Saturday, September 23, 2006

Young And Over-Educated In Sweden?

by Edward Hugh

Well its been a quiet week over here at DM, and today is a grey drizzly day in Barcelona, so lets try and liven things up a bit with a (somewhat) controversial post.

It is curious to watch how some ideas which are rather badly thought out sometimes gain an acceptance and a status which they hardly merit. A classic case in my book is the Goldman Sachs idea of BRICs (this is ill-thought-out since Russia is very different from the other three, and it would be more coherent to have BTICs, substituting Turkey for Russia. We could then develop the parallel concept of the IRs - energy-rich non-democracies with serious problems: Russia and Iran). But another case in point (and it is the relevant one for this post) emanates from a McKinsey report which came out in the summer which was entitled Sweden's Growth Paradox.

Now first it is important to take note of the fact that McKinsey have a lot which is very much to the point about Sweden in the report, especially related to sustainability in the conext of population ageing:

Second, demographic change will put Sweden's public sector under intolerable pressure unless its productivity improves. An aging population will require more welfare services—paid for by taxes levied on working-age people, whose share of the population is falling—and technical developments in health care constantly increase the demand for it. If nothing else changes, the resulting increase in welfare costs would become too large to finance through the current tax system in only 10 to 20 years. Even our base case scenario indicates that the municipal income tax rate would rise to roughly 50 percent over the coming 20 to 30 years, from about 30 percent today, unless productivity rises. Since the taxpayers are hardly likely to accept such an increase, the quality of public welfare and health care services would have to decline.

So I want to be clear: Sweden obviously needs reform, this is not at issue here.But in this post I want to focus on one simple theme (or meme) in the report (For a review of some of the recent blogsphere 'noise' on Sweden in this context, see postscript). Essentially the idea in question is the following one:

Overall Sweden's inability to create new jobs has a negative effect on economic development and creates a growing de-facto unemployement. Today more than 15% of the able working population is without full employment. This includes students who want to work but remain at university since they cannot get a job, part-time employees looking for more work, and people who are on sick-leave or early-retirement above and beyond the levels seen in and around 1970.
Extract From: Sweden's Economic Performance: Recent Developments Current Priorities Synthesis, May 2006

Basically McKinsey suggest that there is a big market imperfection in the way young people in Sweden take choices about education, and essentially young Swedes are getting too much education. This idea is a widely accepted one, and none other than RGE Monitor's very own Brad Setser recently argued something similar in an Afoe thread:

I would say neither the US or France has produced enough jobs -- and certainly not enough jobs that match the wage expectations of their native-born population -- over the last few years, despite a similar housing boom. in france that shows up in persistently high unemployment rates, and, i suspect, in a tendency to stay in school a bit longer than is required just to create human capital (lots of folks seemed to do several DEAs while looking for a job back when I studied in france). In the US, this shows up in a falling employment to population ratio.

Now the interesting thing here is the idea of 'over-education'. This would seem to be a rerun of the young and ’overeducated’ argument first run by Lester Thurow some years back (I suspect it may also be connected with Easterlin’s version of cohort theory). The thought would seem to be that in unfavourable labour market conditions, young people in a 'challenged' cohort may be encouraged to continue their education by the difficulties of finding a job.

Now this interpretation may have had a certain validity in the US in the 70s (and in the presence of the boomer generation) but it isn’t clear that it is the case in Europe today where there are small and not 'boomer' cohorts. One of the problems is that no-one really knows how much education you need. US thinking seems to veer towards the lower end of the band, and to then - given the uncertainty - let the markets decide the rest, but as people from Paul Romer to Alan Greenspan have been arguing, the market mechanism seems to be resulting in an under-educated US population, heavily dependent on importing qualified labour.

I think this is to get thinks the wrong way round. What we may have in operation in Europe today is the confluence of two market imperfections which in combination may, via the law of unintended consequences, just serve to cancel each other out. The first imperfection undoubtedly comes from rigidity in the labour market, and the other from a time consistency problem in the way in which a well-functioning market would determine the level of education needed in the context of declining age cohorts.

Let me explain.

Basically in the US and in Europe what is currently being widely proposed is a model of skilled inward migration. This, I think, is a mistake and leads to the sort of resentment towards immigarnts that Nandan is worried about.

