sou · H3B353en · 2015-06-04 00:00:00 — Note: The chart is an ”added variable plot” based on a regression of growth over the period 1960- 2000 on initial income and education both measured quantitatively (average length) and qualitatively (test results in math and natural sciences). All countries on which the regression is based are included in the figure. Source: Hanushek and Woessmann (2011). The wage distribution is formed via the interaction between labour demand and supply. All theories of the wage distribution attribute a role to relative supplies and demands.54 If labour demand increases (decreases) for a particular type of labour, its relative position will improve (deteriorate). The development in the wage structure can be seen as the race between education and technology 54 It is also deeply ingrained in trade theory, cf. e.g. the theorem. Bilaga 4 till LU15 as exposed already by Tinbergen (1972).55 Empirical work shows that the educational expansion during the 1960s and 1970s in a number of countries had an important effect on wage distributions. This debate has been revived in recent years due to widening wage inequality. Technological changes and globalization have been highlighted as the drivers of this development. Goldin and (2009, p. 291) conclude that the “lion’s share of rising wage inequality can be traced to an increasing educational wage differential”. The traditional focus on the implications of skill-bias has recently been amended by the discussion of tasks and its implications for labour demand, see Autor and Acemoglu (2010). It is very difficult empirically to disentangle the contributions of different factors to increasing inequality. Technological changes and globalization are intertwined processes, and (de)regulation is undertaken in response to changes in the economic environment. (2011) presents empirical evidence that globalization is less important than technological changes, but that policy changes like product market deregulation, lower unemployment benefit replacement ratios, declining tax wedges have contributed to the increase as well (see also Jaumotte, and Papagerogiou (2013)). The key distributional issues are illustrated in Figure 5.5 capturing the stylized facts given in Figure 5.3. The positive association between inequality in education and inequality in market income is given by relation A0, and the one between inequality in market income and disposable income by relation B0 (the redistribution line). With an initial distribution of qualifications Iq(0), the distribution of disposable income becomes Id(0). Consider now changes in the labour market tending to increase inequality; the A0 locus shifts to A1. For an unchanged distribution of qualifications and redistribution mechanisms, the inequality in disposable income increases to Id(1). To restore the level of inequality in disposable income to its original level, Id(0), one would have to either make the system more redistributive (shifting the redistribution line from B0 to B1 entailing more passive redistribution) or change the distribution of qualifications 55 “The income distribution may then be derived from the distribution required and qualifications available. Income could become almost equal if there is no tension between the two distributions. People would not need to be of equal productive quality in order to attain this near-equality of incomes”, Tinbergen (1972, p. Bilaga 4 till LU15 to Iq(1), i.e. Both and passive redistribution56 must be financed via taxes, which in turn affects both the level and distribution of market incomes. This raises questions on the relation between and passive redistribution and the optimal use of the two instruments. Figure 5.5 Inequality in qualifications, market income and disposable income 5.2Public intervention in education There is a large literature discussing public intervention in education motivated in capital market imperfections (see Section 4), externalities57 (see Section 4) or risk (see Section 6 and e.g. (1982)). It is beyond the scope of this paper to give a comprehensive overview, see e.g. Hanushek (2002), and the focus here is on the interaction between distributional aspects and education choices and how it relates to vs. passive (re)distribution. One strand of literature has considered how to allocate educational resources. This literature primarily considers 56In the presence of risk, ex post redistribution also performs an ex ante role of providing insurance, see Section 6. 57Externalities give an obvious reason for public involvement in education, but are not directly related to the distributional issue discussed here. Bilaga 4 till LU15 educational choices along the intensive in a setting where agents differ in abilities. Arrow (1971) pointed to a regressive bias in the allocation of educational resources. If a given amount of educational resources are to be allocated across agents with different abilities, human capital production is maximized by allocating according to abilities under the assumption that the marginal human capital effect of a given educational input is increasing with abilities. From a human capital perspective, resources should be devoted to the more able, and passive redistribution should address the distributional aims (see also Hare and Ulph (1979)). Allowing for private education choices, Bovenberg and (2005) and (2012) argue that a government wanting to redistribute should also subsidize education. The argument being that the income tax financing redistribution distorts educational choices and this can be circumvented by educational subsidies.58 While these are important findings, they do not directly address the issues raised here since they only focus on education along the intensive . The distributional issue pertains mainly to education along the extensive , that is, to increase the number of skilled/educated workers. Historically it has been a great achievement to increase the share of educated, but as discussed above significant problems remain. Distributional aspects have a direct influence on educational choices in the presence of market failures. Even if agents have the same abilities and preferences, educational inequalities and path dependencies may arise when capital markets are incomplete.59 A seminal contribution by Galor and Zeira (1993) considered an overlapping generations model with private financing of education 58 These studies assume that the government can commit. If the government has a commitment problem, it will ex post tax the return to education excessively, and this motivates educational subsidies, see e.g. and (2003). 