Growth Models
Human capital

Empirical observation suggests that parental human capital and resources invested in education are complements in the production of human capital and that technological progress is positively related to the average level of human capital. In Discussion Paper No. 971, Oded Galor and Research Fellow Daniel Tsiddon demonstrate that the interplay between the `home environment' and `global technological' externalities determines the evolution of the human capital and income distributions, the wage differential between skilled and unskilled labour and the growth rate. When the home environment externality dominates, the human capital distribution becomes polarized, but convergence occurs when the global technological externality dominates. The growth process is influenced by the composition of human capital as well as its average level, and the relationship between the human capital distribution and growth may govern that observed between income distribution and growth.

Galor and Tsiddon maintain that a poor economy that values equity as well as prosperity may therefore face a difficult trade-off between short-run equity and long-run equity and prosperity. While a wide distribution of human capital may be needed to raise aggregate human capital and output in the early stages of development, inequality enables the better educated to increase investment in their own human capital. As this investment increases and income inequality widens, the accumulated knowledge trickles down through technological innovation in production, which enhances the returns to skill and hence to investment in human capital for all. Galor and Tsiddon maintain that developing countries may therefore do better to subsidize education for selected groups that will ultimately generate enough externalities to achieve equity and prosperity for the entire society in the longer term. In contrast, an economy that prematurely implements policies to promote equality in income distribution may become trapped at a low-output equilibrium and never attain prosperity.

Human Capital Distribution, Technological Progress, and Economic Growth
Oded Galor and Daniel Tsiddon

Discussion Paper No. 971, June 1994 (IM)