Cross-Section Dependence and Latent Heterogeneity to Evaluate the Impact of Human Capital on Country Performance

Abstract: Human Capital has been recognized as the most important force behind economic growth of countries. However, the effect of this important growth factor on economic growth remains ambiguous due to endogeneity and latent heterogeneity. By using a dataset of 40 countries over 1970-2007, we estimate the global frontier and explore the channels under which human capital and time affect the production process and its components: impact on the at- tainable production set (input-output space), and the impact on the distribution of efficiencies. We extend existing methodological tools - robust frontier in non parametric location-scale mod- els - to examine these interrelationships. We use a flexible nonparametric two-step approach on conditional efficiencies to eliminate the dependence of production inputs/outputs on common factors. We emphasize the usefulness of “pre-whitened” inputs/outputs to obtain more reliable measure of productivity and efficiency to better investigate the impact of human capital on the catching-up productivity process. Then, we take into account the problem of unobserved het- erogeneity and endogeneity in the analysis of the influence of human capital on the production process by extending the instrumental nonparametric approach proposed by Simar, Vanhems and Van Keilegom (JoE 2016) to account also for cross section and time dependence