Mind the (wage) Gap! Effects on the development of human capital across EU countries

May 11, 2018


Addressing the concept of wage differentials across EU countries, the event organised by European Generation on Tuesday provided the opportunity to investigate from both a macro and a microeconomic perspective the deep roots of wage setting and, in particular, education.

As pointed out by prof. Devillanova, who moderated the dialogue between Carlotta de Franceschi (President and Co-Founder of Action Institute) and Luca Solari, (Professor of Organisation Theory and Human resource management at the University of Milan), wage differentials are relevant for explaining both growth and migration. Empirical evidence shows that within the Union there is still a remarkable discrepancy between the average salary in the richest countries, Denmark and Luxemburg, and the poorest, Romania and Bulgaria. For instance, the median salary in Denmark is currently 7.6 times the one in Bulgaria. Why such a wage gap? The relationship between wage inequality and human capital is not a trivial one.

In order to answer this fundamental question it is important to understand how wages are set.

Prof. Solari took an internal approach to explain wage setting, by looking at how companies react to the pay gap and how the latter is a consequence of human resource managers’ choices. In this sense, he claimed, wage gaps are the product of managers’ decisions that, in a completely frictionless world, should follow from differences in productivity. However, evidence shows that also formal and informal institutional frameworks matter, generating a different type of wage gap, which is no longer explained by productivity alone. In order to account for these ‘bad types’ of wage differentials, Prof. Solari proposed some possible solutions. First, we should abandon the axiom that increasing mobility leads to the smooth of agents. Actually, non monetary mobility costs – most prominently, languages – persist, consistently lowering employment opportunities in other Member States. Second, we need to remove fiscal barriers and promote administrative harmonisation. Third, following the example of UK regulation (i.e. companies with more than 250 employees must calculate and publish data about wage differentials, gender gap etc.), models of pay transparency should be employed in order to turn waging into a significant index for both firms themselves and the public.

What is then crucial when talking about wage gap (between and within countries and between and within firms) is the distinction made between bad and good wage gap. The former, coincides with discrimination and it can happen at different levels. The latter, instead, is the remuneration of qualities, and it mainly depends on human capital. Human capital is indeed one of the main elements contributing to the growth of a State, together with the quality of the institutions, the level of taxation and foreign investment. This point was particularly stressed by Mrs. De Franceschi, who focused on social and economic conditions and policy measures aimed at fostering human capital.

With a particular focus on the Italian case, Mrs. Franceschi identified the root causes of Italian inadequateness of human capital in the lack of proper education. Quoting prof. Giavazzi, she said that ‘The Italian education system was designed to be efficient and egalitarian and it failed in both’. On the one hand, Italian education often privileges schooling rather than training, which results into an absolutely unprepared labour force. On the other hand, students are not properly oriented, neither about university programs nor about different returns to schooling according to the sector. In this view, Action Insitute proposes, for instance, to modify the “Alternanaza Scuola-Lavoro” policy for high school students so to include the possibility for students to spend some time at the University. Moreover, they suggest organizing specific orientation programs where HR directors are invited, in order to allow high school students to make informed decisions.

However, the weakness of Italian human capital is not the only problem. Actually, low remuneration of skilled human capital also matters. In fact, Italy is the worst country both in terms of skills activation (i.e. the time it takes for students to start working after university) and in terms of investment in value added, with the consequence that returns to education are almost insignificant. In this regard, an interesting study conducted by the Action Institute showed that marginal gains from education when passing from High School to University are minimal in Italy, as if university only provided “formal titles”. Therefore, Action Institute suggests to implement policies which lower the cost of hiring high skilled labour. Italy and France have already implemented some measures in this respect, for example by reducing social contribution for PhD graduate.

A second policy recommendation by Mrs. De Franceschi focused on differentiating education. In particular, the President of Action Institute highlighted the need to develop a proper entrepreneurship education in order to lay the foundations for enterprises capable to invest in value added. The understanding of business models is no longer only an attitude: also soft skills matter. “Nowadays - concluded Mrs. De Franceschi -  the only way to not be left behind is indeed having certain skills”.

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