Saturday, September 21, 2013

21/9/2013: Human Capital & Social Mobility: Capital Tax v Education Spending Reforms

A new paper Human Capital, Social Mobility and the Skill Premium (September 18, 2013, CESifo Working Paper Series No. 4388. Available at SSRN: by Angelopoulos, Konstantinos and Malley, James R. and Philippopoulos, Apostolis produces fascinating insights into the relationship between human capital, physical capital and skills/wage premium.

The main drivers of the skill/wage premium are commonly recognised to be: 
  1. Skills-complementary technical change (SBTC - B standing for 'biased'), "which raises the demand for skilled labour, and the relative supply of skilled versus unskilled labour". Economic policy can influence this channel by increasing R&D and innovation which lead to increased technology contribution to the economic activity and in turn generate demand for complementary skills.
  2. "Occupational choice of economic agents, usually focusing on the distinction between entrepreneurs and workers, and its implications for social mobility." Here, economic policy too can have an impact via, say labour markets regulations and interventions, as well as general taxation policies.
  3. Direct policy impact via stimulating "capital accumulation via tax reforms" and direct "labour markets …intervention".

In contrast, "although education policies and tax policies have been considered as important determinants of social mobility, their impact on the joint determination of social mobility and the skill premium has generally not been studied."

Human Capital, Social Mobility and the Skill Premium "develops a dynamic general equilibrium model to highlight the role of human capital accumulation of agents differentiated by skill type in the joint determination of social mobility and the skill premium."

The authors find that "the model with endogenous social mobility can capture the empirical co-movements of the skill premium, the relative supply of skilled to unskilled workers and aggregate output in the U.S. data from 1970-2000." The study shows "that the model predictions for these empirical co-movements are improved when we allow for positive externalities from skilled human capital on social mobility." In other words, skill premium for skilled and unskilled workers tends to rise/fall jointly (co-move) and this co-movement is strengthened when increased social mobility of skilled human capital is associated with increased social mobility of unskilled human capital.

The authors' "policy results first show that endogenous social mobility creates additional incentives for the agents which enhance the beneficial effects of policy on aggregate outcomes and wage equality."

"Second, that important dynamic effects of policy on the skill premium are captured by allowing human capital accumulation to affect social mobility. In particular, post reform, the skill premium is higher in the short- to medium-run than in the long-run."

"Third, that although all policy reforms considered lead to an increase in output and social mobility, their implications regarding the skill premium differ. In particular, the skill premium increases after a capital tax cut and decreases after an increase in spending on education for unskilled agents and in spending on education for skilled

In other words, the authors show that "endogenous social mobility and human capital accumulation are key channels through which the effects of capital tax cuts and increases in public spending on both pre- and post-college education are transmitted."

Note: in my view this tends to support the idea - outlined by me in my TEDx Dublin talk last Saturday - that we are witnessing migration to the age of tech-enabled human capital away from the skills-enabled tech capital. 

"In particular, social mobility creates additional incentives for the agents which enhance the beneficial effects of policy reforms. Moreover, the dynamics of human capital accumulation imply that, post reform, the skill premium is higher in the short-to medium-run than in the long-run."

Note: in the context of my TEDx Dublin theme, the above reinforces my concept of new policy paradigm of C.A.R.E. (policy dimension aimed at establishing a comprehensive economy that is capable of Creating, Attracting, Retaining and Enabling human capital).

"Regarding all three results above, the effects of public spending on education for skilled agents are dependent on the externality that skilled human capital has on social mobility. In particular, a negative externality generally reduces many of the positive effects of this policy reform."

What about a capital tax cut

The "improvement in aggregate outcomes" following tax cut "also implies increased wage inequality. The reason is that the policy-induced increase in the capital stock is skill-biased because capital complements skilled labour more than unskilled. Hence, …the skill premium increases with the capital stock post-reform."

However, this "increase in the skill premium works to encourage the accumulation of unskilled human capital, as a means to increase social mobility to capture the higher returns associated with skilled employment. In turn, …the resulting increase in the relative skill supply acts to lower the skill premium. In fact, the reduction in the skill premium starts taking effect 20-30 years after the reform, when the increase in the share of skilled labour is sufficiently strong to counterbalance the increase in the capital stock."

Note: in my TEDx Dublin talk context, the above relates to the changes in underlying drivers for growth I highlighted in the chart - in particular, the lags we are experiencing in terms of the Age of Tech translating with a delay into future wage premium erosion (some might argue we are already witnessing this today). 

Education spending increase for unskilled workers: "As expected, the stock of human capital for unskilled labour increases and this raises output in all models and social mobility in the models that allow for endogenous skill accumulation. In turn, this increase in the relative supply of skill leads to a decline in the skill premium in the medium- to long-run. However, initially, the skill premium increases …because the labour productivity gains, brought about by the increase in human capital, also increase the return to physical capital and thus lead to increased capital stock, which tends to increase the skill premium." 

Over time, "when the relative skill supply has increased sufficiently, the skill premium starts to decline. In this case, in fact, the increase in the share of skilled in the population is sufficiently strong to decrease the skill premium in the long-run."

"The dynamic processes of human capital accumulation and social mobility have non-trivial implications on the …determination of …skill premium-social mobility" co-movements. Long-run: wage inequality is reduced along with increased social mobility. Short-run: wage inequality increases.


(1) In the long-run, "government spending on unskilled education, by increasing the labour productivity of unskilled labour and increasing their skill accumulation, raises output, reduces wage inequality and improves social mobility. However, "the increase in government education spending crowds out private consumption." In the short-run, unskilled education increases lead to increased inequality and social mobility declines.

