The Medium Run Effects of Educational Expansion: Evidence from a Large School Construction Program in Indonesia

This paper studies the medium run consequences of an increase in the rate of accumulation of human capital in a developing country. From 1974 to 1978, the Indonesian government built over 61,000 primary schools. The program led to an increase in education among individuals who were young enough to attend primary school after 1974, but not among the older cohorts. 2SLS estimates suggest that an increase of 10 percentage points in the proportion of primary school graduates in the labor force reduced the wages of the older cohorts by 3.8% to 10% and increased their formal labor force participation by 4% to 7%. I propose a two-sector model as a framework to interpret these findings. These results suggest that physical capital did not adjust to the faster increase in human capital. This suggest that adjustment processes are extremely slow in developing countries. ∗I thank participants at the conference “New Research on Education in Developing Countries” at the Center for Research on Economic Development and Policy Reform of Stanford University for comments, and particular to Hanan Jacoby for his discussion of the paper. I also thank two refrees and the editor for very useful comments. I thank Lucia Breierova for excellent research assistance, Daron Acemoglu, Abhijit Banerjee, Robert Barro, Ricardo Caballero, Michael Kremer, Emmanuel Saez and Jaume Ventura for very helpful discussions, and Guido Lorenzoni for his insights about transitional dynamics.