Tertiary education, skills and productivity

The contribution of education to productivity

New Zealand and the OECD

New Zealand maintains one of the highest rates of tertiary education in the OECD. Based on the proportion of 25 to 64 year olds with a bachelors degree or higher, New Zealand rate is well above the OECD average (OECD, 2009). However, in terms of labour productivity, New Zealand is in the lower third of the OECD, performing somewhat ahead of the Eastern European countries but well behind Japan, Australia, the United States and Western Europe. This situation raises the question about what contribution increased educational attainment has made to productivity and why the effect appears to be so limited in New Zealand.

Figure 5:  Comparison of productivity and tertiary education attainment for selected OECD countries

Sources: OECD (2009) and The Conference Board and Groningen Growth and Development Centre (2009)

Education and labour productivity

Razzak and Timmins (2010) looked at the effect of educational qualifications, as a proxy for human capital and skill levels, on economic output per person. They found that increases in the proportion of employees with bachelors degrees and above and increases in the average gross domestic product per person were highly positively correlated. Thus, there has been a general benefit from increased tertiary education to the economy as a whole.

They also found that the combination of increased private investment in research and development, together with an increased proportion of the workforce with bachelors degrees and above, had a strong positive effect on gross domestic product per capita. However, this effect has been limited by New Zealand’s low investment in private research and development compared with many of its trading partners (Statistics New Zealand, 2009b).

Razzak and Timmins’ models suggest that a 10 percent increase in share of degree-educated workers results in a 0.5 to 1.0 percent increase in gross domestic product per capita. The effect is higher in industries that have a lower percent of degree-qualified employees. A smaller effect on gross domestic product was found for increasing the proportion with tertiary qualifications below degree level.

Skill shortages and skill premiums

Razzak and Timmins (2008) went on to look at skill shortages and skill premiums in New Zealand. The skill premium is the wage paid to skilled workers relative to unskilled workers.

They concluded that the New Zealand economy had been experiencing a strong upward shift in the demand for skilled labour and a significant equal increase in the supply of skilled workers. A major driver has been the adoption of new technology, which drives up the demand for skills and also motivates workers to upskill, increasing the supply of skills.

The increase in premiums paid for higher skills has been small, as the increase in demand has only been slightly higher than the increase in supply of people with those skills. Using qualifications as a measure of labour skill, they estimate that demand has been about 2 percent ahead of supply annually.

They found significant differences in patterns across industries. Demand for skills was relatively higher in service industries (such as finance, insurance, real estate, business services and community, social and personal services) which are more dependent on information technology.

Does quality matter in labour input?

Szeto and McLoughlin (2008) looked at whether the increase in qualifications levels across the workforce, along with increased labour force participation, migration and demographic changes, had resulted in improvement to the quality of labour input. Quality of labour input was examined using qualifications, as a proxy for skills, and age, as a proxy for experience.

They found that increased qualification levels, particularly at degree level and above, as well as a more experienced workforce, had contributed to a large rise in labour quality since 1988. It was stronger in the period 1988 to 1997 and dampened from 1997 to 2005 due to more low-skilled people entering the workforce.

They estimated that around a third of the growth in labour input over this period came from increased labour quality. Around 30 percent of the quality increase could be attributed to demographic changes and the remaining 70 percent to rising qualification levels.

The annual rise in labour quality was similar to that experienced in Australia, the United  States and Europe. However, once labour productivity had been adjusted for improvements in quality, the annual growth in New Zealand was much less than comparable growth rates in Europe, the United States and Australia.

Statistics New Zealand has since developed a composition-adjusted series for labour productivity (Statistics New Zealand, 2009a). This series adjusts for changes in qualifications and experience of the workforce. The adjusted productivity series shows the amount by which productivity has grown over and above changes in the quality of labour. The series shows that adjusted labour input growth has been higher than unadjusted growth. This implies that that the average experience and skill levels in the workforce have been increasing. This, in turn, lowers the adjusted productivity growth. The fact that adjusted productivity growth remains greater than zero means that factors other than just improvements to labour quality have also contributed to labour productivity growth.

                                                       

Table 2: Average annual percentage growth in labour inputs and productivity, unadjusted and adjusted for labour composition

	Labour input growth		Labour productivity growth
	Unadjusted	Adjusted	Unadjusted	Adjusted
1998-2002	1.1	1.8	2.2	1.4
2002-2006	2.7	2.8	1.5	1.3
2006-2008	1.6	1.8	1.0	0.8

Source: Statistics New Zealand, Productivity Statistics

Variations in earnings and composition of employment

While not looking specifically at the question of qualifications and skills, Maré and Hyslop (2008) examined the impact of the economic expansion from 1999 to 2007 on earnings and the composition of employment. They found that workers entering the workforce during this period had 19 percent lower earnings than the average worker in that period and that more hours were being worked by lower-paid workers. Their analysis confirms the idea that economic expansion has brought an increased number of lower-skilled workers into the workforce, thus lowering average productivity.

They also looked at the effect of changes in firms on wages. They found that firms that started up during this period paid 8 percent lower than average, as did firms that were closing down. The employment shares of entering and exiting firms were roughly equal and accounted for about 20 percent of the workforce in total. Overall, firm turnover accounted for a 1 percent decline in average earnings during this period. From this analysis it is not possible to conclude whether firm turnover had much effect on dampening productivity in this period. A longer time series of data, over several economic cycles, would be needed to form a strong conclusion.

