Summary

Purpose

This report looks at how human capital policies can help achieve “Inclusive Economy” objectives. In particular, it looks at evidence on the following questions:

• What sort of human capital policies would be best for New Zealand to pursue to raise economic growth?
• What human capital policies should it use to improve the distribution of well-being?
• Are these policies the same? In what way do they differ? To what extent is there a trade-off in pursuing these objectives. For example, do they involve competing demands on scarce resources?

Human capital is linked with earnings, economic growth and well-being

“Human Capital” has been defined as “acquired human capabilities, which are durable traits, yielding some positive effects upon performance in socially valued activities”[1]. It has many dimensions, and is acquired through a range of processes, in a variety of settings (family, school, firms and the community).

A wide range of policies may be used to influence its accumulation – though typically most governments in developed countries substantially rely on direct provision, and, more widely, the funding of formal education at all levels. Second order policies include support for families in undertaking the task of raising children, non-tertiary labour market training, adult literacy programmes and certification and subsidy of training provided or purchased by employers.

Over the last 40 years, the human capital literature has established a strong and consistent association between years of education, qualifications and higher earnings. Though less certain, and less robust, an association between human capital and economic growth has also been established.

In addition, education is positively associated with a range of other individual and societal goods – for instance, healthier life-styles, lower propensity to commit crime, higher levels of trust, richer social networks, and greater participation in volunteering and in democratic institutions. Moreover, higher levels of human capital in one generation of families and communities are strongly associated with higher levels in the next.

The literature has not reached consensus as to how much these associations represent causal effects, and how far they represent other causal factors correlated with human capital. There is uncertainty, too, about the extent to which the associations represent “reverse causality” – for instance, countries which grow faster or have higher output per capita, spend more on education. There is also a question about how far the effects on growth found for a larger sample of countries apply to OECD countries – where it is possible that there are diminishing marginal returns to additional average years of education. Moreover, to a greater or lesser extent, the relationship between education and individual earnings may be due not only to the skills and capabilities imparted by education, but also to educational qualifications being used to “signal” innate ability to employers.

Nevertheless, recent empirical studies using better data and methodologies support a growing consensus (see Temple, 2000) that, even for OECD countries, there is a causal relationship between average years of education and the long-run level of output per worker. There is also evidence that, in many OECD countries, there has been a long term rise in the earnings premia accruing to well-educated workers, despite increasing supply of such workers. In a number of countries, this has been associated with a widening dispersion of earnings, particularly over the last 20 years. Likewise, labour economists tend to accept that the association between education and earnings represents real productivity effects, with true annual returns to an extra year of education being in the order of 5–15%.

Human capital is a complement to technological progress

Economists generally conceive long-run growth in output per worker as being due to technological progress. Some economists place particular emphasis on the process of technology creation and adoption as the driver of economic growth. They emphasise the role of experts engaged in industry research and development – though, obviously entrepreneurs and managers capable of adapting organisations to take advantage of technological innovation are also important. Other economists emphasise the importance of a skilled workforce, capable of utilising new “skill-biased” technologies in the workplace. Some, indeed, argue that the availability of such workers induces the creation and adoption of new technologies.

Rapid “skill-biased” technological progress may partly explain a widening dispersion of earnings

Many economists believe that skill-biased technological progress is also the main cause of increasing skill premia, and a widening dispersion of earnings in many OECD countries, particularly over the last 30 years. Analysis suggests that, even with an increasing supply of tertiary educated workers, skill premia are not likely to reduce quickly, and may continue to rise.

In sum:

• High rates of economic growth are likely to require a mix of highly skilled technical specialists, skilled entrepreneurs and managers capable of seeing and putting in place new opportunities for productivity gains, and workers with good, medium-level skills to operate new “skill-biased” technologies.
• The most effective human capital policies to reduce dispersion and improve adequacy of earnings are likely to be those that increase the skills of those in the bottom part of the skills distribution. There is also reason to believe that raising human capital in the bottom of the distribution (as opposed to elsewhere) will have particular benefits for other aspects of individual well-being and a well functioning society.

New Zealand has high rates of participation in tertiary education…

By OECD standards, New Zealand has high rates of enrolment in tertiary education, high graduation rates and also high participation in other forms of adult education and training. As graduates enter the workforce, replacing less educated workers, New Zealand should be able to maintain or even increase its ranking in terms of average years of education in the working age population[2]. Its best graduates are able to enter top universities around the world, and some have successful top ranking careers overseas.

Nevertheless, two areas stand out for further policy development and action. One, improving the quality of selected parts of tertiary education to world-class, is primarily relevant to raising economic growth. The other, raising skills among the less able, while making its main contribution through improving the distribution of well-being, will also raise employment and productivity.

New Zealand has been remarkably successful in rapidly increasing the output of tertiary graduates over the last 15 years, while keeping real government outlays tightly constrained. This has been achieved through bulk funding tertiary institutions on the basis of student numbers, with students expected to contribute a part of tuition costs (able to be financed through student loans). This bulk funding includes an element to cover research – but does not provide strong incentives for excellence in research. Quality assurance systems are designed to ensure tertiary providers exceed minimum standards. The main mechanism to make provision responsive to the needs of the economy is student demand for courses, which in turn is presumed to be impacted by differences in labour market returns to educational investments.