Pethokoukis, Economics, U.S. Economy

Study: No economy in the world rewards smart, skilled workers more than America’s

Eric A. Hanushek, Guido Schwerdt, Simon Wiederhold, and Ludger Woessmann

Eric A. Hanushek, Guido Schwerdt, Simon Wiederhold, and Ludger Woessmann

A new study adds another interesting wrinkle to the debate about income inequality in the United States. “Returns to Skills around the World: Evidence from PIAAC” by Eric Hanushek, Guido Schwerdt, Simon Wiederhold, and Ludger Woessmann examines the actual literacy, numeracy, and problem-solving skills — rather than completed education years — of workers across advanced economies and how those cognitive and workplace abilities affects earnings. Here are the results:

Existing estimates of the labor-market returns to human capital give a distorted picture of the role of skills across different economies. International comparisons of earnings analyses rely almost exclusively on school attainment measures of human capital, and evidence incorporating direct measures of cognitive skills is mostly restricted to early-career workers in the United States.

Analysis of the new PIAAC survey of adult skills over the full lifecycle in 22 countries shows that the focus on early-career earnings leads to underestimating the lifetime returns to skills by about one quarter. On average, a one-standard- deviation increase in numeracy skills is associated with an 18 percent wage increase among prime-age workers.

But this masks considerable heterogeneity across countries. Eight countries, including all Nordic countries, have returns between 12 and 15 percent, while six are above 21 percent with the largest return being 28 percent in the United States. Estimates are remarkably robust to different earnings and skill measures, additional controls, and various subgroups. Intriguingly, returns to skills are systematically lower in countries with higher union density, stricter employment protection, and larger public-sector shares.

I find particularly interesting the finding that (a) the return to skills is highest in America and lowest in Nordic-land, and (b) returns are higher in economies with more open, private-sector based labor markets. Wouldn’t this seem to argue that higher US inequality — based on pre-tax, pre-transfer market incomes — reflects 21st century market forces rewarding ability rather than some sort of breakdown in social norms? If so, shouldn’t the policy response favor creating, as much as possible, a labor force better and more broadly capable of flourishing in this environment rather than artificially lowering the return to skills and America’s growth potential?

3 thoughts on “Study: No economy in the world rewards smart, skilled workers more than America’s

  1. Fully agree … but the big question is:

    Is Capitalism broken or what exactly has happened to this “fountain of money and growth” to draw such irritation among Wall Street financiers today?

    I personally don’t believe that capitalism is broken but it is a fact that capitalism requires freedom to work. It frankly is not and has never been designed to work in an environment dominated by market controls, regulations, artificial barriers to entry, monetary manipulation, and a myriad of other government interventions. To the extent that these things are present, I am afraid capitalism will appear broken. It is a wonder that what little capitalism that remains can still tug us along the path of progress as much as it does.

    By the same token, it is clear to everyone by now that the US is a more mature economy with lower growth possibilities and decreasing marginal returns. So I guess it all depends on what kind of capitalism we are talking about.

    Modern market capitalism has shifted recently with the domination of money markets and the financial system over the actual trade of goods. In effect you’ll make more money trading in derivatives than actually physically trading in commodities. In short capitalism, or the recent move into financial market dominated capitalism, works very well for a small percentage of the developed world. Bankers, hedge fund managers, derivative traders … and the rest would argue that it works well but having tax payers bail you out when it goes wrong simply means the risk has shifted from corporation to state, or you and me. Many would say that means a broken model.

    The second part is to look at trade…specifically manufacturing. What has happened here is a fundamental shift in where we make things. Corporations have outsourced their manufacturing base to China and India, or, more often than not are Chinese or Indian owned. The garment industry is a classic example of this shift where Bangladesh garment workers make a huge amount of clothing for big Western brands. The effect is twofold, a decline in manufacturing base in the developed world and a reduction in income from industry (direct result is a broadening trade deficit). Another example is car manufacturing where the U.S. ran a trade deficit in 2012. It imported $160 billion worth of cars, trucks and auto parts, while only exporting $81 billion, running a deficit of $79 billion. Add other industries and spread out the time period and it shows a serious problem. Outsourcing also negatively affects ROA as does a shift from manufacturing to a service based economy. Factors that, amongst others, that create a vicious circle of deepening budget deficit. Protectionism is one solution but so is paying everyone in the world a living wage and encouraging people to buy US or British – problem is we don’t make anything anymore.

