The Role of Human Capital in

Economic Growth

Introduction
In the year 1992 Mankiw, Romer and Weil published an article in the Quarterly Journal of
Economics in which they offered the Human Capital Augmented Solow Model related to
the economic growth of a country. The model is considered as the most significant work
related to growth economies of the last decades. The three scholars collected evidences from
different countries and found that they are more or less consistent and thus amplified to
include human capital in the Solow Growth Model (Newland and San Segundo, 1996;
Frank and Bernanke 2007).
The Human Capital-Augmented Solow Model explains for approximately 80 % out of the
total across country distinction of income per capita and rightly calculated the flexibility of
output for both physical and human capital in the samples (two out of their three samples)
(Solow 2001). In case of the twenty-two OECD countries i.e. in their third sample, the
scholars noticed that the explanatory power of the steady-state requirement of Augmented
Solow Model is low which is one-third of the other 2 samples. It is an extrinsic growth model
set inside the scaffold of Neoclassical Economics (Newland and San Segundo, 1996;
OECD 2008). The Solow Model has attempted to give explanation related to growth of
labour/ population, accumulation of capital and amplification of productivity affecting long
run the economy of a nation. In the centre of the Model lies the neoclassical aggregate
production function similar to that of Cobb-Douglas Production Function which helps the
model to make connection with microeconomics (Newland and San Segundo, 1996; Solow
2001; Frank and Bernanke 2007).

Human capital a significant contributor to economic growth of a

country
Human Capital is one of the major contributor to growth in economy is an unknown
concept to the researchers (Solow, 2001; Frank and Bernanke 2007). Several theoretical and
empirical studies are present till date which highlights the importance of social indicators for
the economic growth of a country. Human capital has been considered as a significant and
unique component for social growth that can be gathered and possibly has external effects
(Nonneman, et. al., 1996; Solow, 2001). An additional essential aspect is the quantification of
human capital. For any research which is based on experiments to establish the relationship
among economic development and human capital the researcher will need to consider all the

possibilities of knowledge acquisition related to human capital by using proxies or by means

of methods of estimation (OECD 2008). From time to time several scholars have tried on
abroad basis to measure the human capital as a contributor to the economic growth of all the
studies till date the Human Capital Augmented Solow Model is the most prominent and
significant.
Acarolu and Ada (2014) examined the relationship between human capital and economic
growth in MENA (Middle East and North Africa) countries, during the period (1990-2011).
Their findings show that when education quality is improved then, GDP per capita will
increase, they also found that spending on education or health human capital has now
significant effect on GDP per capita levels. Haldar and Mallik (2010) examined the behaviour
of physical and human capital investment in India (1960-2006). They show that the physical
capital has no short -run nor long- run effect on GNP, but the human capital investment has a
significant impact on the long -run on GNP. Jajri and Ismail (2012) examined the effects of
human capital on economic growth in Malaysia for (1980-2009), the finding of the study
were that while the traditional production factors like physical capital and labour have a
significant role in the short-long run economic growth. They also found the human capital
has a short run effect on economic growth in Malaysia. Bader (2012) analysed the
relationship between education and economic growth in Jordan for (1976-2007), he
concluded that education effects positively the economic growth in Jordan even more than the
other explanatory variables he used in his study.
Historical study on human capital measurement in History
In the neo-classical theories that were developed during the 1950s nowhere, any emphasis
has been given on human capital. Most of them advocated that physical capital has an effect
on the GDP of a country and it one of the contributors towards economic growth.
Human capital and its notion arouse not because of the awareness related to physical capital
all alone and were not sufficient to explain the long run growth of the economy (McDonald
et. al., 2002; Frank and Bernanke 2007). Social indicators several in number for instance
enrolments to education and human life expectancy were combined to form a common term
known as human capital (Nonneman, et.al., 1996; McDonald et. al., 2002). Formal and
informal education is often implicitly referred to as human capital; though other factors like
children raising costs, health costs and the ability to do it. In the research study historically
human capital became particularly famous after the development of growth theory in around

