Why is education so crucial for economic growth?

"The roots of education are bitter, but the fruit is sweet." Aristotle

After a span of more than two thousand years these words by Aristotle have lost none of their meaning.

Of late, the education system of Latvia has been subject to severe criticism.  Concerns about drops in learning standards both in secondary and university education emerge from all sides. University teachers complain about the declining level of knowledge of secondary school leavers, while businesses voice their dissatisfaction with universities failing to train employees demanded today by the labour market. A spoonful of tar spoils a barrel of honey, a Russian proverb goes, and this may be said about the public discussion-added negative inferences: there are too many university graduates among the unemployed, and the Latvian universities do not take top positions in international ratings.

Does education help in the labour market?

Even though people with university education can be found among the unemployed, their numbers fall behind the ratio of the university educated within the population. According to labour survey data of the CSB, in the second quarter of 2010, of all jobseekers 10% were with higher education, 20% were graduates of vocational or professional schools, 24% had left general schools, and 31% had acquired basic education. In other words, university education reduces the likelihood of becoming unemployed two times vis-a-vis vocational education and three times vis-a-vis basic education.  In addition, during the economic downturn, the role of education in the labour market considerably increased: less than 8% with basic education were among jobseekers at the close of 2007 (4% with university education).

Higher education is a prerequisite not only for job position but also for higher remuneration. According to Eurostat survey data for 2006 (most recent available), employees with a higher degree of academic education in the EU are paid twice as much as general secondary school leavers. In Latvia, the respective remuneration gaps are similar.

Although the role of education can never be overestimated, the shortage of low-skilled labour in 2005–2007 gave rise to a delusive stereotype about doing very well without quality education. Young people who then opted to quit learning or studied superficially in the period of labour shortages and took up jobs in the construction or real estate sectors are the losers today. It is they that were most severely dismissed when the economy plunged into downturn.

It should be noted, however, that common sense should prevail everywhere:  not all who opt for higher academic education, their choice being determined by average numbers, turn out to be winners. One can argue that secondary school leavers with excellent artistic or sports skills would not gain much from becoming mediocre bachelors in economy if they reject a profession in which they can realise themselves, create the highest value added and get the best remuneration. In cases when they do so, individuals will not realise their innate natural endowments and, in addition, are most likely to join the army of the unemployed soon after.

The role of human capital in the economic growth

Why are employees with university education highly demanded in the labour market? Is this demand founded? Higher education raises human capital and labour productivity accordingly: on average, an individual with higher education can generate higher value added in a man-hour than one without it; the former receives a higher pay accordingly. Value added or national wealth actually is the number of man-hours worked multiplied by average productivity. Consequently, an increase in productivity may result in a higher welfare for the community even without an increase in the number of the employed. Due to negative demographic trends or a low birth rate, productivity improvements are of paramount importance for the economic development of the EU countries, including Latvia as well.

According to econometric estimates, every additional year of education increases productivity and employee's remuneration by 6%-10% on average (Acemoglu, 2007, p. 132.). This is a person's private gain from education verified by the Eurostat data on education referred to above regarding the impact of education on pay.  Public gains from education may be much more important, as education is likely to raise remuneration not only for the educated alone but for other community members as well. The neoclassical growth model shows that, if physical capital and human capital complement each other (e.g. only educated labour force can use complex equipment effectively), higher qualification of labour boosts the average per capita level of physical capital and also productivity of each employed, thereby pushing up remuneration as well (Acemoglu, 2007, p. 492.). Implied community benefits are reflected in the Balassa-Samuelson effect. Even though a German hairdresser is not more productive than his Latvian counterparty (the same time spent on a hairdo of the same type), the former is remunerated higher than the latter. That is so because the production sector of Germany's economy boasts of higher overall productivity and secures higher wages and salaries for the community overall, including also in the services sector.

Some economists maintain that it would be optimal to forecast accurately the number of specialists Latvia would need in 20 years, and the state procurement should meet the calculated training needs in compliance with such projections. The stance cannot be supported in full, as for instance, who could have anticipated 20 years ago that such significant structural reforms would be implemented in Latvia and across the globe? Also, it is not clear at present which of today's sectors will undergo the fastest development in the future. Of course, both industry and information technologies should retain their place in the economic structure, and specialists in these branches shall be educated accordingly. Yet it should be remembered at the same time that, in order to take advantage of the next growth wave, Latvia should focus on enhancing the human ability to innovate rather than only train specialists of certain professions. The economic development over longer horizon relies on technical progress, which, in turn, primarily depends on new ideas or scientific innovations. Thus, the education system has obtained a new objective of not simply producing good or even excellent specialists, but also of promoting students' innovation potential.

Life-long learning is taking an ever more important position across the globe: the employed not only acquire more knowledge and new skills on a regular basis via in-house training but also enhance their abilities attending various courses.  If the long-term economic development cycles (known as Kondratiev waves) are really contracting (according to observations, they had contracted by the lifetime of one generation by the middle of the 20th century), today's students will have either to change profession or, at least, to improve and to expand their knowledge and skills, since the buoyant progress of contemporary technologies renders any 10 or more years old know-how out of date.