Education, market rigidities and growth
GAICIL Insights
Economists have spent decades arguing whether labor and product market regulation helps or hurts growth, and finding every possible answer.1 Education, market rigidities and growth, by Philippe Aghion, Philippe Askenazy, Renaud Bourlès, Gilbert Cette and Nicolas Dromel, suggests why: the answer depends on where a country stands relative to the technological frontier. The authors use macro-panel data for OECD countries to examine how education, product market regulation and employment protection affect productivity growth.
The findings confirm that education and labor and product market rigidities have different effects depending on whether a country is far from or close to the frontier. Close to the frontier, education level, product market rigidities and employment protection legislation are significantly related to total factor productivity growth. The interaction between labor and product market rigidities contributes substantially, with the most significant results obtained after lagging product market rigidities by two years. At the frontier, flexibility and skills are the fuel.
The results build on earlier work. They are consistent with studies focusing on product market rigidities while going further, characterizing cross effects of labor and product market rigidities and differentiating effects close to the frontier. The public sector size component of product market regulation appears to have no significant effect.
The paper explains a puzzle. There is no consensus on how labor and product market rigidities affect growth, with studies finding no effect, positive effects or negative effects. Dependence on position relative to the frontier explains the disparity. Ignoring the heterogeneity may yield varying results depending on which countries are sampled and their distance to the frontier. The literature's contradictions may come down to sample composition.
Bring the result forward to the present. AI raises the stakes for frontier economies. Countries at the frontier compete through innovation, and AI is a frontier technology. For such countries, education levels and labor and product market flexibility matter significantly for productivity growth. Economies seeking AI leadership should invest in advanced education and avoid rigidities impeding the reallocation and experimentation innovation requires. A frontier country with rigid markets is running with weights on.
The interaction is the sharpest point. Rigid product markets may limit entry and competition; rigid labor markets may limit reallocation of workers to new activities. Together they compound obstacles to innovation. AI-driven growth requires new firms entering markets and workers moving to new tasks, making joint flexibility valuable. Reforming one market while freezing the other may deliver little.
Education's frontier role is significant. Frontier innovation requires highly educated workers able to create and apply new knowledge. As AI raises demand for advanced skills, investment in higher education and research becomes more important for frontier countries.
Distance-dependent effects counsel tailored policy. Countries far from the frontier may benefit from different priorities, such as basic education and policies facilitating technology adoption. AI policy should reflect each country's position, avoiding one-size-fits-all prescriptions. Exporting frontier reform recipes to catching-up economies may disappoint, and the reverse holds too.
The methodological contribution helps policy debate. Debates often cite conflicting evidence on regulation and growth. Recognizing that effects depend on distance to the frontier reconciles the evidence and supports more nuanced advice.
For advanced-economy policymakers, the message is clear. Productivity growth at the frontier depends on education and flexible labor and product markets. As AI reshapes the economy, reducing rigidities and investing in education can enhance the capacity to innovate and grow.
The thread running through it all: the growth effects of education and market rigidities depend on proximity to the technological frontier. Close to it, education and flexible markets significantly raise productivity growth, and labor and product market rigidities interact. As AI becomes a central frontier technology, these findings guide policies strengthening the foundations of innovation-led growth.
For frontier economies worried about AI disruption, the sting is this: protecting jobs and incumbents through rigid rules may be the costliest response. The evidence points the other way, toward flexible markets combined with heavy investment in education.
Introduction
The paper exploits macro-panel data for OECD countries. Close to the technological frontier, the education level, product market rigidities and employment protection legislation would be significantly related to TFP growth, with a substantial contribution of the interaction between market rigidities.
Takeaway
The results presented in this paper confirm that the education level and rigidities in labour and product markets have different effects whether the country is far from or close to the technological frontier. This recalls the results synthesised in Aghion and Howitt (2006).2 The presented estimates are consistent with previous studies that mainly focused on product market rigidities (see for example Nicoletti and Scarpetta, 2003) but did not attempt either to characterise the crossed effect of rigidities on labour and product effects or to differentiate a specific effect close to the frontier (see Crafts 2006 for a survey). As regards the rigidities, an interaction between labour and product market regulations clearly appears; most signification results are obtained after lagging product market rigidities by two years. This confirms the results of previous analyses, as Blanchard and Giavazzi (2003). Concerning the product market regulations, the “public sector size” component appears not to have a significant effect. There is no consensus in the empirical literature on the effect of labour and product markets rigidities on growth. Numerous studies assess very disparate results: either no effect, or a positive or a negative impact (for a survey emphasising this diversity, see Babetskii and Campos, 2007). Pointing out the dependence upon the position relative to the technological frontier, our study provides an explanation for this disparity.1
Ignoring this heterogeneity may lead to various results depending on the countries present in the panel and their distance to the technological frontier. The above analysis should of course be viewed with the usual caution. They rely on inevitably fragile estimates conducted on a small panel of industrialised countries. The estimates, nevertheless, suggest important gains in productivity growth, i.e. in potential growth, that may be achieved in some industrialised, mainly European, countries after undertaking ambitious reforms to increase the education level in the workforce and decrease rigidities in labour and product markets.
Acknowledment The authors thank an anonymous referee, seminar and conference participants at various places for useful comments and suggestions.
Notes
- Philippe Aghion et al., Education, market rigidities and growth, 102 Econ. Letters 62 (2009), https://doi.org/10.1016/j.econlet.2008.11.025. Takeaway source: 4. Conclusion, reproduced from a free author or repository copy. ↩
- Aghion P., Askenazy P., Bourlès R., Cette G. and Dromel N. (2007): “Education supérieure, Rigidités de marché et Croissance”, CEPREMAP Working Paper, Docweb n° 0705, September, www.cepremap.ens.fr Aghion P. and Howitt P. (2006): “Joseph Schumpeter Lecture – Appropriate Growth Policy : A Unifying Framework”, Journal of the European Economic Association, Vol. 4, Issue 2-3, April-May Bassanini A. and. ↩
Cite as: Philippe Aghion et al., Education, market rigidities and growth, 102 Econ. Letters 62 (2009), https://doi.org/10.1016/j.econlet.2008.11.025
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