If we want to correct (in the short run, in the long run this will be impossible) imbalances in the population pyramids, what we need are lots of unskilled migrants. So one reform that is badly needed in many parts of Europe is an institutional one, which makes this possible, and which facilitates a massive expansion of relatively low wage employment.

OTOH what is also needed is reform in the educational system which means that young people in developed economies get a better eduction, and are thus well-placed to take advantage of the supply-side push created by the migrant influx and which will have a demand-side impact as people are needed further-up the value pyramid.

This kind of migration is much more sustainable, since the local population can clearly see themselves to be beneficiaries.

If you don't have this 'dual' process, then you risk having the kind of problem which exists in Italy (see this post) where according to the OECD:

Compared with other OECD countries, an above-average proportion of the Italian population has only lower-secondary education. This is especially true for older age-groups, but it is also true for younger ones. Forty per cent of 25-34 year-olds are in this category compared with an EU and OECD average close to 25%, and the results of the OECD Programme for International Student Assessment (PISA) show that Italian 15-year olds have attainments well below the average in particular in mathematical and problem-solving skills. There is a high proportion of youth which is in neither education nor the labour force, suggesting a difficult school-to-work transition. The risk of unemployment later in life is also considerably higher for those with only lower secondary education.

Furthermore, a smaller proportion than the OECD average has completed tertiary education, even though a relatively high proportion embarks on it. Years spent in obtaining an undergraduate degree are greater than the average, raising the opportunity cost of tertiary education and discouraging the formation of high level skills. The demand for high-skill workers may be hampered by the specialisation of Italian industries in low tech sectors and the small size of Italian firms, which reduce their R&D spending capability. At the tertiary level, a problem is an insufficient number of younger professors, for whom there are barriers to entry. Academic appointments lack transparency, promotion is not always linked to productivity, and Italy spends far less than the OECD or EU average on research and development, and significantly less on tertiary education. As a consequence Italy suffers from a pronounced net brain-drain.


So what we need to think about here is sustainability, demographic sustainability, social and political sustainability, and economic growth sustainability. Effectively what I am proposing is a new model for migration, and one which puts up-front the real needs of the developed economies. If this path is not followed then what we risk is a permanent drift down the value chain, as the scarce resource (young people) is over-priced in under-performing activities (someone has to care for the growing number of young people, and look, for eg at the growing importance of the health sector in the US economy). This creates, of course, a growing sense of frustration and increasing inequality, and a permanent feeling that what we have is a weak labour market, rather than the reality which is, of course, a shortage of young people.

Postcript: There has been a lot of commentary around the blogs over the last week on the change of government and the need for reform in Sweden. New Economist has given some pretty thorough coverage (see here, and here, and here), while my Afoe co-blogger Emmanuel has a rather different take, and indeed links to an article in the Economist which cites - guess what - the Mckinsey report. Also Mark Thoma recently had a post on Economists View which is not entirely irrelevant to the point at issue here. Basically the quality of education received by large sections of the US population needs to be improved, so it isn't only Sweden which is in need of reform.

8 comments:

ramki830 said...

Am i right in saying that life expectancy(LE) also has a role in deciding/influencing the overeducation factor in Sweden? I beleive that Scandinavian nations have one of the highest L.E at birth and could this be influencing the citizens to stay longer in university???

joeimp said...

I believe that the costs of post-secondary education are a critical factor in determining how many people get University degrees, and how long they stay in University.

Is it a coincidence that two of the OECD nations that have the highest percentage of post-secondary education expenses coming from private sources, the US and Japan, also have two of the largest and strongest economies in the planet? No. Overspending by governments on education leads to delayed reproduction and labour market distortions - i.e. overeducated workforce. This leads to a weak economy. The US and japan seem to have the right idea - let the private sector take care of most post-secondary education expenditures.

I believe that governments need to reduce spending on post-secondary education. Is your view similar, or are you looking at government spending on post-secondary education as something that has a unique optimal setpoint in each nation, with the setpoint determined primarily by demographics?

Edward said...

Ramki,

"Am i right in saying that life expectancy(LE) also has a role in deciding/influencing the overeducation factor in Sweden?"

