The award of the Nobel prize for economics can capture a key moment in political economy. The award to Milton Friedman was the final seal of respectability for the monetarist account of inflation. The 1999 award to Robert Mundell raised topical questions about the euro. And the most recent award to James Heckman is another such moment. He is one of the world's leading labour market economists, who has questioned the conventional wisdom about investing in human capital popularised in America by Robert Reich and in Britain by Gordon Brown. Heckman reaches his sceptical conclusions not on the basis of abstract theory but with the authority that comes from being the world's foremost expert in the empirical evaluation of social programmes, especially in education, training, and welfare to work.
It has been an important part of New Labour's political rhetoric to present their spending programmes as "investment." Instead of Old Labour tax and spend we have New Labour investment in human capital. It is supposed to raise the economy's growth rate without heavy-handed interventionism or Thatcherite deregulation. It is also supposed to tackle the international trend for a widening gap in the earnings of the unskilled and the highly skilled, not by redistributive taxation but by raising the earning capacity of the least well-off. As Tony Blair put it, "A better trained and educated population not only raises productivity and living standards. It helps reduce inequalities by giving people increased earnings power." It is because this has become the conventional wisdom that the Nobel prize award to Heckman is so refreshing. He takes the political rhetoric at face value and appraises education and training schemes to see what returns they yield.
The evidence shows that returns to training and welfare to work schemes are much lower than claimed. But that is just the start. Heckman asks us to imagine that further education and training do indeed yield a very favourable rate of return-say, 10 per cent. In other words, imagine that every ?10,000 you spend educating or training someone over 16 yields an extra ?1,000 per year of earnings. How much do you then need to spend in order to achieve the reductions in inequality that are claimed to follow? I have replicated his methodology and applied it to Britain. One would have to secure an extra ?24 billion per year of income for the less well-qualified to restore the income differentials of 1979. Assuming a return of 10 per cent this means an investment in training of ?240 billion. It puts Labour's ?4 billion New Deal into perspective.
There may of course be powerful social reasons for this programme. But Heckman just appraises the schemes as if they were simple investments. His conclusion is unpalatable for left and right: "The fact is that policies that seek to alleviate poverty by investing in low-skilled workers conflict with policies that raise the welfare of society at large. Taking the evidence at face value, the most economically justified strategy for improving the incomes of the poor, especially low ability, low skilled adults, is to invest more in the highly skilled, and then to tax them and redistribute the money to the poor."
Heckman does not stop there. He also has a very different model of the labour market from the one which dominates British debate. He argues that the importance of public qualifications is exaggerated and that what really matters is the privileged information which employees and employers gain about each other. He argues that much of the apparent increase in job mobility is really younger workers spending longer trying out different jobs before they settle down. At that point the employer and the employee find a relationship with which they are both comfortable and which could well last for a long time. Learning by doing matters. It is one of the reasons why the jobs of the over-30s are more secure than conventional wisdom recognises.
There are some big policy implications in all this. First, credentialism-trying to make as many of the skills as possible publicly recognised may undermine the ability of an individual and an employer between them to create a stable employment contract. It weakens the privileged special information that the employer has about the employee's skills and therefore may reduce job security.
Heckman's insight also shows how job subsidies can reduce the human capital of the people who receive them. One effect of job subsidies is to reduce the hours that people work. But if learning by doing matters, then the fewer hours that people spend working, the less opportunity that employers will have to assess their qualities.
I am not claiming that Heckman just reaches a convenient set of Conservative conclusions-far from it. He is a sympathetic advocate of early years intervention, for example. But perhaps his contribution to labour market economics is even greater than the fascinating conclusions that he has reached. His greatest single contribution has been developing very sophisticated techniques for evaluating the effectiveness of training schemes. If he doubts that they work, it is on the basis of the most sophisticated empirical appraisal. We all want public policy to work and to succeed, but the best way of ensuring that it does is for ministers and their advisers to listen honestly when economists of the calibre of Professor Heckman force them to look at what is not working and why. n
