Human versus physical capital: issues of accumulation, interaction and endogeneity

The human capital and physical capital are inextricably linked. Increase in the physical capital is assumed to affect the stock of human capital and vice versa. This paper examines the impact of increase in human capital on accumulation of physical capital and vice versa for a panel of 237 countries during the period 1971–2015. We also analyzed the interaction between these two types of capitals after disaggregating the countries by their income level. We used 3SLS and fixed effects estimation methods to obtain consistent and unbiased results in the presence of endogeneity. We found that investment in physical capital positively affects accumulation of human capital, but the impact of human capital investment on physical capital accumulation is not uniform. The impact of additional factors such as democracy, trade openness and ethnic fractionalization on human and physical capital is moderated by level of economic development of the countries. Results suggest that in order to accumulate physical capital subject to the resource constraints, low income countries must focus largely on primary education while high income countries should invest in secondary and more importantly in tertiary levels of education.