When the topic of economic output comes up, economists are quick to formulate equations that point to capital and labor as the essential ingredients that every company needs. While no one argues that these two inputs are absolutely necessary, a constant battle has been waged over the years between academics and business leaders as to whether capital or labor is more important. Indeed, this debate has troubled the world of economic thought since Paul Douglas and Charles Cobb first published their definitive function in the American Economic Review in 1928 in the following form: cdfunction_transp-150x28While this article is not intended to join the pedantic mêlée and champion a single input factor, a contextual argument can be made that labor would contribute more to output relative to capital if more of the right kind were available. Because of advances in technology and the ability of capital to interconnect and transmit huge amounts of data in what has come to be known as the “Internet of Things”, the need for labor that can understand this kind of information and use it to deliver value has skyrocketed all over the world.

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Source: iStockphoto

The View from Above

While developed economies have always needed educated workers to create value within the knowledge economy, the educations of these workers haven’t always needed a strong technical orientation. After all, without detailed data it’s rather difficult to make detailed calculations. The ability of companies to communicate and collect data in commercially meaningful quantities is a relatively recent phenomenon, having only been made possible by advances in computing power, internet connectivity, databases and programming languages over the last 25 years. As the prevalence of these new tools have grown among employers, the number of graduates with backgrounds in the topics necessary to use these tools, primarily those with backgrounds in science, technology, engineering or mathematics (collectively known as STEM topics), has not kept pace with the increase in demand. While the overall supply of STEM graduates on the labor market has increased, there is still an enormous shortage. The European Union member states highlight this issue perfectly. According to the European Commission’s “EU Skills Panorama 2014” report, the demand for science and engineering professionals within the EU will grow by 13% from 2015 to 2025 as compared with 3% for all occupations. This striking increase in demand for STEM skills is confirmed by studies conducted at the national level. Based on the results of its 2015 report, Engineering UK notes that for technical employees there will be a supply gap of 1.82 million by 2022. In Germany the situation is similarly acute: according to Die Welt, by the end of 2020 the shortage of technical employees will exceed 1.3 million. Information from Digital Europe demonstrates that professions in information and communication technologies will experience a similar, if less severe, increase in demand for their services as the EU-wide shortage for professionals in this category reaches 825,000 by 2020. While a significant portion of this demand for STEM labor is the result of the expansion of technology-related industries, the rest is a consequence of the looming demographic shift. As many as 66% of those technical positions that will need to be filled in Germany by 2020 will be empty as a result of current employees leaving the labor force. This problem is endemic to the EU as a whole: according to the “2015 Ageing Report” from the European Commission, the total labor supply in the region is projected to remain constant until 2023, at which point it will begin to decline. At a time when employers are seeking more skilled STEM labor due to growth in their industries, the competition for the available labor is only going to get worse.

The View Up Close

These macroeconomic trends have already begun to manifest themselves at the microeconomic level. Recruitment costs for positions requiring STEM skills are increasing as potential candidates become scarcer and more difficult to find. When suitable candidates are found, they naturally command relatively high wages. In addition, the trainings that these recruits need as a part of their onboarding are increasing due to the fact that they need to interact with the current tools used in the workplace. All of these factors raise the total recruitment costs for a successful candidate, and if a recruit leaves or is rejected due to a poor fit these costs climb even higher. As a result, the operational budgets of companies are being squeezed and potential growth limited as a consequence of their search for qualified talent. Despite these dire conditions, some companies are using the opportunity to boost their competitive advantage. In particular, multinationals with large HR budgets and access to low-cost financing are in a position to poach scarce talent from all over the world. While this activity constitutes a perfectly ethical business practice, it leaves small and medium-sized companies (SMEs) in a lurch. These companies simply do not have the cash reserves or the access to cheap debt financing that would enable them to secure the talent resources they desperately need to sustain their business models. And before we dismiss this predicament as simply the efficient work of the “invisible hand” described by Adam Smith or a consequence of the process of “creative destruction” preached by Schumpeter, let us recall that most businesses in the EU are SMEs. In fact, the “Annual Report on European SMEs 2013/2014” by the European Commission points out that 99% of all businesses in the EU are SMEs and that they employ 67% of the workforce. Should this trend continue unabated, the SMEs that are vital to the health of the European economy will begin to fail and destabilize the entire political-economic structure. Now is it clear why labor is so important?

A View of the Future

While individual companies would certainly welcome any money sent their way to help them scout for talent, an efficient and realistic solution that can support a range of SMEs at once would need to be more cost effective, focused and sustainable. Think of a manufacturer set in rural Germany with a revenue of €40 million p.a. In terms of HR management, the owner of this business needs four things to ensure that she and her employees remain in business for the foreseeable future: 1) direct access to a large pool of qualified talents, 2) access to this pool for a reasonable price, 3) a way to compare candidates to see which ones fit the company culture and 4) a means to train and on-board recruits quickly. While many job platforms and recruitment agencies can fulfill two or even three of these requirements, very few services on the market are able to fulfill all four simultaneously. As a result, the demand for skilled labor will continue to climb and SMEs will continue to look nervously toward the future. To return to the assertion postulated at the beginning of this article, the point being argued here is not that labor is more important than capital as an input factor. Indeed, the massive advances in capital over the past quarter century are the reason that skilled technical labor is in such high demand; were it not for the sophisticated capital available on the market today, the provision and procurement of such labor would not be the subject of numerous government and industry reports. The claim postulated here is if more of the right kind of labor were available, labor would contribute more to output relative to capital. The first step in proving whether this hypothesis is right or wrong will be to find some way to provide more of this highly skilled, technical labor to the market in such a fashion that the four requirements mentioned above are met. A difficult task, to be sure, but not an impossible one.  


This article was written by Nathaniel Harrold, M.Sc. and Prof. Dr. Dietmar Kilian.
Dietmar Kilian is a professor of Business Process Management and Networks at the Management Center Innsbruck. He is also the managing partner of PDAgroup GmbH and Chairman of the Supervisory Board of Academy Cube gGmbH.