Human Capital Contributions To Economic Growth in India: An Aggregate Production Function Analysis

Human Capital Contributions to Economic Growth in India: An Aggregate Production
Function Analysis
Author(s): Jandhyala Viswanath, K. L. N. Reddy and Vishwanath Pandit
Source: Indian Journal of Industrial Relations, Vol. 44, No. 3, Corporate Social
Responsibility (Jan., 2009), pp. 473-486
Published by: Shri Ram Centre for Industrial Relations and Human Resources
Stable URL: http://www.jstor.org/stable/27768219
Accessed: 27-04-2018 14:45 UTC
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Contributed Article
Human Capital Contributions to Economic Growth in

India: An Aggregate Production Function Analysis
Jandhyala Viswanath, K L N Reddy & Vishwanath Pandit
Education is a merit as well as a About the Study

public good and is associated with
large sets of externalities which are Traditional economic theory gen
often indirect, invisible and non erally viewed capital in physical terms
quantifiable. The modern theory of only. Economists during the late 1950's,
endogenous growth has brought based on aggregate production function,
this out very prominently. Using an found that the standard measures of
aggregate production function simple labour and physical capital were
approach, the present study incapable of explaining adequately the
estimates the contributions of rapid post-War growth. Speculations on
human capital and physical capital what were missing were diverse. Some
to economic growth in India using argued that the principal explanation
cross section data for 26 Indian lays in the lack of appropriate adjust
states and union territories relating ments for improvement in the quality of
to the years 1995-96 and 1998-99. physical capital and the embodiment of
Several alternative specifications technical progress in that capital. Others
of functional forms are estimated suggested that the most important
and most of them gave robust omission pertains to the organizational
results. The important finding that advance or a vaguely specified "human
emerges from this study is that a factor". The "residual" of unexplained
strong positive relationship exists growth was at first ascribed to
between investments in human technology (Solow 1957). But later, the
capital and economic growth. "residual" was defined to include
improvements in the quality of capital
Jandhyala Viswanath is Manager, Export Import
(Denison 1962, Griliches & Jorgenson
Bank of India, Mumbai 400005 (Email: 1964) and the investment in human
viswanath@eximbankindia.in). K.L.N. Reddy is beings (Schultz 1959, 1961). Human
Associate Professor, Department of Economics, Sri capital is formed from investment in
Sathya Sai University, Prasanthi Nilayam, Andhra skills and education. Although Adam
Pradesh (Email: klnklnreddy@rediffmail.com).
Vishwanath Pandit is Vice Chancellor, Sri Sathya
Smith did not specifically use the term
Sai University (Email: vnpandit@gmail.com) "human capital", he included in the
The Indian Journal of Industrial Relations, Vol. 44, No. 3, Jan. 2009 473
category of fixed capital the skills and or determinant of growth of an economy.

useful abilities of human beings. Education variable in production
Marshall provided an elaborate account functions implicitly consider the skills
of estimating returns to human capital. as well as the values it inculcates and
But the contribution of Nobel laureate the externalities it produces. The im
Theodore Schultz (1961) marks the portant role of education in imparting
beginning of the formal induction of skill and abilities, enhancing labour
human capital into the main stream of productivity, overall well-being and
economic analysis. He stated '...invest eventually economic growth is being
ment in human capital accounts for most recognized. This study aims at empiri
of the impressive rise in real earnings cally estimating the relative contribution
per worker.'The best-known application of human capital and physical capital to
of the idea of "human capital" in economic growth in India based on an
economics is that of Mincer and Becker. aggregate production function approach
Becker (1962) built on Schultz's work using OLS method. The study based on
by developing a broader theory of human inter-state data in India pertains to two
capital. In the early years of economics time periods namely 1995-96 and 1998
of education, controversy prevailed on 99. The selection of the sample period(s)
the 'flower and seed' or the 'chicken and has been mainly influenced by the
egg' relationship between education and availability of the data.
economic growth (Vaizey 1962).
Education not only imparts
Education being a merit good and a knowledge but also changes
public good is most often associated with people's pei ^eptions and expec
a large set of externalities that are tations of themselves and the society
most often indirect, invisible and most around them.
importantly 'non-quantifiable'. Besides
merely teaching and learning, education
also encompasses something less tangible Human Capital in Theories of
but more profound: the imparting of Growth
knowledge, good judgement, wisdom and
above all inculcation of values in students Economists have observed that
and imparting of culture from generation education contributes to economic growth
to generation. Education promotes in for the country as a whole in the following
individuals the ability to make moral, ways (Miller 1967, Schultz 1963). First,
rational and ethical choices among education not only imparts knowledge but
alternatives and then act on them. also changes people's perceptions and
expectations of themselves and the
The non-quantifiability of the society around them. Education may
benefits accrued from education is alter the attitude to work, consumption
responsible for it often not being preferences, saving propensities, eco
included explicitly as an important factor nomic rationality, adaptability, inno
474 The Indian Journal of Industrial Relations, Vol. 44, No. 3, Jan. 2009
Human Capital Contributions to Economic Growth in India: An Aggregate Production Function Analysis
vativeness, flexibility, attitude towards that the rates of return to investment in

