Economia do Trabalho Pedro Telhado Pereira. Universidade da Madeira2 The paradigm of the two islands...

Economia do Trabalho

Pedro Telhado Pereira

Universidade da Madeira 2

The paradigm of the two islands – Pereira and Martins (2004)

two islands (I1) with a productivity per capita of P (I2) with a productivity per capita of Q P<Q. The inhabitants of the islands live an

eternal life (all are born at the same moment) and maximize the present value of their production.


The inhabitants of I1 can move to I2 if they spend one period learning how to swim.

The only cost is the product they forgo during that period.

The discount rate is uniformly distributed between (r1, r2); f(r)=1/(r2-r1).


The decision of learning to swim is made by comparing(E1)

0 )1(iir

P

and(E2)

1 )1(iir

Q


There is a value of r, rc, such that E1=E2.

Let us assume that r1 < rc < r2. If r < rc then E1 < E2 and the individual

decides to learn to swim and thereafter swims from I1 to I2.

If r > rc then E1 > E2 and the individual does not learn to swim and stays on I1.


Therefore, there will be S1 proportion of swimmers, where

rc

r

drrfS1

)(1

We end up with three groups of individuals:

1) living on island one,

2) living on island two and born there, and

3) living on island two and born on island one.


The “labour economists” want to explain the differences in productivity and therefore they can do so by examining the place where the person is living (the wage equation approach).

But suppose that we are interested in studying the “returns” to education (learning to swim). We must then look at the persons born on island one and see the differentials in their productivities as the return we are looking for. This is what “education economists” look for.

We could never find this return if we considered the place of residence as one of the explanatory variables of the productivity differential, the reason being that this covariate is a result of learning to swim for people born on island one.


This example illustrates

the difference between wage equations - where education is one of the explanatory variables - and returns to education - where all the indirect effects should be accounted for.


When an individual (or his family) decides the amount of education he wants to have

he knows that education is going to bring him a better paid job,

but at the same time gives him more opportunities in choosing other characteristics as, for instance, the sector and firm where he ends up working in.

Part of the private return from education to the individual is going to be through the return he will get from the posterior choices he can make.


In econometric terms

Let us assume that wages depend on education (S) and other covariates, represented by an indicator (C). To make it as simple as possible and following the Mincer specification we have

CbSbbwage 210)ln(

where b1>0 and b2>0 or b2<0


If b2>0, people with more education will choose the largest C and therefore there is a positive relation between S and C.

If b2<0, people with more education will choose the smallest C and therefore there is a negative relation between S and C.


If we assume this relation to be linear, we have

C g g S= +0 1

and

l n ( ) ( ) ( )w age b S b g g S b g b b g S= + + + = + + +b b0 1 2 0 1 0 2 0 1 2 1


The rate of return of Education

r b b g= +exp( )1 2 1


Main conclusions:

To obtain the full effect of the education on wages we should only regress the ln(wage) in education and/or not consider the covariates that depend on schooling

If we include covariates that depend on education on the regression the coefficient of schooling decreases (at least in the expected value of the estimators).


What has been considered in the wage equation

The efficiency wages hypothesis (see, inter alia, Krueger and Summers, 1988) warrants the inclusion of sectors of activity, firm size and firm age.

Hartog, Pereira, Vieira (2000)


Following the seminal work of Krueger and Summers (1988), several studies have been carried out in a large number of countries and shown the existence of inter industry wage differentials for apparently equally skilled workers. Although part of these differentials can be explained by unobserved heterogeneity, this does not explain all the variation

These findings pose a challenge to textbook competitive models of the labour market and alternative explanations based on efficiency wage mechanisms or rent sharing have been put forward

Nevertheless, the existence of such differentials has not been clearly understood and remains an intricate and unresolved puzzle.


The data were drawn from Quadros de Pessoal for the years of 1982, 1986 and 1992.

Conclusion:– The study shows Portugal has a high inter-industry

wage inequality. The size of the inter-industry wage dispersion in Portugal seems similar to that of countries rated as having a decentralised wage setting.

– Nevertheless, the dispersion decreased during the1980s.

– We argue that shifts towards a more centralised and co-ordinated wage setting may have played a role here.


The existence of “rents” and trade unions or agency models (see Freeman and Medoff (1986), Pencavel (1991), Hart and Holmstrom (1987), among others) justify the inclusion of the bargaining regimes.

Hartog, Pereira and Vieira (2002)


labour economists have increasingly realised that wage structures and labour contracts may also be instruments to the firm.

Moreover, the influence of the institutional environment of the labour market has led to greater interest in the role of bargaining between trade unions and management.


The data used - Quadros de Pessoal for 1986 and 1992

Conclusions:– The results show that after controlling for a

large set of individual and job related characteristics, the firm bargaining regime coverage apparently is important in explaining the variability of wages.

– The main results reveal that wage differentials between the bargaining regimes are in some cases sizeable.


– that multi-firm contracts tend to generate higher wages

– sectoral contracts tend to generate the lowest wages.

– Compulsory regimes and single-firm contracts align at an intermediate level in the ranking.


Internal wage structures (see Lazear (1998), for instance) justify the inclusion of seniority (tenure).

