Introduction to Modern Economic Growth ³ ´ ³ ´ ˆ kˆ constant, (10.41) implies that kˆ should increase, since ˆ kˆ and h Holding h ³ ´ ³ ´ ˆ kˆ and ˆ kˆ > h the left-hand side has increased (in view of the fact that h ∂ F (k, h) /∂k∂h > 0) Therefore, capital-skill complementarity combined with the pecuniary externalities implies that an improvement in the pool of workers that firms face leads to greater investments by firms Intuitively, each firm expects the average worker that it will be matched with to have higher human capital and since physical and human capital are complements, this makes it more profitable for each firm to increase investments by firms, in ³ ´ ³ their ´ physical capital investment Greater ˆ h for each h, in particular for h ˆ kˆ Since the earnings of type turn, raise F k, ³ ´´ ³ ˆ h ˆ kˆ , their earnings will also increase as a result workers is equal to λF k, of the response of firms to the change in the composition of the workforce This is therefore an example of human capital externalities, since greater human capital investments by one group of workers have increased the earnings of the remaining workers In fact, human capital externalities, ³ in ´´this economy, are even stronger, ³ ˆ h ˆ kˆ /∂h and thus encourages further because the increase in kˆ also raises ∂F k, investments by type workers These feedback effects nonetheless not lead to divergence or multiple equilibria, since we know from Proposition 10.3 that there exists a unique equilibrium with positive activity We summarize this discussion with the following result: Proposition 10.6 The positive activity equilibrium described in Proposition 10.3 exhibits human capital externalities in the sense that an increase in the human capital investments of a group of workers raises the earnings of the remaining workers 10.7 Human Capital Externalities The previous section illustrated how a natural form of human capital externalities can emerge in the presence of capital-skill complementarities combined with labor market imperfections This is not the only channel through which human capital externalities may arise Many economists believe that the human capital stock of the workforce creates a direct non-pecuniary (technological) spillover on the productivity of each worker In The Economy of Cities, Jane Jacobs, for example, argued for 492