3 - Educação e Formação

Education and on-the-job Training
Economia do Trabalho
Mestrado em Economia
FEP, U.Porto
2023/2024
A Carneiro (U Porto) Education and on-the-job Training 2023/2024 1 / 62

These slides are based on Cahuc, Carcillo, and Zylberberg (2014) and
Boeri and van Ours (2021).

Navigation
1 Some Facts
2 The Theory of Human Capital
3 The Theory of Signaling
4 On-the-job Training
5 Evaluating the Returns to Education

Introduction
If you think education’s expensive, try ignorance! Derek Bob
People bring into the labor market a unique set of abilities and
acquired skills known as human capital
Workers add to their stock of human capital throughout their lives,

especially via education and on-the-job training
Di¤erences between individuals’human capital may be due to

di¤erences in their innate ability, investment in schooling/training,
and investment in nonschooling characteristics
Innate ability represents the productivity of the worker without any

investment
Some facts: Spending on education

Some facts: Graduation rates

Some facts: Years of schooling

Education and labor market performance
Education is strongly correlated with:
Labor force participation rates

Unemployment rates

Unemployment rates
Earnings

Education and employment
Employment rates by highest completed level of education
2014 2017 2020 2023

Portugal
%
Total 50.7 53.7 54.5 56.9
Highest completed level of education

No level of education 13.3 11.9 9.2 8.6
Basic education - first cycle 33.5 31.4 26.8 21.4
Basic education - second cycle 59.3 62.4 61.7 60.0
Basic education - third cycle 51.5 53.9 51.5 56.0
Secondary and post-secondary education 63.5 67.6 65.0 69.7
Tertiary education 73.6 76.8 76.5 79.6
Source: INE, Inquérito ao Emprego 4º T

Education and unemployment
Unemployment rates by highest completed level of education
2014 2017 2020 2023

Portugal
%
Total 14.5 9.2 7.0 6.5
Highest completed level of education

No level of education 22.9 17.3 n.d n.d
Basic education - first cycle 15.3 9.6 5.3 6.4
Basic education - second cycle 15.4 9.7 5.9 6.9
Basic education - third cycle 16.9 10.5 7.8 7.9
Secondary and post-secondary education 15.3 9.9 8.4 7.5
Tertiary education 10.0 6.5 5.8 4.6
Source: INE, Inquérito ao Emprego

Education and unemployment

Education and earnings
Monthly Wage (base+regular benefits+extra)

Portugal, 2021
euros
Less than Basic 849,5
Basic - 1st cycle 928,2
Basic - 2nd cycle 978,3
Basic - 3rd cycle 1013,3
Secondary 1160,6
Bachelor 1957,1
Graduate 1935,6
Master 2062,1
Doctorate 2797,6
Source: Quadros de Pessoal.

Education and earnings

Theory of human capital (Becker, 1964)
The basic assumptions in the human capital model of education are

threefold:
1 more education leads to higher productivity


threefold:
2 higher productivity leads to a higher wage


threefold:
2 higher productivity leads to a higher wage
3 individuals choose their level of education based on …nancial

considerations.

The optimal level of schooling depends on the expected bene…ts and

the costs of schooling
The expected bene…ts are determined by the higher wage and higher
employment probability associated with a higher educational
attainment and also by the expected length of time over which the
returns to education materialize (the period between the time the
education is …nished and the time an individual retires)

Investment in education
Earnings and
Costs
wS
Monetary benefits
w0
Forgone earnings
0
S T
Years of schooling and age
Direct Costs
-C

The individual has to compare two options:

The …rst option is to start working immediately and have annual
earnings w0 ,which are considered to be constant for the remaining
labor market years until retirement at age T .
The total costs of s years of schooling are the direct costs and the
forgone earnings from 0 to s; the monetary bene…ts are the higher
earnings over the period s to T .

