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HUMAN WEALTH AND ECONOMIC GROWTH

By Theodore W. Schultz

Theodore W. Schultz teaches economics at the University of Chicago and heads the Research Advisory Board of the Committee for Economic Development. He has studied-and helped to improve economic conditions in Europe, India, and Latin America, especially Mexico. This article is based on his talk at the Cleveland conference of the American Humanist Association last November.

We Americans have traditionally taken it for granted that expansion, growthparticularly economic growth-is in itself a good thing. But recently we have witnessed the beginnings of a debate; it is being argued that we are putting too much emphasis on economic growth in national policy and in our thinking, and that it should be given a lower priority. This essentially is the thesis of a recent book by Professor Galbraith of Harvard, "The Affluent Society." In effect, Dr. Galbraith closes the United States off and says that we have grown fairly rich now, and why then be concerned about more economic growth?

This amounts to a very sophisticated new brand of isolationism with which I would quarrel seriously; and I was glad to see an article by Leon Keyserling (the New Republic, Oct. 27, 1958) in which he took Mr. Galbraith and others very much to task for this limited view. Mr. Keyserling said very effectively-not speaking as an economist, and more effectively than an economist could have said it-that if we were truly aware of our responsibility in the world today, we would see that we are indeed very poor.

That is not to argue that economic growth will necessarily solve all the problems of the world. It cannot give us all the necessary and sufficient conditions for world peace. Nor is rapid economic growth always a comfortable process for the countries involved. Very heavy stresses and strains are implicit in the changes brought by rapid growth in the economy. We in the West do not usually consider this when we urge poor countries to move ahead more rapidly. But it is easier to see at home, for example in American agriculture, where change has been so rapid that the social cost is very high. During just one peacetime year, from April 1956 to April 1957, we had 2 million people leaving American agriculture. That was 10 percent of the American farm population. In leaving a sector of the economy they normally had to change both location and job, giving up not only their occupation but their community life as well. When change occurs at such a fantastic rate, the social cost is proportionately high. And we should bear in mind that when rapid growth occurs in poor countries, the same kind of thing happens. This is not to argue against economic growth, but to say that order too has value for the community; that order and change should each have a place in the thinking and experience of communities where change is going on. What then, we may ask, do people want economic growth for? Do people, as individuals and as communities, want economic growth? Is it important to them, and why? My answer is that economic growth is important on a worldwide scale because there is so much poverty in the world. And we no longer believe that poverty is ordained by God. Men today will not be kept down in poverty because it is a part of the symbolism of a caste or class or religion, Men can, and men will, do something about it.

The example of early industrial development in the West, of Japan later on and Russia more recently, has become common knowledge all over the world. People in the areas we think of as backward-Africa, some of the Asian countries, even the Indians in the mountains of Peru-are rapidly becoming informed and aware of these vital matters. They want first-class citizenship and the right to enjoy some of the fruits of living, and not the bare subsistence that has for centuries been their lot.

Economic growth, therefore is important both for us here in the United States and for others; and it is important for us to comprehend the way in which it is brought about. I believe that we in America do not really understand our own economic growth and how it was achieved. Much of our debate on the subject is in terms of material as against spiritual values; and we think of economics as materialistic, partly because we have identified capital with goods-reproducible goods-and have not seen it in its human context. And this applies to Marxian theory as well as to our own non-Marxian thinking.

At the individual

level, the way to achieve economic growth can be stated very simply: work, and thrift. You work hard, you are thifty and save, and you accumulate something called capital. It helps to have chosen your birthplace wisely, to be born where there is plenty of oil, and coal, ores, rich farmlands, harbors and rivers; but I suspect that this is less important than has been supposed. Consider the prosperity of landlocked, mountainous Switzerland; or look at what the Puerto Ricans are doing on an island that has almost no resources, or at Mexico, which is far from rich in this sense. And there are other examples. The key to economic development, I believe, is in man himself, and not in material resources. Another road to economic growth has been revolution-followed by a generation or two of enforced accumulation of capital achieved by forced labor of one kind or another along with drastic limits on consumption. The human cost of that road is, of course, appalling. It is shown in Boris Pasternak's much-discussed novel, "Dr. Zhivago," where we see the lives of a few people who try to save their souls from the crushing excesses of a vast revolution. Similar excesses characterized the French revolution, and in some ways also the Mexican revolution. It would be a mistake to see the novel as a purely political document, rather than as an account of what happens to human values during such a revolution. William Faulkner's account of other human values, in "Intruder in the Dust," with its setting in our society, is if anything sharper and more devastating than anything in "Dr. Zhivago.'

