Saturday, 12 June 2010

Six reasons why there are too many graduates

Talking of identity economics, I can now identify the author of almost every Worthwhile Canadian Initiative posting within the first couple of sentences. They are trying to confuse me by throwing two new authors into the mix, but I have figured out their wily ploy.

So in the first Frances Woolley post I have recognised, she has mentioned in passing a mysterious fact.
Squidward Tentacles, SpongeBob's co-worker, probably did better in school than SpongeBob did. He has intellectual pretensions, to play clarinet and to dance. But these aspirations only make him miserable in his job as a cashier at Krusty Krab.
Canada, like many other countries, has expanded access to post-secondary education, but the demand for educated workers has not kept up to the supply. A study by Marc Frenette based on data from the 1980s and 1990s found over thirty percent of university graduates were over-qualified for their jobs.
But the quantity demanded and supplied should be equal in equilibrium - at least roughly. For supply and demand to be thirty percent out of balance over a thirty year period is a spectacular market failure.

What explains this? There are several possible reasons.

First, it could be down to subsidy. Higher education is indeed subsidised by most governments, and we would normally expect this to result in oversupply. So perhaps people are going to university who would not do so were this a free market.

However, even if there is an oversupply, we'd expect graduate wages to fall until enough demand is created to mop them all up. The oversupply would result in people having more education than is optimal, but it would not mean that skills go to waste. If we subsidise cows, people will eat more beef but there won't be piles of it rotting away in the streets.

So the second question is: why would employers not create enough jobs for the graduates to do? Well, production requires a balance between labour and capital, but also a balance between different kinds of labour. It's likely that expanding employment of skilled people would also require more employment of unskilled people. And if everyone is getting a degree, there's only one place to get unskilled people - overseas. So, since most rich countries have strict immigration controls (especially on unskilled labour), graduates end up having to do unskilled jobs.

The third factor is that employers do not reduce graduate wages so they can hire more graduates. Instead, they pay efficiency wages - wages above the market rate which help to buy honesty and loyalty from staff. Another way to express this is that employers deliberately keep the labour market oversupplied, so their bargaining position is stronger.

So there is some logic in this market, and a reason for employers - the demand side of the market - to act as they do. Why do employees (or rather school-leavers) cooperate with them? Even if the government pays some of the costs of education, student must still give up three or four years of their life

The fourth possibility is that - in the short-term, there could be a simple problem of wrongly predicting demand. Any supplier who needs to spend time building a product (or in this case, a body of knowledge) has to forecast what demand might be by the time they are finished. Anyone starting a degree in a booming economy in 2004 or 2005 had the bad luck to come out in the middle of a recession. But this can't explain a consistently wrong forecast for three decades in a row.

Fifth, students might be gaining private utility from their education which is nothing to do with future employment. University is quite good fun, and future life is enhanced by the having of knowledge. This, like the public subsidy, would create an extra supply of graduates.

Sixth and perhaps most overlooked, the overconfidence bias. A well-known test of students at Harvard asked them, at the beginning of term, to estimate the class ranking they would gain at the end [I can't find a reference for this right now - please comment if you know where it is]. Around 25% of students thought they would be in the top 10%. 50% thought they'd be in the top quarter. And every single student predicted they would be in the top half of the class.

You will be unsurprised to hear that not every student did end up in the top half. Perhaps, however, everyone entering university firmly believes they will be in the top 70% who do achieve gainful employment which uses all of their skills. After all, the propaganda they've all heard in their school years points towards it. Nobody knows - until it's too late - that they will end up in the bottom third who get left behind.

And perhaps this is, after all, exactly the outcome that society wants. An increase in skills and knowledge across the population has big positive externalities. This justifies the subsidy of education, and - perhaps - justifies the costs borne by those individuals who don't end up with the career of their dreams.

Should the public therefore consider compensating those individuals for the time they've spent in our interests? An interesting question. If so, a graduate tax is a terrible policy. But that's a debate for another posting.

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