Economia do
Trabalho
Pedro Telhado Pereira
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.

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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/(r2r1).

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The decision of learning to swim is made by comparing
(E1)

P

i
i  0 (1  r )
and
(E2)

Q

i
i 1 (1  r )
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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.

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Therefore, there will be S1
proportion of swimmers, where
rc
S1   f (r ) dr
r1
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.
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
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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.
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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.
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When an individual (or his family)
decides the amount of education he
wants to have
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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.
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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
ln( wage)  b0  b1 S  b2 C
where b1>0 and b2>0 or b2<0
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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.

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If we assume this relation to be
linear, we have
C = g0 + g1S
and
l n ( w a g e) = b 0 + b1S + b 2 (g0 + g1S) = b 0 + b 2 g0 + (b1 + b 2 g1)S
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The rate of return of Education
r = e x p (b1 +b 2 g1 )
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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).
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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)

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
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.
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
The data were drawn from Quadros de
Pessoal for the years of 1982, 1986 and
1992.
 Conclusion:
– The study shows Portugal has a high interindustry wage inequality. The size of the interindustry 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.
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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)

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
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.
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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.
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– 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.
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Internal wage structures (see Lazear
(1998), for instance) justify the inclusion
of seniority (tenure).
 Lima, F. and P. T. Pereira (2003)

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
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.
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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?
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Data used
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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.
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Conclusions:

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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.
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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.
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Data used

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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).
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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.

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Conclusions:


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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.
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
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.
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Final Remark
Returns to education and changes in
productivity can be very distinct
realities.
 Both are worth studying but one should
distinguish between them.

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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.
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