1. Education, Human Capital, and Regional Economic Differentials YAO Xianguo & ZHANG Haifeng Zhejiang University, China Dec. 17, 2006

2. Education, Human Capital, and Regional Economic Differentials Introduction Regional differentials in China have been one of key issues. In 1978, GDP per capita are 175RMB and 680RMB in poorest and richest provinces, respectively. In 2004, GDP per capita in Shanghai, the richest region, is 55306RMB, while the poorest Guizhou is about 4125RMB. As Human Development Report (UNDP, 2005) noted, If they are countries, Guizhou would rank just above Namibia and Shanghai alongside Portugal.

3. Education, Human Capital, and Regional Economic Differentials Introduction Why does output per capita vary so much across regions in China? And what policies can be implemented to reduce the growing gap? A number of researchers focus on these questions and have done many helpful investigations on Chinas regional differentials. And education is one of the important factor. Different from the previous literature, we collect provincial matched-pair panel data, and attempts to provide some new empirical evidence for these questions.

4. Education, Human Capital, and Regional Economic Differentials Literature Review Lin et al. (1998) argue that regional disparities are reflected in different development opportunities after analyzing the changes of regional disparities during the period from 1978 to 1995. In Démurgers paper (2001), he notes that differences in infrastructure, such as traffic network, electronic power supply and telecommunication equipment, can explain regional disparities in part. Several studies focus on the relationship between FDI and regional economic growth (e.g. Wei, 2002; Wang et al., 2002)

5. Education, Human Capital, and Regional Economic Differentials Literature Review Bao et al. (2002) examine the relationship between geographic location and regional economic growth during Chinas transition period. Like many cross-countries literature, many studies discuss regional economic convergence and its conditions within China. Although in Lucas (and many others) view, human capital is the key factor of international income differences, there is little consensus on the magnitude of human capital. Particularly in Chinas case, human capital is always absent from studies until recent years.

6. Education, Human Capital, and Regional Economic Differentials Econometric Strategies The basic idea is simple and its originally from the method which is often used to estimate the return to schooling using twins sample. E.g., Ashenfleter & Krueger (1994). In our case, twins are urban and rural sub-regions within the same province. Compared with the differences between two provinces, the two sub-economies have many homogeneous background charac- teristics, government policies, cultures, geographic location (coastal or inland), resource endowment, marketization process, and so forth. So, the two sub-economies, urban and rural, can be considered as a matched-pair.

7. Education, Human Capital, and Regional Economic Differentials Econometric Strategies Following Topel (1999, p.2959), consider logarithm of earning equation, where i denotes regional fixed effect (at province level). And lnh it can usually be rewritten as a linear function of all kinds of human capital. So, the key econometric issue is whether unobservable i correlates with our interested variable.

8. Education, Human Capital, and Regional Economic Differentials Econometric Strategies As Hall & Jones (1999) noted, differences in institutions and government policies (he calls them social infrastructure) is the key determinant because these infrastructure determines the differences in capital accumulation and productivity. In other words, omitted variable errors may arise if these regional fixed effects are excluded in simple cross-sectional regressions. One method to resolve these biased estimations is using fixed or random effect estimator.

9. Education, Human Capital, and Regional Economic Differentials Econometric Strategies Different from existing literatures, we estimate the following equation after first-order difference between urban and rural within the region. where Variable denotes Variable ur -Variable ru in the same year and region. Meanwhile, we also estimate the traditional fixed effect estimator with interactions to allow parameters to vary between urban and rural.

10. Education, Human Capital, and Regional Economic Differentials Data summary Data used in this paper is from China Statistical Yearbook, China Population Statistical Yearbook, and Fixed Assets Investment Statistical Book: 1950- 2000. All nominal economic variables are deflated to comparable real variables by price index (CPI of each sub-regions ). Like many other studies, average schooling and illiteracy are our main proxies for human capital. Unfortunately, other kind of human capital, such as overall life expectancy and skill level, can not be controlled for in empirical estimations due to data limitation, thus our estimates may be biased upward. Other variables are presented in text paper.

