The Returns to Education A Review of Evidence, Issues and Deficiencies in the Literature

The Centre for the Economics of Education is an independent research centre funded by the Department of Education and Employment. The view expressed in this work are those of the authors and do not necessarily reflect the views of the Department of Education and Employment. All errors and omissions remain the authors. The estimation of the return to a year of schooling, both for the individual and society more generally, has been the focus o f considerable debate in the economics literature. Simple analysis of average earnings for different levels of education can mask a number of issues, which stresses the role for multivariate regression analysis. Work based on this approach for the UK typically suggests a return to a year of schooling of between 7% and 9% using a relatively parsimonious specification controlling for schooling and experience. This would appear to be at the upper end of returns to schooling in Europe, where Nordic countries in particular have low average returns to schooling. The returns to schooling are relatively stable to changes in this simple OLS specification. The returns to education may also differ across the wage distribution – for example the returns are higher for those in the top decile of the income distribution compared to those in the bottom decile. One explanation for this phenomenon is a complementarity between ability and education – if higher ability persons earn more this might explain the higher returns in the upper deciles of the wage distribution. In addition, given the increase in the supply of educated workers in most OECD countries there is also a concern that the skills workers bring to their job will exceed the skills required for the job leading to a lower return to years of schooling in excess of those required for the employer. One of the main problems with this literature is the often-poor definition of overeducation in available datasets, typically based on subjective measures given by the i ndividual respondent. Where a more comprehensive definition is used based on job satisfaction the apparent negative effect of overeducation is eliminated when ability controls are included, but when overeducation appears to be genuine the penalty may be m uch larger than was first thought. It is also possible that the return to education actually reflects the underlying ability that education signals – in other words education is a signal of inherent productivity of the individual …