Poiic RESEARCH WORKING PAPER 2031

# Summmary findings

NFo cotntry has achieved sustained economic development without substantially investing in human capital.. Previous studies have shown the handsome returns to various forms of basic education, research, training, learning-by-doing, and capacity-building. But education by itself does not guarantee successful development, as history has shown in the former Soviet bloc, Sri Lanka, the Philippines, and the Indian states of Kerala and West Bengal.

The question is, when and how does education bring high payoffs?

Although theory has suggested a strong causal link betweern education and growth, the empirical evidence has not been unanimous and conclusive.

L6pez, Thomas, and Wang examine two explanatory factors. First, who gets educated matters a good deal, but the distribution of education is complex and not much has been written about it. They construct an asset allocation model that elucidates the importance of the distribution of education to economic development.

Second, how education affects growth is greatly affected by the economic policy environment. Policies determine what people can do with their education. Reform of trade, investment, and labor policies can increase the returns from education. Using panel data from 12 Asian and Latin American countries for 197094, they investigate the relationship between education, policy reform, and economic growtlh.

Their empirical results are promising.

First, the distribution of education matters. Unequal distribution of education tends to have a negative impact on per capita income in most countries. Moreover, controlling for human capital distribution and the use of appropriate functional form specifications consistent with the asset allocation model makes a difference for the effect of average schooling on per capita income. Controlling for education distribution leads to positive and significant effects of average schooling on per capita income, while failure to do so leads to insignificant, even negative effects, of average education.

Second, the policy environment matters a great deal. Our results indicate that economic policies that suppress market forces tend to dramatically reduce the impact of human capital on economic growth. Investment in human capital can have little impact on growth unless people can use education in competitive and open markets. The larger and more competitive these markets are, the greater are the prospects for using education and skills.

- This paper a joint product of the Office of the Director and the Macroeconomic Management and Policy Division, Economic Development Institute -is part of a larger effort in the institute to develop a core course on development. The study was funded by the Bank's Research Support Budget under research project "When Learning Makes Reform More Productive" (RPO 682-02). Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Tanya Shiel, room G4-030, telephone 202-473-6317, fax 202-676-9810, Internet address tshiel@worldbank.org. The authors maybe contacted at vthomas@worldbank.org or ywang2(worldbank.org. December 1998. (70 pages)

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less thani fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, iinterpretations, and consclusions expressed in this paper are entirely those of the authors. They do not necessarily represen_ **_t_** _he view of the World Bank, its Executive Directors, or the countries they represent._

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