ESSAY PRACTICE Returns to
Education Applied Economics
1. What does evidence suggest is the causal effect of a year of
schooling on later life wages? How does this evidence influence the
debate on whether to subsidise higher education?
1. Define the Mincer Equation used to estimate the returns to education.
Estimations of the returns to education from the Mincer equation are
prone to an ability bias. Describe the ability bias and critically discuss
economic techniques which can potentially overcome the bias.
2. Using economic theory and evidence evaluate whether the
government should subsidise university education.
1) Define the Mincer Equation
Around the 1960s the topic of returns to education became very central
in research to try and understand why individuals invest their time and
money in further education. Education is one of the first most important
investments an individual will make for their future. Furthermore,
education is useful in preparing young people for the workplace and
ensures access for individuals to gain qualifications in order to signal
their skills for job roles on their CVs. If years of schooling has a
significant impact on future earnings then it may give reason as to why
policy makers should consider increasing years of compulsory
education. As economists we can measure this causal effect between
years of schooling and earnings empirically to provide evidence to
policymakers to motivate such policies. One way to do this is to use the
following Mincer earnings regression (Mincer, 1974):
Human Capital Earnings Function/ Mincer Earnings regression (Mincer,
2
1974): 𝑙𝑜𝑔𝑦 = α + β𝑆 + γ𝑋 + δ𝑋 + µ
Where y is earnings, S is level of schooling, X is years of experience, µ
is the residual and α, β, γ and δ are parameters to be estimated in
regression analysis.
, 2) What is the causal effect of a year of schooling on later
earnings/wages according to empirical evidence?
Angrist and Krueger (1991) find in their paper that there is a positive
relationship between years of compulsory education and later earnings.
The aim of their paper was to use a natural experiment to examine the
effects of compulsory schooling laws. They measured this through
establishing that the season of birth is related to educational attainment
because of the school starting age policy and compulsory school
attendance laws. In their empirical work they estimated the impact of
these laws on earnings by using quarter of birth as an instrument for
education. They found from their results that students who are
compelled to attend school longer by compulsory schooling laws earn
higher wages as a result of their extra schooling. The return to education
instrumental variable being so close to the OLS estimate suggested that
there was little bias in their conventional estimates. Due to the fact that
one’s birthday is unlikely to be correlated with personal attributes other
than age at school entry, season of birth generates exogenous variation
in education that can be used to estimate the direct impact of
compulsory schooling on education and earnings.This tested whether or
not the estimated schooling-earnings relationship was actually a result of
compulsory schooling and not anything else. This evidence therefore is
very reliable in the literature.
The paper by Psacharopoulos (1994) looks into the profitability of
investment in education on a global scale. Not far into this paper, there
was remarks on the Mincer regression and some insightful criticisms
worth mentioning in this essay. Although very convenient and easy to
use, the Mincer equation uses reported data in calculating the overall
return to one year of schooling. It should be noted that these dummy
variables labelled ‘return to education’ are in fact just marginal effects on
the wage, not rates of return from investment in education. Second of all,
there should be differences in weightage for school years in primary
education and other levels of schooling. When using the full discounting
method, it is very easy to assign for instance, only three years of
opportunity cost to primary education, but when using the basic earnings
function method, foregone earnings are automatically imputed to the rate
Education Applied Economics
1. What does evidence suggest is the causal effect of a year of
schooling on later life wages? How does this evidence influence the
debate on whether to subsidise higher education?
1. Define the Mincer Equation used to estimate the returns to education.
Estimations of the returns to education from the Mincer equation are
prone to an ability bias. Describe the ability bias and critically discuss
economic techniques which can potentially overcome the bias.
2. Using economic theory and evidence evaluate whether the
government should subsidise university education.
1) Define the Mincer Equation
Around the 1960s the topic of returns to education became very central
in research to try and understand why individuals invest their time and
money in further education. Education is one of the first most important
investments an individual will make for their future. Furthermore,
education is useful in preparing young people for the workplace and
ensures access for individuals to gain qualifications in order to signal
their skills for job roles on their CVs. If years of schooling has a
significant impact on future earnings then it may give reason as to why
policy makers should consider increasing years of compulsory
education. As economists we can measure this causal effect between
years of schooling and earnings empirically to provide evidence to
policymakers to motivate such policies. One way to do this is to use the
following Mincer earnings regression (Mincer, 1974):
Human Capital Earnings Function/ Mincer Earnings regression (Mincer,
2
1974): 𝑙𝑜𝑔𝑦 = α + β𝑆 + γ𝑋 + δ𝑋 + µ
Where y is earnings, S is level of schooling, X is years of experience, µ
is the residual and α, β, γ and δ are parameters to be estimated in
regression analysis.
, 2) What is the causal effect of a year of schooling on later
earnings/wages according to empirical evidence?
Angrist and Krueger (1991) find in their paper that there is a positive
relationship between years of compulsory education and later earnings.
The aim of their paper was to use a natural experiment to examine the
effects of compulsory schooling laws. They measured this through
establishing that the season of birth is related to educational attainment
because of the school starting age policy and compulsory school
attendance laws. In their empirical work they estimated the impact of
these laws on earnings by using quarter of birth as an instrument for
education. They found from their results that students who are
compelled to attend school longer by compulsory schooling laws earn
higher wages as a result of their extra schooling. The return to education
instrumental variable being so close to the OLS estimate suggested that
there was little bias in their conventional estimates. Due to the fact that
one’s birthday is unlikely to be correlated with personal attributes other
than age at school entry, season of birth generates exogenous variation
in education that can be used to estimate the direct impact of
compulsory schooling on education and earnings.This tested whether or
not the estimated schooling-earnings relationship was actually a result of
compulsory schooling and not anything else. This evidence therefore is
very reliable in the literature.
The paper by Psacharopoulos (1994) looks into the profitability of
investment in education on a global scale. Not far into this paper, there
was remarks on the Mincer regression and some insightful criticisms
worth mentioning in this essay. Although very convenient and easy to
use, the Mincer equation uses reported data in calculating the overall
return to one year of schooling. It should be noted that these dummy
variables labelled ‘return to education’ are in fact just marginal effects on
the wage, not rates of return from investment in education. Second of all,
there should be differences in weightage for school years in primary
education and other levels of schooling. When using the full discounting
method, it is very easy to assign for instance, only three years of
opportunity cost to primary education, but when using the basic earnings
function method, foregone earnings are automatically imputed to the rate
