The motivation for this post largely stems from something that I’ve been looking in my macroeconomics classes. In particular, we’ve been studying Romer, Mankiw and Weil (1992), where they put the Solow model through its paces. Amongst other things, they find a positive correlation between % of child population at school and GDP. It is this result that I focus on in this post.
One inference from this result is that education increases GDP. Specifically, the higher proportion of people that are in education, the higher your GDP level will be. Bear in mind that this isn’t a controversial statement - it makes sense intuitively, and there has been a large amount of academic work on this topic (see here for a comprehensive review of the literature).
But does this mean that governments should strive to make every child go into as high an education as possible? Does it necessarily mean that if 100% of country's young population went to higher education, it will have higher GDP than if only 90% did? A simple model that I’ve tried to construct suggests that this might not be the case.
First, we have to define the role education takes in society, of which there are many theories. The obvious one is that it is an investment for the future (the idea of human capital) - going to school gives you the skills required to do any job. Though this may be true by-and-large, there are other theories put forward as well. An interesting one is that education is a consumption good, meaning that people enjoy learning just like they enjoy going to the movies or eating at a restaurant. Another, and the one that I embrace here, is that education acts a signalling mechanism for employers. Michael Spence (1973) was the pioneer of this line of thinking, and went about characterising it famously in his seminal paper. In discussing the effect of education on economic growth, I develop a variant of the Spence model to express my ideas.
The model
Say there are two types of individuals: ones with high ability and ones with low ability. There are also two types of education: high education or low education By assumption, education works predominantly as a signalling mechanism of ability. As the employer doesn’t know what type of ability an individual is, they can only gauge this by level of education. Thus, the employer can only characterise high education as synonymous with high ability, and low education with low ability.
The table below summarises the model, using two elements, wages and productivity stemming from jobs for the two types of individuals and education levels.
Wages (denoted by the first entry in each cell of the matrix element):
As a result, high ability individuals who have pursued high education are hired into industries where they receive a wage of 4, while high ability people who have low education are hired into industries where they receive a wage of 2 (note that the employer can’t tell they are high ability, so only offers them a low ability job).
A low ability person with high education gives an employer the impression that they are of high ability. This gives them a chance to earn the same wage as a high ability person - 4. Through the vetting process though (interviews etc), some low ability people are found out, and only get jobs where the wage is 2. But some low ability individuals pass these interviews and get a wage of 4. The average wage for them ends up being somewhere in the middle, say 3. Similar to the high ability worker with low education, a low ability worker with low education receives a wage of 2.
Let there be some outside opportunity that ensures not all individuals can enrol in high education. There may be, for example, monetary or family circumstances restricting them from pursuing higher education. This ensures that the signalling mechanism remains intact. (As the expected wage after high education is higher than low education for both ability types, there has to be an outside opportunity or else everyone would pursue higher education, rendering the signal useless to employers.)
Productivity (denoted by the second entry in each cell of the matrix):
Because education solely serves as a signal for employers, no matter how much education someone gets, their ability is the single determinant of which jobs they will be good at. Consequently high ability people will be more productive at jobs requiring high ability and low ability workers will be more productive at jobs requiring low ability. High ability workers can only offer productivity of 4 in jobs that require high ability. Similarly, low ability workers can only offer productivity of 4 in jobs that require low education (and hence low ability). The other productivity entries are 2, signifying the loss of productivity of workers in the wrong jobs.
Intuitively, this could be for a number of reasons. High ability people might, for example, feel demotivated - they know they should be getting paid more, but instead are having to do jobs which they dislike. This could easily lead to a reduction their productivity in these low ability jobs. Likewise, low ability workers just do not have the cognitive skills to be productive in a job requiring high ability individuals, and so can only offer productivity of 2.
It's worth noting here that I am not using the notion of linking wages to productivity, like the vast majority of economic literature does. In fact, as education is purely a signal for ability (and hence productivity), I link wages to the employee's PERCEIVED productivity, gauged by his education level.
So what?
Due to the existence of this wage differential between high and low ability workers, low ability individuals are incentivised to pursue high education in the hope of employers classing them as high ability and giving them the associated job (with the corresponding high wage). As education hasn’t taught them anything meaningful about how to do the job, they aren’t as productive in the jobs requiring high ability as they would be doing a low ability job. On the macro-level, this leads to an inefficient allocation of workers, who are employed in ill-suited industries. This then amounts to a less-than-optimal growth profile for the economy as a whole.
A couple qualifiers
Clearly, this is a gross oversimplification of the distribution of ability and education levels across an economy. There are obviously not just two types of education and abilities. However, as is common in economic modelling, simplifying the problem into ‘bitesize chunks’ or taking an idea to one extreme allows for easier inference of outcomes. Subsequent analysis of the effect of relaxing assumptions also become easier once this is done.
Education is by no means only a signalling mechanism. There are certainly things that I have learnt in university that are useful for any job. But a quick look at the cohort of any graduate class shows that there certainly is an element of signalling in the hiring process. Generally, graduate recruitment schemes do not solely hire from one department in a university that teaches only the specific set of skills required for a job. More often than not, young employees are urged (some even required), to undertake further professional qualifications in their field of work. This, to some extent, shows that employers see education as more than just an accumulation of human capital, but rather a signal of motivation, ability and so on. It is within this context that I think this idea relevant to the debate of economic growth.
The bottom line
As many studies have shown, the returns to higher education is positive. Inferring that increasing student school rates from any beginning level will increase a country’s GDP, I think is taking the prescription too far. Furthermore, it could actually reduce the growth rate of the economy, as workers (hoping to get a higher wage) go for higher education and aim for jobs in industries where they are not well-suited, eventually reducing the economy’s productivity.
I hope to do some further empirical work on this in the future before accepting this theory for something legitimate, but for now, it’s something I think is worth contemplating nonetheless.
Special thanks to Professor Alwyn Young and Tejus Morland for acting as sounding boards for ideas on this topic.
Very interesting thought, I look forward to more on this topic!
ReplyDelete