This is from my Carleton colleague Frances Woolley:
Part I: Education
Every undergraduate student in labour economics gets told the story of human capital. Education and experience make people more productive. The skills so acquired are called “human capital.” This explains why some people earn more than others, and why some countries are richer than others.
Is human capital theory the literal truth? There is an element of truth in it. The typing skills learnt from Mr. Darby in grade 9 make me more productive than my hunt-and-pecking colleagues. Educating girls reduces fertility rates (pdf), promotes female autonomy, and has a host of other productivity-enhancing benefits. But there are many things that human capital cannot explain.
For example, if what is taught at universities actually makes people more productive, then simply taking university courses should be enough increase earnings. In fact, to get much of a payoff from university education, you have to finish your degree (the “sheepskin effect” ). One reason education pays is that completing a degree “signals” your ability, determination, competence and general stick-with-it-ness.
Perhaps we should think of human capital as a fairy tale, a reassuring bedside story. But the power of fairy tales is that they reflect certain elemental truths about the human condition. People who teach economics may find it deeply comforting to think that their pay is justified by their high levels of human capital.
But human capital is more than a comforting story – it is a myth that shapes our understanding of the world and thus public policy. Ontario’s government is urging universities to increase retention rates, so everyone who starts university completes a degree. If the human capital theory is true, then this is sound policy: more students completing university means more human capital means a more productive economy. If, however, the value of university education is as a signal of ability, then one of the most important things that universities do is fail students. Unless some students fail, the ability to complete a university degree confers no special distinction on the graduate.
Whether or not human capital theory is true determines the best response to the demographic challenges much discussed this blog. If education makes people more productive, then more education can increase the productivity of our economy – possibly enough so that fewer workers are able to support the large number of pensioners. If, however, education is basically about sorting workers – if people are getting more and more degrees in hope of eventually capturing that one elusive stable professional job with benefits – then the best way of responding to the demographic crisis is to scale back post-secondary education. Doing so would effectively increase the size of the working age population substantially, easing demographic problems.
Part II: The experience part of the human capital equation.
To recap: Human capital theory says that education and experience are forms of “human capital” that make people more productive. In part I, I talked about education. What about experience? Does experience actually enhance productivity?
What economists mean by experience is usually time on the job. Up to a point, practicing skills on the job makes you better at your work – I would rather have my surgery done by a surgeon who’s done the procedure 1000 times than one who is doing it for the first time. But some cognitive skills peak in the 20s or early 30s, and most studies find that a worker’s overall productivity begins to decline by 50 or 55.
Physical capital wears out over time, it makes sense that human capital does too. What human capital theory can’t explain is why people’s earnings are often stable or increasing after age 50, or in any event do not drop as rapidly as productivity does. There are lots of economic theories as to why employers might not want to fire or demote older workers – I don’t want to go into them here. But even if it makes sense for a young company at one point in time to pay older workers more than their actual productivity, is it sustainable long-term?
If a person’s pay perfectly reflects his or her productivity, keeping on highly paid older workers is great for the economy, because these workers must be super-productive. If the pay of older workers exceeds their productivity, then keeping on older workers has economic costs. If we want to pay some workers more than they produce, we have to pay other workers less than they produce, because there are only so many economic resources to go around. But anytime there’s a wedge between what a person produces and what he or she gets paid, economic efficiency can be compromised.
Ontario has recently eliminated mandatory retirement. For the self-employed, and workers in many parts of the private sector, the elimination of mandatory retirement means little – as yet. A firm struggling to make a profit will not keep on a worker if he or she is not productive. Without a union or a collective agreement, there is nothing to stop a firm from firing unproductive workers. And let’s face it - for many workers, life at the cottage is much more appealing than life on the job.
University professors, however, were at the forefront of the fight to end mandatory retirement. And for universities, the implications of the end of mandatory retirement are serious. University professors’ salaries continue to increase until they retire, but productivity peaks much younger. It is hard to terminate a professor due to poor performance, so academics generally work as long as they choose. And because being a university professor is so much fun (what other job would allow you to blog at work?), and because the value of university pension funds has declined considerably, the current generation of professors could continue to work well into their 70s.
Universities are facing tough financial times. Government revenues have been squeezed by an economic slow-down, at the same time as expenditures are rising due to the health care needs and demographic entitlements of the first wave baby boomers. Low fertility rates twenty years ago mean there are fewer and fewer potential students to teach. How long can universities afford to protect tenure in the absence of mandatory retirement? What steps will universities have to take to ensure that older faculty members continue to produce and contribute enough to justify their salaries?
I’ve written here about Ontario universities because this is the world that I know. I’d like to hear what people working in other sectors and other places think.
The above is by Frances Woolley.