Daniel Aaronson

Daniel Sullivan

English

Research Papers in Economics

ESSAYS ON ISSUES THE FEDERAL RESERVE BANK FEBRUARY  2002
OF CHICAGO NUMBER 174
Chicago Fed Letter
Growth in worker quality
by Daniel Aaronson, senior economist,
and Daniel Sullivan, vice president
and senior economist
Improvements in the quality of workers
due to changes in the distribution of
education and work experience are
among the key determinants of the
economy’s potential rate of growth.
The rate of such improvements is thus
of substantial interest to monetary and
fiscal policymakers concerned with
maintaining balance between aggre-
gate supply and demand. It also is of
importance to officials charged with
planning the future of programs such
as Social Security, whose projected fi-
nancial condition is highly sensitive
to assumptions about long-term eco-
nomic growth.
In this Chicago Fed Letter, we provide
estimates and forecasts of the rate of
improvement in quality of the work
force up through 2000, the latest data
available. Consistent with previous
research, we find that changes in the
distribution of workers’ education
and work experience levels account
for a significant portion of the growth
in labor productivity. In particular, of
the 2.7% average growth rate in labor
productivity since 1965, we find that
about 0.22 of a percentage point is
attributable to the growth of labor
quality. This contribution has fluctu-
ated significantly over the last 35 years.
For instance, as recently as the late
1980s and early 1990s improvements
in worker skill levels were adding
about 0.40 percentage points per year
to the growth of output. However, by
the end of the 1990s, this figure had
fallen to about 0.18 percentage points.
Our forecasts call for a further de-
cline to about 0.05 percentage points
by 2010.1
What is worker quality?
Our measure of worker quality relies
on economic models of human capital.
Workers invest in productivity-increas-
ing skills through formal education
and on-the-job training. Moreover,
firms hire additional labor until work-
ers’ marginal productivity coincides
with their wage rate. This allows us to
infer the effects of worker character-
istics on productivity, which are not
directly observable, from their effects
on predicted wages. We use statistical
models of wage determination to val-
ue additional years of education, ex-
perience, and other forms of human
capital. Applying these value estimates
to the changing distributions of hu-
man capital indicators yields estimates
of the growth in average worker quality.
The last 35 years have seen several ma-
jor shifts in the distribution of human
capital characteristics of the labor
force, most notably an increase in the
share of college-educated workers and
an influx of relatively inexperienced
women and baby boomers in the
1970s. In addition, the nature of the
skills learned through formal educa-
tion and on-the-job training have
changed, with, in particular, a tremen-
dous increase in workers with comput-
er skills in the 1980s and 1990s. Human
capital models quantify the extent to
which these transformations have
caused the growth of total labor input
to differ from that of raw hours worked.
This difference is known as worker
quality growth. It is positive when to-
tal labor input is growing faster than
the raw total of hours worked.
Trends in human capital
accumulation
We begin by documenting some of
the broad trends in human capital
accumulation that underlie estimates
of worker quality growth. We concen-
trate on the two most important factors:
increases in educational attainment
and fluctuations in the age distribution.
Education
U.S. levels of formal education have
expanded greatly over the last centu-
ry. During this period, high school
graduation went from a rarity to the
norm. College attendance and gradu-
ation rates also rose rapidly during
the twentieth century, especially after
World War II with the introduction of
the GI Bill and increased growth in
federal funding of higher education.
Increasing graduation rates have led
to a corresponding increase in the
percentage of workers with high school
and college education. In 1964, the be-
ginning year for the data we use for
this study, less than 58% of workers
had completed high school or had a
GED (general equivalency diploma).2
By 2000, this figure was over 90%. In
1964, less than 12% of workers had
college degrees. By 2000, more than
28% did. There were also healthy in-
creases over the same period in the
share of workers with at least some
college education and with postgrad-
uate education.
Though still significant, growth in aver-
age levels of education has slowed
since its high point in the early 1960s
and late 1970s. The increase in high
school graduation rates has fallen rel-
atively steadily from around 1.7 per-
centage points per year at its peak in
the early 1970s to only about 0.1 per-
centage points in the last several years.
Increases in college graduation rates
have also declined over time, but the
drop has been smaller.
The increase in average educational
levels comes about for two reasons.
First, younger workers entering the1964 ’68 ’72 ’76 ’80 ’84 ’88 ’92 ’96 ’00
-10
0
10
20
30
40
percent
1. Difference in worker graduation rates
Note: Graph shows difference in worker graduation rates, age 25 to 29
minus age 55 to 59.
Source: Authors’ calculations based on data from U.S. Department of
Labor, Bureau of Labor Statistics, Current Population Survey, 1964–2000.
High school
graduates
College
graduates
years
2. Average age of the labor force
Source: Authors’ calculations based on data from U.S. Department of
