Education and Wages Pedro Telhado Pereira May 2004

Education and Wages Pedro Telhado Pereira May 2004 Part 1

Let us look at the Portuguese case – Portuguese workers show a low level of formal education Years of study of the Portuguese workers 16/03/2018 Universidade da Madeira 2

If we compare the education of the Portuguese with the education in other European countries 16/03/2018 Universidade da Madeira 3

Younger population in Portugal doesn’t seem to be overcoming the gap 16/03/2018 Universidade da Madeira 4

n All countries showed an increase of more than 30% between the generation 55 -64 and the one of 25 -34 n Spain showed an increase of 41% n Portugal showed an increase of less than 20% 16/03/2018 Universidade da Madeira 5

Should we look to Education as an Investment? n Education as an investment – Reduces consumption at present – Increases consumption in the future – There is a risk involved n Education as Human Capital – Increases productivity 16/03/2018 Universidade da Madeira 6

Important difference between Capital and Human Capital belongs to the individual and can only be rented for periods of time. n You can not sell (buy) human capital to (from) others – this would be considered slavery. n This difference makes the firms not prone to invest on human capital of their workers. n 16/03/2018 Universidade da Madeira 7

Let us assume that a firm pays the studies of one of its employees n At the end of his studies the employee will produce more, but the firm can not pay him all his increase in productivity as part of it has to be used to pay for the costs of education. n The employee can move to another firm where we can receive more… 16/03/2018 Universidade da Madeira 8

But will education lead to higher wages? Let us look again to the Portuguese case 16/03/2018 Universidade da Madeira 9

Wages in Portugal for different education levels 16/03/2018 Universidade da Madeira 10

What can we see from the previous graph? n Education n Older increases wages people get higher wages n Wage depends on education and age (experience) 16/03/2018 Universidade da Madeira 11

How will a wage profile look like? 16/03/2018 Universidade da Madeira 12

Analysis of the decison to go on studying – cost/benefit analysis Costs n Benefits Additional Costs that the person will have to study – Books – Fees – Costs of going to school –… 16/03/2018 Difference in wages n Other that we will see later. n Universidade da Madeira 13

Let us assume that we have two profiles 16/03/2018 Universidade da Madeira 14

How to compare the two profiles? n We have to use the present value of the two profiles and compare the result 16/03/2018 Universidade da Madeira 15

We have the two profiles 16/03/2018 Universidade da Madeira 16

Or in terms of gap between the profiles 16/03/2018 Universidade da Madeira 17

We have to evaluate the present value n For a given discount rate 16/03/2018 Universidade da Madeira 18

How to decide to go on studying n The previous expression is positive – continue studying n The previous expression is negative – do not continue studying. 16/03/2018 Universidade da Madeira 19

An alternative it is to evaluate the internal rate (IRR) of return It is the rate that equals to zero 16/03/2018 Universidade da Madeira 20

How to decide? n If the internal rate of return is sufficiently high – continue studying. 16/03/2018 Universidade da Madeira 21

Which method to use? The two methods can give different orderings when there are different time of study choices. n The second method accepts that you can have a rate of return of your savings equal to IIR. n The present value method seems to be more adequate n 16/03/2018 Universidade da Madeira 22

How to estimate the rate of return of education: n Let us assume that a person as to decide to study one more year n The person lives for ever n Earns W 1 if he studies one more year and W 0 if he doesn’t study n There is no other costs 16/03/2018 Universidade da Madeira 23

We have two present values n With no education 16/03/2018 Universidade da Madeira 24

n With Education 16/03/2018 Universidade da Madeira 25

Their difference is zero when 16/03/2018 Universidade da Madeira 26

In logarithms As ln(1+r) is very close to r for small r 16/03/2018 Universidade da Madeira 27