How does economic growth contribute to education?

The knowledge capital of nations: good education as a growth engine

In economic policy there is never really time to look at the long term. Most of the time there is a crisis - financial crisis, euro crisis, refugee crisis - there are always more important things. Or the economy is in a downturn, so you have to deal with the short-term problems. The foundations of long-term prosperity are easily forgotten. What can politics do to promote high macroeconomic productivity in the long term that will secure our prosperity and that of the next generation?

Education in Growth Economics

Growth research has been emphasizing for a long time that the education of the population plays a central role in long-term prosperity.1 From an economic point of view, education can be understood as an investment - in knowledge, skills and abilities of the population. This enables people to do their jobs more productively and to develop and apply innovations. Macroeconomic growth theory emphasizes two general mechanisms through which education can influence the long-term economic development of an economy.

  1. Education is a factor of production that can be accumulated. It is an investment that not only increases individual productivity, but also, through aggregation, overall economic productivity. In the transition from the old equilibrium of aggregate production to the new, higher equilibrium, the growth rate of the economy increases. In such extended neoclassical growth models, education increases macroeconomic productivity by accumulating human capital.
  2. Education works by generating new technologies and facilitating their diffusion. Ultimately, the long-term growth rate of an economy depends on technological progress. Improvements in the technology that converts factors of production into output (total factor productivity) are based on product and process innovation. In endogenous growth models, such innovations arise from targeted investments in research and development. This process is fueled by the underlying inventions of people, which arise from their knowledge and skills. Better educated people generate a continuous stream of new ideas and technologies, which increases the innovative capacity of the economy and thus triggers sustainable growth dynamics.

The knowledge capital of nations

Who would not agree with such theoretical considerations on the economic importance of education for the population? At least in Sunday speeches in good economic times. But how important is good education really for the economy? For example, can it explain such fundamental long-term phenomena as the East Asian economic miracle or the Latin American growth puzzle?

To illustrate the importance of education for the prosperity of nations, it is worth doing a little thought experiment.2 Imagine if you were in 1960 and had to predict which regions of the world will stand out economically in the next half century and which will stand still. At that time, the countries of Latin America were about twice as rich as those in East Asia or sub-Saharan Africa, and the average years of education of their population were significantly higher. Latin America seemed ready to catch up with the rich countries of the western world.

Today we know that it turned out very differently. The people in East Asia are - measured in terms of gross domestic product per capita - more than seven times as rich as their grandparents, but the people in Latin America are not even two and a half times as rich and the people in Sub-Saharan Africa are not twice as rich. That is the power of different growth rates - from an annual average of a good 1% to over 4% - over a long period of time. On average, Latin America grew a good one and a half percentage points more slowly than the rest of the world, while East Asia grew around two and a half percentage points faster. However, the different number of years of education in the population can hardly explain these differences. So is it all wrong with the economic theories about the supposed importance of education for economic growth? Certainly, some development strategies that focused on an expansion of the duration of education have rather disappointed.

But before we write off the importance of education for long-term prosperity, we should realize that one year of education in Latin America compared to East Asia may convey very different amounts of knowledge, competencies and skills. Let us take a look at the basic competencies in mathematics and natural sciences measured in the previous PISA studies.3 The differences are striking: East Asian students are three school years ahead of their peers in Latin America in terms of knowledge, and four school years ahead of those in Sub-Saharan Africa. So, per year of education, people in Latin America and Sub-Saharan Africa simply have much less acquired knowledge than in East Asia.

These differences in the competencies of the population - which we summed up as the “knowledge capital” of nations - can statistically fully explain the slow growth in Latin America and the rapid growth in East Asia.4 The same applies to the even slower growth in sub-Saharan Africa. If differences in knowledge capital are taken into account, there are no significant differences in growth between world regions left. Differences in the duration of education, however, do nothing to explain the differences in growth.

What does that mean in concrete terms? In the 1960s, in Peru, as in South Korea, many people were farmers who could barely support their families. Today, after attending school for ten years, the grandson of the Peruvian corn farmer carries out simple jobs in a small company. He's doing better than his grandfather, but not much. The grandson of the South Korean rice farmer, on the other hand, after ten years of school, has high-quality jobs in an IT company in a booming metropolis that no longer has anything to do with the poor conditions of the grandfather generation. A large part of the different economic developments in the countries around the world can be traced back to differences in people's skills. Development strategies that succeed in improving people's actual skills therefore promise great success. On the other hand, development strategies that only focus on the duration of education without improving what has actually been learned must lead to disappointment.

