(This essay was published in Hong Kong Economic Journal on 18 November 2015.)

 

What do worker complaints about long working hours, parental dissatisfaction with the Territory-wide System Assessment (TSA), dishwasher salaries, and earnings inequality have in common? They are all symptoms of two wider developments in society that need urgent attention.

 

First, the labor market has become increasingly tight as our labor force is no longer growing as fast as it used to be for demographic reasons. Second, the number of more educated workers is too low relative to less educated workers.

 

The increasing shortage of educated skilled workers has been driving up the private rate of return to schooling continuously over time (see Figure 1). Among men, the rate of return to first-degree education has increased from 16.2% in 1976 to 25.1% in 2014, a rise of 8.9%. For secondary school education it has increased from 11.6% in 1976 to 14.2% in 2014, a rise of 2.6%. The rate of return to primary school education has actually fallen over time from 4.7% in 1976 to 0% in 2014. The results are similar for women.

 

Why has this happened? The simple answer is that the economy has been growing continuously due to technological progress, and markets have become more efficient and better integrated in the world. Hong Kong has a very tight labor market. But the shortage of skilled workers is far more severe than that of unskilled workers and it has not expanded rapidly enough to meet this demand. This drives up the rate of return to schooling, especially at higher levels of education.

 

The ratio of wage rates for working men with first-degrees relative to those with secondary school education increased from 1.76 in 1976 to 2.14 in 2014 (see Figure 2). The ratio of wage rates for working men with secondary school relative to primary school education fell slightly, from 1.67 in 1976 to 1.40 in 2014. Similar results are found among women, where wage rates have increased even faster among the better educated.

 

The rising wage premium associated with more education is the fundamental reason for the intensification of study and examination pressure in the universities and schools. Reforming the school curriculum and assessment methods will not fundamentally reduce this pressure so long as the supply of university places falls short of demand and keeps driving up the private rate of return to university education. More students will still go to private tutoring services to get drilled even if the TSA were abolished. The appearance of superstar tutors and tiger moms is the direct result of the rising rate of return to education.

 

The shortage of skilled workers also implies their weekly work hours relative to unskilled workers will increase over time. This has in fact been the case. The ratio of hours worked by all men with first-degrees relative to all men with secondary school increased from 0.76 in 1976 to 0.91 in 2014. For those men educated to secondary school relative to primary school, the ratio increased from 1.08 in 1976 to 1.23 in 2014 (see Figure 3). Similar results are found among women, where their hours of work have risen even faster among the better educated. Among all women the ratio of hours worked by those with first-degrees relative to the secondary schooled increased from 0.73 in 1976 to 1.18 in 2014.

 

Since individual earnings are the product of both the wage rate and hours worked, a positive correlation between these two components also explains why earnings inequality has risen over time. The shortage of more educated workers relative to less educated workers is a powerful underlying force driving this increase. The undersupply of higher education therefore is the key factor behind rising earnings inequality.

 

A corollary of this undersupply is that there is a relative abundance of less educated workers. Since the mid-1990s, the labor force has increased by about half a million, all due to the entry of women into the job market. A large proportion of the increase comprises less educated recent immigrants from the mainland.

 

Because there are so many less educated workers, their wages and earnings have fallen increasingly behind the better educated over the past 40 years. The laws of supply and demand tell us that the prices of things in relative abundance are necessarily cheaper. Figure 4 shows the percentage growth in earnings from 1976 to 2014 according to the percentile distribution of earnings. The growth in earnings is higher for those at the upper end of the wage distribution for both men and women, and especially the latter.

 

This brings us to a curiosity: dishwashing jobs have very low skill content, so why are they paid $12,000 a month in this market? This is not the rock-bottom monthly earnings in Hong Kong. However, dishwashing is a job with no learning opportunities. Such jobs will not enhance productivity in the future so there is little room for wages to ever rise. A job where one cannot accumulate human capital will only appeal to elderly workers, and these folks are disappearing from the workforce. It is again a matter of supply and demand.

 

Hong Kong’s tight labor market will get tighter in the years and decades ahead. Given the continued shortage of skilled workers, one can expect wages and earnings inequality to continue rising. It is a no-brainer what government should do – invest in human capital and try to attract more skilled and talented people to Hong Kong. This will be good for both economic growth and economic equality.

 

Current anti-poverty measures alleviate earnings inequality through government income supplements, but have no effect on what is driving earnings inequality. If we provide more education opportunities, then some of the less educated workers of the future will become better educated. This will reduce the relative abundance of less educated workers and market forces will work to increase their wages and earnings. This is how the iron law of supply and demand operates.

 

Many critics argue that “trickle down economics” has not worked. They point to the fact that economic growth in the past 30 years has not benefitted the low earnings worker, and earnings inequality has widened. What they have missed is that education opportunities have not increased sufficiently despite the rapid economic growth. And education policies in Hong Kong and pretty much everywhere else in the world are largely under the control of government.

 

Governments decide how many education places to subsidize, which more or less fixes the access to higher education. Governments also directly control immigration policy. The alleviation of poverty and inequality will come by tackling education and population policy – income redistribution policies alone will not be enough to get us there.

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