04 December 2013

Wasted and Misused Human Capital

Our 21st century economy does a better job of analyzing and making rational decisions regarding physical capital and financial capital, than it does human capital, where inertia and tradition have produced maladaptive and outright wasteful management of human capital.

Where do we go wrong?  Here are a few examples:

Early Retirement Of Productive Workers

It seems incredibly wasteful to have skilled professionals who are perfectly capable of doing valuable work in their fields retire early.  Retirement ideally should coincide with greatly reduced marginal productivity.  In manual labor or military service, that date may come early.  In law and medicine and a host of other "knowledge based" professions, that date may not arrive on average, until someone is in their seventies.  Early retirement is a symptom that we are paying these professionals too much, leaving them sated in their need for money for further consumption so that they seek leisure instead.  It may make sense in a highly productive era to shrink the labor force with early retirement for many, but this should not be a path chosen for those who are capable of being highly productive in their golden years.

If a neurosurgeon finishes medical school and a residency becoming a full fledged specialist physician at age 32 and retires at age 57 after 25 years as a physician, instead of at age 67 after 35 years as a physician, the productivity return on that person's education and inborn talent (collectively, his human capital), is reduced by 29%.  In dollar terms, this early retirement deprives society of something on the order of $5 million in medical services that would otherwise have been produced.

Curiously, some professions, like medicine and financial services (which are in my opinion probably overcompensated in our economy on average due to market failures in the U.S. economy) seem to have far more early retirements of highly compensated able bodied individuals than law, where it is not uncommon for even very successful professionals to continue to work part-time as "of counsel" attorneys or "senior judges" into their early 70s.  It would be interesting to get better empirical data on early retirements.

This example is extreme.  But, it is the early retirements of the most elite and highly paid workers in our economy that impact our nation's productivity the most.  A retirement of a thirty hour a week minimum wage worker, ten years earlier, in contrast, deprives society of just $120,000 or so dollars of productivity.

Higher Education Funding Not Well Matched To Academic Ability

Another huge source of waste in our economy is the way that higher education resources are used. Assume that academic ability of graduating high school students can be broken into four categories of equal size, A, B, C and D with A being the most able, and D being the least academically able.  

Unsurprisingly (for different reasons in different political-sociological and economic theories) affluent families tend to have more children in the higher category than the lower category.  It turns out that one of the big picture empirical messages of educational psychology (basically academic testing and test analysis) is that this reality is highly resistant to policy intervention on a consistent and widespread basis even with considerable education expenditures.  Education spending helps kids achieve their potential in a way that benefits us all, but is a far less potent force for upsetting the socio-economic status quo than early public education advocates had assumed. 

Probematically, the likelihood that a child of an affluent family with academic ability D goes to college is about the same as the likelihood that a child of a working class family with academic ability A goes to college.  Household spending on higher education is not very well linked to academic ability, even though academic ability is closely linked to return on higher education investments.  Public spending on higher education is also not very closely tied to academic ability.  The group of students who attend and graduate from college is dramatically more skewed towards the affluent than the group of students in academic ability group A.

Thus, our society spends vastly too much in public and private funds educating academically weak rich kids, and vastly too little educating academically strong poor kids.

How important is this?

A February 2013 paper using the natural experiment of employment desegregation after the civil rights era opened the doors to women and minorities in a variety of professions and occupations quantified the economic returns attributable to that reallocation of talent.
This paper measures the macroeconomic consequences of the remarkable convergence in the occupational distribution between 1960 and 2008 . . . . We find that 15 to 20 percent of growth in aggregate output per worker over this period may be explained by the improved allocation of talent.
The current disparities in higher education access are probably not quite so direly skewed (although probably worse than they were at the most meritocratic moments from 1960 to 2008), but it isn't unrealistic to think that 5 to 10 percent of growth in aggregate output per working in the next fifty years could be achieved by improving the nexus between academic ability and how we allocate economic resources to providing students with higher education.

Child Care For Low Income And High Income Parents Of Young Children

The somewhat counter-intuitive pattern in the U.S. economy is for it to be much more common for college educated mothers of young children (who are very likely to be married) to leave the workforce temporarily to focus on parenting and homemaking than for mothers of young children who have no college education to do so (these mothers are also less likely to be married).

At the household level, this is understandable.  Being a stay at home mother is considered a form of leisure than is easier to substitute for consumption of third party goods and services in an middle class family that can provide a comfortable living for itself with one income (or perhaps one and a half incomes), and this leisure is too expensive for working class families with only the bare necessities of life with all adults working full time to afford.