59 There is an analogy between the distribution of land and human capital. A more equal distribution of land is associated with economic development, and likewise for human capital. There is also the interrelationship between the two. For a discussion and references see e.g. Galor, Moav and (2009). Bilaga 4 till LU15 in a setting where capital market imperfections are captured by the rate of return on borrowing exceeding the savings rate. Under this capital market structure, the initial wealth distribution, and thus the ability to self-finance education, becomes crucial. Agents able to self-finance education have a lower opportunity cost than those who have to borrow to finance education. In the specific model considered by Galor and Zeira (1993), financing capabilities depend on bequests, (altruistic parents) and thus the wealth of parents. Income and wealth depend on education, and this creates an intergenerational link in education and income. Low educated parents have low income and leave bequest, implying that their children do not become educated, and oppositely for educated parents.60 In this way the capital market imperfection implies a social stratification in educational choices and outcomes. The important policy implication is that the income/wealth distribution matters for educational choices and outcomes. This does not, however, imply that any form of passive transfers would strengthen educational possibilities for children from low income families. In the specific model considered by Galor and Zeira (1993), it is effectively assumed that increased transfers would directly affect the educational possibilities, but in a more general setting this is not necessarily the case. The transfers have to be directly targeted to the imperfection, the scope for financing education. Historically, the scope for educational financing has clearly been of importance. It is debatable whether it is presently the most binding constraint in and the other Nordic countries given the extensive public financing of education, implying that the direct economic costs of education are not as important as in countries with primarily private financing of education.61 As already discussed in Section 4, the social contract in the welfare state can overcome capital market imperfections. However, this does not imply that there are no constraints on educational 60In the original Galor and Zeira (1993) model agents either become educated or noneducated, and the economy converges to a steady state where children of non-educated are non-educated and vice versa for educated families; i.e. there is no social mobility in the longrun equilibrium. 61Educational choices can moreover be affected by myopia. For low-income families the opportunity costs of education in terms of foregone labour income may also be larger (since marginal utility of income is higher). Bilaga 4 till LU15 Ample evidence shows that social background is important for educational attainment, and this gives a different rationale for public intervention than capital market imperfections. The role of social gradients in educational options and choices is of a particular policy concern since it questions equality of opportunity in pursuing abilities and developing interests and motivation. Ensuring equal opportunities is an ethical value in itself, but may also have other effects. Equality of opportunity concerns both the formal access and entry possibilities into the educational system as well as the outcomes. When social and cultural capital matters, a removal of economic and formal barriers for entry into the educational system is not sufficient to create equal opportunities in outcomes. From an efficiency point of view it implies that the human capital potential in the population is not exploited as best as possible, or phrased by Halsey (1961) that there is an unused “pool of ability”. The social gradient in education is strong. While the precise mechanisms are debated there is ample empirical evidence that the social background of children and youth affect their educational attainment (entry and performance). To list a few key findings of importance for the following discussion:62,63 –The odds that young people will attend higher education are low if neither of the parents has completed higher education, and much higher if one of the parents has a higher education, (2012). –The barrier is not only economic, but cultural, and social capital matters critically (and Jæger, 2007). Even for children with comparable performance in primary and lowersecondary school in terms of grades, there is a social gradient in educational choices (, 2012). 