Work of Denison

Denison’s work on the national income data for the U.S. during the period 1929 - 58 showed that the average annual rate of economic growth was 3.9 per cent. Denison attributed 1.6 per cent of this growth to the share of capital and 1.0 per cent of this growth to labour. Hence 1.3 per cent growth was left unexplained. The traditional neo classical factors of production viz. land, capital and labour could not explain it. The residual percentage was as high as one third of the total economic growth in the United States. Denison began to analyse this residual so as to identify its elements and their share, if any, in total output. For this reason, it has also been called as the Residual Analysis Approach.

Traditionally, the contribution of labour to national product was conceived in terms of ‘effort’, that is, in terms of the number of hours of work put in by individual labourers multiplied by the total number of labourers in the work force. But Denison began to look at labour not only as effort but in terms of acquired ingenuity, skills, techniques, health status, formal education etc. He was conscious of the fact that the residual is left unexplained because the quality of inputs had not been accounted for. In spite of attention to these factors/variables there will still remain a residual, a new one, which will be left unexplained. Denison expanded the Cobb Douglas production function equation by breaking up the rate of increase in labour quality into three constituents: L_E , L_A and L_W; E representing changes in educational achievement, A for changes in labour quality attributed to age and sex composition of the work force, and W for changes due to varying average work weeks in a year. With these factors incorporated, Dennison found that during the reference period 1929 to 1958, labour quality in the U.S. work force, measured in terms of health, fitness, experience, skills and educational attainments, grew at a rate of 1.4 per cent per annum. He also could deduce that changes in labour quality accounted for over fifty per cent of the annual growth in A with nearly 40 per cent of the change in A due to changes in L_E i.e. the educational attainments of the work force. He, therefore, concluded that education represented a form of capital, known as human capital.

The work of Denison was furthered by Theodore Schultz who identified different sources by which human capital is developed. He identified formal education in schools and colleges, non formal education, and on the job training which may be either pre service or in service as the three major sources. The implications of the study by Denison read with the analysis of Schultz indicated that expenditure on education is a form of investment and not just consumption. In other words, education is not merely a welfare proposition but an investment avenue. Schultz reworked with the same data that Denison had used and arrived at identical results. Later, Becker also did growth accounting analysis and demonstrated the values of health and education as forms of human capital. Abramovitz had earlier called this residual as ‘a measure of ignorance’ of economists regarding the sources of economic growth while Solow attributed this to refinements in technology. Many hardcore economists subsequently toyed with technology as the factor contributing to the residual growth denying thereby a high degree of value to human capital in explaining the constant ‘A’ in the production function equation.

The human capital theorists still held on to their contention by observing that an improvised technology cannot be transferred or adopted in a vacuum without a human medium. Technology can only minimise human labour but would still require a high level of human capital for its operation. With this argument conceded the inference that expenditure on relevant science and technology education is a form of investment assumed credence. However, a similar inference in respect of primary education was not straightaway possible due to certain factors outlined below. Does the money spent on primary education constitute consumption expenditure or an investment avenue? People with just primary education will not participate in secondary sector activities. Between the sexes, a large proportion of consumers of primary education remain as housewives. Given this scenario, how can primary education contribute to increases in productivity by utilisation of technology? For instance, even if new agricultural practices/technology has to be publicised through a programme of extension education, formal primary education is not an essential requirement for the same.

It is observed that even illiterate farmers in developing countries adopt new agricultural practices. It is for this reason Schultz distinguished three types of education viz. (a) education for current consumption, (b) education for long term future consumption, and (c) education/training for skills and knowledge directly used for production. Any education that helps an individual to understand nature and society, as well as assist him to adjust and live in harmony with them, is treated as education for current consumption. An education that provides skills and knowledge for farmers and workers in agricultural and industrial production are illustrations of knowledge/skills used for production [i.e. type (c) above]. Higher levels of technical or professional education leading to higher degrees of human capital would be of value for long term future consumption. Human rights champions are cautious of the debate regarding the status of education as consumption or investment. For them, primary education is a basic human right. It is essential for the simple functions of life as food is for the body. It is the duty and obligation of the well provided and privileged sections of society to concede this basic human right and extend adequate facilities for honouring the same. It is not that in the interest of welfare of the weaker sections of the society primary education needs to be universalised but even in the larger interests of the well being, continuity and progress of human civilisation primary education requires to be provided for all.

Denison’s technique of analysis was later adopted by Jorgenson. Jorgenson and Grilliches (1984) worked on U.S. data on national income first for the period 1958- 1973 and later for the period 1974 to 1988. Jorgenson accounted for all the possible factors that contributed to national income including non market productive activities. His residual analysis approach demonstrated the contribution of skills and education to increases in production. It highlighted the significance of quality of labour in the process of development. Every addition to the level of education or stepping up of skills resulted in increases to national products. Differential contributions to national product indicated the marginal values of educational levels. However, the residual analysis approach could not help in deciphering whether the educational levels were profitable at a given point of time, especially from a macro perspective. Though a higher level of education appeared to be profitable, the exact margin of benefit for the individual and the society was not clear. Further, at higher levels, the diversity in specialisation of courses also meant varying degrees of economic value. The benefits generated by the variety of educational programmes could not be captured by Residual Analysis approach. The life time returns on alternative investment possibilities was thus not clear. These and similar issues are more effectively tackled by cost benefit studies.