WHAT CAUSES ECONOMIC GROWTH?

Let us consider economic growth in the United States, and how it came about. Do the increases in man-hours of labor, the total man-hours worked as our population and labor force have grown, plus the increases in the stock of real capital, account for most or all of our own economic growth throughout our history? Several recent studies have been made that bear on this question, and they all tell very much the same story.

Consider the period from 1929 to 1953, which is fairly recent and avoids some of the measurement problems that would be met if we went back further. During this time, the total national real income-and by real income we mean, not money income, but "real things”—of this country a little more than doubled. If we think of it in terms of compound interest, this is an increase of something more than 3 percent per year.

During this period from 1929 to 1953, while total real income doubled, our resources in terms of total man-hours in the labor force increased by 17 percent. At the same time, the total capital stock-that is, the value of material resources, manufacturing plants, etc.-went up 42 percent. If these figures are weighted properly, the total rise in input (man-hours and capital stock combined) is about one-third-or, in compound interest terms, an increase of 1.2 percent per year as compared with the 3 percent increase in real income.

The increase in resources, then, would seem to account for about two-fifths of the rise in real income, leaving three-fifths open and to be explained. We added a third to our resources, and ended up with twice the product. Where did the rest come from? What explains the difference? This is the enigma of our history; we do not understand it ourselves, and I think most of the political debate on this issue is quite beside the point. Both the liberal and the conservative views on economic growth are probably wrong.

Businessmen and others who tend to the conservative view would probably argue that if we want more rapid growth in the American economy, we will have to give larger incentives to people to "hustle," to work, save, invest, accumulate capital, build new plants, and so on. Lower taxes on these activities might provide these incentives. And conservatives would also argue, no doubt, that when decisions by Government result in waste of resources, these should be corrected. A fair case might be made here in connection with--for example-some of the transportation decisions made by the Interstate Commerce Commission and some of our agricultural policies. If, however, as we have just seen, growth in capital accounts for such a small proportion of total growth, it would seem impossible that even substantially higher incentives to increase capital in reproducible goods would result in a substantially greater increase in total growth. It might be wise to do some of these things on other grounds, but that they alone bring about appreciably more economic growth, can be denied.

On the liberal side, our friends in labor would say that to get rapid growth we should reduce unemployment; that if, instead of running 5 to 6 percent

unemployment on the average, we could get this figure down to 3 or even 2 percent as they are doing in some European countries, the problem would be solved. Certainly this would result in a larger product in the beginning; there would be a rise when the extra resources in human effort were "allowed" to work. But it does not follow that this would lead to a higher rate of growth from then on, and the picture in European countries at present bears this out. Again, I do not mean to argue that a decrease in unemployment is not a desirable thing to achieve; but it cannot by itself bring about economic growth of the explosive kind shown in the unexplained figures just given.

Another liberal argument is that the public sector of the economy should be enlarged, and more resources given to the Government to spend in certain ways, in order to achieve this kind of rapid growth. Of course, the list of things that ought to be done on the public account is a very long one: urban renewal in our large cities; enlargement of social security; conservation of natural resources; improving our parks, rivers, and harbors; development of water sources, dams, power; building highways, schools and hospitals; and so on. But I doubt that even if each of these were increased by 20 percent, this would lead to appreciably more economic growth. Certainly we are woefully behind in some public facilities in our society today, and for the welfare of our citizens we should be spending more funds on these things. But I do not believe a case has been made for the achievement of economic growth in this way.

THE FORMATION OF HUMAN CAPITAL

What then is the key to economic growth? The hypothesis which follows has become the center of my own work in studying this subject, and I do not wish to state it dogmatically as proven; but it seems to organize the relevant facts of our history and experience better than any other hypothesis I have worked with.

