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The Effects of Investing in Early Education on Economic Growth*

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The Effects of Investing in Early Education on Economic Growth* THE BROOKINGS INSTITUTION 1775 MASSACHUSETTS AVENUE, NW WASHINGTON, DC 20036-2188 TEL: 202-797-6000 FAX: 202-797-6004 WWW.BROOKINGS.EDU THE EFFECTS OF INVESTING IN EARLY EDUCATION ON ECONOMIC GROWTH* BY WILLIAM T. DICKENS, ISABEL SAWHILL, AND JEFFREY TEBBS April 2006 Introduction Economists have long believed that investments in education, or “human capital,” are an important source of economic growth. Over the last 40 years output has grown about 3.5 percent a year and the productivity of labor has grown about 2.4 percent per year. The contribution of education to labor productivity growth is estimated to be between 13 and 30 percent of the total. Further, many people believe that investments in human capital will become even more important in the future as we become a post- industrial, knowledge-based economy, and they worry that we are giving insufficient policy attention to the development of an educated workforce. Why might a more highly educated workforce increase economic growth? A more educated labor force is more mobile and adaptable, can learn new tasks and new skills more easily, and can use a wider range of technologies and sophisticated equipment (including newly emerging ones). It is also more autonomous and thus needs less supervision, and is more creative in thinking about how to improve the management of work. All of these attributes not only make a more highly skilled worker more productive than a less skilled one but also enable a work place that employs more educated workers to organize differently, manage differently, choose technologies and equipment * The views expressed in this working paper are those of the authors and should not be attributed to the staff, officers or trustees of the Brookings Institution. This work was funded by the National Institute for Early Education Research with a grant from The Pew Charitable Trusts – Advancing Quality Pre- Kindergarten for All. William T. Dickens is a Senior Fellow at the Brookings Institution. Isabel Sawhill is Vice President and Director of Economic Studies at the Brookings Institution. Jeffrey Tebbs is a Research Analyst at the Brookings Institution. 2 differently, and adjust better to changes necessitated by competition, by technical advances, or by changes in consumer demand. What is true for the firm may also be true for the whole economy. Skills beget more skills and new ways of doing business, workers learn from one another, and firms adapt their technology and their use of capital to the skills of the available workforce. The benefits of having a more educated workforce accrue to everyone, not just to the organization where these individuals happen to work. Further, these kinds of indirect (or spillover) effects for the firm or the economy as a whole may be especially important in an increasingly competitive global marketplace. Imagine an economy lacking in people able to read directions, use a sophisticated copier or a computer, or understand prevailing norms of behavior. Even if a single organization in that economy were able to find or import such skills, other organizations would not be able to invest in certain kinds of equipment or certain kinds of businesses with any assurance that they could make the investment profitable. Beyond that, a more educated workforce may produce a less crime-ridden and healthier environment with better functioning civil institutions and all the benefits that flow to the business sector from that environment. In this paper we develop a model that is flexible enough to allow a wide range of assumptions about the role of education in promoting economic growth. The model is particularly elaborate in its treatment of the breakdown of the population into different cohorts and in determining the amount of education people in different cohorts receive. This treatment allows us to develop a realistic estimate of the timing of the growth effects of a program that will take many years to have its full impact. Theories of Growth: A Brief Review of the Literature and the Models Used in this Analysis Past Work on Education and Growth Since nearly its inception, the study of economic growth has focused on the importance of education. Robert Solow (1957, pp.312, 317) described growth of national income as resulting from three sources: increases in the stock of physical capital (machines and buildings that are used to produce goods and services), increases in the size of the labor force, and a residual representing all other factors. This residual contributed considerably more to per capita growth than the increase in the capital stock. Solow dubbed the residual “technical progress” and noted that increasing levels of education were one of the factors that contributed to its growth. Using the same basic approach as Solow, but taking explicit account of the role of education, Edward Denison (1985) estimated that between 1929 and 1982, increasing levels of education were the source of 16 percent of the growth of total potential output in nonresidential business (and 30 percent of the growth per person employed in that sector). A more recent study by Dale Jorgenson and Kevin Stiroh (2000) puts the contribution of education to economic growth at 8.7 percent of total growth over the recent period 1959 to 1998 and 13 percent of growth in output per worker. 3 In the expanded Solow framework education is treated as a separate factor of production. The “stock” of human capital is measured in a way similar to the stock of physical capital. A person year of education is valued at the cost of producing it and all the person years are added up to get the stock. Increases in the stock of human capital, or in any other specific factor of production, are assumed to produce less than proportional increases in output since the various factors must be combined to obtain an increase in output. Specifically, a one percent increase in the stock of human capital is assumed to cause somewhat less than a half a percent increase in national income. In the Solow framework the impact of a one percent change in the stock of a factor of production is equal to its share in national income. A one percentage point increase in the capital stock causes only about a third of a percentage point increase in output because capital’s share of national income is only about a third. Labor gets most of the other two-thirds, and typical studies attribute two-thirds of that to human capital as opposed to raw labor. Thus increases in the number of workers, with no change in the total number of years of education, would have an impact smaller than an equal proportional increase in the stock of physical capital. But an equal proportional increase in the stock of human capital (person years of education) would have an effect twice that size. Some other theories of how education affects output suggest the gain could be even larger than this. An alternative to treating human capital as a separate factor of production is to take account of the effects of education by assuming that it is not a separate factor of production but instead simply increases the productivity of labor. In this framework an economy with twice as much human capital per worker could produce the same amount with half as many workers. Hirofumi Uzawa (1965) was the first to propose a model of economic growth with human capital impacts of this sort. In his model a one percent increase in the amount of human capital per worker causes an increase in national income of about two-thirds of a percent. This is because a one percentage point increase in the stock of human capital per worker causes a full percent increase in the effective supply of labor, which produces an effect on output equal to labor’s share of income. But Uzawa’s model may still understate the role of education in determining the level of output and growth. Both the Solow and Uzawa models assume that if we double the amount physical capital and human capital per worker we will at most double the amount of output and that each factor will get a fixed share of the increase equal to its average share of existing output. However, many economists have argued that doubling capital inputs more than doubles output and that this accounts for some of the unexplained residual in a Solow-type analysis of the sources of growth. When doubling inputs results in more than a doubling of output there are said to be “increasing returns to scale.”1 1 Increasing returns to scale cause a problem if they are thought to apply at the level of the firm. With even modest increasing returns to scale large firms have huge cost advantages over smaller rivals and can easily drive them out of business. In a world where increasing returns to scale were common at the firm level a single large firm would dominate in nearly all industries. However, if the advantages of increasing scale do not accrue to the firm, but to the economy as a whole (that is they are external to the firm) then this is not a problem. Thus growth models with increasing returns to scale typically assume that education has effects that are external to the firm. Many reasons have been proposed as to why a more educated workforce, in 4 Robert Lucas (1988), building on Paul Romer (1986, 1987), proposes a model of economic growth where the effects of human capital are greater than even the Uzawa model. Since the model has increasing returns to scale, increasing all factors of production proportionally can cause a greater than proportional increase in output.
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