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Table 5.3 presents the value of the human capital index, the estimated value of human capital (based on the price of $92,899 shown in table 5.
2), and the country fixed effects for selected countries. It is clear that human capital is the dominant form of intangible wealth in rich countries, but a sizable “residual of the residual” (that is, intangible wealth excluding human capital) remains in most cases.8 Other factors, such as total factor productivity, may be part of the intangible wealth story in high-income countries.
As table 5.3 also shows, the fixed effects for developing countries are large, negative, and significant, often more than $200,000 per capita.
This could be viewed as an artifact of using a single average global price for human capital.
But an alternative interpretation is that this average global price represents the potential value of a unit of human capital, potential that is not realized in developing countries owing to negative endowments, including institutional quality, geography, and history.
The Role of Intangible Capital in Development In growth accounting (see, for instance, Mankiw, Romer, and Weil 1992) there is a long tradition of using data on factor accumulation to explain the growth
100 THE CHANGING WEALTH OF NATIONS
in economic output. The basic approach is to estimate a production function, using panel or cross-sectional data for countries, to relate output to factor inputs.
We follow this tradition using our panel data set on produced, natural, and intangible wealth. First we regress the logarithm of output against the logarithms of the production factors. As a variant, we also use our calculated human capital
INTANGIBLE CAPITAL AND DEVELOPMENT 101index as a production factor in place of intangible capital. The log-log specification means that we can interpret the resulting regression coefficients as elasticities of output with respect to the different production factors, since the underlying functional form for the production function is Cobb-Douglas.
Table 5.4 reports the results of our estimation of output elasticities across different production factors and different subsets of countries.
In all cases we use country fixed effects and time dummies. The first column reports the results of estimating the production function for all countries using our human capital index rather than intangible capital as a factor of production. In this formulation, only produced capital has a significant coefficient; the elasticities for natural and human capital are not significantly different from zero.
In the second column we report the estimated coefficients for a production function where we use intangible capital rather than human capital as a production factor. The largest elasticity is for produced capital, but now both natural and intangible capital are significant factors of production. The final two columns in table 5.4 report the estimated elasticities when we split the sample into developed and developing subsets of countries. In each case we treat intangible wealth as a factor of production. For developing countries the results are very similar to those obtained when the sample consists of all countries—produced, natural, and intangible capital have significant output elasticities, and the magnitude is similar in both samples. When the sample is limited to countries of the Organisation for Economic Co-operation and Development (OECD), however, only intangible capital is significant and the elasticity is very large, roughly 0.5.
Summing up, we would intuitively expect that produced, natural, and human capital would all be statistically significant factors of production, but we obtain this result only when we treat intangible capital, rather than the human capital index, as a factor of production. This is consistent with the preceding subsection on explaining intangible capital, which shows that intangible capital
certainly includes the value of human capital but clearly measures more than that, including elements of institutional quality and technical progress as well.
The results for the OECD country subsample suggest a different, and perhaps more substantial, role for intangible capital in high-income countries.
Summing Up The finding that intangible capital makes up 60–80 percent of total wealth in most countries raises important questions for policy. As long as intangible capital is a black box, governments may be tempted to conclude that all public expenditures (excluding physical infrastructure) are in some sense investments in intangible wealth. Considerable unproductive expenditures could ensue, wasting precious fiscal resources. The analysis in this chapter helps clarify the composition and contribution of intangible capital to development.
On composition, the key finding is the dominance of human capital as a constituent of intangible wealth. An expected result, this turns out to be unequivocally true for high-income countries. For developing countries the potential value of human capital is extremely high when a single average global price is used for human capital, but this is offset by the negative endowment measured by the country fixed effects. It is certainly conceivable that the quality of institutions and the legacy of geography and history for developing countries can explain these large, negative fixed effects.
Our analysis also shows that intangible capital is a significant factor of production across all countries. It would be surprising if this were not the case;
the striking finding is that intangible capital is the only significant factor of production in OECD countries. This suggests that the accumulation of tangible factors—produced and natural capital—is not a significant contributor to growth in high-income economies. In these advanced economies all of the potential constituents of intangible capital—the quantity and quality of human capital, the constituents of total factor productivity, and institutional quality beyond the rule of law—may be the key drivers of production and growth.
