Jeffrey M Lacker: Education, Innovation and Economic Growth
Speech by Mr Jeffrey M Lacker, President of the Federal Reserve Bank of Richmond, at the
2015 Emerging Issues Forum "Innovation Reconstructed", Raleigh, North Carolina,
10 February 2015.
* * *
I am grateful to Jessie Romero, Kartik Athreya, Jamie Feik, Ann Macheras, and Urvi Neelakantan for assistance
in preparing these remarks.
Highlights:
• Innovation is the primary driver of long-run economic growth, and human capital is a
key driver of innovation.
• New innovations recently have tended to increase the demand for skilled workers,
leading to higher wages for them. But, in general, as the higher wages spur more
people to obtain the necessary education, the supply of skilled workers responds to
the demand, and the wage differential narrows.
The increase in the college premium over the past several decades suggests that
•
we are not keeping pace with the economy's demand for skilled workers.
Strategies to increase human capital investment include providing students with
•
more information about college preparedness; informing them about multiple career
and educational options; and laying a foundation with early childhood education.
• A comprehensive approach to human capital investment is essential to our nation's
prosperity and to providing workers with the skills to share in that prosperity.
****
Good morning. It's a pleasure to be here and to be a part of this important conversation
about the role of innovation in North Carolina's future growth and prosperity. Of course, as
you all know, innovation is an elusive concept, and no less elusive is what we can do to
create more of it. But I do believe we can be certain about three things. First, innovation is
essential to economic growth. Second, human capital - the knowledge and skills that make
people more productive - drives innovation. Finally, innovation in turn affects the return on
investment in human capital. These three insights have important implications for our efforts
to help individual workers make fruitful investments in their own human capital and to create
the skilled workforce our economy requires. Today, I'd like to talk about several key elements
in a comprehensive approach to improving human capital investment: providing students with
a better understanding of college preparedness; informing them about multiple career and
postsecondary education options; and laying the foundation for success with early childhood
education. Before I discuss these ideas in more detail, I must note that these are my own
views and should not be attributed to anyone else in the Federal Reserve System.
Innovation and human capital
I started out by saying that innovation is an elusive concept. So what do I mean by
innovation? There is a consensus among economists that long-run growth in economic
standards of living depends critically on the rate of technological change. Growth occurs not
only because we have more people working or more machines (or, in economic terms, more
labor and more capital) but also because technological advances make existing workers
more productive. Such advances might be entirely new types of machines, such as the
steam engine or the transistor, or they might be new techniques for making existing products.
In the 1980s, for example, the steel industry was transformed by the introduction of mini-
mills, which used scrap instead of iron ore and dramatically lowered the time and cost of
producing steel. (As an aside, the first mini-mill was developed by Nucor, whose
headquarters are just a few hours south in Charlotte.)
The million-dollar question, of course, is how and why do such innovations occur? There are
a variety of economic forces and incentives at work, but a large body of research suggests
that human capital is an important determinant of long-run growth in productivity. Countries
with more initial human capital appear to have a greater capacity to develop new
technologies and to copy or adapt technologies developed in other countries.
But innovation and human capital also are linked by the fact that new technologies
sometimes increase the demand for skilled workers who can operate those technologies, a
phenomenon known as "skill-biased technical change." Because it takes time for people to
learn new skills, this increase in demand initially leads to higher wages for skilled workers
relative to less-skilled workers. But as the higher wages spur more people to obtain the
necessary education, the supply of skilled workers tends to respond to the demand, and the
wage differential tends to narrow.
Economists Claudia Goldin and Lawrence Katz have documented this dynamic - the "race
between education and technology" - throughout the 20th century in the United States.1 In
the early 1900s, new technologies such as typewriters and adding machines created a new
class of white-collar clerical jobs that required a high school education. Because few people
had a degree, these jobs paid about twice as much as jobs that did not require a high school
degree.2 The response was a dramatic increase in high school graduation rates. Between
1910 and 1940, the number of 19-year-olds in the United States with a diploma increased
from 9 percent to 51 percent.3 Over that same time period, the wage premium associated
with high school completion collapsed.