That hypothesis can be stated this way: looking at our own economic growth from 1929 to 1953, or at the rapid growth of Japan or Germany or other countries, one observes what I shall call an underspecification of resources. We have omitted a part of wealth, and my thesis is that this omission is represented by the additions that have been made in the stock of human wealth. This human wealth consists of improvements in human effectiveness arising from the fact that man has developed capacities that result from investments in man. We may feel a bit touchy at having this concept of capital taken over from the realm of reproducible, material things, and applied to ourselves as humans. And yet perhaps the greatest capital formation that has been going on in our society is this investment in ourselves. It may be that these investments in ourselves-in our abilities, our talents, and capacities, in our stamina, our health, the way we live and what we eat are the very kinds of capital that make the greatest returns in terms of reward for our efforts.

One aspect of this human wealth, of course, is the great increase in useful knowledge. I first became aware of the importance of this when I tried to understand the rapid growth that has taken place in some part of Latin America, Mexico, for example, has been an extraordinarily poor country. If anyone had told me, when I first studied it in 1930, that Mexico could achieve the increase in output, in its total production, that it has achieved since that time, I should have said it would be impossible. Particularly I should have said this about the economic area I knew best, agriculture. If I had been told that Mexico, with its pitifully poor resources, could actually double its output in agriculture-traditionally one of the hardest kinds of output to increase-I should have denied it. But that is what the Mexicans have done. Their gross national product has been rising

by 7 or 8 percent a year, but the agricultural product has been rising even faster. In the past 12 years, they have had an increase in gross national product of approximately 80 percent and they have again doubled their output in agriculture. Although less dramatic, yet similar things have been happening in Brazil and in other places, such as Puerto Rico.

These observations prompted a second look at some earlier work in which I had found that in this country, since 1923, for every 25-percent increase in agricultural output, we had increased our input in man-hours and material resources by no more than 3 to 5 percent. It suddenly occurred to me that some of these countries that are moving forward so rapidly now are doing much the same thing. They have found a way to get a greatly increased output without an input that is proportionately that large. This would appear to be a direct contradiction of the doctrine of the 18th-century economists, Ricardo and Malthus, who held that for every increase of, say 10 percent in input, a country would get somewhat less than 10 percent growth in output-the classic image of diminishing returns.

In order to discover just what was going on in these areas, my colleagues and I began a series of studies, particularly of Argentina, Mexico, and Brazil. These studies showed that Brazil and Mexico in particular began to develop, in the late twenties, and achieved an increase in agricultural output that was substantially greater than the additional input. Argentina showed a pattern

of growth that looked very much like that of Canada and the United Statesuntil Perón came to power; and then it reversed itself. And unfortunately, Argentina has not begun to move forward again even now, 3 years after Perón's downfall.

In another study, I then undertook to try to discover whether these unexplained, omitted "inputs" could be represented as the return on the investment that has been going into humans. One of these investments is education, in high schools, colleges, and graduate schools in the United States. Comparing figures for two dates, 1920 and 1956, we can identify what the economists would call gross capital formation, in ourselves, for this one kind of investment during that period. In 1920, counting all the costs as you would if you were developing capital in the physical sense, our investment in education in the United States was $1.6 billion. In 1956, this figure had risen to $22.7 billion. This is a much more rapid increase than the value of our physical capital during the same period. In fact, it was 7 percent of gross physical capital in 1920, and in 1956 it was up to 28 percent. And even this is an understatement. In terms of net capital (that is, the life of capital when its depreciation is subtracted), the comparison is even more striking, because during this period the life of human capital has been increasing very substantially. A person invests in himself, and then has a longer period of useful activity in society than he would have had 30 years ago. At the same time, the life of so-called physical capital is getting shorter and shorter. This is one of the notable phenomena of our time.

RETURNS ON INVESTMENT IN KNOWLEDGE

The individual and social returns on our investment in education are suggested in the results of a recent study in which Morton Zeman of the University of Chicago tried to explain the very large differences in the average earnings of urban workers, Negro and white. Using census figures, Dr. Zeman was able to classify people, white and Negro, by region, city size, age, and education. He found that in the North, comparing Negro and white workers all of whom had had 5 years of school, the average difference in their earnings was small. The average earnings of northern Negroes were slightly less than those of whites of the same educational level.