You are absolutely in the right ballpark here. Simple investment theory (like eg Becker) suggests this, a trade-off between quantity and quality, and reproduce-now/reproduce-later. The first is about the number of children and the second is aboutr when you have them (ie how much investment goes into each child for how long). Clearly living longer healthier lives means that there is a higher return on an initial investment, and also that it is worth investing more.

There is also the question of moving up the value chain, and the growing skill bias of technology. So better prepared children can earn more over the longer haul. This is simple economics, though few seem to recognise it.

Edward said...

Hello Joe Imp

I appreciate your views although I don't agree with them.

"Is it a coincidence that two of the OECD nations that have the highest percentage of post-secondary education expenses coming from private sources, the US and Japan, also have two of the largest and strongest economies in the planet?"

Well, I'm afraid your initial point of departure is flawed. You need to take a long hard look at Japan. Japan does not have one of the strongest economies on the planet. Japan has been in an economic crisis since 1989, and has been comparatively shrinking since then.

It also has a chronic deflation problem, which is still not, IMHO, resolved. This deflation problem is associated with having an ageing population, and a consequently weak internal demand structure (increased relative saving to consumption). Japan is the classic case of why I got interested in all this.

There is a simple test coming: Japan's recent recovery will not be sustainable, it is China and US driven, and as and when these two economies slow, Japan will slip back into deflation (if, with the recent drop in oil prices it isn't already doing so).

This wasn't the main point of your comment I know, but I think unless you start to get to grips with what is actually happening in the rest of the world you will be at sea without a rudder.

You express a view which is very common at present among US economists. Unfortunately it is largely an ideological one (markets are the key) and is in many ways now well behind the curve.

You see the basic and fundamental market failure is that popuations don't reproduce themselves (at least not outside the US they don't, and we have had all sorts of arguments here about why this should be).

So this is the mother of all market imperfections, in the shadow of which all the rest fades into near-trivia.

You see, according to neo-classical growth theory:

Y = A f(K,L).

This is the simplicity of Solow's brilliant insight.(A here is technology, which is ultimately neutral, since via market clearing and convergence, others ultimately catch up).

Now if we look at this from a supply side point of view, what you need is labour and capital (savings).

In low-fertility ageing societies the latter becomes scarce, and the former plentiful.As a result global interest rates hit rock bottom, which is a phenomenon we have all been seeing of late.

Given that labour is scarce it is sound economics to invest more in it, and this is what is happening in some of these low-fertility societies. They have few better-prepared children. As a result they need migrants as a complement. This is the only really big change Sweden needs to make, to open the doors to unskilled workers from across the planet. With all those well prepared young people, and the highly efficient global MNC structure they have, growth would be assured. All the debate about the social model is largely off-topic here. What they need to do is flexibilise the bottom end of the labour market.

Now I know you don't agree with the way I am putting this - we have here to some extent culture clash - but I would ask you to try and see what I am getting at.

"I believe that the costs of post-secondary education are a critical factor in determining how many people get University degrees, and how long they stay in University."

Well, if you recognise this, then you need to think, how will a poor country like India get its labour force onto a level where it can compete with the US? Only by massively subsidising education I think, since people in India find it hard to pay for MBAs at Stanford.

Markets are important, but on their own they cannnot equilibrate something which is badly out of equilibrium, not to say stuck in a 'trap'.

This is the whole issue.

"Overspending by governments on education leads to delayed reproduction and labour market distortions"

No! I hold exactly the opposite view. The inherent skill-bias in the rapidly evolving new technologies (coupled with the life expectancy/investment theory component Ramki mentions) is what makes it necessary to delay reproduction in order to be able to raise the lifetime earnings profile.

Early reproduction normally puts you nearer the unskilled pole. I believe that this situation is producing all the inequality in the US which is the cause of the current debate there. Basically the early-reproducers are much more subject to the process which Roach calls global labour arbitrage, and their wages will (relatively) trend down.

Also you need to think about life expectancy in the US. It is significantly lower than in most other developed economies. This relatively shorter life outlook may be influencing investment decisions in education.

So you may have a bad equilibrium, and in the longer run you need to correct to maintain your standard of life. This, I take it is what Romer and Greenspan are on about.

