Part Three  Human Capital, Economic Growth and the Distribution of Income

Skill-biased technological progress is an important driver of economic growth and partly explains a widening dispersion of income in some countries

Parts one and two together suggest that:

• There is reasonably strong evidence that skill-biased technological change has played a strong role in economic growth in developed economies over the last 70 years, and, at least over the last 25 years, has played a significant role in the widening of the distribution of income in a number of countries[35].
• The relationship between skill-biased technological change, economic growth and the distribution of earnings is complex, and influenced by a range of factors. Much will depend on the circumstances of particular countries: the sectoral structure of their economies; the way in which their industries are organised; labour market regulation and welfare policies; the nature of formal and informal education and their linkages to industry; and the quality and distribution of the existing stock of human capital. In addition, increased supply of skilled labour may, itself, induce further technological change. Countries show marked differences in both growth patterns and the trajectory of income inequality over time[36].

Countries with a wide dispersion of skills are likely to experience a widening dispersion of earnings in the face of rapid technological change

• All else being equal, it is likely that the faster the pace of skill-biased technological change, the more likely there will be a widening dispersion of earnings.
• Countries that utilise a high-skill/low-skill mix of labour inputs (see Broadberry, 2000) are likely to be more vulnerable to a widening dispersion in the face of rapid skill-biased technological change. This is partly because the current level of human capital in families and communities has a strong effect on formation of human capital in the next generation. Similarly, much human capital is formed “on-the-job” – people who have only worked in low skilled jobs will have a weaker base from which to adapt to new skill-biased technologies.
• An important issue for New Zealand is that it is a small, open, middle-income country, competing in an international market for highly skilled labour. To an extent, earnings at the top of the distribution of skills are likely to be set externally, irrespective of the numbers of skilled workers produced locally.

Technological progress requires a mix of highly specialised and general skills

• Technological progress drives growth, and seems to require at least the following types of capabilities (aspects of which are not acquired primarily through formal education):
  1. People who have the high technical skills (in the appropriate areas) and creativity to create or adopt new technologies – and behind this, people who have high levels of generic skills that will enable them to learn efficiently specific technical skills demanded by emerging technologies;
  2. People with the required entrepreneurial and management skills to identify opportunities, organise the financing of investments, and design and manage new ways of organising to make optimal use of new technologies;
  3. People with the skills to operate the new technology and to work effectively in the new forms of organisation. While there is evidence that cognitive skills have become more important, a range of other skills and qualities are also important, including the ability to work in teams, to problem solve, and to be adaptable.
• On the other hand, the most effective human capital policies to address income adequacy and income distribution concerns are likely to be aimed at raising the skills of people in the bottom part of the distribution of skills.

Raising skills in the bottom part of the distribution will reduce pressures on other policy instruments

In addition to direct effects on well-being, improving skills to address distributional concerns will reduce the need to use other instruments (such as income transfers, labour market regulation, and taxation) which appear to have adverse effects on economic growth over the longer term[37]. As Part Four discusses, raising skills at the bottom will likely have other positive effects on social functioning that may also have indirect effects on economic growth.

Comparisons with other developed countries will help guide where New Zealand should put its effort

If the best human capital policies to improve the production of skills for growth are different from those to raise incomes for those at the bottom of the distribution of skills, and each require large amounts of extra resources, then clearly there will be a trade-off. The trade-off might be evaluated in terms of contributions at the margins to productivity and economic growth, but other effects on well-being and equity objectives also need to be considered. One guide to evaluating these issues are comparisons of levels and distribution of human capital across similarly developed countries. Part five will consider how New Zealand compares with other OECD countries in these respects.