Commerce, Bureau of the Census (1975) and U.S. Department of Labor,
Bureau of Labor Statistics, Current Population Survey, 1964–2000.
labor force are constantly replacing
older workers reaching retirement
age. The younger workers typically
have more education. Second, some
of those in the age ranges typically
associated with working choose to ac-
quire more education, often while
continuing to work part or full time.
Figure 1 suggests that the effect of new
entrants replacing retiring workers
may be declining. Figure 1 plots the
difference in high school and college
graduation rates between those near
the end of their careers (55 to 59 year
olds) and those near the beginning
of their careers (25 to 29 year olds).
As the graph shows, in the 1960s, there
was a more than 30-percentage-point
difference between the high school
graduation rates of older and young-
er workers. Likewise, the expansion
of college graduation rates in the 1970s
led to a more than 15-percentage-
point difference between the college
graduation rates of older and young-
er workers. These large gaps between
workers entering and leaving the work
force were a major factor behind the
rapid growth of average educational
attainment during those periods. But
those differences, and their resulting
implications for labor quality growth,
had all but disappeared by 2000. This
is one of the factors underlying the
slower growth in average labor quali-
ty growth in the 1990s.3
Work experience
Workers’ labor market
experience is a second
important determi-
nant of skill levels.
Until they reach their
early 50s, workers’
wage rates and, thus
by inference, their
productivity, tend to
increase with age.
These increases pre-
sumably reflect skills
learned over time in
the labor market. As
a rough indication of
the trends in labor
market experience,
figure 2 shows the av-
erage age of workers
between 1890 and
2000. Consistent with greater life ex-
pectancies and lower birth rates, the
average age of workers grew from 35
at the turn of the century to over 40
at its apex in the mid-1960s. However,
starting in the late 1960s, the first of
the large Baby Boom cohorts entered
the labor force, causing the average age
to drop for the next 20 years, reaching
a bottom at around 37.5 in the early
1980s. As we show later, this drop in
experience levels partially offsets the
labor quality improvements arising
from the tremendous gains in formal
education during the 1970s. Since the
early 1980s, the aging of the Baby
Boom generation has helped to push
the average age of the
working population
back to about 39.5,
roughly where it was
in the early 1970s.
The Worker Quality
Index
When we put these
trends together, along
with other changes in
the composition of the
working population,
we come up with esti-
mates of labor quality
growth. Figure 3 dis-
plays these estimates
for 1965 to 2000.
There are several notable features of
figure 3. First, labor quality is some-
what countercyclical; peaks in the data
occur near the troughs of recessions
in November 1970, March 1975, No-
vember 1982, and March 1991. This
is consistent with firms reacting to
economic downturns by first dismiss-
ing low-quality workers, resulting in
an increase in the aggregate quality
of the working population (but not
the full population). We would cer-
tainly expect to see a similar situation
in 2001 and 2002.
However, as hiring heats up during
expansions, low-productivity workers
find employment more readily and la-
bor quality drops. Typically, toward the
end of expansions, we might expect
to see labor quality growth slow even
further, as the pool of available human
capital is drained. This seems to have
happened somewhat in the 1990s but
not during the 1980s expansion.
The extraordinary increase in educa-
tional attainment during the 1970s
and 1980s offset any cyclical effect
from the declining pool of high hu-
man capital. This brings us to the
second notable feature of the data:
the deceleration, acceleration, and
deceleration of labor quality over
the last three decades. During the
late 1960s and 1970s, labor quality
grew by approximately 0.2% per year.
This coincides with the beginning of
the post-1973 productivity slowdown,
1885 ’05 ’25 ’45 ’65 ’85 ’05
34
36
38
40
421960 ’65 ’70 ’75 ’80 ’85 ’90 ’95 ’00 ’05 ’10
-0.4
0.0
0.4
0.8
1.2
Michael H. Moskow, President; William C. Hunter,
Senior Vice President and Director of Research;  Douglas
Evanoff, Vice President, financial studies; Charles
Evans, Vice President, macroeconomic policy research;
Daniel Sullivan, Vice President, microeconomic policy
research;  William Testa, Vice President, regional
programs and Economics Editor; Helen O’D. Koshy,
Editor; Kathryn Moran, Associate Editor.
Chicago Fed Letter is published monthly by the
Research Department of the Federal Reserve
Bank of Chicago.  The views expressed are the
authors’ and are not necessarily those of the
Federal Reserve Bank of Chicago or the Federal
Reserve System. Articles may be reprinted if the
source is credited and the Research Department
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Chicago Fed Letter  and other Bank publications are
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ISSN 0895-0164
percent
3. Labor quality growth
Note: Dashed line indicates projections.
Source: Authors’ calculations based on data from U.S. Department of Labor,
Bureau of Labor Statistics, Current Population Survey, 1964–2001.
which lasted for two decades. But the
slowdown in labor quality did not last
long. Beginning in the early 1980s, the
U.S. experienced a sizable acceleration
in labor quality growth, rising to 0.4%