The policy conclusion for developing country governments from this analysis is that investments in human capital are an important part of the development process. This is no surprise. But the analysis also suggests that strengthening institutions and developing the capacity to generate and use knowledge—the precursors to total factor productivity growth—will also be wealth-enhancing.
Finally, our growth accounting analysis leads us to a model where an increase in the quantity of one factor will increase the marginal product of all other factors.
So governments also need to ensure that complementary investments in infrastructure and natural resource management will support these investments in intangible capital, and vice versa.
INTANGIBLE CAPITAL AND DEVELOPMENT 103Notes 1 As will be seen in the next section, it is net income, rather than GNI, that equals the return on total capital. The implicit rates of return reported in table 5.1 should therefore be multiplied by a factor of about 0.85.
2 The SNA has precise definitions for intangible fixed and intangible nonproduced assets, which include items such as mineral exploration expenditures and the value of patents. In this chapter we use the term “intangible” to include all nonphysical, nonfinancial assets.
3 While SNA 1993 requires inclusion of the value of commercial natural resources in the balance sheet accounts, to date only Australia has published such accounts.
4 In our analysis we transform the Kaufmann-Kraay-Mastruzzi rule of law figures into an index ranging from 0 to 100.
5 We include dummies for upper-middle-income, lower-middle-income, and low-income countries.
6 Chapter 7 of Where Is the Wealth of Nations? (World Bank 2006) also included remittances as a type of return to human capital in its model specification. Remittances were not significant in any of the specifications of the model of intangible wealth presented here.
7 We also performed F-tests for the joint significance of country and time fixed effects. In both cases we rejected the hypothesis that the fixed effects are equal to zero.
8 The exceptions are Canada and Japan.
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Human Capital and Economic Growth in China
WEALTH ACCOUNTS SHOW THAT INTANGIBLE CAPITAL IS THElargest component of wealth in virtually all countries and that human capital accounts for the majority of intangible capital. Many analysts believe that human capital is an important source of economic growth and innovation, an important factor in sustainable development, and a means of reducing poverty and inequality (see, among others, Stroombergen, Rose, and Nana 2002; Keeley 2007). For example, a detailed analysis of human capital accounts for Canada, New Zealand, Norway, Sweden, and the United States unambiguously shows that human capital is a leading source of economic growth.
Developed countries have recognized the importance of monitoring human capital accumulation. Toward this end, they have established national and international efforts to measure human capital stock and develop national human capital accounts. Seventeen countries have joined a consortium under the auspices of the Organisation for Economic Co-operation and Development to develop human capital accounts: Australia, Canada, Denmark, France, Italy, Japan, the Republic of Korea, Mexico, the Netherlands, Norway, New Zealand, Poland, Romania, the Russian Federation, Spain, the United Kingdom, and the United States. Two international organizations, Eurostat and the International This chapter is based on a more detailed report by Li et al. (2009).
106 THE CHANGING WEALTH OF NATIONSLabour Organization, are also participating. But most developing countries have yet to start programs to measure human capital. Recent work to estimate human capital stocks in China represents an important step toward filling that gap.
The Chinese economy has grown at a dramatic rate since the start of economic reforms in the 1980s. There is evidence that human capital has played a significant role in the Chinese economic miracle (see, for example, Fleisher and Jian 1997; Démurger 2001). Studies also show that human capital has an important effect on productivity growth and on reducing regional inequality in China (Fleisher, Li, and Zhao 2010). Despite the important role of human capital in the Chinese economy, however, there has been until now almost no comprehensive measurement of the total stock of human capital, and none that quantifies the changes in human capital in rural and urban areas and among males and females.
Human capital measures for China can contribute greatly to an understanding of the global importance of human capital, for a number of reasons.
First, China is the most populous country in the world. It is important to understand how the dynamics of human capital in China are affected by demographic changes (driven, for example, by the one-child policy, migration, and urbanization) and by the rapid expansion of education during the course of economic development. Second, such measures would allow for better assessment of the contribution of human capital to growth, development, and social well-being in empirical and theoretical research.