A Reevaluation of the Effect of Human Capital Accumulation on Economic Growth; Using Natural Disasters as an Instrument

Introduction

1.1 Background of the study

Theoretic models of economic growth suggest that human capital accumulation is a significant determinant of rising per capita income. Microeconomic evidence of the positive relationship between schooling and wages supports this prediction. Estimates using macroeconomic data demonstrate that the initial stock of human capital is an important determinant of economic growth, but empirical estimates of the effects of changes in human capital (human capital accumulation) poorly match theoretic predictions (Barro and Sala-i-Martin (1995) and Benhabib and Spiegel (1994)). Most studies approach this poor match as a measurement error problem (Temple (1999a), Mankiw, Romer, and Weil (1992), Krueger and Lindahl (2001)), including correcting for imperfect measures of quality (Hanushek and Kimko (2000), Wossmann (2003)).

Other studies have focused on the effects of outliers (Temple 1999b) or the use of incorrect specifications (Englander and Gurney (1994) Gemmel (1996), Bassanini and Scarpetta (2002), Engelbrecht (2003)). These studies suggest that restricting the sample to OECD countries can generate a generally positive effect of changes in schooling or school enrollments on growth that is similar in magnitude to those found in microeconomic estimates based on survey data, but tell us little about the experience of countries outside the OECD, which are often considered to be the developing countries.

Our contribution to the literature is based on the possibility that the poor match between theory and empirical work results not from how we measure human capital, but from the potentially endogenous relationship between changes in human capital and economic growth. Using data from developed and developing countries, we present evidence suggesting that human capital is, in fact, endogenously determined and therefore empirical analysis requires an instrumental variable approach. Of course, we are not the first to introduce instrumental variables to this literature. Pritchett (2001) and Krueger and Lindahl (2001) apply an instrumental variables technique to estimate the effect of changes in average years of schooling on growth, using Nehru, Swanson, and Dubey (1995) and Kyriacou’s (1991) schooling data as instruments, respectively.2

Their purpose in using the instrumental variables method is to overcome the measurement error issue, and not necessarily to address endogeneity per se. Indeed, the Nehru, Swanson, and Dubey and Kyriacou schooling variables are not appropriate instruments if one is trying to address endogeneity. A valid instrument in this context is one that determines changes in schooling but is not a direct determinant of economic growth; alternative measures of schooling are arguably just as important a determinant to growth as is the Barro and Lee measure of schooling. Furthermore, researchers like Glewwe and Hanan (2004) have shown that demand for education is positively correlated with increases in household income and wealth, thus emphasizing the two-way relationship between economic growth and human capital accumulation. It appears that a key reason that researchers have not yet addressed the endogeneity issue is because of the lack of valid instruments.

To our knowledge, no studies exist in which the endogeneity of human capital accumulation is tested, and if found to be present, the instrumental variables method is used to estimate the effects of changes in human capital on growth. Skidmore and Toya (2002) demonstrate that climatic natural disasters affect growth through human capital accumulation, indicating that a climatic disaster variable may be an appropriate instrument. In the aftermath of the 2004 Southeast Asian Tsunami that killed more than 280,000 and affected millions, it is not unreasonable for economists to consider how the threat of natural disasters might affect human and physical capital decisions. Skidmore and Toya (2002) suggest that due to relatively recent advances in forecasting, climatic disasters (as opposed to geologic disasters) are primarily a threat to immobile physical capital but not mobile forms of capital such as human capital.

The relative increase in exposure to risk of physical capital provides an incentive for economic agents to invest relatively more heavily in human capital. The correlation between exogenous natural disasters and endogenous investment decisions over time suggest that disasters are a valid instrument for factors that affect growth. In this paper, we use measures of the propensity for natural disasters to test for the endogeneity of schooling enrollment and changes in average years of schooling over the 1960-1990 period. We find evidence of endogeneity. We therefore employ instrumental variables techniques to estimate the effects of changes in human capital on economic growth.

The instrumental variables estimation procedure yields a coefficient on human capital accumulation that is larger in magnitude than found in our OLS estimates and in most previous studies that use data from a wide range of countries and is closer to theoretic predictions. Bils and Klenow (2000) attempt to determine the causal relationship between schooling and economic growth. They point out that a common belief is that “reverse causality” or simultaneity is likely to lead to an over-estimate of the effect of human capital accumulation on growth because anticipated increases in future economic growth could cause schooling to increase.

Statement Of The Problem

To our knowledge, no studies exist in which the endogeneity of human capital accumulation is tested, and if found to be present, the instrumental variables method is used to estimate the effects of changes in human capital on growth. Skidmore and Toya (2002) demonstrate that climatic natural disasters affect growth through human capital accumulation, indicating that a climatic disaster variable may be an appropriate instrument. In this background the researcher wants to investigate the reevaluation of the effect of human capital accumulation on economic growth using natural disasters as an instrument.

Objective Of The Study

The objectives of the study are;

1. To ascertain the effect of human capital accumulation on economic growth using natural disaster
2. To ascertain the relationship between human capital accumulation and economic growth
3. To ascertain the relationship between economic growth and natural disasters

Research Hypotheses

For the successful completion of the study, the following research hypotheses were formulated by the researcher;

1. H0: there is no effect of human capital accumulation on economic growth during natural disaster
   H1: there is effect of human capital accumulation on economic growth during natural disaster
2. H0: there is no relationship between economic growth and natural disasters
   H2: there is no relationship between economic growth and natural disasters

Significance Of The Study

This study will give a clear insight on the effect of human capital accumulation on economic growth using natural disasters as an instrument. The study will be of great benefits to government of Nigeria how human capital accumulation affect economic growth, it will also of benefits to lecturers, students and any researcher that will embark on this study

Scope And Limitation Of The Study

The scope of the study covers a reevaluation of the effect of human capital accumulation on economic growth using natural disaster as an instrument. The researcher encounters some constrain which limited the scope of the study;

a) Availability Of Research Material:

The research material available to the researcher is insufficient, thereby limiting the study

b) Time:

The time frame allocated to the study does not enhance wider coverage as the researcher has to combine other academic activities and examinations with the study.

c) Organizational Privacy:

Limited Access to the selected auditing firm makes it difficult to get all the necessary and required information concerning the activities.

Definition Of Terms

Reevaluation:

The action of assessing or evaluating something again or differently.

Human Capital:

Human capital is a term popularized by Gary Becker, an economist from the University of Chicago, and Jacob Mincer that refers to the stock of knowledge, habits, social and personality attributes, including creativity, embodied in the ability to perform labor so as to produce economic value.

Economic Growth:

Economic growth is the increase in the inflation-adjusted market value of the goods and services produced by an economy over time. It is conventionally measured as the percent rate of increase in real gross domestic product, or real GDP.

Natural Disaster:

A natural disaster is a major adverse event resulting from natural processes of the Earth; examples include floods, hurricanes, tornadoes, volcanic eruptions, earthquakes, tsunamis, and other geologic processes

1.8 Organization Of The Study

This research work is organized in five chapters, for easy understanding, as follows

1. Chapter one is concern with the introduction, which consist of the (overview, of the study), historical background, statement of problem, objectives of the study, research hypotheses, significance of the study, scope and limitation of the study, definition of terms and historical background of the study.
2. Chapter two highlights theoretical framework on which the study is based, thus the review of related literature.
3. Chapter three deals on the research design and methodology adopted in the study.
4. Chapter four concentrate on the data collection and analysis and presentation of finding.
5. Chapter five gives summary, conclusion, and recommendations made of the study