LSE Institute of Global Policy
Investing in Human Capital:
The Role of the Global Financial System
Nora Lustig
Samuel Z. Stone Professor of Latin American Economics, Director of the Commitment to Equity Institute at Tulane University and a nonresident fellow of the Brookings Institution, Center for Global Development and the Inter-American Dialogue
Nora Lustig
Human capital is a key determinant of economic and social progress. The salient importance of human capital was prominently acknowledged in Proposal 1 of Making the global financial system work for all, the report by the G20 Eminent Persons Group on Global Financial Governance, released during the IMF and World Bank Annual meetings in 2018. More precisely, the report calls for refocusing on human capital as a foundation for a stronger investment climate, building more inclusive societies, and reaching the Sustainable Development Goals (SDGs).

Investing in broad-based human capital distinctly creates a three-way win-win. Human capital is key for economic growth. Human capital investments are also key for building equitable societies. And human capital is not only “capital”—that is, an input for production—but higher levels of human capital immediately translate into superior quality of life. Better health and nutrition, achieving literacy and numeracy, and access to modern sanitation services not only make people more productive but vastly improve their living conditions and well-being. Human capital improvements translate into longer, healthier, and more fruitful lives.

Is the global financial system ready to support human capital investments of the type and in the scale that the world needs? For now, it is not. The required type and scale of human capital investments will only happen if financial resources, data, knowledge, coordination, leveraging, surveillance capacity, and governance in the IFIs are revamped and realigned. The EPG report recommends actions and reforms conducive for the needed revamping and realignment of the IMF and the multilateral development banks.

Human capital improvements translate into longer, healthier, and more fruitful lives.
The international financial institutions (IFIs) are indeed in a unique position to help governments achieve the human capital/human development goals embedded in the SDGs. IFIs could provide adequate support with:

  • Better inter-institutional coordination: Proposals 2 and 3 focus on building country and regional collaboration platforms to facilitate joint and mutually re-enforcing efforts, while Proposal 7 proposes integrating trust fund activities into core operations to avoid fragmentation.
  • Better data and cutting-edge knowledge: Proposal 8 focuses on the importance of IFI’s continuing to invest in data and policy-relevant research.
  • Innovation and capillarity at the grassroots level: Proposal 9 focuses on the importance of leveraging more on the ideas and operating networks of business alliances, NGOs, and philanthropies.

The IFIs are also uniquely positioned in helping governments estimate how much reaching the human development goals would cost and find the mechanisms to finance these investments. In particular, the IFIs can help governments ensure tax collection is efficient and progressive and target resources where they are most needed, reduce waste and corruption in public spending, and adopt best practices in the deployment of education, health, and sanitation services.

The IFIs can also provide realistic assessments of how much of the financing of investments in human capital can actually rely on improvements in domestic resource mobilization. The IMF estimates that, on average, low-income developing countries will need additional annual outlays of 14 percentage points of GDP on average in the areas of education, health, water and sanitation, roads, and electricity to achieve the SDGs. Across 49 low-income developing countries, about $520 billion a year in additional spending is needed.

However, where will the additional needed resources come from? Boosting domestic tax revenue is an obvious option, especially for emerging economies but it will not be sufficient to meet the financing needs of most low-income developing countries. In fact, too much emphasis on domestic resource mobilization—especially in the poorer countries—could backfire: if, for instance, consumption taxes are raised, the poor may be left worse off. Moreover, borrowing may not be an option for many of these low-income countries because they are at risk or are already experiencing debt distress. Foreign assistance will have to continue playing its part, but this too will not suffice. Recognizing these limitations, the EPG report makes a central recommendation: Proposal 4, to shift the basic business model of Multilateral Development Banks from direct lending towards risk mitigation (including political risk insurance schemes) to mobilize significantly greater private equity investment.

As important as finding ways to invest more and more efficiently in human capital is, it is also crucial to prevent human capital from falling. We often forget that one of the greatest costs of financial crises, natural disasters, and pandemics is the destruction of human capital, which often can never be rebuilt. Malnutrition at an early stage in life cannot be reversed by consuming more food at an older age. Adult literacy programs cannot replace not attending school or not completing primary school.

Human Capital Stacking Business Blocks
Malnutrition at an early stage in life cannot bereversed by consuming more food at an older age.
Hence Proposal 6, which focuses on the importance of strengthening the joint capacity of the IFIs to tackle challenges of the global commons. Challenges include preventing and coping with environmental threats related to climate change, degradation of ecosystems, water scarcity, systemic health risks from pandemics, and the rapid spread of antimicrobial resistance. Crucially, the EPG report devotes an entire section (Section II) to recommendations that should prevent financial crises from happening in the first place and help countries manage crises at the minimum cost to their economies and people. In particular, it calls for: strengthening the risk surveillance and policy follow-up capacity of IMF and other central actors (Proposals 12 and 13), ensuring an adequately-resourced and reliable global financial safety net at the earliest (Proposal 14), establishing a standing IMF liquidity facility to give countries timely access to temporary support (Proposal 15), and enabling the IMF to quickly mobilize additional resources in the face of severe global crises (Proposal 16).
Nora Lustig is Samuel Z. Stone Professor of Latin American Economics and Director of the Commitment to Equity Institute (CEQ) at Tulane University. She is also a Nonresident Senior Fellow at the Brookings Institution, the Center for Global Development and the Inter-American Dialogue. Professor Lustig’s research is on economic development, inequality and social policies with emphasis on Latin America. Her most recent publication Commitment to Equity Handbook: Estimating the Impact of Fiscal Policy on Inequality and Poverty, (Brookings 2018) is a step-by-step guide to assessing the impact of taxation and social spending on inequality and poverty in developing countries. Prof. Lustig is a founding member and President Emeritus of the Latin American and Caribbean Economic Association (LACEA) and was a co-director of the World Bank’s World Development Report 2000, Attacking Poverty. She serves on the editorial board of the Journal of Economic Inequality and is a member of the Society for the Study of Economic Inequality’s Executive Council. Prof. Lustig served on the Atkinson Commission on Poverty, the High-level Group on Measuring Economic Performance and Social Progress, and the G20 Eminent Persons Group on Global Financial Governance. She received her doctorate in Economics from the University of California, Berkeley.