The individual has to compare two options:

The …rst option is to start working immediately and have annual
earnings w0 ,which are considered to be constant for the remaining
labor market years until retirement at age T .
The second option is to attend s years of schooling during which direct

educational costs have to be paid and then earns ws > w0 until
retirement age.
The total costs of s years of schooling are the direct costs and the
forgone earnings from 0 to s; the monetary bene…ts are the higher
earnings over the period s to T .

Investment in education - Optimal years of schooling
Consider the decision whether an individual who has s years of

schooling should opt for another year of schooling.
If the individual does not attend this additional year, the annual
earnings over the remaining labor market years until age T will be ws .
If the individual attends s + 1 years of schooling, the annual earnings

from age s + 1 to age T are equal to ws +1 .
The annual costs involved at school are equal to cs .

The individual will do the extra years of schooling if the present value
of doing so is larger than the present value of not doing this.
Thus, the individual makes a decision on the basis of a comparison of

present values of both ‡ows of earnings and costs.
If i is the market interest rate, the net present value with s years of
schooling is
T t T t
1 1
NPVs = ∑ 1+i
ws = ws + ∑ 1+i
ws (1)
t =0 t =1

The net present value with s + 1 years of schooling is
T t
1
NPVs +1 = cs + ∑ 1+i
ws +1 (2)
t =1
The individual will attend another year of schooling if the present

value of doing so is larger than the present value of abstaining:
NPVs +1 > NPVs :
T t
1
∑ 1+i
(ws +1 ws ) > ws + cs (3)
t =1

If the costs of schooling are small, cs 0,and after some rewriting it

follows that:
(ws +1 ws ) > ws i
ws +1 > ws (1 + i )
So,
ln(ws +1 ) > ln(ws ) + ln(1 + i ) ln(ws ) + i
ln(ws +1 ) ln(ws ) > i (4)

The left-hand side of eq. (4) represents the rate of return to an

additional year of schooling: ln(ws +1 ) ln(ws ) = r .
In other words, the individual will do the additional year of schooling

if r > i, i. e., if the rate of return to schooling at educational level s
is larger than the market interest rate.
The individual will invest in schooling if it is more pro…table than an

investment in the capital market.

Stop rule: optimizing behavior implies that the individual will choose
s such that i = r .
The individual will keep investing until the marginal rate of return to
schooling equals the market interest rate.
The internal rate of return will depend on the ability of the individual
and the costs of funding study.
Thus, di¤erent individuals will have di¤erent rates of return to

shooling and will choose di¤erent levels of schooling accordingly.

Education as a signaling device
The …rst of the three basic assumptions underlying the human capital
model is that education increases productivity.
This need not be the case. If employers …nd it di¢ cult to establish the
productivity of workers, educational achievements may be used as a
signaling device even if education itself does not increase productivity.
Information that is used to allocate workers in the labor market is

called a signal.

Spence (1973) put forward the idea that education also - and perhaps
even primarily - serves to select individuals, without really in‡uencing
the productive e¢ ciency that they will display in their future
professional lives.
The premise of Spence’s theory is that those persons who perform

most e¤ectively in active life are also the ones who perform best while
studying.
If productive e¢ ciency is not observable by potential employers, then

success as a student simply serves to signal the presence of such
productive characteristics - hence the term theory of signaling given
to this view of education.

If employers use education to screen workers, it will still be worthwhile

for high-ability individuals to attain a high educational level because
the signal attached to it pays o¤.
Thus the private returns to schooling are still there.
However, the social returns to schooling (percentage increase in

national income) are much lower.
If education does not increase productivity, the only bene…t from

educational systems is that it helps employers …nd the employees they
are looking for (promotes matching of workers and jobs in the labor
market).

On-the-job training
After …nishing formal schooling, individuals may increase their

productivity through on-the-job training (OJT).
Two types of OJT (Becker, 1964):

General: training that is useful at all …rms once it is acquired
Here the issue is whether the worker or the …rm pays for the training.