But, given the considerable cost of child care for pre-schoolers, despite the fact that early childhood child care providers are among the very lowest paid workers in our entire economy, the economic returns of working to a household with a low income mother net of child care costs a very meager relative to the economic returns of working to a household with a potentially high income mother with a college education and the beginnings of a professional career.

Yet, the fact that middle class mothers are predominantly willing to make the immense economic sacrifices in lifetime earning potential that they do in order to be stay at home mothers for their children, suggests that the perceived benefits to a household of this form of child care relative to outsourced child care for young children is considerable indeed.

Women who don't leave the workforce tend to generate incomes comparable to men.  College educated women who do leave the workforce, even if they return five or ten or fifteen years later, see deep reductions in their lifetime earnings, far in excess of that reduction associated with simply shortening their total number of years in the workforce by that many years; but non-college educated women pay only a modest lifetime premium beyond simply having a shorter number of total years in the work force for taking time off.

Does it really make sense to have an economic system that overwhelmingly causes women with young children who have potential incomes of $1,000 to $1,500 per month less child care expenses of $300+ per month (net $700-$1,200 per month) to be in the work force, while overwhelmingly causing women with young children who have potential incomes of $5,000 to $7,500 a month less child care expenses of $500+ per month (net $4,500-$7,000 per month) to stay out of the work force?

A culture of "welfare queens" is decried by conservatives.  But, doesn't it make sense to tweak the incentives in our economy in some way that causes highly economically productive women with young children participate in the workforce at higher rates than those who are less economically productive?

A fair amount of progress has been made in determining why this happens.  But, if we want to make better use of human capital, we need to find ways to better use the human capital of college educated, highly productive women who chose to stay at home mothers for some period of time, and we also ought to rethink the intensity of our current incentives for low income women to enter the workforce rather than providing very valuable parenting to their own young children in critical years for their development.


Permanent harm from temporary household economic collapse

The most economically catastrophic thing that can happen to most households is for one of the adults in the family to be involuntarily unemployed.  Only a tiny share of households have enough savings or access to debt to sustain their normal level of consumption and debt service expenditures for more than a few months.  Fear of unemployment is a powerful incentive for employees to meet employer expectations in the American economy.  And, only a modest percentage of American workers are capable of self-employment at something comparable to what they could earn as employees - even then, many are capable of doing so only if they begin with considerable working capital and start up cost investments.

Temporary loss of income can lead to permanent economic waste and harm to households by causing households to lose investment opportunities and equity in property due to fire sales necessitated by immediate needs to pay current expenses and debt service that current income can't cover.  This waste is often blameless in the sense that the inability to pay was unforeseeable when the obligations to pay many of these expenses and debt service obligations was incurred.

Thus, one problem caused by unemployment is household economic scarcity that causes disproportionate harm.

Unemployment isn't intrinsically a product of economic waste of human capital by any given firm.

In a rapidly changing economy, employers legitimate needs to lay off workers, and to fire poorly performing workers are real.  The economic costs of prohibiting them from doing so, or strongly discouraging them from doing so are great.  The employer need to reduce their work forces and trim under performing workers is particularly great during economic recessions when unemployment is highest.  Often, during economic downturns, public sector and private sector firms simply do not have the funds needed to make payroll every month.

Likewise, there are very legitimate reasons why, particularly during recessions, a particular firm has no economically viable opportunities to hire new employees to carry out its existing line of business, so that they are not wasting or misusing human capital either.

Thus, unemployment can create wasteful losses to household that can exist even if firms that are terminating the employment of employees, or failing to hire new employees, are not wasting or misusing human capital at all.

Instead, unemployment is not fundamentally a problem of too few jobs, or of too many workers.  It is fundamentally a failure of entrepreneurship and the new business forming sector in general.  Unemployment happens when nobody can find anything economically worthwhile to do at any legally permissible rate of compensation with available unemployed human capital resources.

Put another way, the firms that are mostly at fault for wasting and misusing human capital in recessions are not the firms that exist, but those that don't exist but should.  Unemployment represents massive opportunity costs that existing firms, by almost definition*, have collectively forfeited.

* Some workers may have negative marginal productivity net of minimum legally permissible compensation rates in every public and private sector firm and every use that could be imagined but is not undertaken by any firm.  For example, if technological change causes many formerly economically productive people to have negative marginal productivity, or if age or disability causes a person who once might have been productive in some capacity to have negative productivity, then unemployment to that extent (together with a minimal necessary job transition employment) is rational and not an opportunity cost.  Estimates of the proportion of the unemployed who are in fact unemployable by any economically rational firm vary considerably and are controversial and tend to flow from political predisposition as much as facts.

