An Analysis of Education Externalities with Applications to Development in the Deep South

A simplified, medium-term dynamic model of endogenous growth is used to analyze education externalities. Returns include not only direct effects but also indirect effects from education on growth and development. Indirect effects are externalities because they arise as the result of the education of others and prior generations. The existing growth literature often discounts these, although they are shown to be larger than short-term effects. Simulations for the U.S. Deep South indicate larger medium-term net education impacts on growth, infant mortality, longevity, and democratization, so policies do matter. These are reasons why micro rate of return estimates are larger than education effects in growth equations. (JEL 121, O40, O10, H23) This article considers not only the direct effects but also the indirect effects over time and generations of education on growth and development. The direct effects of education are its effects not only on market outcomes such as earnings and growth but also on non-market outcomes and development goals such as health, further education, and institutions, which yield additional nonmarket benefits to human welfare. Indirect effects can be sharply distinguished from direct effects since they arise as education operates through some other intervening variable to affect either market or nonmarket outcomes. For example, to the extent that education has direct effects in improving civic institutions and political stability, this can facilitate economic growth, an indirect effect of education on growth through its effect on political stability. Externalities in contrast are defined in the standard way as spill over benefits or costs, where the education of one person benefits others in the family, the community, or in future generations. When analyzed, almost all externalities arise as indirect effects, a point discussed in detail later. So although strictly speaking "indirect effects" and "externalities" have clearly different meanings, the analysis will reveal that they have largely overlapping effects. These matters are set out in a simple three-equation dynamic model that is consistent with endogenous growth models. It is used to distinguish the direct from the indirect effects of education, and the short from the longer term impacts, and to isolate education externalities. The indirect effects (or education externalities) set the stage for further growth. The signs of the parameters in this simple dynamic model are inferred from a survey of microeconomic studies. The model then can be solved to prove analytically that the medium-term effects that are 40-45 yr in the context of this article are larger than the short-term 5-yr (or even 10 yr) effects. These short-and medium-term impacts of education are then shown through simulations that capture the indirect effects as they feedback on growth while netting out the effects of other policies. Short-and medium-term net impacts that include education externalities are shown for Louisiana, Mississippi, and Arkansas, three of the poorer states in the Deep South, and compared to the U.S average over time. The basic contribution in this article lies in the theoretical analysis of the short- and medium-term dynamic process and of education externalities. The illustrative simulations are scenarios generated by recursive solutions of the more complete model in appendix B, starting from the initial conditions given for each southern state, the data for which is given in appendix A. The complete model is a 38-equation model that has been estimated based on worldwide data, except for the growth equation, which has been estimated based on Organization for Economic Cooperation and Development (OECD) data. This allows enough variation in slow, long-run development processes that the parameters are more meaningful than in excessively homogeneous and short-run contexts. The technical properties of the complete model and the body of opinion supporting this approach to obtaining more stable parameters (e. …