Insuring skills

by Henry on October 17, 2003

Via “William Sjostrom”:http://www.atlanticblog.com/archives/001196.html#001196, this rather remarkable “specimen of codswallop”:http://www.opinionjournal.com/editorial/feature.html?id=110004152 from Gary Becker, Edward Lazear and Kevin Murphy. These gathered luminaries argue in the Opinion Journal that cutting taxes has a double pay-off. It starves the beast, making cuts in welfare state spending more likely, and it also encourages workers to invest in “human capital,” i.e. job skills.

bq. The evidence is clear: Cutting taxes will have beneficial effects. Tax cuts will keep government spending in check and will provide the incentives necessary to produce a highly skilled, productive work force that enables high economic growth and rising standards of living.

This claim rests on some rather heroic assumptions which I won’t go into. It’s also, very possibly, self-contradictory; you can make quite a strong case that the two effects interfere with each other. Torben Iversen and David Soskice provide some decent “evidence”:http://www.people.fas.harvard.edu/~iversen/PDFfiles/SocialPreferences.pdf to suggest that people with high levels of specific skills actually want a beefy welfare state. More pertinently, where people don’t have such a welfare state, they may have a strong incentive to “avoid investing”:http://www.people.fas.harvard.edu/~iversen/VofCchapter.pdf in job-specific skills. If this result holds, then the benefits of tax cuts for human capital formation are _not_ clear at all. Starving the welfare state will deplete valuable forms of human capital.

Why would a strong welfare state affect people’s willingness to invest in job-specific skills? Simplifying slightly, Iversen, Soskice and their collaborator, Margarita Estevez-Abe, argue that people, if they’re economically rational and risk averse, are going to be less likely to invest in job or industry specific skills if they think that this investment is risky. People who have invested heavily in job or industry specific skills will get into trouble if there is a weak welfare state, and they get fired, or their firm goes bankrupt, or, worst of all, if their entire industry takes a serious downturn. They have difficulty in finding a new job, because they’ve invested in skills that are non-portable across firms or industries. In some countries, they may have to take the first job that’s offered to them or lose their welfare benefits, even if that job doesn’t match their existing skills. If, however, there is a strong welfare state, then individuals with job or industry specific skills have a safety net. They can take their time trying to find a new job that matches their previously existing skill set.

The implication is obvious – social welfare isn’t only about distribution, it’s about insurance. Furthermore, a certain level of welfare state provision may be necessary to encourage people to invest heavily in risky skills that nonetheless may have important economic pay-offs. Individuals who are faced with a weak welfare state are likely to invest primarily in generalist skills, which are easily portable from job to job, and from industry to industry. To be sure, skills profiles of this sort have their advantages (especially in periods of flux and change). However, these self-same individuals are likely to underinvest in specialist skills without a strong welfare state – these skills will often be too risky to be worth it. Conversely, if a strong welfare state exists, individuals will feel much much happier about taking the risk of investing in skill profiles that may make it more difficult to find a job in economic downturns.

If Estevez-Abe, Iversen and Soskice are right, tax-cuts that starve the welfare state are likely to have perverse consequences. They’re going to lead to underinvestment in economically beneficial skills. Some industries and professions clearly require an intensive investment in specific skills; these industries are likely to do poorly in countries with lousy welfare states. It’s almost certainly easier to cultivate certain kinds of human capital in Sweden than in the latter-day US. And that’s something that Becker et al. don’t even begin to think about.

{ 29 comments }

1

Ratherworried 10.17.03 at 8:07 pm

This twisted logic has me completely confused. If I can ask, when did there become this amazing connection between job skill investment and the welfare state?

How can it be necessarily stated that a highly skilled worker cares one way or the other about a welfare state? Which industry are we talking about? What level of skill constitutes ‘highly skilled’?

The lack of a welfare state will make me invest in my job skills. OK I can vaguely see a distant muddy connection between the lack of a safety net and my job skills.

But…

I do not want to live in a country which is so draconian that all of the workers live in constant fear that they will loose their job and die of starvation.

Also…

The lack of a safety net will have a rather dramatic impact on all kinds of economic activity. You have to be pretty dumb not to see the connection between a societies overall prosperity and social welfare systems.

