Education and Wages Pedro Telhado Pereira May 2004 Part 1

Education and Wages

Pedro Telhado PereiraMay 2004Part 1

Universidade da Madeira 2

Let us look at the Portuguese case – Portuguese workers show a low level of formal education

Years of study of the Portuguese workers


If we compare the education of the Portuguese with the education in other European countries


Younger population in Portugal doesn’t seem to be overcoming the gap


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%


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


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.


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…


But will education lead to higher wages?Let us look again to the Portuguese case


Wages in Portugal for different education levels

Graph 4 - Average Hourly Real Wages, Different Skill Groups, Men, 1982-19981998 Escudos

0

500

1000

1500

2000

2500

3000

1982 1985 1986 1987 1988 1989 1991 1992 1993 1994 1995 1996 1997 1998

Years

Young, Low Ed Old, Low Ed Young, Med Ed Old, Med Ed Young, High Ed Old, High Ed


What can we see from the previous graph?

Education increases wages

Older people get higher wages

Wage depends on education and age (experience)


How will a wage profile look like?


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.


Let us assume that we have two profiles


How to compare the two profiles?

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


We have the two profiles


Or in terms of gap between the profiles


We have to evaluate the present value

For a given discount rate


How to decide to go on studying

The previous expression is positive – continue studying

The previous expression is negative – do not continue studying.


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

It is the rate that equals

to zero


How to decide?

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


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


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 doesn’t study There is no other costs


We have two present values

With no education


With Education


Their difference is zero when


In logarithms

As ln(1+r) is very close to r for small r

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Education and Wages Pedro Telhado Pereira May 2004 Part 1