Lima, F. and P. T. Pereira (2003)


The relationship between employers and employees is rather complex and subject to different dimensions of analysis.

One such dimension is the wage growth associated with the employee’s career progression inside the firm.

The real world is replete with examples of job ladders that individuals climb during their working lives and of the major pay changes that accompany those steps.


The main questions

What is the effect of promotion on the wage growth?

How does the wage growth depend on the hierarchical position held by the employee?

To what extent are human capital accumulation and learning about individual abilities reflected in wage paths?

What is the effect of demotions?


Data used

The data set used is a sample of firms drawn from the survey Quadros de Pessoal collected annually by the Ministry of Employment.

A random sample of firms was drawn, stratified according to economic activity, location, firm’s legal form, and number of employees.

The sample is a longitudinal matched employer-employee panel of 74 large firms from the manufacturing sector, with more

than 500 workers each year and followed between 1991 and 1995. T

he employment history of all workers in the firm and several firms’ characteristics are available.

The original sample has 391,618 observations.


Conclusions: Promotions and/or transitions to upper job levels

imply a positive and important wage premium. Demotions are associated with negative wage

premiums. The negative wage premiums are more important at

the bottom job levels, probably as a result of the (negative) learning effect.

The wage premiums for promotions are higher at the tails of the hierarchy, generating a U-shaped relationship between the workers’ career path and wage growth. – In the context of the model discussed, it suggests

a stronger learning and/or human capital accumulation effect at the bottom of the hierarchy and a stronger job assignment effect at the top.


The influence of covariates on returns to education Pereira, P. T. and P. S. Martins (2004), Returns to Education

and Wage Equations, Applied Economics, forthcoming.

A meta-analysis - is a regression that takes as dependent variable the outcomes from different studies that focus on the same topic and employ the same general methodology. The regressors describe the characteristics (in terms of equation specification, in sample size, in year of estimation, and so on) underlying those different results and/or studies. A meta-analysis is therefore a useful tool for summarizing several results on a given topic, allowing a researcher to have a global and quantifiable view on the link between the structure of a research project and its results. In the present study, we examine the influence of covariates in the return to education.


Data used

A meta-analysis uses two kinds of data, which we label here as foreground and background data.

The former is the directly-used information, which includes the coefficients of education that were obtained in different studies, and the presumably relevant characteristics of those studies. By such characteristics, we mean the regressors used, sample size, and so on.

Background data, on the other hand, is simply the primary sources (data sets) used for computing the returns to education (or better, a coefficient to education).


Wage equations in Portugal

Have used between two ( experience and experience squared) to a maximum was 37 explanatory variables.

The number of explanatory variables - in the background regressions - corresponds to the number of regressors used besides education and a constant.


Conclusions:

The use of the Mincer equation in its simpler form (education, experience and experience squared) seems to give an approximate value for the total return to education.

If more covariates are used in this equation and these covariates are choice variables that depend on education, then the coefficient of the education should fall.

This result is supported by the meta-analysis we performed using data for Portugal.

The coefficient decreases with all combinations of variables used and can drop to half of its size, especially when the sector of activity is one of the covariates used.

The education-related choice of sector is an aspect that should reflect itself in over-education in the better paying sectors.


Sample size, the use of monthly wages instead of hourly wages, the interaction between education and experience and tenure do not seem to influence the coefficient, which shows its robustness to sample size, specification of the simple Mincer equation and variables that are independent of education.

The increase of the return to education when regions is used as one of the covariates needs further research, as it seems to show that in the Portuguese case the mobility due to job opportunities is rare.


Final Remark

Returns to education and changes in productivity can be very distinct realities.

Both are worth studying but one should distinguish between them.


References: Freeman, R. B. and J. L. Medoff, (1986). The Two Faces of Unionism. In: L. G.

Reynolds, S.H. Masters and C. H. Moser, eds,. Readings in labor economics and labor relations, Fourth edition, Englewood Cliffs, N.J.: Prentice Hall.

Hart, O. and B. Holmstrom (1987). A theory of contracts. In: T. F. Bewley, Advances in Economic Theory, Fifth World Congress, Cambridge: Cambridge University Press.

Hartog, H., P.T. Pereira and J. C. Vieira, (2000) 'Inter-Industry Wage Dispersion in Portugal: High But Falling', Empirica, 27/4, 353-364.

Hartog, H., P.T. Pereira and J. C. Vieira, (2002) "Bargaining Regimes and Wages in Portugal", Portuguese Economic Journal, vol.1, n. 3, 237-268.

Krueger, A. and L. Summers (1988). Efficient wages and the inter-industry wage structure. Econometrica 56(2), 259-293.

Lazear, E. P (1998). Personnel Economics for Managers, New York: John Wiley and Sons.

Lima, F. And P. T. Pereira (2003), Careers and Wage Growth within Large Firms ", International Journal of Manpower No 7, Volume 24, 2003.

Pencavel, J. (1991). Higher Education, Productivity, and Earnings: A Review. Journal of Economic Education 22:4, 331-359.

Pereira, P. T. and P. S. Martins (2004), Returns to Education and Wage Equations, Applied Economics, forthcoming.

Economia do Trabalho Pedro Telhado Pereira. Universidade da Madeira2 The paradigm of the two islands...

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