General Equilibrium Effects of Investments in Education and Changes in the Labor Force Composition

In this paper, a novel approach to modelling education and human capital formation in a computable general equilibrium model is proposed. Rather than adopting microeconomic-based assumptions of human capital formation, the method is based on an empirical relationship between labor force composition and expenditure on education services. It is found some robust correlation between workers’ shares in the labor force and educational expenditure, in real terms and per capita. To assess the implications of these findings, the impact of an increase in public expenditure devoted to education is simulated in a conventional CGE model for Ethiopia. The simulation results highlight the existence of a multiplicative effect, such that the overall increase in the supply of education services, in the final equilibrium state, is more than three times larger than the initial demand push. This comes associated with a positive supply shock, entailing gains in productivity, income, and welfare, as well as changes in the structure of the economy.