Education and Wages

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Education and Wages

• Pedro Telhado Pereira
• May 2004
• Part 1

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Let us look at the Portuguese case Portuguese
workers show a low level of formal education
Years of study of the Portuguese workers
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If we compare the education of the Portuguese
with the education in other European countries
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Younger population in Portugal doesnt seem to be
overcoming the gap
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• All countries showed an increase of more than
  30 between the generation 55-64 and the one of
  25-34
• Spain showed an increase of 41
• Portugal showed an increase of less than 20

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Should we look to Education as an Investment?

• Education as an investment
• Reduces consumption at present
• Increases consumption in the future
• There is a risk involved
• Education as Human Capital
• Increases productivity

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Important difference between Capital and Human
Capital

• Human Capital belongs to the individual and can
  only be rented for periods of time.
• You can not sell (buy) human capital to (from)
  others this would be considered slavery.
• This difference makes the firms not prone to
  invest on human capital of their workers.

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Let us assume that a firm pays the studies of one
of its employees

• 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.
• The employee can move to another firm where we
  can receive more

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But will education lead to higher wages?Let us
look again to the Portuguese case
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Wages in Portugal for different education levels
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What can we see from the previous graph?

• Education increases wages
• Older people get higher wages
• Wage depends on education and age (experience)

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How will a wage profile look like?
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Analysis of the decison to go on studying
cost/benefit analysis

• Costs
• Additional Costs that the person will have to
  study
• Books
• Fees
• Costs of going to school

• Benefits
• Difference in wages
• Other that we will see later.

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Let us assume that we have two profiles
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How to compare the two profiles?

• We have to use the present value of the two
  profiles and compare the result

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We have the two profiles
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Or in terms of gap between the profiles
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We have to evaluate the present value

• For a given discount rate

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How to decide to go on studying

• The previous expression is positive continue
  studying
• The previous expression is negative do not
  continue studying.

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An alternative it is to evaluate the internal
rate (IRR) of return

• It is the rate that equals

to zero
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How to decide?

• If the internal rate of return is sufficiently
  high continue studying.

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Which method to use?

• The two methods can give different orderings when
  there are different time of study choices.
• The second method accepts that you can have a
  rate of return of your savings equal to IIR.
• The present value method seems to be more adequate

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How to estimate the rate of return of education

• Let us assume that a person as to decide to study
  one more year
• The person lives for ever
• Earns W1 if he studies one more year and W0 if he
  doesnt study
• There is no other costs

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We have two present values

• With no education

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• With Education

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Their difference is zero when
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In logarithms
As ln(1r) is very close to r for small r