Wealthy folks are not always Democrats because they love to pay higher taxes…they know that the overall economic activity of the poor and middle class increases the more graduated our tax structure is. This improves the value of corporations and thus secures an increase in the income of the wealthy.

It would seem pretty easy to shoot holes in the job skills/welfare state connection without the verbal gymnastics of your response.

2

David W. 10.17.03 at 8:12 pm

I wish I could find a reference for this, but while visiting Toronto over the Labor Day holiday last month, one of the papers there had an article reporting that Canadians were more likely to take risks on business ventures than those in the U.S., in part because they did not have to worry about health care issues if things didn’t pan out.

3

alkali 10.17.03 at 9:35 pm

ratherworried writes:

How can it be necessarily stated that a highly skilled worker cares one way or the other about a welfare state?

I don’t know what “necessarily stated” means, but you can find out by asking whether a person is highly skilled, and you can also find out by asking whether that person also has opinions about the size of the welfare state. If you ask enough such people, then you have a survey, and you can perform statistical tests on the survey data to see if there is any correlation between responses to the two questions. You can also suggest a reason why people who are highly skilled might have particular opinions about the welfare state — a “model,” if you will — and see if the survey data supports your model. That’s what the referenced authors did.

Which industry are we talking about? What level of skill constitutes ‘highly skilled’?

There are standard, very detailed classifications of job types and skills that are used for all sorts of purposes. The classifications these authors used are described in the linked paper.

4

Sindelar 10.17.03 at 10:04 pm

I must say I am quite gobsmacked at the level of analysis put out by these eminent economists. First it ignores the fact that some jobs such as medicine are not that sensitive to pay, let alone tax rates–Imagine a child’s response when asked what they want to be when they grow up–“well I thought about becoming a doctor but the darned higher tax bracket really puts me off”.

But there may be a more serious response that tax cutters can make to rebut the rebuttal Henry describes. And that is that within-firm training is still far more valuable than external training. And firm investment in individuals is far more significant in terms of scale than individuals’ own investment. And that can be affected by, among other things, corporate taxes. However, the right response is to leave it to the market and to better competition to ensure that firms cannot afford not to invest. And in any case, firms, particularly small businesses about taxes that prevent them from investing in low skill workers tend to talk rubbish because even when they can afford to do it, they don’t.

5

baa 10.17.03 at 10:54 pm

Those codswallop peddling Nobel laureates, that really is a problem. Let’s ignore the alleged human capital creating/destroying effects of the welfare state –what about the effects on spending Becker et. al. allege. henry, do you dispute that tax cuts will, on average, reduce government expenditure? Or that given a surplus, governments tend to spend it?

6

Jack 10.18.03 at 12:08 am

Tax cuts have yet to curb public spending.

Tax cuts can also be undone so they do not reduce the revenues available.

The thinking about incentives seems rather unintuitive — no one worries about security for example.

My question is how is it not just economic orthodoxy? The conclusions about the link between government spending and tax revenue has presumably been peer reviewed. The growth argument is as far as I know a textbook case.

7

Brad DeLong 10.18.03 at 3:20 am

It is remarkably. As if they enter a zone when they start writing for the Wall Street Journal in which each of their IQs is cut by two-thirds…

8

bigring55t 10.18.03 at 3:27 am

Baa- taking the current occupant of the White House as a case study, it would be fair to say that tax cuts increase government expenditure. In fact, if you look carefully, you will find that there is a correlation in the last 30 years between tax cuts and government spending increases. Don’t believe me, look at the numbers themselves.

9

Barry 10.18.03 at 4:03 am

“It is remarkably. As if they enter a zone when they start writing for the Wall Street Journal in which each of their IQs is cut by two-thirds…”

Posted by Brad DeLong · October 18, 2003 03:20 AM

Well, it could be that. Maybe they just have a hard time thinking about economic issues. I’d have though that 30 years in elite econ departments would render a person more likely to be incapable of *not* thinking with economic rigor.

Or maybe they are very dishonest people. A while back, Brad, you had some very appropriate remarks about a Yale professor who was critical of unionizing TA’s. However, you also had some uncalled-for comments about how people without economic training tend to be doubleplus ungood:

“There is something about other social-scientific disciplines that provokes illiberal and destructive patterns of thought:…”
An Appalling Article on Graduate Student Unionization by Yale Historian Paul Kennedy
.

