The Supply Side of the Race Between Demand and Supply: Policies to Foster Skill in the Modern Economy

In his celebrated book on income inequality, Jan Tinbergen (1975) wrote about the race between demand and supply in determining the evolution of wages and inequality. The demand side of the recent labor market is well understood. Skill-biased technical change favors skilled workers in many different economic environments. The supply side is less well understood. In the Netherlands, until recently, the supply side was winning and the returns to education were declining or stagnant. The exact reasons for this phenomenon are not well understood. Recently, however, there is evidence that suggests that the returns to schooling are increasing and that demand is outstripping supply, as it has done in most developed countries around the world. This has produced rising wage inequality. Unless more active supply side measures are undertaken, this trend is likely to continue. This problem, joined with the persistent problem of immigrant assimilation and the growing role of immigrants in the Dutch economy, renews interest in the supply side of the labor market. This lecture examines the determinants of the supply of skills in the short run and the long run. It examines the roles of short- term credit constraints and long-term family factors in fostering or retarding skill accumulation. It summarizes the evidence on a number of policy proposals to foster skills including early childhood programs, programs to alleviate short-term financial pressure, job training and second chance programs, and tax policies. This lecture stresses the cumulative dynamic nature of skill production and the importance of recognizing that skill begets skill in designing suitable policies to reduce inequality and foster economic growth. While the evidence is based on American data, the lessons are relevant for economies around the world. Specific lessons for the Netherlands are emphasized.