Wednesday, October 26, 2011

Repowering US economy: Fix education, not taxes

THE Republican presidential debates have been replete with discussions about our economic future, but to listen to the candidates you'd think that the biggest problem is an onerous US tax code.
By Edward Glaeser

I'm all for sensible tax reform, but prosperity depends far more on our skill base than on cutting tax rates that are already low by international standards. If the Republicans want to battle for a more prosperous, and stronger, country, they must start spending a lot more time fighting the failures of American education.

The attached figure shows the correlation between the logarithm per capita income levels last year and maths Pisa test scores in 2009. The Organisation for Economic Cooperation and Development's Programme for International Student Assessment (Pisa) tests 15-year-olds in a range of generally prosperous countries, and takes on values from 200 to 800 (similar to the maths Scholastic Assessment Test, or SAT). Tests are also given for reading and science - the scores are quite closely correlated across subject area - but the maths results are the best predictor of incomes across countries. I excluded Luxembourg and Liechtenstein because of size, and subnational Chinese areas, such as Hong Kong and Shanghai.


Maths scores and gdp
The graph illustrates that a 46-point test score increase, which is about 10 per cent of the average score across countries, is associated with an increase of more than 90 per cent in country level incomes. The test score variable can explain, in a statistical sense, the lion's share of income differences across these countries.

Although it's sensible to be a bit sceptical about figures like this, there is a long and distinguished literature linking education with economic outcomes at the individual, country and metropolitan area level. Economists have found that earnings rise with education even among identical twins and that randomly getting a better kindergarten teacher produces higher adult earnings.

At the metropolitan level, education predicts earnings growth, not just income levels, and the presence of a land-grant college prior to 1940 is a strong predictor of economic success today.

At the national scale, fears of reverse causality are allayed by the fact that education predicts improvements in income and government quality, but ameliorations in those areas don't predict improvements in education.

All in all, the link between education and prosperity is about as solid as anything in the social sciences.

By contrast, the statistical link between tax rates and prosperity is far weaker. Across countries, incomes are typically higher where governments spend more, as a share of gross domestic product. This is known as Wagner's Law, and it doesn't mean that big government increases prosperity, because government spending is primarily reflecting, not causing, high incomes.

But empirical studies, compromised by a host of tricky statistical issues, have typically found a murky relationship between government size and economic growth. US tax cuts also typically appear to have modest impacts on economic activity.

This may not be surprising because America's tax rates are already low relative to world standards.

Similarly, the US' economic problems don't primarily reflect deficient infrastructure or too expensive energy or the actions of the Environmental Protection Agency.

I support smart reform in all these areas, but if we fail to address the primary issue - our skill deficit - we're fiddling while the country declines. Indeed, the figure shows that US wages are already high relative to our skill levels. The big challenge is to ensure that Americans have the tools to thrive in an information age.

Current Pisa maths scores put the US in the middle of the pack. We're on a par with Portugal, ahead of Italy and Azerbaijan, and behind Hungary and Slovenia. We're far behind countries such as South Korea and Singapore.

Why should we expect an American with limited skills to earn dramatically more than an equally skilled counterpart in China or India? An American consultant doesn't expect to earn a wage premium for advising an Indian company just because she's from the US.

People who sell their time through the online marketplace Amazon Mechanical Turk can't expect to earn more because of their location. Place matters - we're still educated by the people around us. The importance of having smart neighbours explains why cities such as Seattle, Minneapolis and Boston continue to thrive.

But proximity is worth less and less if you aren't learning from the people around you. Once upon a time, Americans could expect to earn more than equivalently skilled Asians or Europeans, because of our natural resources and a government that was exceptional in its stability, rule of law and embrace of capitalism.

Today, there are plenty of countries where entrepreneurs can thrive.

The would-be Republican candidates all champion enduring American greatness, but how can that greatness persist unless the US is one of the most skilled countries on the planet? The 20th century was America's century in part because Americans were so well educated.

Americans will earn what our talents produce. Any Republican or Democrat who wants to repower our economy must recognise that the nation's future depends on its human capital, far more than infrastructure or energy or finagling with the tax code.

The writer is an economics professor at Harvard University and a Bloomberg View columnist.