Maybe there is nothing about economics which necessarily leads one to virtue. Perhaps economists can be every bit as evil as non-economists. It could be that there are some elite economics professors who are actually every bit the right-wing apologists that some liberals believe.

And perhaps, just perhaps, these WSJ editorials fit Michael Kinsley’s definition of a gaffe – when somebody says exactly what they are thinking.

10

An Economist 10.18.03 at 5:34 am

A big problem with economics is that for some reason only conservatives are allowed to spew such nonsense. Sure, our good friend Brad DeLong is a “liberal,” or something close enough to it, but he couldn’t get away with publishing the liberal equivalent of this nonsense.

11

Lucy Furr 10.18.03 at 6:43 am

Yikes, this is one ugly blog! Hey man, cut the serif font and the funky underlines — it’s just annoying, not cool.

If it didn’t hurt my eyes, I’d be perusing this blog every day. But not when it’s this ugly.

12

Andrew Boucher 10.18.03 at 10:45 am

Chirac in France is trying the Reagan strategy now, lowering the rate of income taxes in the top bracket by 10% since his re-election and increasing the deficit to 4% of GNP. And then, using the justification of a fiscal crisis, the government is being ruthless in terms of social spending.

13

Brett Bellmore 10.18.03 at 12:04 pm

“People who have invested heavily in job or industry specific skills will get into trouble if there is a weak welfare state, and they get fired, or their firm goes bankrupt, or, worst of all, if their entire industry takes a serious downturn. They have difficulty in finding a new job, because they’ve invested in skills that are non-portable across firms or industries.”

This is utterly irrational. By definition, people with skills are perfectly capable of taking unskilled jobs. Their skills, then, INCREASE the number of jobs available to them! I’m a machinist, but if necessary I could flip burgers. It’s the person who can only flip burgers who’s really in trouble.

However, even taking the thesis seriously, there are two ways to increase skills investment. The OTHER way is binding contracts for extended employment in return for training. No, it’s not a violation of the 13th amendment, and it works quite well for the military. It could work for industry again, if once again permitted.

14

Ophelia Benson 10.18.03 at 2:38 pm

There’s another aspect of this kind of argument that always irritates the hell out of me, and that doesn’t seem to get noticed enough (or maybe I just always miss it). That implication that anti-progressive-taxation types are madly keen that all workers should develop their skills and thus get better wages. Err – not exactly! Those people also want a large pool of cheap labour, and better yet, a large pool of cheap labour that won’t complain and won’t unionize and won’t call the Feds about dangerous conditions or interference with union organizing. It’s a pious *fiction* that ‘we all’ want all workers to be well-paid and in good, secure jobs. They don’t. They want their housecleaners and gardeners and meat-packers and lettuce-pickers and garment workers to be poor and desperate and biddable, thank you very much. That’s the real reason they hate welfare – it means that people have an alternative, however minimal and nasty, to taking a brutal backbreaking badly paid job. Bad news for the upper tax brackets. Good thing those days are over!

15

Barry 10.18.03 at 3:41 pm

Brett, think of it this way:

As a machinist, you could learn skils which are highly transferrable across industries (‘general’),
or those which are only highly transferrable across companies within one industry(‘industry-specific). You could also learn skills which are valued by your present employer, but which wouldn’t be valued (and might be negatively-valued) by any other employer (‘company-specific’).

In the absence of a safety net, it makes a lot more sense to prioritize general over industry-specific, and industry-specific over company-specific skills. The reason is that you don’t want to flip burgers in the event of losing your current job; you’d prefer to go to another company as a machinist.

16

doctorem 10.18.03 at 3:49 pm

Look. The primary and glaring flaw of ANY argument that says “tax cuts are good” irrespective of anything else (which IS what Grover Norquist and his minions including 90% of the “modern” Republican party argue), is that it leads very simply to the logical conclusion that there should be no taxes whatsoever.

Virtually everyone agrees that there is SOME optimum level of taxation greater than zero, one that is determined by a sober evaluation of our society’s resources and needs. People will disagree about what that level is, but NOBODY can know for sure whether current tax rates are above or below the optimum rates and, ay any given time, it is just as likely to be either.

