3.1 Elements of the system

The three parts of the framework—endowments, policy settings, and decisions—are inextricably linked. Each factor affecting the earnings benefit is inevitably affected by all three. However, the classification encourages us to consider whether the factors are primarily fixed (endowments), the result of government policy, or private (firm hiring) decisions.

3.1.1  Endowments

The individuals in the economy are endowed with particular opportunities and abilities that influence their human capital and their decisions about investment in it. Disadvantaged groups within society may have fewer opportunities to invest in tertiary education. Similarly, people with a lower aptitude for, or interest in, tertiary education will be less likely to choose to gain a tertiary qualification. [16]

At an economy-wide level, New Zealand is endowed with certain characteristics. For example, it is a small country a long way from other markets. It also has a climate and geography suited to particular activities.

Further, current capital stocks, industrial structure, and expertise can be thought of as endowments to the extent that they have been accumulated over time and reflect the comparative advantages of the past. From the point of view of a potential student, the capital stock and distribution within the economy is exogenous to their decision, which is why we class it as an endowment. In the long run it is also a substitute for labour.

All of these endowments have a strong influence upon the choices of the firms that operate in New Zealand, and consequently upon their demand for tertiary qualified labour.

3.1.2  Policy settings

Government policy and regulation also influence each decision identified. Since the government regulates and subsidises the provision of tertiary education in New Zealand, policy influences both the private cost of education and the number of graduates (eg, through enrolment caps[17]). The government also affects the supply of skills to the labour market via immigration policy, which can compensate for a lack of domestically provided skills.

On the industry side, the government's industrial policies favour some industries over others, which influences the demand for skilled labour. The tertiary return is then determined within a market for labour that the government regulates. The government is also a major employer, which enables it to directly influence the market.

The government also determines the taxation regime, but this effect is directly accounted for in the OECD's indicator.

3.1.3  Decisions

Individuals' decisions begin with the choice to obtain a tertiary qualification. In the labour market individuals are rewarded for providing skills to firms, which can be thought of as the individuals' human capital. Obtaining a tertiary education both builds the human capital of the individual and provides a signal about the skills and endowments that individuals have. Each is important in the labour market and the individual will weigh their expected return to those against the cost of obtaining tertiary education, which is represented largely by the foregone earnings since the direct cost is borne primarily by those already in work via the tax system.

Firms must decide, based upon the market opportunities open to them, what production technology and techniques to use. Entrepreneurs also decide which industry to enter when they form a company. The topic of New Zealand's general economic performance is beyond the scope of this study, but there are aspects of it that directly relate to tertiary returns. In particular, factors that cause skill-biased technological changes such as the relative cost of capital and labour are likely to increase the returns to tertiary qualified labour. In addition, differences in the composition of our economy—our lower share of large firms relative to the rest of the OECD, for instance—may affect the demand for tertiary qualified labour.

In concert, these two sets of decisions form the market for tertiary qualified labour. By setting the wage for tertiary qualifications they determine the gross earnings benefit to graduates, which is the primary determinant of the returns to tertiary education (Figure 2).

It is important to remember that firms are looking for skills, or human capital, as opposed to tertiary qualifications. The qualification itself is partly a proxy measure for the human capital gained, and partly a signal of endowed ability that helps to overcome the asymmetric information in the market. Because qualifications are only a proxy for skills, it is to be expected that there will be some mismatch in a well-functioning labour market between the jobs and qualifications of workers.[18] For instance, a law graduate may work as an education policy analyst using the research, writing, and analysis skills they gained during their law degree. That would register as mismatch on some measures, but may actually be an optimal outcome.

3.1.4  Dynamic nature of the system

The schematic diagram above depicts the process of human capital accumulation and bargaining with firms happening in one direction. In fact, this is a dynamic process with lags and feedback loops.

First, the prevailing wage in the labour market is a signal to people considering investing in their human capital by obtaining a tertiary qualification. Secondly, the strength of the domestic economy is a major determinant of the foregone earnings during study, which influences the decision to study. There are also lags between each of these signals and the entry of the resulting graduates into the labour market because it takes time to complete a qualification. Additionally, the level of human capital in the economy influences the growth of the economy, and consequently the wages paid.

Each of these effects is important when considering the dynamic adjustment of the labour market and the influence of human capital on growth. This is important to bear in mind when interpreting the data and results. What we see in the OECD indicator is cross-sectional data and reflects only the current state. To properly understand what it is telling us requires knowing the historical context and the expectations that people have, based upon current endowments and policy settings.

For example, there are presently a large number of vocationally qualified graduates in the labour force. That is due in large part to individual responses to increased demand for skills, and policies which aimed at encouraging people to gain tertiary qualifications irrespective of level or field of study. Current policy is now more focused on higher level education eg, degree-level. Our analysis has no temporal element and cannot capture these changes, which makes it difficult to say what effect current policy has upon the outcomes observed. That might usefully be the focus of further research.