DP5471 | Market and Public Provision in the Presence of Human Capital Externalities


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This paper suggests that human capital externalities are important in determining whether goods and services should be privately or publicly provided. We study situations where that the cost incurred by an individual provider for providing quality is affected by the human capital of her colleagues. This is the case for goods such as health, education, legal services, police protection, and so on. The mode of provision (private or public) affects a supplier?s incentive to acquire human capital and therefore her colleagues? cost of provision. The paper shows that either mode of provision may be preferable, depending on the nature of the human capital externality: private provision of the final goods and services provides stronger incentives to human capital acquisition (and may therefore be socially preferable) if own human capital and one?s colleagues? human capital are substitutes, and suppliers with high human capital benefit more benefit more than suppliers with low human capital from their colleagues? human capital, but not excessively so.