    Again the state has to fund the deficit by borrowing. Add to this the byproduct of modern market capitalism. Pollution, decimation of fish stocks, land grabs, reduction in health and safety, poisoning of land, massive waste, lack of sustainability, open cast mining, the pushing out of small independent retailers by big box retailers, tax evasion, fraud, illegal dumping and removal of workers’ rights are all expensive byproducts the state has to pick up or irreversible shocks to the ecosystem, none of which are taken into account on a profit and loss sheet. As a fair and effective way of trading in goods capitalism is definitely broken, as a way of making a small elite incredibly rich it’s as utopian as you can get.

    Bottom Line: I believe Capitalism is still alive and well. It is based on Competition, Progression, Innovation, and Advancement. And it rewards those who are willing to take the risk. We should all have the right to take a risk and win…or lose everything … this in theory. But in reality, when the “new Capitalism” is based on mathematics rather than trade; credit default swaps over goods and services; when odds are stacked in the favor of big banks because of hedging, derivatives and CDS’s; when there is little to no penalty for market manipulation by investment banks, power brokers, ponzi schemers…these inefficiencies in the market cause redistribution of wealth to the people in power who design the system.

    Market inefficiencies like greed, fraud, and manipulation aren’t factored in with philosophical debate on whether capitalism works or not. And because some economics students (and certainly the big banks) would say that we must leave the market unregulated, and that capitalism wasn’t “designed to work in an environment dominated by market controls, regulations, artificial barriers to entry, monetary manipulation, and myriad other government interventions” the theft, manipulation and scheming will continue.

    Had the government not “intervened” some three years ago with the collapse of the financial system, most major banks in the US would have gone under…by their own hand.

    So I guess the answer to the question ” What is wrong with Capitalism Today? ” is dependent on who you ask. If you ask Goldman Sachs, they may give a different answer than if you ask the people picketing Wall Street.

    Capitalism works for capitalists. Problem is 90% of Americans are not capitalists, they are employees. Most of their ‘capital’ is tied up in housing, the rest in non-performing stocks. Median household net worth is the same now as in 1990 — $77,000. Since 1979, average income of the bottom 90% declined $900, while that of the top 1% increased $700,000.

    We are quickly reaching the tipping point where growth in GDP in any particular country comes at the expense of growth in GDP of another. We do not have global organizations capable of managing these tension points nor are societies willing to curb growth and consumerism. Capitalism as currently practiced is simply not sustainable.

    What do you say?

  2. I would just question the inherent assumption that return on skills equals growth potential.

    With regards to the US, I can see two reasons why there is such a stark return. First, that being low on the skills totem pole can be pretty lousy and lead to a lot of low-wage retail-type jobs. Second, that the cost to accquire those skillsets in the US is enormous so people will have to be paying off those debts for many years meaning the “true” returns may be much lower than indicated.

    All-in-all, this seems to be more just a basic measure of inequality than economic growth potential. Keep in mind, in all cases there is an economic incentive to be more skilled it’s just a question of how much the difference is from being less skilled.

    So yes, markets obviously reward higher skilled people more but the inherent question from a public policy standpoint should be how much more. Too much means you are going to leave a good chunk of society behind and too little may mean not enough incentive to produced a highly skilled workforce (though that certainly seems very debatable from these data).

  3. Two things grazed upon, but not fully addressed here:

    1. The costs of gaining qualification to enter into the labor market in the U.S. are significantly higher than in many other (union-burdened) labor markets. To gain the skills necessary to attain a higher level of income, one must also assume student debt that is unheard of in Scandinavian countries, for instance. The lifetime “Black Friday” (the point at which you have moved from being in the red to being in the black in the form of solvency) is much later for the average American, house mortgages notwithstanding. And that’s also not addressing the disparity in the burden of healthcare costs.

    2. The numbers in the graphic above are a mean based on the aggregate. It is very well known that the return at the upper end of the scale is disproportionately higher than even those found in the middle. This skews the mean upward. If you happen to be someone in finance or another high paying career field, you can become quite rich. Your ability to turn a 6-figure salary into a personal fortune drowns out groans from those earning barely enough to meet expenses (or not). Even those in the $30K – $100K range (being generous here) will largely still have to contend with the costs from item #1 for the privilege of qualifying for skilled work if they get there via post-secondary education, which means that whatever their earnings, a big chunk never makes it to their personal estate.
    By contrast, even lower-middle income workers in more tightly regulated labor markets are able to begin amassing a personal estate via savings. For all the economic shifting going on, the US only outpaces Japan in personal savings among OECD countries (

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