In the latter half of the 20th century, as the computer revolution took hold, demand for
college-educated workers began to rise, and hence their relative wage rates rose as well. As
one would expect, there has been an increase in the number of people with a college
degree. In 2013, about 29 percent of adults over age 25 had at least a bachelor's degree; in
1980, that number was only 17 percent.4 And yet, the "college premium" has continued to
increase: In 1980, the average worker with a college degree or higher earned about
40 percent more than the average worker with only a high school diploma. In 2013, the
college-educated worker earned over 80 percent more.5 The inescapable conclusion is that
we are failing to keep pace with our economy's growing demand for skilled workers.
This has implications not only for our ability to develop and implement new technologies but
also for the distribution of income in our society. Recent data on economic inequality and
economic mobility show that inequality has increased in recent years, while mobility has
either decreased or remained flat. In other words, the rich are increasingly likely to remain
rich and the poor are increasingly likely to remain poor. Many factors contribute to inequality
and the persistence of that inequality both within and across generations. But the growing
disparity in the acquisition of skills, often in the form of college education, appears to play a
significant role.
Preparing a skilled workforce
You don't need to be an economist to be concerned that we are not adequately preparing the
next generation of workers. Nationwide, about 20 percent of high school students fail to
graduate within four years, and there are significant disparities in graduation rates between
white students and black or Hispanic students, and between students from high-income and
low-income families. In some large urban school districts, as many as 40 percent of students
do not graduate in four years.
A growing share of those who do complete high school now go on to college. But far too
many of these students fail to earn a degree: Nationally, the college dropout rate is around
40 percent.6 The benefits of attending college for a few semesters without graduating are
relatively small. The unemployment rate for workers with some college education but no
degree is comparable to the rate for workers with only a high school degree. And while
students who have attended some college do earn on average about 15 percent more than
high school graduates, this pales in comparison with the average earnings of those who have
completed bachelor's degrees.
There is also substantial anecdotal evidence that employers are having difficulty finding
workers with the right skills. This is a common refrain on our visits to communities throughout
the region, and it's supported by employer surveys. For example, 75 percent of
manufacturers reported a moderate to severe shortage of skilled workers, such as welders,
who must have strong math skills and be able to read blueprints.7 There is an ongoing
debate among researchers about the actual amount of "skill mismatch" in the labor market,8
but many employers certainly seem to perceive that such mismatch is real.
The key question is what can we do to increase the supply of skilled workers? The large
increase in the college premium has led many policymakers and educators to advocate
college for all. But as the high college dropout rate indicates, there is a big difference
between enrolling in college and graduating. During focus group meetings held recently in
Virginia by the Richmond Fed, representatives from four-year colleges and community
colleges shared that many students are surprised to discover they lack the basic math skills
necessary for college-level work. If students overestimate their readiness for college, they
may be more likely to enroll in college but then drop out after they get there. That can be a
costly lesson to learn; the average debt burden among college dropouts who took out loans
is more than $14,000.9 The high college dropout rate thus suggests that many students could
benefit from more information about what is required for college success.
Of course, it's not enough to simply prescribe what students need to know; we must also
help them learn it. This points to the value of improving the effectiveness of the K-12 portion
of our education system. While that subject is beyond the scope of this talk, I applaud the
ongoing efforts here in North Carolina and across the country to increase student
achievement and close the gaps between students of different backgrounds.
I also believe we should supplement information about college preparedness with information
about other career and postsecondary education options. Community colleges, for example,
are a venue where students can learn more about their interests and aptitudes and hone the
skills that are required for success at four-year schools. Moreover, there are a range of other
post-high-school educational institutions that can help students acquire the skills they need
to succeed without a college degree. One factor in the high school dropout rate may be the
increasing focus of many high schools on college preparation. Some students, however, may
not wish to attend college or may see large barriers to doing so. If these students believe that
the only reason to complete high school is to attend college, they might not see much value
in doing what's required to graduate. Learning about alternative career and educational
opportunities that also require a high school degree could increase the perceived value of
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high school completion and improve their labor market outcomes relative to dropping out.