On-the-job training
After …nishing formal schooling, individuals may increase their

productivity through on-the-job training (OJT).
Two types of OJT (Becker, 1964):

General: training that is useful at all …rms once it is acquired
Speci…c: training that is useful only at the …rm where it is acquired
Here the issue is whether the worker or the …rm pays for the training.

General training
General training in a …rm increases productivity, but it can also be

used by other …rms.
Because workers are free to leave, …rms can never recoup their
investment in general training.
Therefore, workers have to pay for this, for example, by accepting

lower wages than their productivity during training.

General training

Speci…c training
The productivity gains from …rm-speci…c training vanish once the

worker leaves the …rm.
Who pays for speci…c training?
Suppose the …rm supports the cost and collect the returns by not
changing the wage in the posttraining period; if the worker quits in
the second period, the …rm won’t be able to recoup the investment;
Suppose instead that the worker pays for speci…c training; workers
would then receive a low wage during the training period and higher
wages in the post-training period; if the worker were to get laid o¤ in
the second period, he would lose his investment because speci…c
training is not portable.
The worker, therefore, is not willing to invest in speci…c training
unless he is very con…dent that he will not be laid o¤.

Speci…c training
Hold up problem: neither party wishes to take the initiative and pay
for the training.
The way to solve this dillema is to set the post-training wage, wpt ,
such that:
w < wpt < VMP
where w is the alternative wage and VMP the worker’s value of

marginal product.
This contract implies that the …rm and the worker share the returns
from speci…c training.
If …rms and workers do share the returns of speci…c training, they will
also have to share the costs.

Speci…c training

Some implications of speci…c training
Speci…c training breaks the link between the worker’s wage and the
value of marginal product throughout the worker’s life cycle.
After the training period, workers get paid less than their value of
marginal product in the …rm that provided the training, but get paid
more than their marginal product in other …rms.
As a result of this contract, workers who have speci…c training are

e¤ectively granted a type of tenure or lifetime contract in the …rm.
The probability of job separation for a given worker (either through a

quit or layo¤) declines with job seniority.
Newly hired workers will have high turnover rates, whereas more
senior workers will have low turnover rates.
Age-earnings pro…le
In all developed countries, for all professions, the relationship between

age and annual income from employment over the life cycle presents
the same characteristics (Psacharopoulos, 1985).
Ben-Porah (1967), Heckman (1976), and Weiss (1986) have shown

that the theory of human capital explains the relationship between
age and labor income very naturally.
The age-earnings pro…le is upward-sloping and concave.
Older workers earn more because they invest less in human capital
and because they are collecting the returns from earlier investments.
The rate of growth of earnings slows down over time because workers
accumulate less human capital as they get older.
Age-earnings pro…le
Earnings
Age-Earnings Profile
Age

Age-earnings pro…le of full-time workers, 2002
Men
1400
College Graduates
Weekly Earnings
1100
Some college
800 High school graduates
High school dropouts

500
200
18 25 32 39 46 53 60
Age
Source: U.S. Bureau of Labor Statistics

Age-earnings pro…le of full-time workers, 2002
Women
1200
1000
Weekly Earnings
College Graduates
800
Some college
600 High school graduates
400 High school dropouts
200
18 25 32 39 46 53 60
Age
Source: U.S. Bureau of Labor Statistics

Evaluating the returns to human capital
Traditionally, empirical evidence of the rate of return to educational
and training investments is derived by performing wage regressions
with the amount of schooling and training as explanatory variables.
Mincer (1974) proposed a form of earnings function based on the

human capital model:
log w = βs + δ1 exp + δ2 exp 2 + ε

where w is the wage rate, s is the number of years of schooling, exp
gives the number of years of labor market experience, and exp 2 is a
quadratic on experience that captures the concavity of the
age-earnings pro…le.
β corresponds to the rate of return to one added year of schooling; δ1

and δ2 capture the rate of growth in earnings resulting from one
additional year of labor market experience; ε is a random error term.
Alternatively, we can use dummy variables for the di¤erent levels of
education:
log w = β1 Basic2 + β2 Basic3 + β3 Secondary +
+ β4 Terciary + δ1 exp + δ2 exp 2 + other variables
where
1 if highest completed level of education is basic-2nd cycle