Edward said...

ramki

Maybe you could mail me at the DM address, that way we would be in tuch.

joeimp said...

edward:

Thanks for your lengthy response. I have much to learn about demographics and I appreciate your comments.

When things get into the ideological realm, I find it best to look at the empirical evidence.

"Well, I'm afraid your initial point of departure is flawed. You need to take a long hard look at Japan. Japan does not have one of the strongest economies on the planet. Japan has been in an economic crisis since 1989, and has been comparatively shrinking since then."

I thought Japan and the US had the two highest GDPs of OECD nations. You are more pesimistic on the Japanese economy than I am.

"You see the basic and fundamental market failure is that popuations don't reproduce themselves (at least not outside the US they don't, and we have had all sorts of arguments here about why this should be)."

Perhaps I am banging my head against a wall here because it seems as though many have tried to figure out the US exception and have not sorted it out to their satisfaction. But I am convinced that there is a public policy rationale for the "US exception". I am still working on it in very rough terms, but I am leaning towards the lower degree of urbanization in the US than in other OECD nations (I need to research this because I am not sure that it is true). Interest rate tax deductibility in the US provides an incentive for new home construction (predominantly suburban and rural) in the US -> surplus housing leads to lower marginal cost of reproduction.

""Overspending by governments on education leads to delayed reproduction and labour market distortions"

No! I hold exactly the opposite view. The inherent skill-bias in the rapidly evolving new technologies (coupled with the life expectancy/investment theory component Ramki mentions) is what makes it necessary to delay reproduction in order to be able to raise the lifetime earnings profile.

Early reproduction normally puts you nearer the unskilled pole. I believe that this situation is producing all the inequality in the US which is the cause of the current debate there. Basically the early-reproducers are much more subject to the process which Roach calls global labour arbitrage, and their wages will (relatively) trend down."

I was under the impression that the balance between skilled and unskilled workers in the US was one of the reasons behind their economic success. As the prominent pundit Mark Steyn put it - (I paraphrase) in Germany far too many go to University for free untiil they are 36. They eventually work a bit, but spend most of their time lobbying for 20 hour work weeks, and then retire at 43 - childless and hanging out at cafes.

"Y = A f(K,L).

This is the simplicity of Solow's brilliant insight.(A here is technology, which is ultimately neutral, since via market clearing and convergence, others ultimately catch up)."

I am very familiar with this equation... Are you conflating technology with education? If you feel that market clearing and convergence spread technology (which I fear that you consider education to be a proxy for), then why invest in it as a government? Copycats will spread the technology.
But I don't believe that. There is evidence that government R&D crowds out provate sector R&D.

Unfortunately I must go but I hope to provide a reasoned response to your post in the near future.

thanks

Edward said...

Hello again joeimp:

"I thought Japan and the US had the two highest GDPs of OECD nations. You are more pesimistic on the Japanese economy than I am."

Well lets leave the US aside, since I think we have no real issue here, but Japan is a much more complex situation. Since the crash in 1989 there have been all sorts of explanations for what has been going on there, but I think it is safe to say that there is a consensus among economists that all has not been well there, where we (the economists) differ is on the interpretion of this.

Many now believe that Japan has 'finally' recovered. I have serious doubts about that, and I think the next twelve months will be very revealing.

Martin Wolf, who is an economist I respect, has this rather intriguing statement in today's FT:

"To doubt the resilience of the world economy must now look perverse. Since 2000, it has overcome so many obstacles: post-bubble traumas in Japan, bla, bla, bla"

The point is, which bubble are we talking about here, the internet one? I think not. The bubble Wolfe is referring to is a stock market one which burst in 1989. Now all of this is to say the very least strange, since we are now in 2006, and it isn't normal for economies to be having bubble hangovers 17 years after they burst.

So I think some attention to why is at least merited, and that people's interpretations of Japan should be at least measured by how seriously they address this.

Personally it was reading a piece by Krugman (back in the late 90s) which attracted my interest in Japan, and lead me to start this long journey thinking about demography.

"When things get into the ideological realm, I find it best to look at the empirical evidence."

