The Role of Education in Economic Development: Theory, History, and Current Returns

Background This paper was prepared to contribute to a special issue on the value of education. Purpose The paper examines the role of education in economic development from both a theoretical and a historic perspective, addresses why education has been the limiting factor determining development historically, discusses why certain countries have provided education to the masses and others have not, provides estimates of the quantitative importance of the direct and indirect effects of education on the economy, calculates the marginal macro return on investment for 61 countries, and examines the implications of these results for government policy. Methodology The paper presents the results from other studies and estimates the marginal product of education and of physical capital and the relative importance of post-secondary education in 2005 using cross-country estimates of national income and the stocks of human capital and physical capital. The estimates of the stocks of human capital were developed from historic rates of public and private investment in schooling, the cost of capital during schooling, and students´ foregone earnings. Results The paper presents evidence that education has direct and indirect effects on national output. Educated workers raise national income directly because schooling raises their marginal productivity. They affect national income indirectly by increasing the marginal productivity of physical capital and of other workers. In highly-educated countries the spillover effect on other workers is minimal, but in less-educated countries the spillover effect on the productivity of other workers appears to be much larger. In all countries the positive effect of rising human capital on the productivity of physical capital is required to offset the diminishing returns to investment in physical capital and make rising investment in physical capital financially viable in the development process. The empirical results indicate that investment in schooling is subject to diminishing returns, but that the marginal product at the macro level is still considerable in highly-educated countries, over 12 percent in 2005. In less-educated countries the marginal product is much larger, in excess of 50 percent, but since most of this effect is indirect, the magnitude of the marginal returns to education is not generally appreciated. The results also indicate that investment in post-secondary education does not provide any additional effect on national income beyond the effect of investment in education generally. Conclusions These very high macro marginal returns to education make it possible for poor countries to grow very rapidly if they make a major public commitment to raising the average level of schooling of the masses.