Government spending on education, human capital accumulation, taxes and growth: a multisector dynamic general equilibrium analysis

It is now well accepted in both academic and policy worlds that human capital accumulation plays a significant role in the increase of standards of living in different countries. Education is a primary source of human capital and is a key aspect in public policies to develop human capital. From a theoretical perspective, several papers have provided insights into the mechanisms through which education promotes economic growth and development. On the one side, education, by imparting skills directly increases the capacity of workers as a factor of production to produce more output. On the other side, education produces a “ripple effect” throughout the economy through a series of positive externalities. Because of the wedge between private and social returns to education, the government provides funding for schooling activities through it spending on education. Yet, this spending has a direct impact on the productivity of human capital accumulation and has, hence, an impact on the growth rate of the economy. In this paper, we assess numerically the growth, welfare and sectoral implications of different methods of financing the increase in government spending on education. We develop a multisector small open economy model with endogenous growth in which human capital accumulation is a key engine of growth. In our model, the representative consumer allocates her time endowment between leisure, work and learning activities. In a situation where the increase in government spending on education is financed through distortionary labour income taxes that affect the time devoted to non-leisure activities, two opposite impacts might occur. On the one hand, the increase in government spending is beneficial to growth, but on the other hand, the tax increase has a detrimental effect on growth as it reduces the opportunity cost of leisure and reduces savings. The evaluation of the impact of government spending on education on the economy is all the more important in a multisector context where not all sectors are equally human-capital intensive. In contrast to most general equilibrium models, our model allows for sectoral wage heterogeneity. Our modeling results will shed light on the benefits and cost of alternative methods for funding public spending on education. See above See above