economics as faith (7)

The data of most economies are filled with apparently inconsistent series. By choosing among them, one can produce almost any estimate of productivity growth imaginable.

Alwyn Young “Gold into Base Metals: Productivity Growth in the People’s Republic of China during the Reform Period”, Journal of Political Economy 111:6 (2003), p. 22.

As Professor Young acknowledges, all growth accounting exercises should be taken with more than a grain of salt. Nonetheless growth accounting is a growth industry for academics. A recent study of China and India reaches new lows, however, in presenting questionable findings without providing the reader with caveats of any kind. The American Economic Association published it last year in their prestigious Journal of Economic Perspectives. Somehow it made it past the editors. I report only on the authors’ adjustment of labour input for skill levels – a glaring example of the general low quality of the piece.

Growth accounting provides a framework for allocating changes in a country’s observed output into the contributions from changes in its factor inputs—capital and labor—and a residual, typically called total factor productivity. ….

This approach is based on a production function in which output is a function of capital, labor, and a term for total factor productivity. …. [L]abor … is adjusted for … skills; we use average years of schooling as a proxy for skill levels and assume a constant annual return of 7 percent for each additional year of education.

Young (2003) provides a useful overview of Chinese statistics on educational attainment …. [H]is analysis of the relationship between earnings and years of schooling finds surprisingly low returns. ….

As noted earlier, our human capital index assumes that each additional year of schooling raises labor force productivity [in China and India] by 7 percent [even though Young (2003, p. 1246) found effects a fraction of that size for China.] This [7%] figure is based on a large number of empirical studies relating wages and years of schooling.

Barry Bosworth and Susan M. Collins, “Accounting for Growth: Comparing China and India”, Journal of Economic Perspectives 22:1 (Winter 2008), pp. 45–66.

The empirical studies alluded to are ‘Mincer equations’ – the regression of wage rates on levels of schooling and (sometimes) experience – and there are literally thousands of these studies. They almost always show that more schooling is associated with higher wages, but this does not prove that schooling increases productivity.

Suppose that schools exist only to screen students for ability, and that school attendance has no effect at all on productivity. In such a world, schooling is privately profitable but socially wasteful. Workers who complete more years of schooling are more productive and enjoy higher wages than workers who drop out of school. But increasing everyone’s consumption of schooling by a year has no effect on productivity or wages! Once there is a large pool of ‘schooled’ workers, employers will find that they have to demand a university degree for jobs that used to require only a high school diploma, because completion of high school no longer signals sufficient intelligence to handle the job. All this is well-known but is disregarded by the authors, who literally pull a 7% figure out of the air and inappropriately apply cross-section regression results to macro models of growth.

Barry Bosworth is Senior Fellow of Brookings Institution in Washington, DC. Susan M. Collins is Dean of Public Policy, Gerald R. Ford School of Public Policy, University of Michigan.

Tags: , , ,

Comments are closed.