family size, and various social attitudes human capital are well above those on
physical capital in a large number of
relevant from the economic point of view
such as migration within countries and countries and it is highest in the case
internationally, towards more productive of primary education. Also, the returns
sectors of the economy resulting in rise to education in developing countries are
in GDP and per capita income. Second, higher relative to those in advanced
education, through investment in human countries, Harberger (1965) showed
beings, imparts the knowledge to develop that both secondary and higher
abundant complementary resources that education yielded rates of return at least
may be substitutes for comparatively above 10 per cent. Nalla Gounden
scarce resources and thus promotes (1967) estimated that about 7 per cent
efficient use of existing resources. of the growth of income in India was
Moreover, education is an alternative to accounted for by education. Tilak
consumption and not saving. Additional (1987) has estimated in detail rates of
expenditure on education can make a net return by levels of education, by caste
contribution to economic growth, even if groups, by gender and by rural and
urban regions. The economic returns to
the rate of return would be lower, because
the investment made in education would education in India, according to Tilak,
otherwise be consumed. Further, edu are estimated to be reasonably high.
cation contributes to economic growth They are comparable to rates of return
most essentially through research and to investments in physical capital. They
also by discovering, cultivating, and are also good in comparison with the
nourishing potential talent. Lastly, as rates of return to education in other
educational levels increase for women in developing and developed countries and
developing nations, the opportunity cost they are found to be increasing.
to stay home and raise families rises. It Duraisamy and Duraisamy (1995) also
increases labour force participation and estimated rates of return to higher
reduces fertility rates for these women. education, and Duraisamy (2002)
Moreover, economists believe that estimated changing rates of return to
educational poverty may lead to absence education over a time period with the
of growth in the economy. This realization help of national level household
has forced investment in education to surveys.
increase at a rapid rate which itself
may account for a substantial part of Rates of return to investment in
the otherwise unexplained rise in human capital are well above those
earnings. on physical capital in a large
number of countries and it is
Rate of Return Approach highest in the case of primary
education
Among many researches,
^sacharopoulos (1972, 1994) observed
Residual & Production Function Hicks (1980), Wheeler (1980), Marris

Approaches (1982), Benavot (1985), Tilak (1986),
Lau et al. (1991), World Bank (1993),
Another most important approach Tilak (2003) though based on different
that has been frequently used by methods, variables, data sets and sample
researchers to analyze the contribution of periods for both developed and
education to economic growth is the developing countries the import-ant role
production function approach. In the that primary, secondary and higher
beginning the unexplained proportion of education play on economic develop
economic growth in a production ment of a country is well recognized.
function, viz. the "residual" was treated Most of the cross-country regressions
as the contribution of education to indicate that the change in education is
economic growth. Solow (1957), positively associated with economic
Svennilson (1964) and Denison (1962) growth once measure-ment error in
suggested that improvements in the education is accounted for.
quality of labour force, including
increased education, were important
Economic efficiency in both
together with other factors such as
physical and human capital and
technological progress and economies of
innovations through improvements
scale and constitute an important part of
the residual. Later economists like in skill and technologies have been
considered as the key sources of
Griliches and Jorgenson ( 1966) were also
economic growth.
of the same opinion and argued that the
residual was not "a coefficient of
. ignorance", as some critics (Balogh 1963) By adding research and development
argued. Human capital, particularly to the neoclassical growth model such
education, forms a significant proportion that agents must allocate resources
of this residual. Though the residual was between producing goods and producing
believed to comprise economies of scale, knowledge. The neoclassical model is
technological progress, external economies, generalized such that decisions to pursue
improved health, education and skill of knowledge are now endogenous.
labour force, better management etc., it Economic efficiency in both physical
was also felt that among all education was and human capital and innovations
as an important factor. With Denison through improvements in skill and
(1962, 1964) and Griliches (1964, 1970) technologies have been considered as the
works, it was made clear that education key sources of economic growth by the
could enter as an important variable modern theory of endogenous growth,
(input) in the production function analysis also called new growth theory. The
of economic growth. endogenous growth models are a recent
conceptualization and they have great
According to Bowman (1964), significance in modern growth theories.
Psacharopoulos (1973), Denison (1979), This endogenous growth theory was
popularized primarily by Lucas (1990, estimates differ considerably from each