1950s and theory related to human capital was promoted by Becker in the year 1964 and in
the year 1961 by Schultz. Before the above mentioned period historian and scholars have
used indicators like education or skill to do a particular work and human capital in their
works Solow, 2001).
Namakura (1981) in his study stated that historians, from the time that they began to ply
their trade, have tended to feature the human factor as the central and critical instrument for
the achievement of progress and the betterment of life. But historians and economists have
very broadly included the concept of human capital in their research studies prior to the time
before the 1950s (Solow, 2001).
With the revolution in and around the 1960s related to human capital, a difference of opinion
can be noticed in different research studies historically. Researchers who were involved in
studying both pre-modern economics remained with the aged proxies as no other better were
accessible (Solow, 2001).
In studies that focused on modern economies especially of the 19th and that of the 20 th
centuries, the economists and the researchers also remained very broad in their research work
related to human capital (Summers and Alan Heston 1988; Solow, 2001). For instance, a
study conducted by Nakamura in the year 1981 on Japan in pre-modern times discussed
human capital largely as labour skills, managerial skills, and entrepreneurial and innovative
abilities-plus such physical attributes as health and strength.
In a study conducted in the year 1996, several measures were used as human capital
indicators of slaves in La Plata and Peru in the 18 th century for instance skills and physical
strength (Newland and San Segundo, 1996; Summers and Alan Heston 1988). On one hand
the researchers considered education and ability of an individual as representatives of human
capital on the other hand considers health and costs involved in raising a child as indicators of
human capital (Temple, 2000). In the pre-modern period some exclusions to this general
description of human capital comes from the economic historians quantitative orientations.
For instance, in the year 2004 researcher van Zanden measured the human capital prices as
the comparative price of skilled labourers, for example, the bricklayers or carpenters in
comparison to those who are unskilled labours.
There are several other research works which considered many factors like on job training,
experience in the same field etc as factors for broader studies human capital a factor having

an influence on economic growth in the long-run. Out of all the studies conducted Human
Capital Augmented Solow Model developed by three Scholars Mankiw, Romer and Weil is
considered one of the most prominent theories. The formula can be easily deduced and crosscountry study of human capital as a factor for economic growth can done with simplicity. The
model deals with human capital in the microeconomic level.
The Solow-Swan Model
The Solow-Swan Model is considered as the base model on the basis of which the Human
Capital Augmented Solow Model has been developed (Summers and Alan Heston 1988;
Temple 2000). The Solow-Swan Model has been developed in the year 1950s is considered as
an extrinsic growth theory. The model is considered as one of the most important predecessor
of all the modern theories related to economic growth that was developed between the period
of 1980s and 1990s (Nonneman, et.al., 1996).
The model originally includes the following:
Labour = L
Physical Capital = K and
Technology = A
The last one extrinsically explains the long run effects of economic growth. However, with
the revolution of the concept of human capital; the Solow-Swan Model accommodated
human capital (Temple, 2000). Assumptions were made for diminishing returns for human
capital no other structural changes were made to the original model. The main Solow-Swan
Model was developed in the year 1956 by Solow and Swan and then again modified by
Solow in the year 1957. It also used Cobb-Douglas production function and human capital
has been augmented to the main formula. Thus, it can be mathematically presented as:

Y t = K t H t (At Lt) 1- (1)

In the above equation, Y represents GDP of a country, K represents physical capital and
AL represents effective labour. It should be noted here that 0 < < 1 and 0 1 << are
all given capital strength of physical capital and human capital which is having diminishing
returns.

However the model has its own limitations and can answer questions related to long-run
economic growth to a limited manner. Thus, the model is not completely suitable for
calculating and explaining long run economic growth of a country and this extrinsic model
is not suitable to how human capital affects cross-country divergence of economic growth.
Scholars highlighted that extrinsic economic growth rates differ from one country to the other
and so this model is not suitable to serve the purpose (Frank and Bernanke 2007).
The economic divergence is not explained by the extrinsic theories, which to certain extent
takes place. Finally, there are a huge number of facts against the extrinsic or exogenous
theories (Nonneman, et.al., 1996). Thus, it has been urged by the scholars to develop
endogenous or intrinsic growth models that will be capable of explaining long-run economic
growth by taking into consideration human and physical capital into account. There is a huge
presence of literature that stated that changes in policies by the government on a permanent
basis will have effects on the growth of national income, which demands for new growth
theories. It has been also stated that increase in population of a country or investments made
towards human and physical capital is not enough to calculate GDP per capita. Thus, it
demanded for endogenous growth calculation giving the rise to Human Capital Augmented
Solow Model.
Human capital as an explanation to the growth theory of economies has till date suffered
certain major issues. First and the foremost issue is the number of variable being considered
for human capital they are huge in number. There are several controversies as to where and
how human capital will be inserted in the growth theory. Finally, accumulation of human
capital is most probably being considered as a topic to be discussed under development of
education on country basis and effects of policies (government policies). This has a strong
affect on the approximated human capital coefficients. All the issues have been very carefully
dealt in the Human Capital Augmented Solow Model where human capital has been
incorporated as an indicator of economic growth with much ease. Thus, the model has been
considered as one of the most crucial economic growth calculator in terms of human and
physical capital on a cross-country basis.