11. Education, Human Capital, and Regional Economic Differentials Empirical Results Table 2 presents the results of first-order difference estimates. The coefficients of average schooling are about 5%, and coefficients of illiteracy are -0.4 or so. After controlling for year effect and excluding municipalities, all these coefficients have a little rise. Table 2 To investigate a comparative analysis, regressions including interactions are implemented with a comparison of OLS, FE and RE (see table 3). It shows that education has more influences on average income in rural areas than in urban areas.table 3

12. Education, Human Capital, and Regional Economic Differentials Empirical Results The results in table 4 come from regressions under the assumption that capital-output ratio is regional fixed effect. (similar to Topel (1999)) And we get the coefficients of average schooling about 12% in rural areas, while 6% in urban areas.table 4 Totally, three conclusions may hold: human capital measured by average schooling is not as important as expected to improve average income level. compared with 1980s, education has increasing impacts on average income level since later 1990s. education has more influence in rural areas than in urban areas.

13. Education, Human Capital, and Regional Economic Differentials Explanations of Results Both human capital theory and new growth theory give much emphasis to the impact of human capital, especially education, on economic development. If so, our estimation results are somewhat surprising. Do our conclusions mean human capital is not important for Chinas economic growth? Otherwise, how to explain it? We think that the background of transition in China should be considered together. In fact, some micro-studies also indicate that returns to education in China is much lower than that in developed economies, but fortunately, it has an increasing trend with the reform deepening. (see e.g. Li et al., 2003; Zhang et al., 2005)

14. Education, Human Capital, and Regional Economic Differentials Explanations of Results The relative lag of factor market reform distorts resource allocation and incentive mechanism. That is, in Zhous view, owners of human capital may close his/her potential human capital without any incentive. Education is the main form of human capital, but not the whole. In Schultzs definition, ability to deal with disequilibria may be the most important especially during Chinas transition. For example, human capital measured by education in Zhejiang province are lower than many other regions, but there are numbers of entrepreneurs in Zhejiang.

15. Education, Human Capital, and Regional Economic Differentials Explanations of Results Human capital externalities are considered as one original drive factor of economic development, such as in Lucas(1988). And some studies show there is a threshold effect of education externalities. That is, the private and social return to education are fairly low unless average schooling reaches certain level. (e.g. Iranzo & Peri, 2006) As we know, there are yet large numbers of illiteracies and semi-illiteracies (about 8.33 of overall illiteracy rate), and overall average schooling level of Chinese people is approximately 8 years. (Central Peoples Government)

16. Education, Human Capital, and Regional Economic Differentials Explanations of Results It is compatible with characteristics of Chinas labor market in terms of different magnitudes of education on urban and rural income. In rural labor market, abundant labors choices for migration or non- farm activities, both of which increase their income, mainly depend on their own qualities (e.g. education). While in urban labor market, institutional protection is the main determinant of their income, while education has little effects. Additionally, there are a good many imitation and learning behaviors in rural area. These behaviors often take place when there are some able-minded or educated people within the villages.

17. Education, Human Capital, and Regional Economic Differentials Conclusions Like many other studies, our estimations find that education has positive effects on regional average income level. We also find evidence different from previous researches that the impacts of education decrease a lot after controlling for other fixed factors. Particularly, a comparative analysis shows that different influences of education on average income level, larger magnitude of effects in rural area than in urban area.

18. Education, Human Capital, and Regional Economic Differentials Thank you very much! Please send suggestions or criticism to cec_yaoxg@zju.edu.cn or haif_zju@163.com

19. Education, Human Capital, and Regional Economic Differentials Empirical Results: Table 2

20. Education, Human Capital, and Regional Economic Differentials Empirical Results : Table 3

21. Education, Human Capital, and Regional Economic Differentials Empirical Results : Table 4