1993), Romer (1990, 1994). This new other possibly due to differences in
growth theory reduces the limitations of source data for the distribution of
the neoclassical growth model by workers by education and the weighting
system, and to some extent in the
allowing increasing returns to scale
through endogenous technological methodology. Using recent data in
progress linked to human capital another inter-state analysis, Mathur and
accumulation. Lucas (1988), Romer Mamgain (2004) also found signi
(1990), Barro (1991) have all reported ficantly increasing effects of education
significant positive effects of education on economic development (NSDP per
on growth. Romer (1990) assumes that capita) by increasing levels of
the growth of productivity depends on education. Sivasubramonian (2004)
the existing stock of ideas and the also found significant positive impact
number of individuals devoting their of education on economic growth in
time to it. He also distinguishes human India though he used time series data
capital from the technology parameter. in his analysis.
Barro (1999) found in his cross-country
regressions on 100 countries that The research that used production
economic growth between 1960 and functions is not unanimous on the
1995 is positively related to the base positive role of education in economic
level ( 1960) secondary and higher levels growth. A few researchers such as
of education attainment of adult Bowman (1980), Islam (1995), Caselli
population. et al. (1996), Barro and Sala-i- Martin
(1995), Benhabib and Spiegel (1994)
were of the opinion that either education
Economic growth between 1960 and
does not contribute to economic growth
1995 is positively related to the base at all or that its contribution to economic
level (1960) secondary and higher
levels of education attainment of growth has been overemphasized. Most
studies (Griliches 1997) however, note
adult population. that measurement error in schooling or
a tendency for more highly educated
A few Indian studies were also workers to enter the sectors of the
conducted in this regard. In line with economy whose contribution to GDP are
Denison's approach, Dholakia (1974) systematically under measured could
tries to quantify the contribution of bias their results.
education to economic growth in India
and estimates it to be 14.01 per cent Aggregate Production Function
during 1948-49 to 1968-69. According
to Psacharopoulos (1973) it was as high An aggregate production function
as 34.4 per cent. But Loh (1995) using approach is used in the present study to
1971-81 data estimated the corres estimate the contribution of human
ponding ratio to be 27 per cent. These capital to economic growth in India
using cross-section data. OLS method Education is considered as the best