Productivity, capital intensity and labour quality – comparing New Zealand with the United Kingdom

Mason and Osborne (2007) compared productivity, capital intensity and labour quality between New Zealand and the United Kingdom across 21 different ‘market sectors’. Their analysis showed that while New Zealand compares unfavourably with the United Kingdom on average labour productivity, there is considerable sectoral variation.

The paper points out that there is a clear link between the relatively low gross domestic product per capita in New Zealand and weak labour productivity. The authors found that in 2002 the average value added per hour of work in New Zealand was 77 percent of that in the United Kingdom. This was down from 82 percent in 1995. They confirmed that New Zealand had achieved faster growth in labour input through job creation. However, this has been at the cost of average labour productivity.

The paper reports that while New Zealand’s productivity is lower than that of the United Kingdom overall, there are some sectors where New Zealand performs better than the United Kingdom. The five areas where there is higher productivity in New Zealand are all in the service industries. The areas where New Zealand does not perform so well are characterised by relatively low physical capital intensity relative to the United Kingdom, such as manufacturing and construction. Part of the difference between the two countries can also be explained by the greater proportion of the New Zealand workforce in lower value-added sectors, such as agriculture.

The Treasury (2008b) explores further the issue of New Zealand’s low capital intensity relative to its trading partners. The paper shows that New Zealand firms face a somewhat elevated cost of capital. However, low capital intensity can also be seen in part as a by-product of low multi-factor productivity. Boosting innovation and use of new ideas and technologies is one way of raising multi-factor productivity, which in turn can lower the cost of new capital investment.

Effects of economic geography

McCann (2009) demonstrates that having taken account of New Zealand’s economic geography, New Zealand’s relative labour productivity performance is much as would be expected. McCann argues that New Zealand’s performance needs to be considered in the context of it being a small economy in a very isolated part of the world and is best understood as part of the larger Australasian economic area.

Over half of the gap in labour productivity between New Zealand and the OECD average can be attributed to geography alone. The small size of New Zealand’s economy further increases this gap. The global trend is towards concentration of capital and skilled labour in major cities. The effect of this for New Zealand is an outflow of both towards the large Australian cities. These outflows are also highly correlated with the productivity gap between the two countries.

The consequence of this analysis is that New Zealand is faced with the dual challenges of reducing the cost of getting goods and services to market and maximising the opportunities for economies of scale.

Impact of migration on productivity

There is limited information on the effect of New Zealand’s high reliance on skilled migration on productivity. Studies of labour-market outcomes show that immigrants start out with lower income and are underemployed, and then take time to adjust to similar outcomes as New Zealand-born workers. For immigrants from English-speaking backgrounds, the adjustment period has been estimated to be 10 to 15 years for employment rates and 15 or more years for income. For immigrants from non-English speaking background, the periods are estimated to be much longer and some studies suggest they may not attain parity within the first generation (Moody, 2006 and Earle, 2009).  The Longitudinal Immigration Survey (Department of Labour, 2009) found that of migrants who were employed within six months of attaining permanent residence, around 30 percent were working in jobs that were at a lower skill level than the job they did in their previous country of residence.

This evidence suggests that migration has a delayed contribution to increasing productivity, in terms of raising the skills of employees, as migrants take time to reach their full potential in the workforce. In this regard, it is not an immediate substitute for loss of skills through emigration. In recent years, the high reliance on skilled migrants may have dampened labour productivity growth.

Immigration can also improve capital investment, if migrants bring capital with them. There is little evidence of on which to judge the extent of this in the New Zealand context. Migrants can also help extend international connections of firms. There are undoubtedly cases of this happening in New Zealand. However, there is limited evidence of the extent to which it has added value across the economy (Moody, 2006).

Modelling of the economic impacts of immigration shows that increased immigration inflows result in a larger economy. The added benefits from immigration can result in a more externally focussed economy and increased gross domestic product per capita. The modelling suggests that the benefits of immigration are greatest when immigrants bring a range of skill levels which enable the economy to grow. It also shows that the additional benefits from immigration only increase significantly when there are accompanying improvements to productivity (Nana, Sanderson and Hodgson, 2009).

How qualifications and skills influence firm productivity

The link between qualifications and national productivity is not straightforward. International literature points to a number of channels of influence (Mason, 2008). Increases in skills and qualifications may have greater effect when combined with physical capital investment and/or the introduction or more effective use of new technologies. The latter is noted above in Razzak and Timmins (2008).  There is also evidence that combining investment in higher skills and in employer-funded research and technology has a greater impact on productivity. This combination can enable both greater innovation and greater take up of innovation within the workforce. This combination effect is noted in Razzak and Timmins (2010) above. Hall and Scobie (2006) found that in the agricultural sector, having domestic capability within in the industry to make use of international knowledge is essential to productivity growth.

Durbin (2004) identified three categories of skill that seem to be important for firm productivity. In addition to technical skills, firms need good entrepreneurial skills to identify and respond to market opportunities and managerial capability to lead and organise effective production. Raising the overall skills of workers is only one mechanism by which skills influence productivity. Durbin also points to the interaction of skills with other inputs such as capital, R&D, technology and sharing of knowledge within and across firms.