Human Capital - Augmented Solow Model

The model is a simple extension of the Solow Model in which the three scholars have very
carefully and easily incorporated human capital in the form of a separate input in a standard
Cobb-Douglas Production Function along with Harrod neutral progress in technology

(augmentation of the labours). It also used the Solow - Swan model as the base for final
deduction of the formula. Finally, the model took its present form as is well known as
Human Capital Augmented Solow Model. The model assumed that only one good is
produced by the economy and its output (Y) (Mankiw, et.al., 1992). The following formula
will help to calculate the good produced:

Y (t) = K (t) H (t) [A (t) L (t)] 1(2)

In the formula: , [0, 1], + [0, 1] and time is denoted by t
This entails that the function for production displayed steady return to the magnitude of its
three factors they are:
K = physical capital
H = Human capital
AL = Productivity-Augmented labour (A = technology and L =Labour)
It is actually a Cobb-Douglas production function. It has been assumed that both the input
market as well as the output market is perfectly competitive in nature (Nonneman, et.al.,
1996; Temple, 2000). It also makes the assumption that all the organisations are identical. In
such a situation the economy of a particular nation can be illustrated by a representative
agent. It can be assumed that the accumulating factors are both human and physical capital
i.e. it can stated that the representative agent accumulates output in order to have extra capital
(either physical capital or human capital or both). The model is highly acclaimed as it helps
to gather data related to cross-country economic growth and is endogenous in nature.
Physical and human capital are treated as accumulating factors. Their equations of motion
are:
K t =s kt Y t K t (3)
H t =s ht Y tH t (4)

Where:
sK and sH are the saving rates for physical and human capital
respectively. They are also exogenous variables, and they depreciate at
the same rate, .

Human capital per effective labour equation of motion

The dynamics of human capital can be illustrated by the derivative of human capital in the
intensive form with respect to time

d ~ d Ht
h=
dt t dt A t Lt

t Lt ]
H t [ t L t + A
A t Lt 2
, and finally we get:

A t Lt H t

A t Lt 2

~
~
ht =s ht ~
y t ht [n+ g+ t ]

....(5)

From equation (5) we notice that Human Capital investment has a positive effect on Human
capital level. However, population growth and and depreciation have a negative impact. Also
equation (5) represents the steady stat of the solow model in which the actual investment in
human capital per effective labour equalise the required investment per effective labour. In
other words, when equilibrium occurs the growth per effective labour of human capital (
d~
h =0
.
dt t
~
s ht ~
y t =ht [n+ g+ t ] ....(6)
with the same logic we have the solow equilibrium equation:
~
s kt ~
y t =k t [n+ g+ t ] ....(7),

the production function in the intensive form is:

Plug equation (8) in equation (6) and (7) to have:
~ ~ ~
s ht k t ht =ht [n+ g+ t ] ....(9)
~ ~ ~
s kt k t ht =k t [ n+ g+ t ]

....(10)

~ ~
~
y t= k t ht ....(8)

Solving equation (9) and (10) we get:

s ht
[n+ g+ t ]
~
(1 )

....(11)
(
)
s kt
k t=[
] 1 1
[ n+ g+ t ]
s ht
[n+ g+ t ]

h t=
~

....(12)

Equation (11) and (12) are the equilibrium steady state equations of both human and physical
capital.
Finally:
s ht
[n+ g+ t ]
~

(13)
(
)
s kt
1
1
y t=[
]

[ n+ g+ t ]
The standard solow model can be recovered from equation (13) by imposing =0.
When logs are taken for equation (13), the following equation for income per capital can be
written as:
ln

Yt
+

= A ( 0 ) +
ln ( + n+ g ) +
ln ( s k ) +
ln ( sh ) ( 14 ) or:
Lt
1
1
1

ln

Yt

= A ( 0 ) +
ln ( + n+ g ) +
ln ( sk ) +
h ) (15)
ln(
Lt
1
1
1

From equations (14) and (15) we expect a positive relationship between human capital and
output per effective unit of labour as the relationship between physical capital and output.

How investing in human capital increases output?

As appeared in figure (1) An increase in the stock Human capital per effective labour enable
the economy to produce more output per effective labour and some of this output will be
invested in physical capital. As a result of investment in human capital leads to rising in

Output per effective labor

output.

Output per effective labour

h

Human capital per effective labour

figure (1): Impact of human capital on output
Both Equation (14) and (15) indicating that there is a relationship between human capital and
the level of output, Suppose as shown in the figure (2). The economy is initially in steady
state as illustrated by the intersection point E between the two curves suppose then that the
investment rate in Human capital increases permanently while the other parameters remain
the same. This implies that the curve of human capital per effective labour will shift upwards,
in this case, the whole economy will rise and the old steady state E will increase gradually
until reaching the new E.
What happens is that the increased sh in the very beginning implies more accumulation of
human capital (but not the physical capital), but as soon as the increased stock of human
capital begins to generate increase in output, more physical capital will also be accumulated.
(Sorensen and Jacobson, 2005).
During the transition to the new steady state both human and physical capital increasing so
the output is increasing. Since the output is output per effective labour, output must increase
at rates larger than labour growth g, but which falls back towards g as the new steady state is
approached. The jump in the growth rate of output caused by the increase in sh is thus much
like the growth jump caused by an increased sk in the general solow model. (Sorensen and
Jacobson, 2005).
We can explain the impact of increasing investment in the physical capital on a fixed amount
of human capital by the same logic.