has been used for estimation of the indicator of human capital though as
aggregate production functions, which Knight (1996) noted, "Not all education
incorporate human capital as an explicit produces human capital and, even more
variable, along with physical capital. importantly, not all human capital is
produced by education", but it still remains
The following semi-log regression the most prominent indicator of human
equation is estimated in the study: capital. Most often enrolment ratios and
literacy rates have been used as alternative
Ln Yt = a + ?l PC + ?2 HC ways to measure the educational
attainment but were however found to be
where, Y represents Net State inadequate and poor indicators as they do
Domestic Product per capita; PC, not make any distinction between various
physical capital measured in terms of levels of education and treat all educated
productive capital; HC, human capital people of various levels alike.
measured in terms of mean years of
schooling, a, a constant term and /?, ?2 There are quite a few important
regression coefficients. attempts made at constructing composite
index of education development, with
Economists have used different the help of simple methods as well as
measures with regard to the measure statistically sophisticated methods like
ment of physical capital. The debate principal component analysis and
starts with the choice between gross taxonomic methods (Tilak 1979, 1981a).
values of physical capital and net values More reliable and sophisticated
measures are now available on human
of physical capital to be considered. It
has been pointed out that the use of gross capital. Mean years of schooling is
considered as the best indicator of the
figures of capital is justified in less
developed countries on the ground stock of human capital in a society and
that capital stock is often used at in recent years it has been used as also
approximately constant level of in this study. Psacharopoulos and
efficiency for a period far beyond the Arriagada ( 1986, 1992), constructed this
accounting life measured by normal index, known as the 'mean years of
depreciation until it is eventually schooling of the labour force', a stock
measure based on educational levels of
discarded or sold as scrap. Few studies
have used gross fixed capital stock as labour force, and years of schooling of
each level of education. The latter is used
capital input. Most of the studies have
used perpetual inventory method and as weights to the former. It may be
thereby overcome all deficiency. We argued that any measure of educational
consider per capita productive capital development might better take the
(PC) (i.e., the summation of working population into account, and not just the
labour force unless one is interested in
capital and fixed capital) as capital for
the 'direct' contribution of the edu
our analysis.
cated labour force only. Hence Tilak productive capital, Tilak ( 1997) for rnean
(1994) modified the index given by years of schooling. The data on M YS for
Psacharopoulos and Arriagada ( 1986), so all the states and union territories in India,
as to cover the total population, and not computed by Tilak is available only for
just the labour force, as follows: the years 1971, 1981, 1992-93, 1995-96
and 1998-99. The selection of the sample
S = I Pi Si, years, 1995-96 and 1998-99, for analysis
has been influenced by the availability of
where, Pi is the percentage share of the state-wise data pertaining to the other
persons in the total population with the variables (like productive capital) and the
i-th level of schooling, and others are as relevance, importance and applicability of
defined above. The results/data are the results to present as well as the future
subject to statistical tests and they were time periods. All data are based on
found to be yielding robust results. The information available up to December 2005.
White's heteroscedasticity test was
conducted on all the models and there Empirical Analysis
was found to be no possibility of
heteroscedasticity. All the equations estimated (Table
1) are in semi logarithmic form. Out of
Sources of Data the adjusted sample of 25 Indian states,
22 states are considered in the first 4
This study uses data pertaining to the equations and 20 states are considered
above macroeconomic variables of 26 in equation 5. The independent variables
Indian States and Union Territories or the regressors in all the models are
obtained from RBI Handbook of Statistics per capita productive capital 1997
on the Indian Economy 2004-2005 (PC97) and mean years of schooling
published by the Reserve Bank of India 1998 (MYS98). NSDP from 1998 to
(RBI), Statistical Abstract of India and 2002 are the regressands in the 5
Annual Survey of Industries fof equations respectively.
Table I: Regression Results: I (using Mean Years of Schooling 1998)
_(Ln NSDP = a + /?) PC + /?2 MYS)

Eqn No. Dep Var Const PC97 MYS98 Adj R2
1 LnNsdp98 0.79 0.06 0.24 0.684 22
(2.85) (3.67) (3.98)
2 LnNsdp99 0.80 0.06 0.25 0.693 22
(3.00) (3.60) (4.20)
3 LnNsdpOO 0.78 0.052 0.27 0.655 22
(2.72) (2.91) (4.23)
4 LnNsdpOl 0.80 0.05 0.27 0.658 22
(2.78) (2.96) (4.22)
5 Ln LnNsdp02 0.72 0.06 0.28 0.726 20
(2.61) (3.44) (4.64)
Note: Values in parenthesis indicate t-values
is not to model the NSDP and to find a

We conclude that both variables are
best fit with a very good R2, but to see
significant though human capital the relative contributions of physical and
turns out to be statistically more human capital towards economic
significant than physical capital in growth. For an in-depth analysis of the
explaining the NSDP in all the cross section regression results we shall
equations. deal with equation 2 and equation 5, as
they are capable of giving a good picture
Observing the t-statistic, we of the entire model. Interpretations for
conclude that both variables are the remaining equations can be made on
similar lines.
significant at 1% level of significance,
though human capital turns out to be
statistically more significant than In equation 2 there is an in-built lag
physical capital in explaining the NSDP effect of 2 years for physical capital and
in all the equations. All equations have 1 year lag for human capital. In case of
reasonably high adjusted R2 between equation 5, there is in-built lag effect of
0.66 and 0.73. We can thus conclude that 5 years for physical capital and 4 year
in the above equations approximately 70 lag effect for human capital. There is
percent of the variation in NSDP is need to introduce a lag effect since both
explained by the independent variables physical capital and human capital have
namely physical capital and MYS. We a gestation period only after which they
re-emphasize the point that our objective can start yielding significant returns.
Table 2: Regression Results: II (using Mean Years of Schooling 1995)
^_(Ln NSDP = a + ? PC + ?2 MYS)