The sooner we recognize this tautology, the sooner we will reject the “no tax pledge” madness which says taxes are ALWAYS too high and upon which the “modern” Republican party bases its domestic economic agenda.

17

Brett Bellmore 10.18.03 at 4:27 pm

I’d be hard put to identify any skills in the field I’m in that could actually be considered employer specific. Use of some company specific software package, maybe? Even that helps your employability, by demonstrating that you’re capable of learning. And hopefully if you lose your job, you won’t be such an ass as to refuse gainful employment just because it’s “beneath you”.

The key point though, is this: An employer does want their employees to be more skilled, but has to be reluctant to pay them to aquire skills which might be taken elsewhere. One might attempt to indirectly solve this with welfare policy, but that’s a very indirect solution indeed. I’m dubious that it works at all; Welfare also lessens the perceived need to obtain skills which provide job security, after all.

The military has a direct solution to this dilemma, which is proven to be very effective: Offer training in return for a commitment to use that training for a specified term in the military’s employ. “Indentured servitude”, if you will. I think industry should be permitted to offer this road out of poverty, too.

18

Ophelia Benson 10.18.03 at 4:44 pm

“An employer does want their employees to be more skilled”

But that’s not true, is it? Not necessarily, not all employees and not all employers. It depends on the kind of work that’s involved and the state of the labor market, for a couple of things, surely. For plenty of jobs no real skill is required, just a lot of damn hard work, which skilled people don’t want to and (with any luck and a good labor market, etc.) don’t have to do. A lot of employers do indeed want, precisely, unskilled workers, because no one else will do the job, especially not for shit pay.

19

Nicholas Weininger 10.18.03 at 4:58 pm

It strikes me that the argument here depends on the hypothesis that when people develop specific skills, it has really big positive externalities– economic effects not captured by the return to employers of having people around with said skills. I don’t see, however, why that should necessarily be the case.

You’re certainly not going to learn about the externality effects of developing specific skills by asking people with those skills whether they favor the welfare state. Of course it’s in *their* interest to have more economic security than their narrowly-tailored jobs might otherwise provide them. But that says nothing about whether taxing other people to give them that security provides a net benefit.

And if externality effects are small compared to direct short-term benefits to employers, then no welfare state is needed to provide skilled people with security. High demand for valuable specific skills will lead employers to pay high salaries to the skill-holders, and the skill-holders can then use those salaries to buy themselves security through savings.

For example, if you can make lots of money– but only sporadically– for knowing an obscure and narrowly applicable programming language, then you go into a job using that skill knowing it’s probably not going to last, and you use the premium salary it provides you to build up investments and savings accounts. This then gives you the wherewithal to tide yourself over during a downturn or to retrain yourself if the whole industry you depend on goes away.

Moreover, companies that have sporadic needs for workers with narrowly tailored skills can do this sort of calculation as well as individuals– they can choose to keep people “on the bench” during downturns, for the longer-term benefit of having them back when they really need them again.

20

Davis X. Machina 10.18.03 at 5:59 pm

What happens when someone in Bangalore, or in Manila, or in Kiev, has the same ‘specific skill’ I’ve been developing, and is employable at a third or a tenth of my cost?

21

Davis X. Machina 10.18.03 at 6:01 pm

I do not want to live in a country which is so draconian that all of the workers live in constant fear that they will loose their job and die of starvation.

Hey, I don’t either, but the people actually running the show seem to have a positive jones for such a state of affairs.

22

Ophelia Benson 10.18.03 at 6:09 pm

“but the people actually running the show seem to have a positive jones for such a state of affairs.”

Well exactly, this is my point. There is a blindingly obvious and very compelling reason for that, and it’s really remarkable how little it gets discussed, at least in journalism. You can find it mentioned in books, but not in the daily fare that makes up the medium we all swim in. So they get away with it. People who are afraid, and for damn good reason, will take crappier jobs for crappier pay than people who aren’t. The correct way to discuss this is to call it a ‘flexible’ labor market. Meaning one that can be fired and underpaid at will.