(2) "…Increases in government spending on the education of the skilled agents has positive effects on output and consumption, as well as encouraging social mobility, despite the reduction in the skill premium. This occurs because, by supporting the productivity of the skilled, the government indirectly increases the potential future benefits of the unskilled, if they succeed in climbing the social ladder. However, these results are sensitive to whether externalities of skilled human capital on social mobility are positive or negative. The former enhance the positive effects on social mobility, wage inequality, and welfare, whereas the latter reverse them for social mobility and wage inequality and lower them for welfare."

(3) "Wage inequality effects of capital tax cuts are significantly dampened by the increase in the relative skill supply, which follows the increased returns to upward social mobility, while, at the same time, the aggregate efficiency effects of the capital tax cut become stronger."


Brian O' Hanlon said...

My ‘big’ idea on education.

We have a whole vast network of ‘Institutes of Technology’ around Ireland, set up at enormous cost to the nation, which are often co-located in cities and centres beside full university third level campuses.

I would imagine, that if we were to create an alternative to standard progression, to ‘fourth level’ education in Ireland (doing the proverbial Masters and adding to the tonnage of academic literature already on the shelves across the nation), . . . and if we were absolutely serious and intent upon capitalizing most on the knowledge economy, . . . then we would establish the ‘Institutes of Technology’ network that we have created in Ireland, at such enormous expense, . . . to create that sort of ’second wash’ cycle, or after-rinse, or whatever one likes to call it, . . . that is needed, in order to prepare our professional graduates for this very digital oriented, foreign direct investment focused Irish economic reality, that we ourselves moulded through generations of domestic policy.

That is my big idea, and radical step to curb unemployment and reverse outward emigration of young people. Unfortunately though, our parliament is stocked to the rafters with folk who as a collective, still do not get it. Bad, bad, bad.

I mean, these jobs that get announced in the news media, and are still out of reach of many third level graduates even, who have to leave the country as a result.

A lot of jobs do require some level of innovation on the part of an individual to combine together ICT skills with their core vocation, be it business, or design, or legal or whatever. It’s a technological based universe these days, and becoming more so in every sector. But our education seems intent on running in the opposite direction.

What the current very challenging job environment does require, is a level of adaptation on the part of individuals, to be able to extend their skillset (not upwards to fourth level as such), but sort of laterally, by bringing to the basic degree that they have won, some things that are from the digital and ICT age.

Increasingly, to gain work, graduates have to be able to graft what they obtained in ‘third level’ on to other things after leaving third level. And it becomes harder to do the same, when one has a ‘learning off’ policy embedded in our education system, all up along.

Working in a digital age, takes no more than bringing ancient ideas and putting them through a ‘filter’ of sorts, so as to create machine-readable language, that will operate out there in the real world of 2013.

In today’s Ireland, where the jobs are often in technological and innovative companies, we don’t manage that transition very well, where fresh young graduates come out and need to adapt. And more fourth level is the answer to some problem, but not specifically the answer to this one. And unfortunately, fourth level has been foisted upon us, as a solution, when it really is not effective.

I think this, more than anything, is why we see more young people leaving on the airplanes, because we aren’t providing them with choices, so that they can legitimately say, they can have the confidence to get that job in Google, or Facebook, or Twitter. And it doesn’t matter how many happy Morning Ireland, or The News at One, stories we announce about a hundred new jobs in social media or something, because for the vast majority of young professional graduates, that job is still a bridge much too far.

Brian O' Hanlon said...

I was trying to argue this point at the Irish economy blog in relation to the tie up between economics second level, and third levels in Ireland. What we have in Ireland, I believe, is a 'fourth level' education investment, which was not created for the purposes that fourth level should be created for, . . . but in order to solve some kind of problem, that we purposefully create at secondary level (and it gets shoved down the line, until it finally ends up getting addressed by universities in a very bad way, through their fourth level programs).

At some way back along the line, a secondary school system ‘threw the in the towel’, and accepted the reality that the best way to PREPARE their students to have a springboard in life, was to learn off the textbook, and point score as much as possible. So it seemed to me looking at the existing Leaving Cert economics textbook a few years back, that from a secondary school teacher’s perspective, their only hope would be to fling chapter after chapter of that stuff, each week at their class, and hope to plough through the book from one end to the other. And that was their side of the deal dispensed with, so to speak.

And that’s fine.

But lets not assume, that the legacy of that, isn’t going to be something other than having a classroom full of young people who move one stage further down the road in education, to what we call ‘third level’, and try to pursue the exact same strategy there. Find the fattest, thickest textbook, and plough their way through it. And this is why also, we have such an artificially high demand in Ireland for fourth level programs such as Masters and PHd’s.

Not because we are any brighter or better in Ireland, than we are anywhere else in the world, or that Irish students have more of a hunger and thirst for knowledge. But the Masters or PHd program now, at third level institutes is about the only place left along the whole line, where the students can finally stop to take a breath, and actually learn about what writing English. Learn about what the concepts really are. Because, unless one gets to a fourth level of education, the idea is to ‘block’ oneself from understanding anything, and just learn it all.

In the innovative-centric reality of today, the one of social media and online companies, I can’t even begin to describe how inappropriate our current conveyor belt system has become in terms of preparing people for the challenges that they will face in a real workplace. In fact, having spoken to a lot of fourth level students know, I definitely notice a pressure placed upon third level institutions to turn fourth level into another ‘profit centre’ to increase student number through-put in colleges, and fourth level has even started to become a bit of a cattle market also.

At some point along the whole system, it needs to get re-evaluated, what exactly we are trying to achieve, and what skills that we hope to furnish the upcoming generations with. At present, the education mission statement is all over the place.