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Why you really need a degree

The economy goes through consecutive stages of transformation in which jobs are destroyed and replaced with better and higher paying ones. This concept of creative destruction is not an intuitive one, but can be explained, like so many other ideas in economics, with the principle of scarcity – in this case, the scarcity of labor. Because workers are scarce, any time an industry finds a way to make things using less of them, the productivity of labor increases and scarce labor moves on to remaining or newly created jobs. In the end, everyone is better off.

It would have been difficult to explain creative destruction to workers displaced from farming or traditional manufacturing during the Industrial Revolution. However, productivity gains at the time were so large that the very same change that removed workers from their old jobs actually put them into better ones in newly created factories. In preindustrial times, when 95% of population was employed in farming, the changes brought by industrialization would have been impossible to imagine. In 2010, the OECD average for employment in agriculture was only 4% (OECD, 2012). This means that since the Industrial Revolution, at least 91% of jobs disappeared and were replaced by new ones. I’d argue that the number is likely closer to 100%, as the nature of farming has also changed dramatically.

A similar change is now in front of us, and it is just as impossible now to foresee the future of employment as it was before the Industrial Revolution. Further, it is just as difficult to explain or justify recent changes in the job market to displaced workers. Any transformation is costly, and many workers are far beyond the stage in their careers where they want to change their specialization dramatically. As Ryan Avast states in his excellent book The Wealth of Humans (2016), “For a laid-off manufacturing worker in a Volvo factory in Sweden, job openings at software firms in London are of a little comfort.”

Current job market transformation is very different than in previous generations. The manufacturing jobs that provided employment opportunities to displaced workers during the Industrial Revolution required very little education (aside from simple literacy, which was also a major leap at the time).

The current technological revolution has also created plenty of new jobs, but in highly specialised fields that demand significant education. There is a shortage of these high skilled workers, however. This means that what we see on the job market nowadays is a relative minority of people with the right skills and education being highly paid, because their labor is scarce, and a majority of workers with basic skills chasing a dwindling number of opportunities in traditional fields such as manufacturing. Because there is an oversupply of labor and decreasing demand, wages in these positions have stagnated.

To illustrate this point, we can look at wage growth in the U.S. during the recent decade. The average inflation-adjusted wage has grown just under 1% per year on average in the period since 1980, but it is a paltry 4% in total for the whole period (or 0.1% per year) when only the median wage is considered. This means that workers in the middle of the scale haven’t received almost any real wage increase since 1980.

Why is this happening? GDP and productivity has grown during the same period (although not at the breakneck speed of growth prior to 1970). The reason is this: new jobs require lots of education, but the pool of educated people is very limited. And because the supply of educated labor hasn’t satisfied the number of new jobs, educated jobs are getting higher salaries (Avast, 2016).

I don’t want you to take my word for it, so I prepared the following charts based on employment data from the Organisation for Economic Cooperation and Development (OECD, 2016).

Chart 1 shows differences between average salaries of bachelor degree holders and workers without a university education. The OECD average gap is 67%, but is even bigger in the United Kingdom (73%), United States (86%) and a staggering 145% in Mexico and 218% in Chile.

This gap further widens when master degrees are considered, as you can see in Chart 2. The average OECD worker with a master’s degree can expect to earn 110% more than an average worker without any university education. A worker in the U.S. can expect 148% more, a worker in Mexico 247%, and in Chile an absolutely unreal 380%. The staggering disparities of the earnings in Mexico and Chile are, however, more a product of their dysfunctional educational systems, which don’t supply as many university graduates as the economy needs.

Chart 3 shows how much of this difference in salary depends on the percentage of workers with a university degree (bachelor’s or master’s) in the economy. You can see the share of workforce with a university education on the vertical axis, and the salary gap on the horizontal axis. The more educated the workforce, the smaller the difference between the salaries of educated and uneducated labourers. Of course, the more sophisticated the economy is, the higher the share of university graduates it needs - a factor not captured by this simple regression. That’s why countries such as the U.S., U.K. and Korea fall so far above the regression line – their economies need much higher numbers of educated workers than France or Mexico do.

Current trends in job markets, which already show staggering differences in wages of workers with and without college degrees, are far from finished. They are, in fact, showing acceleration. Barring few exceptions, jobs in the future economy are likely to be for educated workers only. It might differ according to where you live, but all current data from the job market points to one conclusion: you need a university education.

List of references:

Avent, Ryan. 2016, The wealth of humans: work, power, and status in the twenty-first century. First U.S. edition, New York: St. Martin's Press.

Organisation for Economic Cooperation and Development. 2016, Education at a glance 2016: OECD indicators, Organisation for Economic Cooperation and Development.