Eqn No. Dep Var Const PC94 PC97 MYS95 Adjusted N
R-Square
lnNsdp95 0.85 0.06 0.22 0.689 26
(4.41) (3.10) (5.53)
InNsdp97 0.84 0.08 0.23 0.777 26
(4.89) (4.25) (6.60)
lnNsdp02 0.81 0.09 0.26 0.805 22
(4.39) (4.00) (6.94)
lnNsdp02 0.85 0.059 0.26 0.828 22
(4.94) (4.55) (7.45)
Note: Values in parentheses indicate t-values
The signs of the coefficient in the equation 2, if there is 1 unit change in

two estimated equations are inMYS there will be 0.25 % growth in
accordance with economic theory,NSDP one year later and for a 1 unit
physical capital and human capital beingchange in physical capital there will be
positively related to GDP. According to0.06 % growth in NSDP two years later.
capable of explain ing a major portion of

According to equation 5, if there is 1 unit
change in MYS there will be 0.28 % the variation in NSDP.
growth in NSDP four years hence and
for a 1 unit change in physical capital For a detailed analysis of the results
there will be 0.06 % growth in NSDP on physical and human capital and to
five years later. In both the cases draw comparisons we shall consider
(equations 2 and 5) our results make it equation 7 and equation 9. Interpretations
clear that physical capital does not have for the remaining equations can be made
a more crucial role in determining on similar lines. In equation 7 there is
growth of GDP than human capital. In an in-built lag effect of 3 years for
fact, human capital has a stronger effect. physical capital and 2 years lag for
human capital. In case of equation 9, there
is in-built lag effect of 5 years for physical
Physical capital does not have a
capital and 7 year lag effect for human
more crucial role in determining
capital. In order to account for the
growth of GDP than human capital.
gestation period involved in physical and
human capital these lags are introduced.
All the equations estimated in Table
2 are in semi logarithmic form. Out of The signs of the coefficient in all the
the sample of 26 Indian states, all 26 estimated equations are in accordance
states are considered in equations 6 and with conventional beliefs that as
7 whereas 22 states are considered in the physical capital and human capital
remaining two equations. The indepen increase, NSDP also increases. Accor
dent variables in all the models are per ding to equation 7, if there is 1 unit
capita productive capital 1994 (PC94)
change in MYS there will be 0.23 %
and mean years of schooling 1995 growth in NSDP two years later and for
(MYS95) except for equation 9 where a 1 unit change in physical capital there
PC97 is used instead of PC94. LnNSDP will be 0.08 % growth in NSDP three
is the dependent variable in all cases. years later and in case of equation 9, if
Here too we conclude that both variables there is 1 unit change in MYS there will
are significant at 1% level of signifi be 0.26 % growth in NSDP seven years
cance, though human capital turns out later and for a 1 unit change in physical
to be statistically more significant than capital there will be 0.06 % growth in
physical capital in explaining the NSDP NSDP five years later. Thus the impact
in all the equations. All equations have of human capital on growth of NSDP
high adjusted R2 between 0.70 and 0.83. seems to be more than that of physical
Approximately 70 to 80 percent of the capital contradictory to the traditional
variation in NSDP is explained by the notion that human capital is not a very
independent variables namely physical significant variable in the determination
capital and human capital, which is of economic growth in an economy and
considered a good measure. We can infer that physical capital has a more vital
that these two types of capital are role.
consider many non-quantifiable but very

