One clue as to why education is worth little more than hula hoops to a society that wants to grow comes from what the educated people are doing with their skills. In an economy with extensive government intervention, the activity with the highest returns to skills might be lobbying the government for favors. The government creates profit opportunities by its interventions.

For example, a government that fixes the exchange rate, prohibits trading of foreign currency, and creates high inflation has created the opportunity for profitable trading in dollars. Skilled people will want to lobby the government on the black market for a fat profit. This activity does not contribute to higher GDP; it just redistributes income from the poor exporter who was forced to turn over his dollars at the official exchange rate to the black market trader.

In an economy with many with many government interventions, skilled people opt for activities that redistribute income rather than activities that create growth. One somewhat whimsical piece of evidence that supports this story is that economies with lots of lawyers grow more slowly than with lots of engineers.

For example, economies with a high black market premium on foreign exchange have low growth regardless of whether they have more growth with higher schooling than with lower schooling.

Schooling pays off only when government actions create incentives for growth rather than redistribution.

Source: William Easterly, The Elusive Quest for Growth, Economists’ Adventures and Misadventures in the Tropics, MIT Press, 2001, page 82.