Summary: No country has achieved sustained economic development without substantially investing in human capital. Previous studies have shown the handsome returns to various forms of basic education, research, training, learning-by-doing, and capacity-building. But education by itself does not guarantee successful development, as history has shown in the former Soviet bloc, Sri Lanka, the Philippines, and the Indian states of Kerala and West Bengal. The question is, when and how does education bring high payoffs? Although theory has suggested a strong causal link between education and growth, the empirical evidence has not been unanimous and conclusive. The authors examine two explanatory factors. First, who gets educated matters a good deal, but the distribution of education is complex and not much has been written about it. They construct an asset allocation model that elucidates the importance of the distribution of education to economic development. Second, how education affects growth is greatly affected by the economic policy environment. Policies determine what people can do with their education. Reform of trade, investment, and labor policies can increase the returns from education. Using panel data from 12 Asian and Latin American countries for 1970-94, they investigate the relationship between education, policy reform, and economic growth. Their empirical results are promising. First, the distribution of education matters. Unequal distribution of education tends to have a negative impact on per capita income in most countries. Moreover, controlling for human capital distribution and the use of appropriate functional form specifications consistent with the asset allocation model makes a difference for the effect of average schooling on per capita income. Controlling for education distribution leads to positive and significant effects of average schooling on per capita income, while failure to do so leads to insignificant, even negative effects, of average education. Second, the policy environment matters a great deal. Our results indicate that economic policies that suppress market forces tend to dramatically reduce the impact of human capital on economic growth. Investment in human capital can have little impact on growth unless people can use education in competitive and open markets. The larger and more competitive these markets are, the greater are the prospects for using education and skills.
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