The impact of human capital on important aspects of human capital, such
growth of NSDP seems to be more as the values in education, the quality
than that of physical capital.s and attitudinal changes that education
brings in etc. This is an important
Conclusions limitation of the present study also. To
the extent that some important facets are
left out the real contribution of education
The pioneering works of Schultz,
Denison, Becker, Mincer, Barro, Romer, to economic growth and more widely
welfare remains understated.
Lucas and others, have highlighted the role
of human capital as an important source
The overall conclusion that emerges
of economic growth. Education in
from this study is that a strong positive
particular has been deemed as the most
relationship exists between investments
important component of human capital.
in human capital and economic growth.
The analysis of human capital is still
Human capital (or educational attain
fraught difficulties like measurement and
ment as measured by MYS) appears to
quantification. Through four decades of
work on human capital (notably by be a significant element in explaining
Denison, Schultz, Becker and Lucas increase in production in India, even
after controlling for physical capital. Our
among others), these problems are partly
solved and economists came to recognise results are quite robust across alternative
specifications of the functional form and
the significant relationship between human cross section data sets.
capital formation and economic growth.
Barro and Lee (1996) and Neruh et

This study, attempted to empirically
estimate the relative contribution of al. (1995) have made estimates of mean
years of schooling of population over 15
human capital and physical capital to
years in various regions of the world
economic growth in India, using an which is summarized in Table 3.
aggregate production function approach
incorporating human capital as an Table 3: Average School Year of Education
explicit explanatory variable, along with
physical capital. In the measurement of Barro and Neruh
output and physical capital, per capita Lee et al.
net state domestic product (NSDP) and AREA 1970 1990 1987
Per capita productive capital (PCAP) Developing Countries 2.66 4.43 4.48
Middle East and North Africa2.05 4.47 4.79
respectively are considered in our Sub-Saharan Africa 2.06 2.93 2.54
analysis. Mean years of schooling, which Latin America 3.82 5.24 5.52
is considered as the best indicator of East Asia and South Pacific 3.80 6.08 5.13
educational attainment has been used in South Asia 2.03 3.85 3.39
7.58 9.02 10.0
our analysis. A time lag has been OECD
introduced, in order to account for Source: Barro and Lee (1996), population over 25.
gestation period in both forms of capital. Neruh et al. ( 1995). population between the ages
15-64.
Such quantitative analyses cannot
482 The Indian journal of Industrial Relations, Vol. 44, No. 3, Jan. 2009
The mean years of schooling for quality education with human values.
India for the year 1995-96 is 4.26 (Tilak Education with human values will pay
2005). The estimates for India for 1995 higher dividends not only to the
96 are higher than only those of the Sub individuals, but also to the whole society.
Saharan African region and the South
Asian region for 1990. This portrays a Acknowledgements
very dismal picture of the state of
education in India and reflects the Revised version of the paper
urgency with which this serious issue submitted to the 90th Annual Indian
needs to be addressed. Having observed Economic Association Conference 2007:
the important role that education plays Growth Theory and Globalisation of
in the growth of an economy the India(25- 27 October 2007), University
implication is clear: for India to grow of Kashmir, Jammu & Kashmir.
and develop, it must accord due
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Human Capital Contributions to Economic Growth in India: An Aggregate Production

Human Capital Contributions to Economic Growth in

Jandhyala Viswanath, K L N Reddy & Vishwanath Pandit

Education is a merit as well as a About the Study

category of fixed capital the skills and or determinant of growth of an economy.

vativeness, flexibility, attitude towards that the rates of return to investment in

Residual & Production Function Hicks (1980), Wheeler (1980), Marris

popularized primarily by Lucas (1990, estimates differ considerably from each

using cross-section data. OLS method Education is considered as the best

Table I: Regression Results: I (using Mean Years of Schooling 1998)

_(Ln NSDP = a + /?) PC + /?2 MYS)

is not to model the NSDP and to find a

Table 2: Regression Results: II (using Mean Years of Schooling 1995)

^_(Ln NSDP = a + ? PC + ?2 MYS)

The signs of the coefficient in the equation 2, if there is 1 unit change in

capable of explain ing a major portion of

consider many non-quantifiable but very

Barro and Lee (1996) and Neruh et

To add to the proverb, Becker, G. (1962), "Investment in Human capital:

Benhabib, J. & M.M. Spiegel (1994), "Role of

Dordrecht: Kluwer Academic Publishers, Wheeler, D. (1980), Human Resource Develop

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