A large amount of work in labor economics has devoted to estimating the wage differences between high and low educated individuals over the life cycle.
Researchers have found that additional schooling gives higher lifetime earnings and steeper age-earnings profile. Relative to this large amount of work, we know surprisingly little about the mechanics of wage growth, particularly among low skilled workers. There are at least two popular explanations for the slow wage progression of low-educated men. One view emphasizes the importance of learning- by-doing and return to work experience. Due to lack of participation in the labor market, low- educated workers do not develop important skills and accumulate job-specific human capital that would lead to large increases in their earnings. Another view stresses the quality of jobs that low-educated men typically work at. These jobs offer little training and opportunity for advancement and, as a result, wages remain stagnant.
The goal of this project is to explain differences in wage progression between low and high educated workers over the life cycle, after they have finished formal schooling. We develop and estimate a behavioral model where individuals make decisions on job mobility, employment and post-schooling human capital investment. Our model features both heterogeneity of the workers (for instance, productivity) as well as heterogeneity of the jobs facing workers in the labor market (for instance, job-specific learning opportunities). Search cost and friction in the labor market implies a dynamic sorting process between workers and jobs. Our model incorporates both of the two popular explanations mentioned above. Yet, we show that these explanations are inter-related. For instance, low education individuals are more likely to search and accept jobs offering little learning opportunity, which, consequentially, leads to high labor market turnover and slow human capital accumulation. We also investigate the role of liquidity constraint as a third explanation which could reinforce low-skilled workers to match with low-quality jobs.
Understanding the mechanisms of wage growth is important for policy. Many of the low- educated men experience frequent transitions between employment and unemployment and are often eligible for welfare payment (such as food stamp in the US, or social assistance in European countries).1 Therefore, understanding the sources of wage growth is also relevant for policy questions related to the design of the welfare programs and unemployment insurance. Policymakers provide retraining and other benefits through “active” labor market policies that incentivize human capital investment during adulthood. For instance, the UK government plan is for 3 million apprenticeships by 2020. One important policy-relevant question is how the career and wages of a worker are affected by participation in a formal apprenticeship (which, in our setting, is equivalent to a job that offers great learning opportunities but low initial wage). In this project, we address these policy questions and conduct policy analysis.
This project closely relates to the goal of the Keynes Fund. Our modeling environment features several types of market imperfections, including credit constraints, and search frictions in the labor market. Relative to the competitive market assumption, wage growth does not necessarily correspond to productivity growth because workers are not paid their marginal product labor. The deviation from the competitive and complete market assumption is important for policy analysis, because it allows other form of policy interventions, such as relaxing credit constraint, to be potentially effective in promoting wage growth among the less skilled.
1 We only focus on men in this project because there are other confounding factors associated with women’s career progression, such as having children. The welfare system for low-skilled women is also much more complicated. We aim to investigate these interesting questions in another future project.
