1. EC326 Topics in Applied Economics 2b Topic 2: Economics of Higher Education Robin Naylor EC236: Economics of HE, 2014-151

2. Topic 2: Economics of Higher Education EC236: Economics of HE, 2014-152 Lecture 1: Human capital theory Lecture 2:Signalling theory Lecture 3:The causal effect of education on earnings Lecture 4:Evidence of returns to HE in the UK Lecture 5:Cohort effects: theory Lecture 6:Cohort effects: evidence

3. Topic 2: Economics of Higher Education Bibliography Blundell, R., Dearden, A., Goodman, A. and Howard, R. (2000), The returns to higher education in Britain: evidence from a British cohort, Economic Journal, 110, F82-F99. Card, D. (1999), The Causal effect of education on earnings, Ch. 30, Handbook of Labor Economics vol. 3A, Ashenfelter, O. and Card, D. (Eds), North-Holland. Chevalier, A., Conlon, G., Galindo-Rueda, F. and McNally, S. (2001), The returns to higher education teaching, Centre for the Economics of Education. Feng, A. and Graetz, G. (2013), A question of degree: the effects of degree class on labor market outcomes, Centre for Economic Performance Discussion Paper 1221. O'Leary, N. and Sloane, P. (2011), The wage premium for university education in Great Britain during a decade of change, Manchester School, 79, 740-764. Walker, I. and Zhu, Y. (2008), The college wage premium and the expansion of higher education in the UK, Scandinavian Journal of Eocnomics, 110, 695-709. Walker, I. and Zhu, Y. (2011), Differences by degree: Evidence for the net financial rates of return to undergraduate study for England and Wales, Economics of Education Review, 30, 1177- 1188. EC236: Economics of HE, 2014-153

4. Topic 2: Economics of Higher Education EC236: Economics of HE, 2014-154 Lecture 1: Human capital theory and signalling theory Some evidence on education and earnings* US Card, D. (1999) Figure 1 (separate handout) Card, D. (1999) Figure 2 (separate handout) Card, D. (1999) Table 1 (separate handout) UK, Europe and beyond Harmon, C., Oosterbeek, H. and Walker, I. Table 2.1 (separate handout) BCS70: some DIY estimates… *We are focusing on earnings, but education affects very many outcomes…

5. Topic 2: Economics of Higher Education EC236: Economics of HE, 2014-155 Lecture 1: Human capital theory and signalling theory Human Capital Theory (Becker (1964), Mincer (1974) (i) Competitive labour market => w/p = MPL (ii)MPL = f(Human Capital) (iii)Human Capital = f(Education, Training) (iv)Education (Training) involves opportunity costs (and possible direct costs too) (v)Theory of equalising differences:

6. Topic 2: Economics of Higher Education EC236: Economics of HE, 2014-156 Lecture 1: Human capital theory and signalling theory Theory of equalising differences: In a competitive labour market equilibrium, wage differentials compensate workers for (opportunity and direct) costs of human capital acquisition => (a)Supply and demand for workers of each education level are equated (b)No worker wishes to alter his/her schooling level

7. EC236: Economics of HE, 2014-157 Lecture 1: Human capital theory and signalling theory Consider the following simple model tsnn s W(s2) W(s1) w e Topic 2: Economics of Higher Education

8. EC236: Economics of HE, 2014-158 Under the theory of equalising differences: where r is the rate of return to educational investments and other terms are as defined in the lecture. Let w e - D = 0. Assume also that, conditional on the level of education, wages per worker are constant over the lifetime. Finally, assume that n = n s. Then the equation simplifies to: Topic 2: Economics of Higher Education Lecture 1: Human capital theory and signalling theory

9. EC236: Economics of HE, 2014-159 => Note that => Topic 2: Economics of Higher Education Lecture 1: Human capital theory and signalling theory

10. EC236: Economics of HE, 2014-1510 Hence it follows that: Thus, Or This is the basic human capital earnings equation. It follows that, Topic 2: Economics of Higher Education Lecture 1: Human capital theory and signalling theory

11. EC236: Economics of HE, 2014-1511 The human capital earnings equation is often extended to allow for Mincer’s emphasis on the importance of experience: where e = age - s – 5 = “Mincer experience”. Problems 1.Omitted variable bias *Ability *Family background Furthermore, likely to be correlated with schooling => estimate of effects of schooling on earnings biased upwards. Topic 2: Economics of Higher Education Lecture 1: Human capital theory and signalling theory

