We Should Focus On Human Capital, Not Capital

Lest anyone has forgotten, Presidential elections are supposed to be national referendums on policy. This time the central economic issue should be how to raise the nation's anemic long-term growth rate. Reducing the much ballyhooed budget deficit is but a means toward that end.

There are three ways to boost output per hour--what economists call productivity. The sweetest way is to improve our technology. As the songwriter said: Nice work if you can get it--and we should certainly try. But economists probably know more about pursuing the other two routes: accumulating more private capital and improving the quality of our work force. Public-infrastructure capital can and should be a useful adjunct to either, but it cannot play the leading role.

Let's be clear. This is not an either-or choice. We must work on both our capital and labor resources. But since no nation can do everything at once, the emphasis matters. Shall we concentrate on augmenting our private capital or on enhancing our human resources? Which will be the engine of growth and which the caboose?

TIRED CLICHE? President Bush has a straightforward answer: Emphasize capital formation by cutting the taxes that investors pay on their capital gains. This, he argues, will lead to more capital formation and thence to faster productivity growth. This "trickle down" argument should by now be familiar enough to give Americans the willies. It is, after all, the tried-and-untrue policy of the 1980s. That it failed so miserably either to accelerate capital formation or improve productivity growth should give us pause.

Governor Clinton's economic plan offers a clear alternative. While neither denigrating nor forgetting the role of capital, this challenger is placing most of his bets on human investments--with a little badly needed public infrastructure thrown in. He wants more and better education, more on-the-job training, greater access to college, and so on.

The advantages of the Clinton approach are many. Let's start with arithmetic. Since labor inputs account for roughly 70% of gross domestic product and capital inputs for just 30%, a 10% increase in the amount of capital per worker would boost productivity 3%. But a 10% increase in labor quality would gain us 7%. Each of these is a tall order, to be sure. But look at the difference in what we gain if we succeed.

The mere fact that 70% is more than 30% would be a debater's point if we knew how to make the capital medicine work but were in the dark about how to apply the human-resource medicine. The truth, however, is closer to the reverse. Tax incentives for saving and investment proliferated in the 1980s, and almost all failed. While the details are in dispute, two salient facts are not: There was no substantial rise in the share of gross domestic product saved or invested, and there was no burst of productivity growth.

In stark contrast, there is mounting evidence that rates of return on human investments are high. One obvious example is that wage gaps between more- and less-educated workers are now near historic highs. But we continue to underinvest shamefully in early education programs, such as Head Start, despite stunningly high rates of return.

SPECTATOR SPORT. As against this, where is the evidence that we can spur productivity growth by reopening the same old tax loopholes that gave us, among other things, all those empty office buildings and shopping malls? To my knowledge, none has been offered. Instead, we are to take it on faith that reducing the capital-gains tax will get America's entrepreneurial juices flowing again.

The case for a human-resource-based strategy doesn't end there. Americans may recall that the policies of the 1980s were not very kind to the lower 80%--or was it the lower 95%--of the population. Some additional income inequality is more or less inherent in the approach. Tax breaks for saving and investment directly benefit only those who hold substantial capital--a small minority even in our great capitalist democracy. Others gain only from what trickles down. Thus the Reagan-Bush growth strategy was bound to exacerbate income inequalities, as it did, and make economic growth a spectator sport for most Americans.

A growth strategy built around human resources has precisely the opposite effects. Almost all of us sell our labor, and the middle class gets most of its income that way. When human investments are the engine of growth, almost everyone gets to play in the economic game. These policies are also more likely to narrow income gaps than to widen them.

Finally, much has been made of the increasingly global economy around which information, goods, and capital freely fly. But labor is far less mobile than capital. American labor, in particular, rarely leaves the country. So, if the U.S. government showers tax breaks on capital, some of the benefits will inevitably flow abroad. But if we spend public funds on improving our human resources, virtually all the benefits will stay at home.

There is a choice in this Presidential election between two very different growth strategies. Let the voters decide.

Before it's here, it's on the Bloomberg Terminal.