Escaping the 'Middle Income Trap' by Investing in Human Capital

01 Aug 2016

 (Photo: ©FaniLlaurado/UNDP Cambodia)

Investing in people has essential and direct implications on meeting development challenges now and in the future. In the absence of people’s ability and adaptability, physical assets such as land, capital and other endowments, are not enough to drive economic growth and sustain livelihoods. Investment in education, skills and health, perhaps defined as spending on human capital, is important for a country's sustainable and inclusive growth as it improves citizens’ participation in socio-economic activities. Well-educated and trained citizens would then act capably in their individual, parental, community, and work lives. Cambodia’s policymakers have increasingly recognized the importance of human capital development for inclusive growth and building resilience. The proof is in the recent education reform drive and the doubling of education and health expenditures as a percent of total government expenditure in the current National Strategic Development Plan (NSDP, 2014-2018). Currently, by looking at the education participation ratios, in Cambodia human capital endowment is extremely low justifying government interventions.

The Cambodian Government’s commitments in education and health development is yet to be seen in terms of inputs (financial and human) and results by the end of the current national plan. Education, particularly basic nine years’ schooling plays a key role in preparing individuals to enter the labour market by equipping them with skills to engage in lifelong learning. However, education development endeavours, if not linked to the needs of the labour market, would have little or no impact on economic transformation since education and labour market outcomes influence one another. Education development, therefore, should not be treated in isolation of labour market reforms and concrete actionable employment-generating programs.

Beyond the challenge of underinvestment, as in the previous rolling NSDP plans in education, Cambodia’s labour market is yet to create incentives for young people to stay in school longer. The private return to investment in education for each extra year of schooling, particularly at the secondary level needs to be improved as the government holds on investing in education. Thus, education endeavours cannot be achieved without coordinated works between human capital institutions such as the education, labor, health, and commerce.

Moreover, investment in education should not be treated as recurring expenditure because education is linked to virtually all dimensions of human development: economic, social, and cultural. It positively affects almost all human development outcomes in reducing poverty and food security, increasing employment and access to basic services such as health, and water and sanitation, and in the dynamics of labour mobility.

For instance, expanding girls’ education has had positive effects on fertility rates, maternal, child and infant mortality, nutrition, and child development. It is also a key factor in improving governance, social and cultural capital, and safety nets as education empowers people, allowing them to develop critical thinking and life skills. In the end, it ensures full participation of citizens in nation building.

Having said the above, there are a number of reasons why government lead is important to promote education and human capital development. First, under certain conditions, the free actions of consumers and producers seeking to maximize their welfare will yield socially desirable outcomes. However, in the labor and skills markets, these free actions and conditions are usually not met, justifying government interventions to improve the functioning of the labour and skills market.

Secondly, education outcomes can be influenced by labour mobility that leads to underinvestment in both the formal education and job-specific training. Employers underinvest in training and skills-building because they fear employees will leave before they, as employers, are able to reap the full benefit of their investments. Furthermore, individuals are less interested in paying fully for their education and training, which ultimately creates weak human capital formation in the economy. This situation is partly true in Cambodia where the private sector and individuals tend to devote inadequate investment in education and skills-building because the distribution of education and training benefits remain uncertain among the individuals and their parents.

Thirdly, a functioning human capital market depends on the availability of access to finance for education and skills building. The fact that credit for education and skills building involves high risk discourages such investment because it is difficult for an individual to predict the value of education since its benefits accrue over a longer period. Finally, information on who provides the best skills and education for young people is important for decisions to be made on investment in education and skills by both the individual and employers. Information deficiency creates underinvestment, necessitating government interventions to correct underinvestment in education and skills building.

In conclusion, as Cambodia crosses the threshold into the middle income country category, government intervention in education is highly justified and desirable to avoid the so called ‘Middle Income Trap’ also called ‘low skills trap’ by correcting the labour market imperfections and proving equal life chances for all citizens in education and skills building.