Of course there are other factors influencing earning power, such as age, city size, and so on; and in the South the picture is still more complex. But the extraordinary thing was that, at any rate in the North, the most important factor determining earning power of both white and Negro workers was the amount of education they had had. This suggests that one of the tragic errors in American history has been our failure to invest in Negroes as citizens as we have invested in whites as citizens. One of the great costs has been the lower productivity in the economy, as well as the individual differences in earnings as revealed by Dr. Zeman.

Other studies, of white and Negro farm families, have yielded similar results. The implication is that our economy pays high rewards for more investment people, as shown even by this crude measure. The fifth year in school, the sixth year in school, the seventh, and eighth, and on through the high schoolswith each added year of education, the rewards increase.

The social returns on investment in new useful knowledge are demonstrated in another set of studies. In a project underwritten by the National Science foundation, we attempted to identify particular pieces of new knowledge that have moved into the economy, and to see what they cost the society and what return they made to the society. One such piece of new knowledge that we were able to isolate and treat in this way was the development of hybrid corn. The history of hybrid corn development in this country goes back to 1910, with relatively few people involved at first, but with a pyramiding of effort in the later stages. A colleague of mine has just published the results of some very ingenious research; he has found that if we count all of the private and public costs of hybrid corn, everything that has gone into its development-and the records on this are quite complete-a total of $130 million has been invested since 1910. (This figure also allows for compound interest over the time period, but that is a technicality.) Then if we measure all of the product that can be identified and attributed to this particular new piece of useful knowledge, we find that its contribution to the consumer surplus-and it quickly becomes a consumer surplus, which is what made the analysis so difficult and required so much ingeniuty-turns out to be no less than $910 million. That is, the return on the $130 million invested is running at 700 percent per year.

Most of the time we consider it an improvement if we can work out an allocation of resources that increases the return from 5 percent to 6 percent. We criticize private or public business if they are sinking funds in 5-percent areas when they could use such resources in activities that produce 6, 7, or 8 percent. My argument is that we should be looking for ways in which human effort and useful knowledge can move us into the range of 50 percent, 100, 200, even 700-percent return. This is the key to the explosion of our own economic well-being.

If my hypothesis is correct, it carries radical implications for our thinking about the rest of the world. It implies that fewer steel mills and other big plants should be built in the underdeveloped countries, and more invested in the people of those countries, as we have invested in ourselves.

As we look at other countries, let me draw a few comparisons. We can now gain new insights on why Great Britain's growth has been appreciably slower than our own during the past 50 years. The British have neglected the education of the middle group in their society. Their elementary education system is much like ours, perhaps better. But at what we call the high school level, before university education begins, the story is of two different worlds. Our high schools, like the elementary schools in both countries, still deal in mass education. At this level we are still investing in people on a mass basis. In Britain, on the contrary, only some 15 to 18 percent of the people go beyond elementary school.

By way of contrast, let us look at Japan, an Asiatic country, highly populated. Something happened in Japan at a very early date, and it began to produce not only industrial products but also much more food under the most adverse circumstances. The agricultural achievements of Japan between 1875 and 1910-before World War I-stand as a miracle. In 1873, Japan moved to universal education, a 6-year program, compulsory all over the country. As a result, they very soon had a literate population; the rural people became more skilled at farming, and a supply of labor was made available to industry that was more sophisticated than even European countries had at that time, and far more so than that of other Asiatic countries. And we should remember that we did not have universal compulsory education for Negroes, or for some whites, in the United States at that time. (Some of my American colleagues, confronted with these facts, have said, "Why, it couldn't have happened. It hadn't happened in the United States yet.")

I think I now understand why Japanese tenant farmers could come to our west coast and do better at farming than many American farmers with whom they were competing. It is often said that they were able to save and buy land because they were willing to accept lower standards of living. But that is not the whole story. I have seen some of these farms; I remember one, of 231 acres, not far from Stanford, which had been acquired by a thrifty Japanese