The picture in Figure 1, looking at 59 countries with available data, is clear: the better the educational performance, the higher the growth. In the simplest model, only the starting level of per capita income and the years of education are included as further explanatory factors. Disregarding educational performance, this model can only explain a quarter of the differences in growth between countries. Taking school performance into account increases the explanatory power to three quarters of the total growth differences. Any effect of the years of education disappears as soon as the performance measure is taken into account. In other words: school education only has an economic impact to the extent that it actually conveys skills. It is not enough just to hit the school or university bench; it depends on what you have learned.

illustration 1
Knowledge capital and economic growth

1 Economic growth: average annual growth rate of the gross domestic product per capita in%, 1960-2000. 2 Educational achievements: achievements in all international math and science tests between 1964 and 2003 in exponential PISA points. Relationship after calculating further influencing factors. Each point stands for a country.

Source: own calculations based on E. A. Hanushek, L. Wößmann: Knowledge Capital, Growth, and the East Asian Miracle, in: Science, 351st year (2016), H. 6271, pp. 344-345.

The magnitude of this effect is considerable: if a country were to improve its educational performance by 25 PISA points - which Germany and Poland, for example, have achieved in the last decade - its annual growth would increase by around half a percentage point in the long term. Calculated over fifty years, this would correspond to an increase in per capita income of more than a quarter.

In addition, it has been shown that both a good educational base across the population and a sufficiently high performance peak have an effect on economic growth. In this respect, broad education and top performance should never be played off against each other: Both are important. When measured correctly, empirical research proves growth theories that attach great importance to education: Education makes people more productive in their work and allows them to come up with and apply new ideas that are the basis for innovation, technological progress and thus long-term prosperity. 5

Causal effect of higher educational achievement

But could it not be, could it be argued that countries that are growing faster for completely different reasons also have better educational performance? In principle, the cause of the correlation could also lie in an opposite effect (growth leads to better schools) or in unobserved institutional or cultural factors that influence both growth and educational performance. Numerous additional studies suggest, however, that the correlation is actually a causal connection.6 First of all, the importance of knowledge capital for economic growth proves to be extremely robust if the model takes into account other factors such as openness to international trade and property security , geographical location, fertility or physical capital.

Then the analysis can be separated in time: If we only consider the tests carried out up to the mid-1980s, they have the same significant effect on later economic growth since the mid-1980s. A reverse causation of growth on student performance is also unlikely because it has been shown that additional resources in the school system, which might be possible through faster growth, are not systematically associated with better PISA performance. More money does not automatically mean better performance.

Another causality test consists in using only that part of the variation in school performance that results from institutional differences between school systems such as central high school diploma, decentralization or the proportion of privately run schools, as part of a so-called econometric instrument variable estimation. In this way, possible distortions due to country differences that remain unobserved can be excluded. The results show a causality of the achievements generated in the school system on economic growth.

The fact that the results are not due to other factors such as a differently effective organization of market processes can also be ruled out by the following study: We looked at immigrants from different countries on the same US labor market. It turns out that immigrants who received their education in their home country earn significantly more in the USA if that country has a better school system, as evidenced by higher test results. However, this does not apply to immigrants from the same country who received their education in the USA. In an econometric difference-in-differences estimation approach, effects that are purely due to the respective country of origin can therefore be excluded, which could have arisen due to cultural factors or the economic framework conditions of the home countries.

Finally, we can also disregard all level differences between countries that could be related to unobserved country characteristics and only look at the changes in test performance and growth rates with our test measure, which is comparable over time. Such an approach eliminates any level effects that might be associated with country-specific institutions and cultures. For the OECD countries, for which both very early test performance and recent test performance are available and thus longer-term trends in student performance can be calculated, it is clear that those countries that have managed to improve their school performance also have a significant one Have experienced an increase in their growth rate.

Policy measures for better knowledge capital

What does all this mean for Germany and Europe? Interestingly, the great importance of knowledge capital for economic growth can be found in developed countries as well as in developing countries. If economic policy does not always want to chase short-term problems, but rather aim for long-term prosperity, it must therefore focus on the education of the population. In order not to be left behind in the global, constantly changing economy, the education system and society as a whole must succeed in equipping the next generation with high skills.

For this, it is not primarily a question of higher educational expenditure: As empirical research has repeatedly shown, higher expenditure, smaller school classes or better computer equipment are not systematically associated with better educational performance either in an international comparison or within countries. But it depends on what you have learned for later prosperity.

Rather, the focus must be on awareness of educational outcomes - both in families and in schools. In addition to good early childhood education for all children and first-class teachers, this requires above all a good regulatory framework in the school system.7 Because the institutional framework determines the incentives for whether it is worthwhile for everyone involved to strive for better results. In order for the school system to successfully impart skills, pupils must be motivated to learn and teachers to teach.

