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Abstract
This research examines the effects of public policy on human capital formation and economic growth. Using a two-sector endogenous growth framework, a model was developed to highlight the role of policy intervention in the presence of education spillover or externality. The model examines public intervention in the form of giving direct subsidies to individuals engaged in human capital formation. For a range of plausible parameter values, the optimal subsidy is in the range of 30-50% of the market wage rate. Total public expenditure under the optimal subsidy plan lies in the range of 5-31% of the social output. I conclude that there is potentially a large role for government in encouraging human capital formation.
I then investigated the dynamic time-series relationship between public expenditure on education and economic growth for a sample of six Asian and five non-Asian OECD countries. I used total public expenditure on education as a percentage of GNP as a proxy for the subsidy to human capital formation. The results showed: (i) India exhibited the most significant permanent effect of public spending level on education to income growth. This finding is robust to the inclusion of demographic variables, (ii) US exhibited the most significant permanent effect of public spending growth shocks to income growth, (iii) Causation from income growth to public spending was detected in Pakistan and Thailand while the presence of bi-directional causality was detected in Japan, Philippines and France, and (iv) Korea posted the lowest feedback estimates and showed negligible effects of public spending on education to income growth.
The absence of a causal relationship and negligible feedback between public spending on education and income growth in some of the countries investigated is disappointing. Relative to what the theoretical model suggests, the actual magnitude of government spending is considerably less than optimal. The fact that spending appears to have such small effects suggests that educational policies are misdirected and that governmental allocation of educational resources if often grossly inefficient.
