Why do most workers with college degrees earn so much more than those without? How does a nation’s education system relate to its economic performance? Knowing how education and training interact with the economy can help you better understand why some workers, businesses and economies flourish, while others falter.
As the labor supply increases, more pressure is placed on the wage rate. If the demand for labor by employers does not keep up with the supply of labor, the wage rate will be depressed. This is particularly harmful to employees working in industries with low barriers to entry for new employees, i.e. they do not have high education or training requirements. Industries with higher requirements tend to pay workers higher wages, both because there is a smaller labor supply capable of operating in those industries and the required education and training carries significant costs.
How Education Benefits a Nation
Globalization and international trade require countries and their economies to compete with each other. Economically successful countries will hold competitive and comparative advantages over other economies, though a single country rarely specializes in a particular industry. This means the country’s economy will include various industries with different advantages and disadvantages in the global marketplace. The education and training of a country’s workers is a major factor in determining just how well the country’s economy will do.
A successful economy has a workforce capable of operating industries at a level where it holds a competitive advantage over the economies of other countries. To achieve this, nations may try incentivizing training through tax breaks and write-offs, providing facilities to train workers, or a variety of other means designed to create a more skilled workforce. While it is unlikely an economy will hold a competitive advantage in all industries, it can focus on a number of industries in which skilled professionals are more readily trained.
Differences in training levels have been cited as a significant factor separating developed and developing countries. Although other factors are certainly in play, such as geography and available resources, having better-trained workers creates spillovers and externalities. For example, similar businesses may cluster in the same geographic region because of an availability of skilled workers (e.g. Silicon Valley).
Employers want workers who are productive and require less management. Employers must consider many factors when deciding whether or not to pay for employee training.
- Will the training program increase the productivity of the workers?
- Will the increase in productivity warrant the cost of paying for all or part of the training program?
- If the employer pays for training, will the employee leave the company for a competitor after the training program is complete?
- Will the newly trained worker be able to command a higher wage? Will the worker see an increase in his or her bargaining power?
While employers should be wary about newly trained workers leaving, many employers require workers to continue with the firm for a certain amount of time in exchange for the company paying for training.
Businesses may also face employees who are unwilling to accept training. This can happen in industries dominated by unions since increased job security could make it more difficult to hire trained professionals or fire less-trained employees. However, unions may also negotiate with employers to ensure its members are better trained and thus more productive, which reduces the likelihood of jobs being shifted overseas.
Workers increase their earning potential by developing and refining their capabilities. The more they know about a particular job’s function, or the more they understand a particular industry, the more valuable they become to an employer. Employees want to learn advanced techniques or new skills to vie for a higher wage. Usually, workers can expect their wages to increase at a smaller percentage than the productivity gains by employers. The worker must consider a number of factors when deciding whether to enter a training program:
- How much extra productivity would he or she expect to gain?
- What is the cost of the training program? Will the worker see a wage increase that would warrant the cost of the program?
- What is the labor market like for a better-trained professional? Is the market significantly saturated with trained labor already?
Some employers pay for all or a portion of the expense of a program, but this is not always the case. In fact, the worker may lose wages if the program prevents him or her from working.
For the Economy
Many countries have placed greater emphasis on developing an education system that can produce workers able to function in new industries, such as those in the fields of technology and science. This is partly because older industries in developed economies were becoming less competitive, and thus were less likely to continue dominating the industrial landscape. Also, a movement to improve the basic education of the population emerged, with a growing belief that all people had the right to an education.
When economists speak of “education,” the focus is not strictly on workers obtaining college degrees. Education is often broken into specific levels:
- Primary – elementary school in the U.S.
- Secondary – middle school, high school, and preparatory school
- Post-secondary – university, community college, vocational schools
A country’s economy becomes more productive as the proportion of educated workers increases since educated workers can more efficiently carry out tasks that require literacy and critical thinking. However, obtaining a higher level of education also carries a cost. A country doesn’t have to provide an extensive network of colleges or universities to benefit from education; it can provide basic literacy programs and still see economic improvements.
Countries with a greater portion of their population attending and graduating from schools see faster economic growth than countries with less-educated workers. As a result, many countries provide funding for primary and secondary education to improve economic performance. In this sense, education is an investment in human capital, similar to an investment in better equipment. According to UNESCO and the United Nations Human Development Programme, the ratio of the number of children of official secondary school age enrolled in school to the number of children of official secondary school age in the population (referred to as the enrollment ratio), is higher in developed nations than it is in developing ones. This differs from education spending as a percentage of GDP, which does not always correlate strongly with how educated a country’s population is. Therefore, a country spending a high proportion of its GDP on education does not necessarily make the country’s population more educated.
For businesses, an employee’s intellectual ability can be treated as an asset. This asset can be used to create products and services that can be sold. The more well-trained workers employed by a firm, the more that firm can theoretically produce. An economy in which employers treat education as an asset in this manner is often referred to as a knowledge-based economy.
Like any decision, investing in education involves an opportunity cost for the worker. Hours spent in the classroom cannot also be spent working for a wage. Employers, however, pay more wages when the tasks required to complete a job require a higher level of education. Thus, while wage earning might be lowered in the short-term as an opportunity cost to becoming educated, wages will likely be higher in the future, once the training is complete.
Cobweb Model: Since training and education take time to complete, shifts in the demand for particular types of employees have different effects in the long and short term. Economists demonstrate this shift using a cobweb model of labor supply and labor demand. In this model, the supply of labor is analyzed over the long term, but the shifts in demand and wages are viewed in the short term as they move toward a long-term equilibrium.
Figure 1: Short-term shifts in demand and wage rate
In the short-run, the increase in demand for better-trained workers results in an increase in wages above the equilibrium level (A). Instead of the increase being along the long-run labor supply curve , it is along the more inelastic short-run labor supply curve (L). The short-run curve is more inelastic because there is a limited number of workers who have or are able to immediately train for the new skill set. As more and more workers are trained (B), the supply of labor shifts right (L2).
Figure 2: New workers’ effect on wage rate
With the increase in the availability of new workers, there is downward pressure on the wage rate, which falls from W2 to W3.
Because of the falling wage rate, fewer workers are interested in training for the skills demanded by employers. This pushes the wage rate up to W3, although the increase in wages is coming in smaller and smaller increments. This cycle of wage increases and labor increases continues until it has reached equilibrium: the original upward shift in demand meets the long-run supply of labor.
The Bottom Line: The knowledge and skills of workers available in the labor supply is a key factor in determining both business and economic growth. Economies with a significant supply of skilled labor, brought on through formal education, as well as vocational training, are often able to capitalize on this through the development of more value-added industries, such as high-tech manufacturing.
Source: Investopedia, written by Brent Radcliffe