The augmented Solow model was proposed by Mankiw, Rower and Weil (MRW) in their treatise “A Contribution to the empirics of Economic Growth”. To better explain the variation in living standards across regions, they propose a model that adds human capital accounting for the fact that labor across different economies can possess different levels of education. To test this model, a proxy variable in the form of human capital accumulation is added as an explanatory variable in the cross-country regression. MRW find that human capital accumulation is directly correlated with savings and population growth and the inclusion of human capital lowers the impact of savings and population. MRW claim that by testing the data, they find that this model accounts for 80% of the cross country income variance [cross–section regression of the 1985 level of output per worker for 98 countries producing an R² of 0.78 ]
The model also predicts that poor countries are likely to have higher returns to human capital. The incorporation of human capital has the ability to tweak the theoretical modeling and the empirical analysis of economic growth. The theoretical impact will be based on the restructuring of growth process ideology. MRW quote Lucas (1988) stating that although there exist decreasing returns to physical capital accumulation when human capital is held constant, the returns to all reproducible capital (human and physical) are constant. The empirical analysis will be altered as human capital will be included as a variable in the regression to explain differences in economic growth.
Adding human capital to the production function, the augmented Solow equation becomes
Y(t) = K(t) ∂H(t) β(A(t) L(t))1−∂− β
(human capital H, physical capital K, labor L and knowledge or technology ): One significant assumption here is that human capital depreciates at the same rate as physical capital as its production function is considered similar to...