On the other hand, we can do more to ensure that well-qualified students don't forgo college
because of perceived obstacles such as cost or because of social norms that cause them to
underestimate the potential benefits or their likelihoods of success. Researchers have found
that providing these students with targeted information and assistance - a fairly low-cost
intervention - can increase their matriculation rates and can play an important role in
changing the beliefs of students who erroneously think they're not college material.11
So far I have discussed ways to increase cognitive skills, the specific things we learn through
formal education or on-the-job training. But non-cognitive skills such as patience, work ethic
and following directions also are critical. These are the skills that make it possible for us to
acquire more-complex cognitive skills, and they also are critical for success in the labor
market. For example, during our focus group meetings, high school teachers and
administrators shared that many students did not know how to self-direct or self-motivate,
skills that are critical for college success. Workforce development professionals we spoke
with reported that a lack of "soft skills" was a major obstacle to employment for their adult
clients. We also hear from the employers who participate in our industry roundtables that
many job applicants are lacking in soft skills.
How does one acquire these non-cognitive skills? Led by the work of Nobel laureate James
Heckman, many economists and other social science researchers have come to a
consensus that the foundation is laid very early in life, and that it can be difficult for children
who fall behind to catch up. Skill gaps are evident as early as age 5 and tend to persist into
adulthood.12 The importance of early skill development also means that the return on a dollar
invested in early childhood education can be much higher than the return on a dollar invested
later in life. High-quality early childhood education thus should be a crucial - and
costeffective - element of a comprehensive strategy to improve human capital investment.
The costs of innovation
Before I conclude, I should acknowledge that while the benefits of innovation are numerous,
there are costs for some individuals. Steel mini-mills were a great advance, for example, but
they also contributed to the demise of former giants such as Bethlehem Steel, which in its
heyday employed nearly 300,000 people in the United States. North Carolina is no stranger
to this tradeoff. For decades, people and communities throughout the state depended on
furniture and textile manufacturing to provide well-paying jobs, but advances in global
transportation and shipping facilitated the movement of much of that activity overseas. And
while there has been a resurgence in manufacturing in the state, the new advanced
manufacturing techniques require far fewer workers. Today, there are only about half as
many people employed in manufacturing in North Carolina as there were in 1990, even
though the value of the goods produced has increased - a story that is true nationwide as
well.
More broadly, while technological innovation may increase the demand for some types of
workers, it often reduces the demand for others - even, sometimes, for skilled workers, as
occurred during the 1800s when new production techniques displaced glassblowers,
shoemakers, bakers and other artisans.13 More recently, computers have not been a boon
for everyone. Many lower-skilled workers have been replaced by machines, and an
increasing number of middle-skill workers, such as tax preparers and paralegals, also are
vulnerable to automation.
But the technological displacement of workers has been part and parcel of rising living
standards for centuries. In 1900, more than 40 percent of the U.S. workforce worked in
agriculture; today, that number is less than 2 percent. Just as technology reduced the need
for farm labor, it also allowed the creation of new jobs in new sectors, and I don't think any of
us would argue that we would be better off if nearly half our population was employed to
supply our caloric needs, rather than being free to work as engineers or truck drivers or
nurses. We must understand the needs of the workers who are displaced and recognize that
adjusting to evolving circumstances takes time, but history provides good reason to be
optimistic that the changes wrought by technological innovation ultimately yield broadly
shared gains.
Conclusion
To sum up, innovation is the primary driver of economic growth, and human capital is
essential for innovation to occur. At the same time, technological advances also change the
skills demanded by our economy. In recent decades, innovation has tilted demand toward
more-skilled workers, and these trends seem likely to continue. An increasingly
bettereducated workforce thus will be essential to the long-term prosperity of a region or a nation.
A comprehensive approach to supporting human capital investment - one that focuses on
the full range of educational stages and options - can help provide our citizens with the skills
they need to share in that prosperity.