Aggregate unemployment decreases individual returns to education

Abstract

Die Discussion Papers dienen einer möglichst schnellen Verbreitung von neueren Forschungsarbeiten des ZEW. Die Beiträge liegen in alleiniger Verantwortung der Autoren und stellen nicht notwendigerweise die Meinung des ZEW dar.Discussion Papers are intended to make results of ZEW research promptly available to other economists in order to encourage discussion and suggestions for revisions. The authors are solely responsible for the contents which do not necessarily represent the opinion of the ZEW.Download this ZEW Discussion Paper from our ftp server:ftp://ftp.zew.de/pub/zew-docs/dp/dp06034.pdf Non-technical summaryAn This paper shows that aggregate unemployment affects not only wages but also individual returns to education. On the basis of a theoretical model, we derive the hypothesis that the wages of less qualified employees are affected differently by changes in the unemployment rate than the wages of higher qualified employees. The main reasons for this are that on the one hand the employment opportunities and unemployment risks of higher qualified employees are better isolated against shocks on the labour market than those of less educated employees. On the other hand the wages of the higher educated may react stronger to changes in the business cycle because lower qualified employees rather leave the labour market than accept lower wages.In addition, the wages of higher qualified employees are rather subject to individual bargaining between employer and employee. Individual bargaining is more sensitive to the topical labour market situation. In contrast, collective bargaining wages are rather stable over time.From our model we conclude that we have to extend the standard Mincer regression to take into account an important factor for individual wages. We include regional unemployment and the interaction term between aggregate unemployment and individual education in order to avoid a misspecification.In our empirical analysis, we use representative individual data and regional panel variation in aggregate unemployment among different German regions.The results show that an increase in regional unemployment by one percent decreases returns to education by about 0.005 percentage points. The observed differences in the regional rates of returns can be almost fully explained by differences in the local labour market situation. This implies that empirical studies on returns to education should take aggregate unemployment into account. Especially international comparisons of the returns to education or comparisons of differents points in time could otherwise suffer from omitted variable bias if the unemployment situation differs strongly between countries or across time.We furthermore check the robustness of our results with respect to the empirical specification and the sample. We split our sample into males and females, East and West Germany, and employees with different tenure. In addition, we take into account unobserved heterogeneity between regions by using fixed effects in a two-step estimation procedure....

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