China’s Investment in Human Capital

Abstract

China, at all levels of government, currently spends about 2.5% of its gross domestic product (GDP) on investment in schooling. 1 At the same time, roughly 30% of its GDP is devoted to physical capital investment. In comparison, the figures for the United States are 5.4% and 17%, respectively. In South Korea, they are 3.7% and 30%, respectively. Table 1 compares China with other countries in terms of expenditure of GDP on education. China is below average even among its peers in its expenditure on investment in people. Its ratio of annual investment in physical capital to human capital is much higher than that of most countries around the world. Perhaps this imbalance is warranted. Perhaps the economic rate of return of physical capital is much greater than the economic rate of return to human capital. Below, I summarize evidence indicating that the true rate of return to education and skill formation is very high and that the imbalance revealed in table 1 is symptomatic of a serious distortion in current policy that serves to retard economic development in China. A basic result of economics is that resources should flow to their most productive use. A policy that equalizes returns across all investment types increases economic growth. Current Chinese policy tends to ignore this fundamental rule and thereby retards the economic growth of China. This article first presents the potential benefits that flow from investment in human capital. Then I discuss the empirical evidence on the rate of return to education in China. I next consider alternative policy reforms that would foster skill acquisition and enable China to harvest the benefits of investment in human capital.