62See e.g. et al. (2011) for an overview and discussion of various methods to separate the two. Among other things it is concluded that “...we think that all these twin, adoption, and IV finding suggest that schooling is in part responsible for the intergenerational schooling link: more educated parents get more educated children because of more education” (p. 63Heckman has in a number of studies analysed the role of (early) intervention in overcoming social barriers for education, see e.g. Heckman and Mosso (2014) for an overview and references. Bilaga 4 till LU15 –Literacy and numeracy proficiency depend positively on parents’ levels of education (, 2014). –Schooling has a substantially larger impact on preparing students from less-educated families to enter higher education. There is a link between inequalities in early schooling and the frequency of students from families with low levels of education enrolling in higher education, see Heckman and Mosso (2014). –The advantage of having highly educated parents is smaller in countries with high educational levels, high overall quality of overall schooling, and large public involvement in education (smaller private costs) (, 2012). –Social mobility is lower in countries with higher income inequality, cf. and Jäntti (2009) and Corak (2013). These findings suggest that education may be constrained by more than economic barriers (credit constraints) and this may be a reason for public intervention. The following considers this issue in some detail, both because it is of relevance in explaining the Nordic position, but also because it is highly relevant in a forward perspective. To clarify the mechanisms, focus is solely on social barriers to education. Clearly, personal characteristics and in particular abilities matter as well, but these aspects are disregarded to focus on the role of social barriers. The following is based on (2015). Consider a standard overlapping generations setting where individuals live for two periods. As young, educational efforts are made to acquire education and become skilled as old. Individuals succeed in education and become skilled with a probability depending on both their educational input and their social background. Children with skilled parents have a higher chance of becoming skilled for a given educational input than children with unskilled parents. This captures key elements of the social factors outlined above. As young, agents can spend time studying or working as unskilled, and as old they work as skilled if succeeding in education and unskilled if non-educated. Education thus has an Bilaga 4 till LU15 opportunity cost in terms of foregone income as young.64,65 Since children with skilled parents other things being equal have a better chance of succeeding in education, they invest more in education, and this tends to reinforce their chance of succeeding in the educational system and become skilled. Similarly, children with unskilled parents are less inclined to pursue and thus less likely to succeed education. In equilibrium there is social mobility, but social status is reproduced in the sense that children with skilled parents are more likely to become skilled than children with unskilled parents and vice versa. There is a dynamic effect of a change in education. If more education inputs are invested, more will become skilled, which in turn affects future educational choices and thus the share of skilled. In this sense there is a virtuous circle in education. This raises questions on the rationale and form of public intervention. Assume for the sake of argument that the public sector can offer educational inputs which are perfect substitutes to private education; i.e. the public sector does not have any options which are not available in the market. In the same vein it is assumed that public education is general and accessible to all at the same term (i.e. it is not targeted specific groups). As a first approximation, this may be said to characterise general public schooling and serves the purpose of not biasing the analysis towards public intervention. Under these assumptions public education will crowd out private education; however, crowding out is in general less than complete. Educational inputs will therefore in net terms increase. The reason is that more public education releases an income effect for the young, which in turn lowers their marginal utility of consumption and thus the opportunity costs of private education. Suboptimal educational choices are in this setting caused by social barriers. There are no differences in abilities or capital market imperfections or the like impeding education. This suggests a possibility that the pool of abilities in the population is not 64Hence, there is no up-front financing requirement to start education, and hence the capital market plays no role. 65Note that the educational decision is entirely driven by economic conditions. The choice sets are the same for all youth, but the “productivity” of their educational efforts differs due to social factors. Bilaga 4 till LU15 Is it possible that public intervention in a setting with social barriers for education can be Pareto improving? In (2015) it is shown that public intervention can be Pareto-improving. The condition is that public education increases total consumption possibilities in society. If this is the case, the gainers are able to compensate the losers. On pure efficiency grounds there may thus be an argument for public intervention. Social barriers are a market failure on par with capital market imperfections. In Figure 5.6 the effect of an increase in public education is illustrated. The figure shows the effects on efficiency measured by aggregate living standards (consumption) and equity by its distribution for various levels of public education.66 It is seen that the relation is hump-shaped. Starting from the laissez-faire situation, an increase in public consumption increases aggregate living standards and reduces inequality, but at some point living standards start declining while inequality keeps declining. The hump shape is interesting since it shows that public intervention over some interval does not raise a conflict between efficiency and equity. increasing public intervention would imply that a turning point is reached, and a conflict or trade-off arises. The curve is flat around the top-point, implying that some reduction in inequality is possible without a large change in average consumption. Note also that if social preferences are increasing in living standards and equality, it is optimal to be on the segment of the