How important is human capital? a quantitative theory assessment of wold income inequality

Abstract

We build a model of heterogeneous individuals—who make investments in schooling quantity and quality—to quantify the importance of differences in human capital vs. total factor productivity (TFP) in explaining the variation in per capita income across countries. The production of human capital requires expenditures and time inputs; the relative importance of these inputs determines the predictions of the theory for inequality both within and across countries. We discipline our quantitative assessment with a calibration firmly grounded on US micro evidence. Since in our calibrated model economy human capital production requires a significant amount of expenditures, TFP changes affect disproportionately the benefits and costs of human capital accumulation. Our main finding is that human capital accumulation strongly amplifies TFP differences across countries: to explain a 20-fold difference in the output per worker, the model requires a 5-fold difference in the TFP of the tradable sector, vs. an 18-fold difference if human capital is fixed across countries.