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The Value of an Educated Workforce: A Comparison of Growth and Inequality Across Countries

Better educated workers earn higher wages. It is commonly assumed that this so called return to education reflects the fact that more educated workers are more productive at their jobs. “If this is true, and if markets work well, then we would expect the social return to be equal to the private return to education”, says Barcelona GSE Affiliated Professor and CREI Researcher Thijs van Rens, meaning that it must be equally beneficial for a country to raise the average education level of its workforce as it is for an individual worker to obtain a higher level of schooling.

In reality, earlier studies have found evidence of only very small effects of increases in countries’ education levels on GDP growth. The literature points to a relationship between education levels and GDP growth across countries, but indicates no effect of changes in education on changes in GDP. These results have led some researchers to believe that more educated workers might not be more productive at all.

Professor van Rens developed a model to describe the evolution of the private and social return to education and used it to estimate the return to education from cross-country data on growth and inequality. The results, developed jointly with Coen Teulings (CPB and Tinbergen Institute), are presented in their paper “Education, Growth, and Income Inequality”, to appear this February in The Review of Economics and Statistics.

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The Review of Economics and Statistics

The intuition behind the model is very simple, says Professor van Rens: “Raising the average education level makes low-skilled workers scarcer, which increases their wages. At the same time, it increases the supply of highly educated workers, effectively lowering their relative wages. As a result, the return on education becomes smaller. This so called compression effect, allows us to retrieve the private return to education from data on income inequality. We then estimate the social returns from a modified growth regression and compare the results.”

The estimates indicate that the social return to education is very similar to the private return in the short run. In the long run, however, the social return to increasing the average education level in a country by one year is much higher than in the short run. The researchers do not observe a similar difference between the long and the short run for the private return. These dynamic effects explain the puzzling findings in the existing literature.

Specifically, the results indicate that an average worker in an average country that went to school for 7 years earns about 14% more on her first job than another worker that dropped out after 6 years in school in her first job. Twenty years later, the difference between their wage is still about 14%. Increasing the average education level of the entire workforce in an average country by one year increases that country’s output by about 8% initially, suggesting the social return is similar to or even a bit lower than the private return. However, eventually the extra year of education raises that country’s output by as much as 42%.

These findings suggest that workers that acquire an additional year of education provide positive externalities for the rest of the economy. The specific mechanism for these externalities put forward in the paper is endogenous technological progress. A more highly educated labor force is more likely to develop or adopt new technologies, which lead to higher growth and benefits all workers. Such externalities provide a reason for government intervention.

“Since individual workers do not reap all the benefits if they go to school a year longer, they acquire less education than is optimal for the country as a whole,” says Professor van Rens, “Thus, by subsidizing education, the government fosters higher growth and welfare. But our estimates also show that it may take several decades for these additional benefits to realize. Thus, investing more in education is a sensible policy for a government that cares about the well-being of future generations.”

About Prof. van Rens

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GSE Affiliated Professor Thijs van Rens in his office

Thijs van Rens is a junior researcher at the Centre de Recerca en Economia Internacional (CREI), Assistant Professor at the Universitat Pompeu Fabra, and Affiliated Professor at the Barcelona Graduate School of Economics. He received his PhD in economics at Princeton University in 2005, and has visited the European University Institute in Florence as well as the University of Chicago. His main fields of interest are macroeconomics and labor economics, with a research focus on business cycle fluctuations on the labor market.

 

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