Basic2 =
0 otherwise
1 if highest completed level of education is terciary education

Tertiary =
0 otherwise
The βs correspond to the relative increase in wages for each level of completed education
relative to the ommited category (basic-1st cycle or less).
Extended versions of the mincerian wage equation control for:

worker characteristics ("who you are"): gender, race, education, age,
etc;


etc;
job characteristics ("what you do"): tenure, occupation, type of

contract, etc;


etc;
job characteristics ("what you do"): tenure, occupation, type of

contract, etc;
…rm characteristics ("where you are"): size, industry, location, etc.

The returns to terciary education in Portugal (Figueiredo
et al., 2017)
Returns to education by degree and field of study

Portugal, 2006-2015
OLS OLS
(1) (2)
Graduates non CTEM versus Secondary 0.434 0.239
Graduates CTEM versus Secondary 0.513 0.264
Masters non CTEM versus Secondary 0.628 0.360
Masters CTEM versus Secondary 0.675 0.360

Notes: CTEM denotes Sciences, Technology, Engineering and Maths.
Model (1) controls for worker characteristics; Model (2) controls for worker, firm,
and job characteristics.
All coefficients are statistical significant at the conventional levels of significance.
S o u r c e : Figueiredo et al. (2017).

The Returns to Education in Portugal, 2010-2020
Prémios Salariais ao Ensino Superior, Portugal 2010-2020

Diplomados < 35 anos Diplomados < 65 anos
1.2
Diferença % relativamente ao secundário 1.2
Diferença % relativamente ao secundário

1
.8 1
.8
.6
.6
.4
.4
2010 2012 2014 2016 2018 2020 2010 2012 2014 2016 2018 2020
Licenciatura Mestrado Licenciatura Mestrado
Figure: Source: Quadros de Pessoal; Carneiro (2023)

Estimating the returns to education - Ability bias and
selection bias
The theories of signaling and human capital both predict that the
high-ability persons study for longer durations and obtain, for a given
level of education, higher incomes.
Thus, duration of education and income are codetermined by

individual capacities: the correlation between the duration of studies
and income simultaneously re‡ects the fact that the high-ability
persons study longer and the fact that education increases income by
improving an individual’s stock of knowledge.

Ability bias
Individuals di¤er in their unobserved ability.
In theory, a more able person gets more from an additional year of

education.
Most productive individuals have an interest in studying for the

longest period.
In these conditions, part of the return attributed to education comes,

in fact, from individual capacities, and so the returns to education are
overestimated.

Ability bias
Dollars Z
w12 B
wA A
w11
PA
11 12
The di¤erence in observed wages between individuals A and B (w12 w11 ) is

due to di¤erences in the level of schooling but also to di¤erences in unobserved
characteristics such as ability. Ignoring the latter may counfound the evaluation of
the returns to education.
How to correct for bias?
Using a "natural" experiment to compare workers of the same ability
Example: comparison of the earnings of identical twins
Question: why do identical twins have di¤erent levels of schooling in

the …rst place?
Instrumental variables: consists in using a variable that in‡uences the

duration of studies while remaining independent of individual
capacities

Identifying the causal relationship between education and
income
Angrist and Krueger (1991) have made an interesting contribution,
which consists of exploiting the existence of events that are much like
natural experiments
The authors noted that individuals born early in the calendar year
have shorter durations of schooling than those born later
This e¤ect is owing to the compulsory duration of schooling where

compulsory schooling laws require students to remain in school until
their 16th or 17th birthday
By assuming that the date of one’s birth is independent of factors

infuencing abilities and preferences, this phenomenon can entail an
exogenous variation in the duration of schooling, which may be used
as an instrument
Illustration - Angrist and Krueger (1991)


