Education and Wages Pedro Telhado Pereira May 2004 Part 1

Universidade da Madeira2 Let us look at the Portuguese case – Portuguese workers show a low level of formal education Years of study of the Portuguese workers

Universidade da Madeira3 If we compare the education of the Portuguese with the education in other European countries

Universidade da Madeira4 Younger population in Portugal doesn’t seem to be overcoming the gap

Universidade da Madeira5 All countries showed an increase of more than 30% between the generation and the one of Spain showed an increase of 41% Portugal showed an increase of less than 20%

Universidade da Madeira6 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

Universidade da Madeira7 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.

Universidade da Madeira8 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…

Universidade da Madeira9 But will education lead to higher wages? Let us look again to the Portuguese case

Universidade da Madeira10 Wages in Portugal for different education levels

Universidade da Madeira11 What can we see from the previous graph? Education increases wages Older people get higher wages Wage depends on education and age (experience)

Universidade da Madeira12 How will a wage profile look like?

Universidade da Madeira13 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.

Universidade da Madeira14 Let us assume that we have two profiles

Universidade da Madeira15 How to compare the two profiles? We have to use the present value of the two profiles and compare the result

Universidade da Madeira16 We have the two profiles

Universidade da Madeira17 Or in terms of gap between the profiles

Universidade da Madeira18 We have to evaluate the present value For a given discount rate

Universidade da Madeira19 How to decide to go on studying The previous expression is positive – continue studying The previous expression is negative – do not continue studying.

Universidade da Madeira20 An alternative it is to evaluate the internal rate (IRR) of return It is the rate that equals to zero

Universidade da Madeira21 How to decide? If the internal rate of return is sufficiently high – continue studying.

Universidade da Madeira22 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

Universidade da Madeira23 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

Universidade da Madeira24 We have two present values With no education

Universidade da Madeira25 With Education

Universidade da Madeira26 Their difference is zero when

Universidade da Madeira27 In logarithms As ln(1+r) is very close to r for small r