The Mystery of Human Capital as Engine of Growth, or Why the US Became the Economic Superpower in the 20th Century

Common to the bulk of the “new” economic growth and development literature is the idea that the process by which less-developed countries break out of a poverty trap and achieve steady, self-sustaining growth in real per-capita income is predicated on persistent production and accumulation of “human capital.” This powerful concept is wrapped up in three layers of mystery. First, unlike physical capital, human capital is not a tangible asset. How, then, can we account for it empirically? Second, what explains its continuous formation over time? Third, how is such formation transformed into growth in real output and personal income? One of the objectives of this essay is to unwrap this apparent mystery through an exposition of a general-equilibrium paradigm of economic development where human capital, or knowledge, is the engine of growth, its accumulation is enabled by parental and public investments in children’s education, and underlying “exogenous” institutional and policy variables are ultimately responsible for both human capital formation and long-term growth. A more specific objective of this paper is to illustrate the power of the “human capital hypothesis” to explain observed differences in long-term growth dynamics across specific countries. The case in point is the emergence of the U.S. as the world economic superpower, overtaking the U.K., and Europe in general. The U.S. was a relatively poor country over much of the nineteenth century. In the last few decades of that century, and especially during the twentieth century, however, the U.S. has overtaken the U.K. and other major European countries, and then developed considerable advantage over these countries in terms of not just gross domestic product, but per-capita GDP as well. What may be less known is that over the same period the U.S. has developed a considerable gap over Europe in the schooling attainments of its labor force, especially at the higher education level. The gap remained significant through the entire twentieth century, although it narrowed in the latter part of it, and is continuing to narrow in this decade. Largely accounting for this gap was the massive high school movement of 1915-1940, but an independent gap emerged as early as the 1860s with the U.S. foray into tertiary education beginning with the first Morrill Act of 1862, and continuing especially with the massive higher education movement following World War II. This paper shows that the U.S. lead in knowledge formation, imperfectly measured by higher educational attainments, has been a major, and perhaps the major instrument through which the U.S. overtook Europe as the economic superpower in the twentieth century. Although the evidence assembled in this paper concerning the long-term growth dynamics of per-capita GDP and schooling attainments is largely “circumstantial,” it appear to be remarkably consistent with the view that human capital formation, even though imperfectly measured by schooling, has been the “secret weapon” through which the U.S. has been able to achieve its robust long-term rate of persistent, self-sustaining growth in productivity and per-capital income. Moreover, it supports the hypothesis that the documented educational gap between the U.S. and Europe in terms of average high school, and especially higher education attainments, is a major factor explaining why the U.S. has overtaken Europe as an economic superpower in the twentieth century. Looking back, it is ultimately the relative efficiency of the free-market and open economy system in the U.S. and the relatively higher reward it provided to skill and creative knowledge, which induced a higher rate of growth and efficient utilization of various components of human capital, whether domestically produced or imported. The democratic political system in the U.S. has also augmented the process of human capital formation through prudent government subsidization of education generally, and higher education in particular, much ahead of similar efforts by Europe. These accommodating factors have been a major determinant of the ability of the U.S. to attract, and put to effective use, human capital from other countries as well. Looking ahead, therefore, one may conclude that continued support of an efficient economic environment that assures a competitive reward to investment in human capital and encourages its persistent formation and utilization could sustain the U.S. lead for years to come. The U.S. still enjoys a significant advantage in terms of the quality of its higher education system and innovative activities relative to Europe and other countries. At the same time, there are strong indications of the failure of the public elementary system in the U.S. to produce competitive educational outcomes relative to other countries. Recognition of current shortcomings in the public education system in the U.S., along with the challenge to compete with educational systems in other countries, may improve human capital formation in the U.S. at all levels. Whether or not the U.S. lead is maintained is ultimately a secondary issue. World welfare would be best served if all countries adopt competitive economic and educational policies yielding continuous human capital formation, per-capita income growth, and equitable income distributions.