Angrist and Krueger present estimates that compare earnings and

education between men born in the …rst quarter of the year and men
born in the last three quarters of the year;
Formally, the Wald estimator of the returns to education is:
w 2,3,4 w1
b
ρWald =
S2,3,4 S1
where w j and Sj denote respectively the average logarithm of wages

and the average years of education of individuals born in quarter j;
hence w 2,3,4 is the average for the last three quarters.
In this case, the Wald estimator is equivalent to an instrumental
variables estimator where a dummy variable indicating whether an
individual is born in the …rst quarter of the year is used as an
instrument for education and there are no covariates.
Wald and OLS estimates of the returns to education (standard errors in parentheses)
(1) (2)
Born in first Born in 2nd, 3rd, Difference
quarter or 4th quarter (2)-(1)
ln(weekly wage) 5,8916 5,9027 .01110
(.00274)
Education 12,6881 12,7869 .01088
(.0132)
Wald estimator .1020
(.0239)
OLS estimator .0709
(.0003)
Source: Angri s t a nd Krueger (1991, ta bl e 3).

income
Another method used to evaluate the returns to education consists of

using data about individuals whose abilities are as alike as possible
Therefore, several contributions estimate the returns to education for
siblings or twins (whose unobserved characteristics are assumed to be
similar)
Then, it is possible to estimate without bias the returns to education
using the OLS, on condition that the di¤erences in duration of study
between twin members are not correlated to di¤erences in aptitude
that may in‡uence their gains
However, if the duration of education is di¤erent between the twins,
they are not perfectly identical anymore. In this case, the assumption
that the di¤erence of schooling durations is not correlated to their
future earnings is not valid

income
Ashenfelter and Rouse (1998): returns to schooling & identical twins
Annual Twinsburg Twins Festival (Ohio) ! interviews 1991, 1992,

1993

income

1993
Sample: identical twins both of whom have held a job at some point in
the previous 2 years

income

1993
Sample: identical twins both of whom have held a job at some point in
the previous 2 years
Schooling di¤erence: each twin reported on own schooling and sibling’s
schooling

income
Returns to schooling ! percentage increase in wage due to 1

additional year of schooling
Account for di¤erences in ability (more able ! more education)

income

US sample of 340 twins

income

Direct estimate 10.2%

income

Twins: 8.8%

income

Twins: 8.8%
Ability bias: 1.4%

income
Ashenfelter and Rouse (1998) …nd that the di¤erences in the returns
to education between genetically identical individuals are slightly
weaker than those obtained by comparing the duration of schooling
and incomes of any two random individuals
Oreopoulos and Salvanes (2011) have used Norwegian administrative

records that supply information on the educational and professional
trajectories of all persons born since 1920.
They found that siblings with one more year of schooling have more
annual income than their less educated siblings, which con…rms the
results of Ashenfelter and Rouse

Private non-pecuniary returns to education
Private gain from years of study does not boil down to the chance of
a better wage
Schooling exerts e¤ects in a range of dimensions by promoting better

decision making in the areas of health, choice of partner, and the
schooling of one’s children
Grossman (2006) suggests increased satisfaction with longer duration
of schooling

a better wage

of schooling
Oreopoulos and Salvanes (2011) stress that schooling may a¤ect
individual preferences so as to be more patient, more goal-oriented and
less likely to engage in risky behavior

a better wage

of schooling
Oreopoulos and Salvanes (2011) stress that schooling may a¤ect
individual preferences so as to be more patient, more goal-oriented and
less likely to engage in risky behavior
Figueiredo et al. (2017) show that higher education is associated with
a set of virtuous behaviors from a collective point of view, such as:
more political and social involvement, more cognitive skills to interpret
social phenomena, more tolerance, and more con…dence in institutions.

The social returns to education
Estimates of the private returns to education no doubt fail to render a

full account of the bene…ts that ‡ow from investments in schooling to
society as a whole.
It is possible that education exerts positive externalities and that the

social returns to education are superior to the private ones.
The few empirical studies available suggest that education does

indeed exert positive externalities, and that the social returns to
education are superior to the private ones.