12. EC236: Economics of HE, 2014-1512 2.Selectivity bias: Length of schooling is not randomly assigned across individuals but is the outcome of rational decision-making: it is endogenously determined. So ‘S’ in the human capital earnings equation above is not exogenous and the estimate of ß 1 is likely to be biased. Causes of endogenous selection: MB 2 S** Topic 2: Economics of Higher Education Lecture 1: Human capital theory and signalling theory

13. EC236: Economics of HE, 2014-1513 Why might MB shift up to the right? Family background Alternatively, why might MC shift down to the right? Family background (access to capital) Ability From your lecture notes in either EC226 or EC203, you will have seen that OLS yields biased or inconsistent estimates if a relevant RHS variable is either omitted or is endogenous. You will also have seen that the use of Instrumental Variables is one possible way around this. You should check your EC226/203 notes on this material. In our context, an IV would be a variable which is correlated with schooling but which does not exert an independent effect on earnings. Topic 2: Economics of Higher Education Lecture 1: Human capital theory and signalling theory

14. EC236: Economics of HE, 2014-1514 Topic 2: Economics of Higher Education Lecture 1: Human capital theory and signalling theory IV Candidates? *Smoking, Rate of discount, Insurance, Distance to college (Results: IV suggests OLS estimates are under-estimates.) Alternatively, *Natural experiments I.e., something which influences length of schooling exogenously (randomly). ROSLA. Again, suggests OLS estimates are under- estimates. Why? *Twins studies

15. EC236: Economics of HE, 2014-1515 Twins studies: Problem Omitted variable bias if f, a are not observed. Twins data Differencing, So is an unbiased estimate of the return to schooling. Topic 2: Economics of Higher Education Lecture 1: Human capital theory and signalling theory

16. EC236: Economics of HE, 2014-1516 So other important influences on earnings: *Non-competing groups So theory of equalising net advantages invalid *Discrimination *Signalling/screening *Product market power *Labour market institutions Topic 2: Economics of Higher Education Lecture 1: Human capital theory and signalling theory

17. Topic 2: Economics of Higher Education EC236: Economics of HE, 2014-1517 Lecture 2:Signalling Theory Spence, QJE, 1973 Phelps, AER, 1972 Arrow, Theory f Discrimination, 1973

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23. EC236: Economics of HE, 2014-1523 Topic 2: Economics of Higher Education

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25. EC236: Economics of HE, 2014-1525 s 0 Topic 2: Economics of Higher Education

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29. EC236: Economics of HE, 2014-1529 s 0 Topic 2: Economics of Higher Education

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35. EC236: Economics of HE, 2014-1535 s 0 Topic 2: Economics of Higher Education

36. EC236: Economics of HE, 2014-1536 Wages and productivity SS Dm £ 0 Topic 2: Economics of Higher Education

37. EC236: Economics of HE, 2014-1537 Costs and Schooling SS c s£ 0 2 1 c 1 2 c Topic 2: Economics of Higher Education

38. EC236: Economics of HE, 2014-1538 Case 1 SS Dm = m - m £ 0 21 Who Invests in schooling in this case? 2 c s 1 Topic 2: Economics of Higher Education

39. EC236: Economics of HE, 2014-1539 Case 2 SS Dm £ 0 Who Invests in schooling in this case? 2 c s 1 Topic 2: Economics of Higher Education

40. EC236: Economics of HE, 2014-1540 Case 3 SS Dm £ 0 Who Invests in schooling in this case? 2 c s 1 Topic 2: Economics of Higher Education

41. EC236: Economics of HE, 2014-1541 Case 3 SS Dm £ 0 Who Invests in schooling in this case? 2 c s 1 SS ab To what do S a and S b correspond? Topic 2: Economics of Higher Education

42. EC236: Economics of HE, 2014-1542 Signalling: is it sustainable in the long run? Employer Learning (Altonji and Pierret, QJE, 2001) (Farber and Gibbons, QJE, 1996) Statistical Discrimination in the Short-run Evidence? (Layard and Psacharopoulos, JPE, 1974) (Riley, JPE, 1979) (Feng and Graetz (2013): see subsequent lecture)

43. Topic 2: Economics of Higher Education EC236: Economics of HE, 2014-1543 Lecture 3:The causal effect of education on earnings

44. Topic 2: Economics of Higher Education EC236: Economics of HE, 2014-1544 Lecture 4:Evidence of returns to HE in the UK

45. Topic 2: Economics of Higher Education EC236: Economics of HE, 2014-1545 Lecture 5:Cohort effects: theory

46. Topic 2: Economics of Higher Education EC236: Economics of HE, 2014-1546 Lecture 6:Cohort effects: evidence