Human Capital Rot

In addition to household economic scarcity, economic data support another cost of unemployment that impacts not just the household of the affected worker, but also the productivity of the economy as a whole, even if all potential employment situations where a new employee would have zero marginal productivity net of compensation at a free market determined compensation rate (ZMP) or more are filled.

This is the finding that long term unemployment reduces the economic value and productivity of an unemployed worker on at least a short to medium term basis, and perhaps even on a long term, lifetime future earnings basis.  Employee productivity is a perishable asset that rots if it isn't used regularly.  Very little current U.S. unemployment policy addresses this well documented phenomena.

The Case For A Right To A Job, Government Created If Necessary

Because productivity rot is real, ideally, unemployment policy should provide not just economic support to unemployed workers, but also interim employment, even if it wouldn't make economic sense for a private, for profit firm. Addressing unemployment by artificially creating jobs for anyone who wants to work and is unemployed, at a minimum legal rate of compensation or the amount that would otherwise be paid as unemployment compensation, without regard to the profitability of this employment, can make sense as an economic policy.  If someone is tasked with simply brokering or directly assigning these make work employees with the most valuable task that they can locate for them to do on any given day given their skills, then existing human capital waste which is a dead loss productivity loss to society is avoided, and economic productivity rot from having people out of the workforce for long periods of time is likewise avoided.

A make work social welfare program like this may very well (and indeed should be if the economy is functioning well) a net public expenditure.  But, this kind of program mitigates the welfare program expense and minimizes waste and human capital rot to the greatest extent possible in a way that is not just a handout and leaves recipients with dignity.  Also, because participants must show up and work in order to receive the compensation under the plan, like any other job, opportunities for fraud present in an application and mailed benefit check program paradigm are avoided.

Unemployment Benefits and Working Class Family Stability

Our existing unemployment system, which provides benefits only to the most "morally worthy" of the unemployed (those who are unemployed solely due to layoffs which are no fault of their own for less than six months), and provides benefits that are stingy and bureaucratically a nightmare to administer also greatly undermine the stability of low income less educated couples.

If unemployment benefits are not generous and robust, a male worker who experiences fairly regular episodes of unemployment is at great risk of seeing his marriage collapse even time this happens, because one of the most powerful predictors of divorce is that the husband makes less money than the wife, which often happens when a man is unemployed for a sustained period of time.  So these men tend to have unstable marriages which is bad for the couple and bad for their children.

But, if generous and robust unemployment benefits or access as a matter of right to some job can prevent able bodied work force participants from periodically becoming economically worthless, they are more likely to be able to sustain their marriages at rates similar to those of college educated men who have far, far lower rates of long term unemployment - something that is good for both the couples and their children.

In contrast, welfare programs that are not tied to employment history, or specifically require that absence of two able bodied adults in a family to qualify, weaken couples and make it less likely that their children are raised by both parents.

Childhood parenting instability for working class families very likely is an important factor impairing human capital development in these families leading to greater inequality and lower aggregate productivity.

Unemployment Benefits And Incentives To Seek Work Or Work Well At A Current Job

Of course, if unemployment benefits are too generous or robust, the incentive of workers to perform on the job in a manner that allows them to keep their jobs declines, and the incentive to look for new jobs declines.  But, the amount and duration of U.S. unemployment benefits, and the difficulties involved in qualifying for them are so minimal that this isn't a problem here as it is in places like Europe where unemployment benefits are far more generous.

Indeed, in the U.S., the opposite problem may be present.  Undue pressure to find replacement employment in the U.S. due to weak savings and stingy unemployment benefits may cause unemployed people to take jobs that are suboptimal in the long run if short term liquidity weren't such a problem.  The magnitude of this cost is hard to measure.

Footnote on Japan and lifetime employment

In Japan, many of the social welfare roles of the state exist, but are performed by Prussian style big businesses that aim to provide "lifetime employment" for much of its workforce, and a variety of other consumer needs, even employer housing, directly and in kind to workers.

Essentially, Japan has tried to deal with the failure of entrepreneurship problem in their economy by internalizing it to large firms that have to lay off employees from their declining lines of business - pressuring them to find alternative lines of business or opportunities for those employees instead.

In the absence of government make work programs, the U.S. has no firms anywhere in its economy that are specifically identified as being responsible for creating new jobs, even on a temporary mitigation basis during economic downturns.

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