An Economic Rationale for Investing in Human Capital

Abstract

There are compelling economic arguments for governments to invest in the human capital of their people-limited access to credit narrows household choices, information failures distort investments, and spillover effects lead to suboptimal family investments. Lack of access to capital is one reason for governments to invest little in human capital-a problem that natural resource revenues can help to overcome. Investing in human capital should be an important part of the portfolio of investments using resource revenues-along with investing in infrastructure and saving through mechanisms, such as sovereign wealth funds, that allow countries to earn international rates of return on investments. A balanced portfolio is desirable, and investing in human capital has a special role to play in resource-rich settings-especially in poor countries-where the need for human capital and infrastructure investments is large. The indirect effects of enhancing human capital on reducing the incidence and cost of conflict are also a large part of the story. Why Governments Should Invest in Human Capital "Perfect Markets" as a Reference Point When markets are functioning perfectly, households have a full range of choices about how to invest their disposable income. They can use their cash for consumption, savings, investing in education and training, and various other types of spending or investing. Since each type of spending has diminishing benefits, at least eventually, people would adjust their spending so that, as economists put it, the marginal returns are equalized across different types of spending. If markets were "perfect," an additional dollar spent on building human capital would yield the same return as the interest rate obtained through savings. If it were higher, households would increase their spending on skills acquisition (perhaps financed An Economic Rationale for Investing in Human Capital From Mines and Wells to Well-Built Minds •