Economics: Tax twist over the skills gap

ROBERT Reich, the US Labor Secretary, likened last week's jobs report from the Organisation for Economic Co-operation and Development to a Rorschach ink-blot test: what people see in it tells you more about them than it does about what they are looking at.

Both the Government and the Opposition claimed the report as a vindication of their views, but in reality it was exactly the sort of compromise you would expect from a committee of 24 countries: it contained something to please everyone while skating over the really tough questions.

The report's diagnosis contained few surprises: employers increasingly want skilled rather than unskilled workers because of advances in technology and competition from developing countries with low wages, but industrialised countries have been slow to adapt.

In North America the private sector has created 30 million new jobs since 1974. But many Americans have had to price themselves into unskilled jobs by accepting low pay and cuts in real earnings during the 1980s averaging 1.3 per cent a year. With employers also more willing to pay a premium for highly educated and well-trained white-collar employees, this has opened up a gap between rich and poor unmatched in the developed world. In the US, 16 per cent of full-timers earn too little to keep a family of four out of poverty.

Most countries in Europe are unwilling to accept inequality on anything like the US scale, so they offer generous social security benefits buttressed by regulations to protect workers' terms and conditions. Europe's low-paid workers have enjoyed pay increases above inflation through the 1980s, but Europe has had higher unemployment than North America and has created a tenth as many jobs.

Europeans are less likely than Americans to lose their jobs, but also less likely to find work quickly once they become unemployed. So while 11 per cent of the unemployed in America have been without work for a year, the figure in Europe is more than 42 per cent.

Britain has spent the past 15 years moving steadily from the European to the US model. In the 1980s the gap between high and low earners has widened at a rate unprecedented in modern times. Britain's experience shows that pursuing a happy medium between the US and European models is not as simple as it sounds.

The OECD's policy conclusions were a mixed bag. The report began by attacking some straw men, rightly arguing that it would be pointless to try to insulate people in the industrialised world from change by opting for protectionism or job-sharing. Protectionism reduces pressure on companies to innovate and hurts consumers by keeping prices high. Job-sharing founders on the unwillingness of full-time workers to accept cuts in income in proportion to the cuts in their working time.

The report instead made several recommendations to improve so-called 'labour market flexibility'. These included removing both restrictions on working times and incentives for early retirement. Taxes should be cut for people on low earnings and restrictions on hiring and firing should be removed. Social security benefits should be made less generous and should be withdrawn if recipients are unwilling to train or join other labour market programmes.

Britain is already well down this road, as the Government was quick to point out last week. Hours of work here are more variable than anywhere else in the EU and in most respects the labour market is regulated with a lighter touch in Britain than elsewhere in Europe.

But the OECD rehearses two pieces of received wisdom that do not stand closer examination.

The report's most publicised proposal was that minimum wage legislation - recommended by the Labour Party and opposed by the Tories - should be abandoned or made less rigid. This was music to Sir Norman Fowler's ears, but it also demonstrates that there is nothing more dangerous in economics than an idea which appeals to common sense.

It seems entirely logical that imposing minimum wages should cut employment because companies will not be able to afford to take as many people on. But evidence from academic studies in Britain and the US suggests paradoxically that minimum wage schemes actually create jobs.

The logic is that employers can get away with paying their employees less than the value of their work because they know that it is costly and time-consuming for them to find alternative jobs. So a minimum wage above what employers want to pay but below what their workers are worth will encourage more people to apply for jobs, and it will still be profitable to take them on.

The OECD, like Mr Clarke, also argued that improving the quality of education would be important in combining American-style job creation with European concern for the least well-off.

Partnerships between business on one hand and schools and colleges on the other should be strengthened to ease the transition from education to work, and people should move between employment and education periodically throughout their working lives. The OECD also supported levies on companies to encourage them to spend more on training.

The chattering classes have been bewailing the quality of education and training in Britain for at least a century. But it is important not to get carried away with the idea that spending more on education and training is a rapid and foolproof way to keep the industrialised world leading the economic race.

Old assumptions need re-examining. It has long been argued that Britain is good at educating people to degree level, but bad at training in the intermediate skills which have sustained the German industrial miracle. But a study published last week by the National Institute for Economic and Social Research found that productivity growth in manufacturing in Britain and Germany was boosted significantly by high-level skills, but not since the mid-1970s by the level of intermediate skills. So the German approach to industry-based training may be becoming outdated.

Even expanding higher education is of dubious value. Martin Weale of Cambridge University argues that raising the staying-on rate into higher education from 30 to 50 per cent would raise the economy's trend growth rate by only 0.08 per cent a year after a generation - chicken feed.

It may be that investment in high-level education and training is becoming a less effective way of boosting national competitiveness. Highly educated and highly productive people are becoming an ever more mobile group to whom national boundaries are increasingly irrelevant. Western educational institutions increasingly cater for international audiences, and with advances in distance learning and multimedia, the location of educational infrastructure is becoming ever less important.

This means that policy-makers in the industrialised world will soon have to drop the complacent assumption that people in South Korea, China and Singapore are any less able to compete in high-skill, high-value-added industries and services in which Europe and the US presume their futures to lie. Remember that not long ago it was assumed that the limit of Japan's economic threat to the West was its ability to make cheap and shoddy cars and calculators.

The existence of a highly skilled, highly productive and internationally mobile elite will intensify the dilemmas faced by the industrialised world, because they can pick and choose the tax regime under which they wish to live.

The measures to improve education and technological research recommended in the OECD report, together with the changes in the tax and benefit systems it proposes to create greater incentives for the low-paid, cannot be achieved without significant increases in the tax rates imposed on the middle and top income scales - an issue the OECD dodged.

The elite may be happy to contribute to a society of enlightened egalitarianism, but frankly there is no guarantee.

A world in which governments compete for highly productive people in the same way that they compete for foreign investment may well be one in which problems identified by the OECD remain largely unaddressed.

(Graphs omitted)