Build For the Future

This is part one of a three-part series on the need for the Western economies to embark on fundamental reforms.

Dealing with the debt overhang is only the first step to protect our long-term well being and high standard of living. We need to invest in our abilities to generate economic growth – and at the same time restructure our welfare system. Postponing this dual task, as current and past governments have regularly done, only amplifies the problem.

Time is running out. Failing to act will have disastrous implications for all of us. These three essays present the ten steps that are necessary to get the West back on track.

Although there are tensions and tradeoffs among these steps, they are all necessary. It is up to each nation to define the right mix of these measures to safeguard its own future.

First steps have to include investments in education and capital stock, later retirement and higher workforce participation of women.

1. Invest in education

Education plays a significant role in improving any nation’s future growth potential. It is the foundation of social mobility and a precondition to fully utilize the innovative capabilities and entrepreneurial talent of all individuals in society. The deteriorating quality of education in most advanced countries undermines our future growth potential.

The China factor

It should be a wake-up call to everybody in the West that when Chinese students were included for the first time in the OECD’s tri-annual PISA tests, they immediately ranked first.

The big divide inside countries

A major problem is the increasing discrepancy of education within the countries of the developed world. In the United States, the “achievement gap” — the performance difference between Blacks and Hispanics and Asians and Whites — has widened, leading to overall poorer results as the share of the first two groups in the population as a whole is growing.

In Europe, it is the descendants of immigrants from the Arab world, Turkey and Africa who tend to perform less well than the descendants of immigrants from other regions or than students from the home country.

Maximizing skills

The developed world cannot afford having a sizeable share of its youth without quality education. Raising the average level of education, notably in the basic skills of reading, writing and math, will improve individuals’ ability to be gainfully employed and reduce the social welfare burden.

Education systems like the one in Germany, where there is a direct link between school and learning on the job, should be implemented in other countries as well.

Improve the quality of teaching

Not all investments in education necessarily improve education quality. Between 1970 and 2007, the U.S. government tripled spending on education in real terms – without any significant overall impact.

However, one type of investment has had demonstrated impact: investing in the education, training and compensation of highly qualified teachers. As the case of Finland’s high-performing educational system shows, investing in the quality of teachers and in small teacher-student ratios is critical to improving student outcomes.

Support the most gifted students

Improving the average level of education is important, but we also need to identify and support the most gifted students. Innovation and entrepreneurship heavily depend on this small group, so we must ensure that these students maximize their potential.

Relevance for economic development

It will be important to redirect students toward those subjects that are most relevant for economic development, most notably science and engineering. Some of this redirection will happen automatically as students become aware of the attractiveness of the careers that such studies lead to.

But the shift can also be accelerated — for example, by limiting the available slots for less economically relevant subjects or by providing financial incentives to students to choose more economically relevant subjects.

Only when these educational challenges are addressed will it be possible for the West to have a promising future. And, by the way, only then will our societies be productive enough to pay for the retirement of the current generation of baby boomers.

2. Reinvest in the asset base

Any global traveler has experienced how much progress the developing world has made in its investment in public and private infrastructure. At the same time, the public and private sectors in the developed world have underinvested in capital stock in the past years. This will have a negative impact, as capital investment is a key determinant for future productivity and income generation.

Modernizing public infrastructure

Modernizing public infrastructure is an important precondition for economic development and national competitiveness. Airports, railway systems, highway networks and energy grids need to be modernized and sized according to future demands.

In order to minimize public debt, infrastructure modernization has to be done in cooperation with the private sector. The private sector should lead the management of public projects, in order to maximize efficiency by improving strategic planning and governance, by reducing process complexity and time to completion, and by improving prioritization and selection of projects.

A decade of underinvestment

Despite record-high profit margins, corporations in the developed economies have significantly reduced their investment in new machinery and equipment. Europe has witnessed a decade of underinvestment, starting before the financial crisis and intensifying since.

The average asset age increased to 10.3 years in 2011 from 7.4 years a decade before, according to a recent Goldman Sachs report. This represents an investment backlog of some €800 billion. The United States shows a clear downward trend in net domestic fixed investments relative to GDP. Given the importance of the quality of the capital stock for productivity and economic growth, it is time to reverse this trend.

Encourage private investment

Governments need to encourage private investment. Tax policies should make it more attractive to invest—for example, by providing tax credits for domestic investment or by raising taxes on dividends. Labor-market impediments have to be removed to encourage investment.

GDP per capita growth has to overcompensate the effects of a stagnating or shrinking workforce. This requires equipping the workforce with state of the art technologies and equipment – meaning: more investment is needed.

3. Prepare for labor scarcity

Between 2012 and 2050, the working age population between ages 15 and 64 in Western Europe will shrink by about 13% (15.8 million people). In Japan, it will drop by 30% (23.8 million people). The U.S. working-age population will grow slightly at 0.4% per year, but that is slower than the annual growth rate of 1.1% during the past 20 years. Countries need to start now to prepare for the coming era of labor scarcity.

People will have to work longer

In general, people will have to work longer and the elderly will become a key component of the labor force. This change is beginning to happen already, driven primarily by the relative lack of well-educated and employable younger people. In the United States, for example, the labor force participation rate of workers aged 65 years and above has increased by almost half, from less than 11% of the total population in this age group in the mid-1980s to 16.7% in 2011.

Since the depth of the recession in 2009, the majority of jobs created – about 4.1 million of a total 5.5 million in total—have gone to workers older than 55. As this trend develops, however, there will be a need for increased investments in training and education. And corporations will need to adapt their processes to the needs of older people.

Labor force participation of women

Growing labor force participation of women has been a major source of economic growth in recent years in the developed world. Still, in many countries the share of women participating in the workforce is below the levels reached in Switzerland, Sweden or Norway. There, between 77 and 82% of all women work.

Women should also be encouraged to study economically relevant subjects such as science and engineering.

Even as women are entering the workforce, they should be encouraged to have more children. This requires additional investment in the provision of widely available high-quality childcare facilities.

Mobilizing the work force potential of Western economies will be critical in the coming decades. This must not be negative news. Given longer life expectancy and good health, many people would like to work longer.

Continue to part II.