McMahon on the Economics of Education

Walter McMahon describes the conceptual framework for the ‘knowledge economy’:

The modern conceptual framework for the “knowledge economy” is rooted in the endogenous growth models of Lucas and his student Romer who provided analytic proofs for the central role of human capital formation and education externalities in the economic growth process. This was accompanied by a flood of empirical research establishing the empirical evidence consistent with this theoretical basis. It now has arguably become the mainstream of modern economic growth theory, research, and the understanding of how longer run economic processes in modern economies work. The theory and research are more recently moving to extend endogenous growth to become endogenous development. The latter encompasses household production of final outcomes and hence the effects of the non-market private and social benefits of education on broader development goals and human welfare.

Historically, building on Alfred Marshall and his dramatic statements about the key roles of education and also new knowledge created by leaders such as Newton, Darwin, and Beethoven, revolutionary developments in economics and the economics of education beginning in about 1960 continue to have enormous implications for new research. These advances were due to largely to Gary Becker and T.W.Schultz, both Nobel Prize winners, who conceived of education including on-the-job training as the key means of creating human capital. This surged as Lucas, another Nobel Prize winner, and Romer developed endogenous growth theory, which, including the empirical evidence consistent with it, became the main foundation for modern growth theory and knowledge-based growth. To incorporate the wider benefits of learning, Becker’s analysis of the allocation of human time and the use of human capital in the household production of final outcomes has become the core element, and is consistent with empirical work tracing these non-market effects from education on development. The result is the extension of endogenous growth to become endogenous development.

Recently Lucas has re-addressed the contribution of ideas to growth. This encompasses both R&D and Schumpeterian innovation. The ideas are not exogenous ‘manna from heaven’, but instead are endogenously determined since they are the result of a large class of educated people spending their entire careers generating and exchanging ideas, solving problems, and generating new knowledge. Again education winds up with the central role essential to idea creation, innovation, and the success and sustained growth of modern capitalist economies.

The theoretical developments mentioned are the logical proofs of the effects of education. They are essential to inferring cause and effect. The empirical tests consistent with these then result in a scientific explanation. Without both there is no scientific basis for the knowledge economy or knowledge-based growth, or for what we are doing in education to foster development. Statistical regressions alone without the logic of the theory behind them are only empirical correlations.

McMahon, Walter W. “Supporting Evidence 1.2: The Economics of Knowledge.”  In New Learning: A Charter for Change in Education. College of Education, University of Illinois at Urbana-Champaign. ||


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