Abstract: We develop a quantitative theory of human capital investment in order to
evaluate the magnitude of cross-country differences in
total factor productivity (TFP) that explains the variation in
per-capita incomes across countries. We build a
heterogeneous-agent economy with cross-sectional variation in ability,
schooling, and expenditures on schooling quality. In our theory, the parameters
governing human capital production and random ability process
have important implications for a set of cross-sectional statistics
- Mincer return, variance of earnings, variance of schooling, and
intergenerational correlation of earnings. These restrictions of the
theory and U.S. household data are used to pin down the key parameters
driving the quantitative implications of the theory.
Our main finding is that human capital accumulation strongly
amplifies TFP differences across countries. In particular, we find an
elasticity of
output per worker with respect to TFP of 2.8: a 3-fold difference in TFP
explains a 20-fold difference in output per worker.
We argue that the cross-country differences in human capital
implied by the theory are consistent with a wide array of evidence including
earnings of immigrants in the United States, average mincer returns
across countries,
and the relationship between average years of schooling and per-capita income
across countries. The theory implies that using Mincer returns to measure
human capital understates differences across countries by a factor of 2.
Keywords: output per worker, TFP, human capital, heterogeneity, inequality
JEL Classification: O1