figure (2): Human -Physical Capital Dynamics

What happen when the labour growth increased?
If the economys labour force growth rate increased, then the economy would converge to a
lower steady state level of output per unit of effective labour as shown in figure (3). Since the
increasing labour force will reduce the physical capital and human accumulation over time.

figure (3): Impact of increasing labour growth rate on equilibrium

Data
The annual data used in this study is for the years between 1990 and 2014. Data compiled
from the statistics of World Bank, UNESCO as in their official websites is used in this study.
Besides, for some years, statistics from the official websites in Jordan have been used as a
data source.
The dependent variable (LGDPLt) is obtained from multiplying GDP per capita and labour
force. And after multiplication the log is taken. And (LIGDP) stood for the average rate of
real GDP investment after taking the log. And (LND) is the log of depreciation and labour
force growth rate. Where (LPTR) stood for the log of Pupil/teacher ratios.

Results and Discussion

A- The Stationary Analysis: The integration order of the variables determines the appropriate
approach of estimation. If all the variables are integrated of the same order, it is possible for
these variables to be cointegrated, and the Ordinary Least Squares (OLS) approach can be
adopted. Otherwise, the results of this approach could be misleading and other approaches of
estimation should be applied.
The ADFURT indicates that LGDPLt and the rest of the variables are not stationary on level
since the critical values are not statistically significant. In this case, as appeared in Table 1we
should take the first difference to examine the stationarity. The calculated values of ADFURT
in the first difference indicating that the variables are stationary on the first difference
Table 1: Stationary Analysis Results ADFURT

variable
LGDPC

ADF
-0.069

Prop.
0.9404

LIGDP

1.54

0.999

LPTR

-1.701

0.4213

LND

-2.134

0.9374

Result
Not
Stationa
ry
Not
Stationa
ry
Not
Stationa
ry
Not
Stationa
ry

ADF
-7.52

Prop.
0.000

Result
Sig.
Stationa 1%
ry

-2.79

0.0693

Stationa 10%
ry

-4.65

0.0437

Stationa 1%
ry

-5.60

0.0001

Stationa 1%
ry

B-The Co-integration Analysis: This analysis aims to check if all variables are co-integrated
cointegrated, i.e., if a linear combination of these variables are stationary. If that is the case,
regression on the levels of these variables would be meaningful and we do not miss any
valuable long-term information.
The Johansen Co integration Test, which tests the assumption of a linear deterministic trend
in the data, is used for the purpose of this analysis. The results of this analysis are shown in
Table (2) below:
Table (2) shows the rejection of the null hypothesis of no co integration at 5% significance
level, and the trace and the Max-Eigen test indicate the existence of one co integrating
equation at 5% significance levels. These results suggest that the researcher could use the
variables in their levels instead of using any order of differencing.

Table 2: Johansen Co integration Test

Unrestricted Cointegration Rank Test (Trace)

Hypothesized
Trace
No. of CE(s)
Eigenvalue
Statistic
None *
0.816736
69.69494
At most 1 *
0.693292
30.66795
At most 2
0.129628
3.485177
At most 3
0.012615
0.291987
Hypothesized
Max-Eigen
No. of CE(s)
Eigenvalue
Statistic
None *
0.816736
39.02699
At most 1 *
0.693292
27.18277
At most 2
0.129628
3.193190
At most 3
0.012615
0.291987

The

0.05
Critical Value
47.85613
29.79707
15.49471
3.841466
0.05
Critical Value
27.58434
21.13162
14.26460
3.841466

Prob.**
0.0001
0.0396
0.9406
0.5889
Prob.**
0.0011
0.0062
0.9330
0.5889

resulting co integrating equation from the Johansen Co integrating Test could be written as:
LGDPLT= 15.10408+0.067LIGDP+ 1.92LPTR-0.289LND (15)
s.e

(0.024)

(0.08)

(0.06)

Where the standard errors are reported between brackets. The co-integrating equation
produces the long - term relationship among the variables and shows that all the explanatory
variables, have positive effect on the dependent variable except LND, and they are
significant. The main point in this study is the effect of human capital on economic growth in
Jordan. As the above equation shows, the contribution of human capital on the output is
significant. This result is compatible with the results of many studies mentioned in the section
devoted to the economic literature and previous studies.
Consequently, we can suggest that these results are, in general in accordance with the
economic theory, and could explain a very important part of the variation of Real Gross
National Production in Jordan.

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