23

Henry 10.18.03 at 8:44 pm

Too many comments to respond to here, so I’m just taking up a couple…

baa – Becker et al.’s argument goes a lot further than arguing that tax reductions will, on average, reduce government expenditure. They’re claiming, without providing any sort of serious evidence, that reducing spending through starving the beast is indubitably a good thing. I’m not a macroeconomist, but Brad DeLong is surely right in saying that very few serious economists take as sanguine a view of this as Becker et al. My strong impression is that they take liberties with theory in order to support a particular partisan viewpoint. Further, I reckon that your implication that Nobelists don’t produce codswallop is manifestly contradicted by the facts. Especially when it comes to Gary Becker. He’s brilliant – but much of his work teeters on the border between genius and lunacy. And for the record, George Akerlof, who’s also a Nobelist, has described Bush’s policy in some rather unflattering terms; I don’t think that Robert Solow is too impressed either.

Nicholas – the extent to which there are externalities is a matter of controversy in the literature. Becker claims that all the benefits can be captured by firms; others disagree. As you likely suspect, I side with the others on this.

Brett – You’re very likely correct – there aren’t all that many specific skills in the field of employment that you’re in. And this is true, I would imagine, of most skilled jobs in the US. Which is precisely the point that Iversen etc are trying to make. Economies such as the US, with weak social welfare systems, tend to specialize in fields of economic activity with generalist skill profiles. As for your recommendation that the problem could be solved through some sort of indenture system – there are rather less draconian solutions available. For example, in Germany, skills training is carried out through industry-level training schemes, which help address the collective action problems inherent to training provision in a free economy.

24

Nicholas Weininger 10.18.03 at 9:40 pm

Henry: your response to Brett begs the question: who cares? What’s wrong with specializing in fields of activity with generalist skill profiles, given that there are plenty, and plenty lucrative, such fields? Far better to do that, I say, than to do as the Soviets did and produce legions of ultra-specialized engineers with no employability outside their sub-sub-fields.

Yes, I know, there are alternatives in between; I’m just pointing out that one *can* go too far the other way. And if weak welfare states may produce underinvestment in specialist industries, strong ones may just as likely produce overinvestment (not to mention all the other economic distortions they produce, but that’s a whole other argument…). The information problems involved in setting the right level of investment in such industries are, to put it mildly, knotty.

Furthermore, can you give some examples of industries that require investment in specific skills and in which the US has fallen behind the likes of Sweden and Germany?

25

Matt Weiner 10.18.03 at 11:14 pm

Nicholas:
It seems to me that Becker et al. care. They argue that highly progressive tax structures discourage people from training for specialized skills, and that’s an argument against those structures. It may be that in fact we don’t want any more people to train for those specialized skills, but then the argument that “Tax cuts incentivize people to train for skills and so are bad” won’t wash.
(It may be that Becker et al.’s response would turn on generalist vs. specific skills–in which case I would have to retire from the fray.)

Incidentally, isn’t it highly questionable whether progressive tax structures really do discourage people from getting better-paid jobs? I’m not economically trained, but I’ve looked at Samuelson’s text, and I recall a passage in which he said that empirical studies had failed to find such effects.

I was also rather flabbergasted by this, from Becker et al.:
Countries that invest heavily in educating their citizens are also those that tend to experience high economic growth following such investments.
Would those not also be countries that collect enough tax revenues to pay for schools?

26

dsquared 10.20.03 at 7:13 am

What’s wrong with specializing in fields of activity with generalist skill profiles, given that there are plenty, and plenty lucrative, such fields?

Basically, it’s crap if you don’t want to be dependent on France and Germany for your precision engineering.

27

Thomas 10.20.03 at 10:48 pm

If there’s a rule I’ve learned, it’s never trust Nobel prize winning economists, and certainly never trust Clark Medal winners, especially when they’re pronouncing on the very topic for which they won such an award.

28

Matt Weiner 10.21.03 at 12:54 am

Well, I would alter that to “Never trust fellows of the Hoover Institution,” whose explicit institutional bias is rather shocking. In any case, you haven’t explained why their argument isn’t incoherent.

29

Thomas 10.23.03 at 6:37 am

Is it your contention that none of their work has any value? That Becker and Murphy are simply…partisans?

Your complaint doesn’t seem to be that there argument is incoherent, but that it is incomplete. That’s a damning criticism, but not of an op-ed piece.

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