Human capital in OECD countries: A new measure and its policy drivers

Human capital is widely regarded in the theoretical literature as fundamental for economic growth. Yet, quantifying the macroeconomic effects of human capital on growth has produced only mixed results. This column introduces a new measure of human capital which exhibits a strong and robust positive correlation with economic growth. The measure is built on recent findings on U-shaped returns to years of education and allows for variation across countries and over time. Empirical analysis shows the importance of pre-primary education, teaching resources as well as school autonomy for this measure of human capital.

Recent OECD studies looking at OECD countries confirm the difficulty of finding a robust positive effect of human capital on income per capita or productivity levels. The estimated effect is sensitive to the measure of human capital and to the estimation method (Guillemette et al. 2017). Including a large number of control variables in the regression analysis tends to reduce or eliminate the statistically significant positive effect. This may be due to a correlation of human capital with other institutions, in particular those representing good governance, leading to an indirect effect through these variables, and weakening the estimated effect of human capital (Fournier and Johansson 2016). Using common time fixed effects appears to further weaken the estimated effect of human capital due to a similar time trend across OECD countries (Égert 2017).

Taking a closer look at measures of human capital, many empirical studies using mean years of schooling also assumed decreasing marginal returns to education. This meant that primary education had the biggest marginal returns, followed by secondary education, with tertiary education having the lowest returns (Hall and Jones 1999, Caselli 2004, Feenstra et al. 2015). Moreover, returns were considered to be constant across countries and over time. But the most recent and authoritative data on returns to education paint a different picture. They suggest that average returns to primary, secondary and tertiary education are U-shaped relative to the time spent in education, not linear as previously assumed (Psacharopoulos and Patrinos 200, Montenegro and Patrinos 2014). The returns also vary substantially across countries. Differences within OECD countries can be as large as 10 percentage points and returns in the BRICS and the rest of the world are substantially higher than in the OECD. The data also indicate that average returns have increased over time in both OECD countries and the BRICS

Figure 1 Rate of return on education

A) Rate of return over time

B) Rate of return across countries

Source: Botev et al. (2019) based on Psacharopoulos and Patrinos (2004) and Montenegro and Patrinos (201

A new measure of human capital which is positively correlated with productivity

Correcting for these shortcomings, in Botev et al. (2019) we build a new measure of human capital based on the observed U-shaped or increasing returns to additional years of schooling and allowing for variation across countries and over time. The data on returns to education are combined with a 2018 update of the mean years of schooling constructed by Goujon et al. (2016). Our measure is based on rates of return, which differ across five groups of countries (advanced OECD, converging OECD, Easter European OECD, emerging market economic, rest of the world) and across three time periods (1979–1989, 1990–2000, 2001–2012). Our macroeconomic measure of human capital shows a positive and statistically significant correlation with multifactor productivity in time-series cross-country panel data regressions in which country and time fixed effects are included, with results robust to the time period, estimation methods, and the set of controls included.

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📌Human capital is the set of knowledge, skills and abilities that individuals accumulate towards personal well-being and improved work opportunities.