Capital is a stock of wealth used to produce goods and services.
Most often, by capital people mean physical capital: buildings,
machines, technical equipment, stocks of raw materials,
and goods. But "human capital"- people's knowledge and skills-
is at least as important for production, and at least as
valuable to people who have it. The importance of the "human
factor" in modern production is reflected in the distribution
of income among people who own physical capital and people
who "own" knowledge and skills. For example, in the United
States in the 1980s the income received on knowledge and
skills (through wages and salaries) was about 14 times that
received on physical capital (through dividends and undistributed
corporate profits). This phenomenon led economists to acknowledge
the existence of human
capital.

Education and Human Capital

Most human capital is built up through education or training
that increases a person's economic productivity- that is,
enables him or her to earn a higher income. Governments,
workers, and employers invest in human capital by devoting
money and time to education and training (to accumulating
knowledge and skills). Like any other investment, these
investments in human capital require sacrifices. People
agree to make these sacrifices if they expect to be rewarded
with additional income in the future.

Governments spend public funds on education because they
believe that a better-educated population will contribute
to faster development. Employers pay for employee training
because they expect to cover their costs and gain additional
profits from increased productivity.
And individuals are often prepared to spend time and money
to get education and training, since in most countries people
with better education and skills earn more. Educated and
skilled people are usually able to deliver more output or
output that is more valuable in the marketplace, and their
employers tend to recognize that fact with higher wages.

Economic returns to education are not always the same,
however. Returns to education may be lower if:

The quality of education is low or knowledge and skills
acquired at school do not match market demand. In this
case investments in human capital were not efficient enough,
resulting in less human capital and lower returns to individuals
and society.

There is insufficient demand for human capital because
of slow economic growth. In this case workers' human capital
may be underused and underrewarded.

Workers with lower and higher education and skills are
deliberately paid similar wages to preserve a relative
equality of earnings- as used to happen in countries with
centrally planned economies. These distortions in relative
wages are being eliminated as part of these countries'
transition to market economies.

The national stock of human capital and its rate of increase
are critical to a country's level and rate of economic development,
primarily because human capital is the most important determinant
of a country's ability to produce and adopt technological
innovations. But investing in human capital, although extremely
important, is not sufficient for rapid economic growth.
Such investment must be accompanied by the right development
strategy.

Consider the Philippines and Vietnam. In both countries
adult literacy is higher than in most other Southeast Asian
countries (see Data Table 2).
Nevertheless, until recently both countries were growing
relatively slowly, largely because of development strategies
that prevented them from taking full advantage of their
stock of human capital. In Vietnam central planning stood
in the way, and in the Philippines economic isolation from
the global market was to blame. In recent years, however,
both countries have realized a return on their investments
in human capital- Vietnam by adopting a more market-based
approach to development and radically improving its growth
rate, and the Philippines by "exporting" many of its educated
workers and "importing" their foreign exchange earnings.

Most governments are playing an increasingly active role
in providing education (Map 7.1 and
Data Table 2). Differences
in public spending on education (relative to GDP) across
countries reflect differences in government efforts to increase
national stocks of human capital. Governments of developing
countries devote a larger share of their GDP to education
today than they did in 1980. But this share is still smaller
than that in developed countries: 3.4 percent of GDP in
low-income countries and 4.4 percent in middle-income counties
compared with 5.6 percent in high-income countries. Using
Data Tables 1 and 2, you
can calculate the absolute gap between per capita public
spending on education in developed and developing countries.
This gap is an important manifestation of the vicious circle
of poverty described in Chapter
6: low per capita income inhibits investment in human
(as well as physical) capital, slows productivity growth,
and so prevents per capita income from increasing significantly.

Data on public education spending does not, however, paint
a complete picture of investment in human capital because
in many countries private spending on education is considerable.
Around the world, the difference between public and private
spending on education varies enormously and does not seem
to be correlated with a country's average income. Among
low-income countries, for example, the share of private
spending on education ranges from about 20 percent in Sri
Lanka to 60 percent in Uganda and Vietnam, while among high-income
countries it ranges from 5 percent in Austria to 50 percent
in Switzerland.

There are, however, certain patterns in the balance between
public and private spending on different levels of education.
Most governments are committed to providing free primary
and often secondary education because it is believed that
not just individuals but the entire country benefits significantly
when most of its citizens can read, write, and fully participate
in social and economic life. At the same time, tertiary
education institutions, both private and public, usually
charge tuition, because more of the benefits from this level
of education are believed to accrue to graduates (in the
form of much higher future earnings) rather than to society
at large.