per year from 1979 to 1987 and close
to 0.6% per year from 1988 to 1995.
Since 1995, labor quality has deceler-
ated to 0.27% per year, although there
was a mild upturn (0.37% per year)
from 1997 to 1999. In 2000, labor qual-
ity growth fell to 0. We can decompose
the growth of overall labor quality into
contributions due to education and
experience, as well as other measur-
able changes, including gender, race,
marital status, and part-time work.4
The overall trends in education and
experience that we saw in figures 1 and
2 are readily apparent when we do this.
The improvement in education attain-
ment in the 1970s and 1980s was the
sole positive contributor to labor quali-
ty growth, adding 0.54% per year be-
tween 1965 and 1985. The slowdown
in education, particularly the lack of
further progress in reducing the frac-
tion of high school dropouts, resulted
in a decelerating education compo-
nent of labor quality growth of 0.30%
per year after 1985 and 0.18% per year
after 1995. The modest increase from
1997 to 1999 is the main contributor
to the pickup in overall labor quality
observed in that period.
Offsetting the big increases in educa-
tion during the 1970s and 1980s was
the drop in work ex-
perience resulting
from the entry of the
baby boomers. This
cut 0.34 percentage
points per year off
labor quality growth
from 1965 to 1980.
However, as those
workers moved into
age ranges associated
with higher relative
earnings after 1980,
the contribution of
labor market experi-
ence averaged a posi-
tive 0.09 percentage
points per year. Thus,
the recent history up
through 2000 repre-
sents the combined
effects of two long-running demo-
graphic trends, the continuing in-
crease in the education levels of the
labor force and the movement of work-
ers toward experience levels associated
with higher wages and productivity,
partially offset by the typical pattern in
a business-cycle expansion, the relative-
ly faster employment growth of low-
education and low-experience workers.
Figure 3 also shows our projections
of labor quality growth. These are
based on projections of the labor force.
Thus, they are free from any varia-
tion due to changes in the level of
unemployment. Consequently, they
do not factor in the current economic
slowdown. Although we believe there
will be a temporary (unreported in
the graph) increase in labor quality
due to the cycle, we expect labor quali-
ty to decline as the decade progress-
es. By 2010, our estimate is for labor
quality growth of only 0.07%, much
below the average of the previous
35 years. Our forecast of a declining
growth contribution from worker quali-
ty derives from two sources. First, we
expect a slight decline in the rate of
educational gains. Second, and more
important, as the decade progresses,
a significant portion of the Baby
Boom generation will move beyond
the highest earnings years that most
workers experience in their early 50s.
Indeed, by the end of the decade, the
leading edge of the Baby Boom will
be at an age associated with lower
than average wage rates. At the same
time, the age ranges associated with
maximum wages and productivity will
become populated with the smaller
cohorts born in the late 1960s and
early 1970s. As a result, changes in ex-
perience levels will turn from a posi-
tive to a negative factor for worker
quality growth.
Conclusion
The characteristics of the labor force
have changed significantly over the
last 35 years. Combining these trends
with shorter-run fluctuations associat-
ed with the business cycle, we provide
information about growth in the qual-
ity of the work force from 1964 to 2000.
We also forecast a slow demise in la-
bor quality over the next decade. Fluc-
tuations in labor quality growth have
had a significant impact on trends in
output growth. Thus, by quantifying
the expected future gains in labor
quality, we can improve forecasts of
potential output growth. In addition,
quantifying past gains in labor quality
is vital to producing productivity growth
estimates that constitute a meaningful
measure of our economy’s progress.
1For more detailed discussion and analysis,
see Daniel Aaronson and Daniel Sullivan,
2001, “Growth in worker quality,” FederalP
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2
Reserve Bank of Chicago, Economic
Perspectives, Vol. 25, No. 4, pp. 53–74.
Other recent work on labor quality in-
cludes M. Ho and D. Jorgenson, 1999,
“The quality of the U.S. work force,
1948–95,” Harvard University, mimeo,
and U.S. Department of Labor, Bureau of
Labor Statistics, 1993, Labor Composition
and U.S. Productivity Growth, 1948–90,
bulletin, No. 2426. Our methodology
and data differ somewhat from these pa-
pers. This leads to some differences in
estimates of labor quality growth. Howev-
er, the broad contours of our results
agree reasonably well with earlier work
for periods in which our results overlap.
2Data come from the March supplements
to the Current Population Survey.
3In our Economic Perspectives article, we also
discuss the importance of fluctuations in
the size of birth cohorts and increased
educational attainment later in workers’
careers for changes in the growth of edu-
cation levels.
4Of the latter measures, the increase in
female labor force participation since the
1970s is the most dramatic change in the
labor force. But even this has little over-
all impact on our labor quality growth es-
timates, cutting only about 0.03 percent-
age points per year over the full period.

Growth in worker quality

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Growth in worker quality

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