Of course, I think we wouldn't disagree here. I am very much influenced by Popper's idea of scientific methodology, and falsification tests. If Japan should really recover then I think I would have to accept that I was going wrong somewhere along the line. But if it doesn't, and especially this 'n' th time round the block, then I think it is rather incumbent on those who have been saying the contrary to do the rethink.

"But I am convinced that there is a public policy rationale for the "US exception"."

Surely public policy plays a part, I wouldn't doubt this.

"but I am leaning towards the lower degree of urbanization in the US than in other OECD nations"

Interestingly low fertility does correlate pretty well with increased urbanisation. This is normally thought to be produced by increased economic clustering, but as you say the US may have a lower density, and this wouldn't at all a simple question of land availability, since in France there is no shortage of land (eg).

"I am very familiar with this equation... Are you conflating technology with education? If you feel that market clearing and convergence spread technology (which I fear that you consider education to be a proxy for), then why invest in it as a government?"

Well education would be one aspect, but I am using it in a much more generalised catch-all sense. I am including eg capital market structure and corporate organisational methodology too. Take ICT. There is no doubt that the US was the first to gain the advantage here. But you could use a Schumpeterian model and say that part of the 'super productivity' that the US got was simply a kind of rent while the others did the copy-cat act. Certainly it is unrealistic to imagine that the EU and Japan won't (or aren't) leverage (or leveraging) ICT just as effectively as the US has done once they see how to do it.

The same for ways of raising capital. Europe also now has quite wide and deep capital markets, and I don't think shortage of capital is a problem in Japan. So the leader has to continually run faster to stay out in front, and this is fine.

"then why invest in it as a government?"

What I am getting at is a supply side issue. Let's stay non-ideological for a moment, and do a Popperian type 'thought experiment'. At present, as we know, the US has to import a significant part of its skilled human capital. It attracts this human capital because of the high economic growth and living standards.

Now just imagine (I said imagine) that one day India and China overtake the US. What happens next?

Well the global skilled labour supply starts to head towards India and China, that's what happens. And this would be what we would want, since this would mean that markets were working well. But where would that leave the US? Short of skilled human capital I guess.

In theory you should be happy with that outcome, since the market would be king. But would you really be
happy?

Basically economics isn't national economics, it is universal, and if we want an optimum level, then this should be a global optimum, not a local national one.


Think about it.

Edward said...

A little late in the day maybe, but I thought a little real life case study might be useful as an illustration of what I mean here. Take the case of my friend Ernest Orts. Ernest is a talented young Jazz musician in his late 20s. You can find him here:

http://www.tomajazz.com/clubdejazz/jazzpana/orts_ernest.htm

Now to many external observers Ernest appears to spend a lot of time doing 'nothing'. Barcelona has a lot of people like this. But from all this doing 'nothing' he may one day become a world class jazz musician, or maybe he won't, the only thing he knows is that he has to try.

Ernets writes to me to practice his English, in this mail he expains the three levels of his life:

Let me try to explain to you my different “levels” in life, in the same way you were talking about this in the bar.

The first level of my life consists of doing something to earn money to eat and to maintain my home and my deal with the bank. I’m sure you know what I mean.

In order to do that I work in a Conservatory, as you already know. I’m lucky because most of my friends who were studying music ten years ago are now working in private schools and earning less money than a “cleaning person”. Well, I know to be able to work in a Conservatory you have to excel and to pass a very difficult test. And I’m also very happy because the Generalitat has just approved a new project I proposed to teach in the Conservatory. It is a collective-theorical-practical jazz subject. I am able to do this because I studied this approach in France some years ago. As far as I’m concerned nowadays it is necessary to spend time doing and improving and learning a lot of things, all them in a precise way, all them with discipline, to become a complete person and to be able to go into the labour market.

Besides, I often play in Jams, and rarely I play concerts. Just a few concerts, but good ones, and ‘well paid’ ones as well. This needs a lot of work at home and some rehearsals too. That would be the second level in my life.

The third one encapsulates a lot of things. Swiming, listening to a lot of music apart from my current work, and last but by no means least, writing to you and trying to improve my English, because I love travelling, apart from the need to learn languages and to apply them in life. My objective now is to become a four-languages-speaker, and to achieve the same level in Catalan, Castellano, English and French.