if GDI, employed labor force and enrollment of the students at the secondary education level is determined from 1990-2005.It revealed that all these factors positively and significantly enhances the growth of the economy.

Our analysis shows that:

The carrier of human capital is human beings who are characterized as both productive and consumptive.

Human capital is a multidimensional concept which consists of different particular factors as employed labor force and the number of enrollments at the secondary education level.

There is an overall positive relationship between human capital and economic growth.

Human capital stocks are positively related with the growth of GDI and in most cases are significant for the developing countries like Pakistan. It further implies that the role of human capital as an agent in attracting physical capital can also be proved. Evidences support that the endogenous growth model may also enable greater investment in physical capital, which in turn generate growth. Overall empirical evidence supports the idea that human capital plays a crucial role in economic growth.

Policy Implications:

The above analysis has the following policy implications for Pakistan:

Greater attention should be given to the areas where the facilities of education.

There is positive relationship between human capital measures especially at secondary level of education and economic growth. It means that if there is increase in human capital investment at this level of education, it helps to increase economic growth. Therefore, the policy alternative should be to increase the investment in human capital for secondary and higher levels of education.

Human capital embodied labor effects positively and significantly to economic growth, so the policy alternative should be that government has to increase investment in training programs for labor and technical education.

The annual budget allocation for education in Pakistan is very low, so there is a need to allocate a significant amount of funds to education sector.

There may be hindrances to the free choice of profession. Racial discrimination and religious discrimination are still widespread in Pakistan. Such hindrances keep the investment in this form of human capital investment substantially below its optimum. The policy alternative should be to reduce such kind of hindrances in the process of growth.

Country develops if human capital is developed.

Productivity in the economy increases.

There is a removal of social and economic backwardness.

It could bring an increase in the employment opportunities.

ANNEXURE 1(A):

The following table contains the data related to the GDP rate of Pakistan from the year 1990-1991 to 2004-2005.It contains the natural log values of GDP according to the criteria of the model mentioned above.

Years

GDP

ln GDP

1990-1991

5.6

1.7228

1991-1992

7.6

2.0281

1992-1993

2.2

0.7885

1993-1994

4.4

1.4816

1994-1995

5.1

1.6292

1995-1996

6.6

1.8871

1996-1997

1.7

0.5306

1997-1998

3.5

1.2528

1998-1999

4.2

1.4351

1999-2000

3.9

1.361

2000-2001

2

0.6931

2001-2002

3.1

1.1314

2002-2003

4.7

1.5476

2003-2004

5.7

1.7405

2004-2005

8.6

2.1518

Source:Pakistan Economic Survey 2005-2006

ANNEXURE 1(B):

The following table contains the data related to the Gross Domestin Investment(GDI) rate of Pakistan from the year 1990-1991 to 2004-2005.It contains the natural log values of GDI according to the criteria of the model mentioned above.

Years

GDI

ln GDI

1990-1991

19.4

2.9653

1991-1992

8.1

2.0919

1992-1993

13.8

2.6247

1993-1994

10

2.3026

1994-1995

13.4

2.5953

1995-1996

16.4

2.7973

1996-1997

8

2.0794

1997-1998

9

2.1972

1998-1999

-3.6

1999-2000

10.2

2.3224

2000-2001

8.6

2.1518

2001-2002

3.2

1.1632

2002-2003

10.7

2.3702

2003-2004

14.4

2.6672

2004-2005

27.5

3.3142

Source:Pakistan Economic Survey 2005-2006

ANNEXURE 1(C):

The following table includes the data related to the Employed Labor Force (ELF) and Enrollment in Secondary School (ESS) in Pakistan.

Years

ELF

ln

ELF

ESS

ln

ESS

ELF+ESS

ln (ELF+ESS)

1990-1991

29.04

3.3687

90

4.4998

119.04

4.7795

1991-1992

30.07

3.4035

90

4.4998

120.07

4.7881

1992-1993

30.92

3.4314

93

4.5326

123.92

4.8196

1993-1994

31.68

3.4557

84

4.4308

115.68

4.7508

1994-1995

31.8

3.4595

86

4.4543

117.8

4.769

1995-1996

32.58

3.4837

86

4.4543

118.58

4.7756

1996-1997

34.59

3.5436

92

4.5218

126.59

4.841

1997-1998

36.36

3.5935

90

4.4998

126.36

4.8391

1998-1999

37.19

3.6160

75

4.3175

112.19

4.7202

1999-2000

36.72

3.6033

91

4.5109

127.72

4.8494

2000-2001

37.5

3.6243

83

4.4188

120.5

4.7916

2001-2002

39.64

3.6798

83

4.4188

122.64

4.8093

2002-2003

40.47

3.7006

94

4.5433

134.47

4.9013

2003-2004

42.24

3.7434

101

4.6151

143.24

4.9645

2004-2005

43.22

3.7663

104

4.6444

147.22

4.9919

Source:Pakistan Economic Survey 2005-2006

ANNEXURE 2:

This contains the tables of output of the OLS regression line.

Table 2.1:

Effects of Human Capital on Economic Growth as Measured by School Enrolment Rates at Secondary Level:

-1.954

11.249

-.174

.866

.475

.376

.483

1.265

.234

.121

1.326

.032

.091

.929

.401

3.151

.055

.127

.901

(Constant)

lnGDI

lnELF

lnESS

Model

B

Std. Error

Unstandardized

Coefficients

Beta

Standardized

Coefficients

t

Sig.

Table 2.2:

Effects of Human Capital on Economic Growth as Proxied by Effective Labor:

-2.181

8.870

-.246

.810

.479

.271

.487

1.769

.105

.508

1.877

.074

.271

.792

(Constant)

lnGDI

lnELSESS

Model

B

Std. Error

Unstandardized

Coefficients

Beta

Standardized

Coefficients

t

Sig.

References:

Jhingan, M.L., The Economics of Development and Planning.Delhi.38th edition.

Qaisar Abbas., "The Role of Human Capital in Economic Growth: A comparative study of Pakistan and India."Pakistan Development Review.Vol 39:4Part II (Winter2000):451-473.

Website :< http://ideas.repec.org/s/pid/journal1.html>.

Website :< http://www.statpak.gov.pk>.

Website: <hhtp://www.fao.org/docrep/x263eod.html>.

Website :< http://www.accountancy.com.pk>.

Pakistan Economic Survey 2008-2009.

Ishrat Husain., "Education, Employment and Economic Development in Pakistan."

S.Akbar Zaidi, Issues in Pakistan's Economy. Pakistan: Oxford University Press.2nd edition.

Hanushek,Eric A. and Kim,Dongwook."Schooling, Labor force quality, and Economic Growth." National Bureau of Economic Research, December 1995.

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