External audits are an important element of this. Analyzes of the international tests show that student performance is significantly better where there are external final exams. This is also proven by a comparison of the German federal states, of which almost half had central final exams until the mid-2000s, the other half did not. External examinations make the actors responsible for what has been achieved and make learning efforts visible to others so that they pay off later. Accordingly, it was also shown that high school graduation grades from external examinations are much more closely related to later income than grades from local examinations

For this reason, the Education Action Council proposes a nationwide common core high school diploma in which a jointly conducted examination component in the core subjects mathematics, German and English based on the agreed national educational standards makes up at least 10% of the final Abitur grade a fair university entrance is guaranteed. There is overwhelming approval among the German population for such external exams: In the representative opinion poll of the Ifo Education Barometer, over 80% of Germans are in favor of uniform final exams for secondary school and secondary school leaving certificates and for the Abitur

In addition, international studies show that students learn significantly more where schools are more independent. School independence and external examinations belong together: A successful education policy sets standards externally and checks whether they have been achieved externally, but leaves it to the schools themselves how they can best achieve them. Schools need more freedom, especially when it comes to personnel issues and day-to-day business issues.

Ultimately, competition between schools for the best ideas, as created by greater choice for parents, is proving to be a decisive factor influencing educational outcomes. If schools have to compete for the parents' favor, they can choose what they consider to be the best alternative, and poor schools lose their students. International analyzes show that school systems that combine a high proportion of privately owned schools with state funding perform best. When all students, regardless of their financial background, have equal access to alternative schools, schools compete for the best concepts that benefit all students.

Conclusion

Despite all the complexity of the underlying scientific analyzes, the conclusion is shockingly simple: In the long term, economic growth rates are directly related to people's skills.The relevant competencies - the “knowledge capital” of a nation - can be measured well with international math and science tests. An understanding of the wealth of nations must ultimately be based on the knowledge capital of nations. That is why economic policy must focus on the education of the population if it is not only to plug short-term holes, but also to secure long-term prosperity. In this sense, a good education policy is probably the best economic policy: With people's knowledge, skills and abilities, the foundation is laid that will sustain the prosperity of society in the long term.

  • 1 See, for example, C. I. Jones, D. Vollrath: Introduction to Economic Growth, 3rd ed., New York 2013; also E. A. Hanushek, L. Wößmann: The Role of Cognitive Skills in Economic Development, in: Journal of Economic Literature, Volume 46 (2008), No. 3, pp. 607-668.
  • 2 See E. A. Hanushek, L. Wößmann: The Knowledge Capital of Nations: Education and the Economics of Growth, Cambridge MA 2015.
  • 3 International comparative tests of student performance in mathematics and science have been in existence since the mid-1960s. For the calculations, the performance of all 36 tests was brought to a common scale using empirical calibration methods, which makes it possible to depict the average school performance of the population for 59 countries for which internationally comparable data on long-term economic growth are also available. See E. A. Hanushek, L. Wößmann: Do Better Schools Lead to More Growth? Cognitive Skills, Economic Outcomes, and Causation, in: Journal of Economic Growth, 17th year (2012), no. 4, pp. 267-321; This: Schooling, Educational Achievement, and the Latin American Growth Puzzle, in: Journal of Development Economics, 99th Jg. (2012), H. 2, pp. 497-512.
  • 4 For details see this: Knowledge Capital, Growth, and the East Asian Miracle, in: Science, 351st Jg. (2016), H. 6271, pp. 344-345.
  • 5 For similar findings in a comparison of the US states see E. A. Hanushek, J. Ruhose, L. Wößmann: Human Capital Quality and Aggregate Income Differences: Development Accounting for U.S. States, NBER Working Paper, No. 21295, Cambridge MA 2015.
  • 6 Cf. E. A. Hanushek, L. Wößmann: The Knowledge Capital of Nations ..., loc. Cit.
  • 7 For an overview of international research on the effects of institutional framework conditions on student performance see L. Wößmann: The Importance of School Systems: Evidence from International Differences in Student Achievement, in: Journal of Economic Perspectives, 30th year (2016) , H. 3, pp. 3-31.
  • 8 G. Schwerdt, L. Wößmann: The Information Value of Central School Exams, in: Economics of Education Review, 56th year (2017), pp. 65-79.
  • 9 Education Action Council: Joint core high school diploma: To ensure national educational standards and fair university access, Münster 2011.
  • 10 L. Wößmann, P. Lergetporer, F. Kugler, L. Oestreich, K. Werner: Germans are ready for fundamental educational reforms - results of the Ifo Education Barometer 2015, in: Ifo Schnelldienst, 68th year (2015), no.17 , Pp. 29-50.

Title: The Knowledge Capital of Nations: High-Quality Education as a Motor of Growth

Abstract: The longrun prosperity of nations is directly related to the skills of their population. The relevant cognitive skills - the “knowledge capital” of a nation - can be measured well by international math and science tests. The consideration of knowledge capital can completely account for the Latin American growth puzzle and the East Asian growth miracle. Several analyzes suggest that the relationship depicts a causal effect of skills. According to the evidence, an understanding of longrun growth ultimately has to rest on the knowledge capital of nations. To further longrun prosperity, policies should focus on education. Effective education systems align incentives with achievement through better educational practices such as external exams, school autonomy, choice and competition.

JEL Classification: O47, I25, J24