Social engagement: Putnam (2007) asserts that "education is one of

the most important predictors of many forms of social engagement,
from voting to charging a local committee to hosting a dinner party
to trusting others"
Criminality and violence: Lochner and Moretti (2004) …nd that

education has a negative impact on criminality and that the
externality connected to the reduction of criminality represents
between 14% and 26% of the private returns to education

Labor mobility: Machin, Pelkonen and Salvanes (2011) …nd that the
length of compulsory education has a causal impact on mobility of
individuals at the lowest levels of educational attainment
Spillover on children: Currie and Moretti (2003) estimate that better

education of mothers exerts a positive impact on the health of their
o¤spring
Knowledge externalities: Rauch (1993) estimates that knowledge

externalities increase the returns to education by 3 to 5 percentage
points

New Technologies: Foster and Rosenzweig (1996) showed that more

advanced education can also favor the discovery and adoption of new
technologies, which themselves exert macroeconomic externalities
that are a source of growth (Nelson and Phelps, 1966; Aghion and
Howitt, 1998).
Growth: Empirical work on international macroeconomic data

generally highlights a positive impact of education on growth (Topel,
1999; Hanushek and Kimko, 2000; Krueger and Lindahl, 2003).

Required readings
Boeri, T. and van Ours, J. (2021), The Economics of Imperfect Labor

Markets, Princeton University Press, chap. 8.
Cahuc, P., Carcillo, S., and Zylbergerg, A. (2014), Labor Economics,

Massachusetts Institute of Technology, chap. 4.

Recommended readings
Figueiredo, H., Portela, M., Sá, C., Cerejeira, J., Almeida, A., and
Lourenço, D. (2017), Benefícios do Ensino Superior, Fundação
Francisco Manuel dos Santos, Estudos da Fundação.

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Education and on-the-job Training

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 1 / 62

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 2 / 62

2 The Theory of Human Capital

3 The Theory of Signaling

5 Evaluating the Returns to Education

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 3 / 62

If you think education’s expensive, try ignorance! Derek Bob

Workers add to their stock of human capital throughout their lives,

Di¤erences between individuals’human capital may be due to

Innate ability represents the productivity of the worker without any

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 5 / 62

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 6 / 62

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 7 / 62

Education is strongly correlated with:

Labor force participation rates

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 8 / 62

Education is strongly correlated with:

Labor force participation rates

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 8 / 62

Education is strongly correlated with:

Labor force participation rates

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 8 / 62

Employment rates by highest completed level of education

2014 2017 2020 2023

Total 50.7 53.7 54.5 56.9

Highest completed level of education

Source: INE, Inquérito ao Emprego 4º T

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 9 / 62

Unemployment rates by highest completed level of education

2014 2017 2020 2023

Total 14.5 9.2 7.0 6.5

Highest completed level of education

Source: INE, Inquérito ao Emprego

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 10 / 62

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 11 / 62

Monthly Wage (base+regular benefits+extra)

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 12 / 62

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 13 / 62

The basic assumptions in the human capital model of education are

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 14 / 62

The basic assumptions in the human capital model of education are

2 higher productivity leads to a higher wage

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 14 / 62

The basic assumptions in the human capital model of education are

2 higher productivity leads to a higher wage

3 individuals choose their level of education based on …nancial

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 14 / 62

The optimal level of schooling depends on the expected bene…ts and

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 15 / 62

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 16 / 62

The individual has to compare two options:

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 17 / 62

The individual has to compare two options:

The second option is to attend s years of schooling during which direct

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 17 / 62

Consider the decision whether an individual who has s years of

If the individual attends s + 1 years of schooling, the annual earnings

The annual costs involved at school are equal to cs .

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 18 / 62

Thus, the individual makes a decision on the basis of a comparison of

A Carneiro (U Porto) Education and on-the-job Training 2023/2024 19 / 62