locus which displays a trade-off. 66 For details on the specific model assumptions, see (2015). Bilaga 4 till LU15 Figure 5.6 Income-equality locus – public investments in education Note: Inequality measured as 100 minus the Gini-coefficient. Results from simulations reported in (2015). Inequality in consumption creates a motive for redistribution. Skilled (old) will have higher income than unskilled (old). Consider a transfer scheme which provides income support to the unskilled old and which is financed by a tax on the skilled. This passive scheme is compared to an scheme providing education to the young, and also financed by a tax on the skilled (old). The two forms of redistribution affect education differently. The scheme increases education, while the passive scheme reduces education. On impact the passive scheme benefits the unskilled old, but over time it implies that the number of unskilled increases. The passive scheme distorts educational choices by lowering the gain from education. Oppositely, the scheme does not on impact benefit the unskilled, but it reduces the share of unskilled over time.67 These different dynamic implications are illustrated in Figure 5.7, which considers three different policy scenarios all starting from an initial situation without any public intervention (laissez-faire): passive redistribution, redistribution and passive and redistribution. It is seen that the share of skilled develops differently. 67 The present case assumes wages. If wages are endogenous, there is the additional effect that more skilled will tend to reduce the wages of skilled and increase the wages for unskilled, and therefore further reduce wage inequality. Bilaga 4 till LU15 tail wind by increasing the share of skilled, which further increases the number of skilled and reduces taxes, while passive transfer works in the opposite direction. Figure 5.7 Dynamic adjustment of the share of skilled, vs. Note: Results from simulation reported in (2015). If market forces increase wage dispersion, there is both a stronger incentive to educate but also a potentially greater need for passive redistribution. How should optimal policies respond to such a change? Clearly this depends on the social welfare function. To work out the response, the following assumes a utilitarian social welfare function and considers welfare in steady state. This particular social welfare function can be contested, but it is widely used in the literature, and hence it is a useful starting point from which to discuss how policies may respond to changes in market conditions. Both and passive redistribution may expand when wage dispersion widens, and in this sense the public sector takes on a more pro-active role. Several effects are at play. First, private incentives to education increase since the wage gains become larger. Second, for the same reason the social gain to public education increases. Since private choices are suboptimal, optimal public education increases. Finally, the widening wage dispersion Bilaga 4 till LU15 increases the gain from passive redistribution. Specifically the marginal utility for the skilled declines (they get a higher wage and thus consumption) relative to the marginal utility for the unskilled, and this increases the gains from passive redistribution. Figure 5.5 illustrates the adjustment of transfers, public education and taxes under the optimal policy to widening wage dispersion between skilled and unskilled. Figure 5.8 Optimal policy responses to widening wage dispersion Note: Policies compared to optimal policies for low wage dispersion, i.e. index = 1 corresponds to policies for wage dispersion = 1.4. Wage dispersion is given as the ratio of wages for skilled to unskilled. Results from a simulation reported in (2015). Finally, although the planner engages in more passive and redistribution it is seen from Figure 5.9 that the net effect is an increase in inequality. , the optimal policy response does not fully neutralize the effect on inequality from widening wage dispersion since that is costly. This leads to two general observations. First, neither nor passive redistribution is costless; hence the larger need has to be weighed against the larger costs. Secondly, the precise response obviously depends on the social welfare function and how it trades-off efficiency against equity. However, with an unchanged social welfare function more inequality is inevitable, even despite the optimal policy response. Bilaga 4 till LU15 Figure 5.9 Widening wage dispersion and inequality - the role of policy 6Risk sharing and economic performance Turn next to the social safety net, the second pillar of the Nordic welfare model. Clearly it serves distributional objectives, but in the present context the question is which role it plays for economic performance. The possible negative incentive effects of the social safety net have been extensively analysed, but are there ways to mitigate those, and could insurance arrangements have positive effects on performance? The discussion of social insurance has a strong focus on the adverse incentive effects of such insurance, in particular in the labour market leading to reduced labour supply, less job search, higher reservation wages etc. However, for a complete assessment it is important to take two interrelated points into account. First, social insurance becomes of relevance due to market failures. Incomplete markets offer insufficient scope for risk diversification, and this can in various ways affect economic behaviour. This brings us outside the realm of the first welfare theorem, according to which competitive markets ensure a Paretoefficient allocation which cannot be improved in the sense that some can be made better-off without others becoming worse off.68 In this situation public intervention may be motivated purely on efficiency grounds if it can repair on some of the consequences of 68 Requires a complete set of contingent markets, cf.