Economists generally agree that an individual’s earnings are positively related to the
knowledge and skills obtained through education and experience. Numerous studies show that,
on average, people with more years of education do earn higher wages. Although some
economists believe that education increases a worker’s productivity and thus differences in
wages to a large degree “reflect the ‘skill premium’ commanded by relatively higher-educated,
better-trained workers” (Henderson 1), others argue that differences in workers individual
characteristics such as talents, personal skills and motivations are the driving forces behind the
wage inequality. Supporters of the screening (signaling) theory argue that education allows
employers “to screen individuals by innate ability” (Hoff and Stiglitz 405).
This claim is based
on two arguments: 1) innate abilities of an individual are known to him/her but unobserved by
the potential employers and; 2) education is less costly for individuals with higher abilities (in
terms of time and efforts required for studying) and, consequently, people with high abilities tend
to obtain more education to “signal” to the employers their innate talents.
between unobserved capabilities and education and difficulties in measuring innate abilities of
workers makes distinguishing between the two effects difficult and, as some econometricians
believe, lead to an overstatement of returns on education-- creates a so called
The estimation of returns on education has important policy implications. If education
raises person’s earnings regardless of his/her abilities, then policies that improve the quality of
education and provide financial assistance for those willing and able to study should be
If, however, different abilities are the underlying reasons for earnings
differentials, as the screening theory claims, then such policies would not be as beneficial.
The goal of my paper is to estimate the effect that education has and on wages and to
determine how it changes when controlled for ability.
For my regression analysis I used the data for 935 men surveyed in 1980. The data set
contains information on monthly earnings, education, experience, some demographic
characteristics, job location and average weekly hours.
After omitting observations with missing values, I had 663 valid observations for male
workers, ages 28-38. Among them, about 7.5% completed less than 12 years of schooling (do not
have a High School Diploma) with average monthly wages of $760.20, about 40.70% are High
School graduates with average monthly wages of $889.04, about 21.27% have associate degrees
or some certificates and earn average monthly wages of $1027.49, 18.25% are college graduates