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Measuring the option value of education

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  • Rulof P Burger

    ()
    (Department of Economics, University of Stellenbosch)

  • Francis J Teal

    ()
    (Centre for Studies of African Economics, University of Oxford)

Abstract

Many recent descriptive studies find convex schooling-earnings profiles in developing countries. In these countries forward-looking students should attach option values to completing lower levels of schooling. Another option value may arise due to the uncertain economic environment in which the sequence of enrolment decisions is made. Most theoretical models that are used to motivate and interpret OLS or IV estimates of the returns to schooling assume away convexity in the schooling-earnings profile, uncertainty and the inherently dynamic nature of schooling investment decisions. This paper develops a decomposition technique that calculates the relative importance of different benefits of completing additional schooling years, including the option values associated with convex schooling returns and uncertainty. These components are then estimated on a sample of workers who has revealed a highly convex schooling-earnings profile, and who face considerable uncertainty regarding future wage offers: young black South African men. We find that rationalising the observed school enrolment decisions requires large option values of early schooling levels (mainly associated with convexity rather than uncertainty), as well as a schooling cost function that increases steeply between schooling phases.

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File URL: http://www.ekon.sun.ac.za/wpapers/2013/wp152013/wp-15-2013.pdf
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Bibliographic Info

Paper provided by Stellenbosch University, Department of Economics in its series Working Papers with number 15/2013.

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Date of creation: 2013
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Handle: RePEc:sza:wpaper:wpapers191

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Keywords: Earnings Regressions; Returns to Schooling; Dynamic programming;

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  1. Belzil, Christian & Hansen, Jörgen, 2002. "Unobserved Ability and the Return to Schooling," IZA Discussion Papers 508, Institute for the Study of Labor (IZA).
  2. Heckman, James J. & Lochner, Lance & Todd, Petra E., 2008. "Earnings Functions and Rates of Return," IZA Discussion Papers 3310, Institute for the Study of Labor (IZA).
  3. Simon Appleton & John Hoddinott & John MacKinnon, 1996. "Education and health in sub-Saharan Africa," Journal of International Development, John Wiley & Sons, Ltd., vol. 8(3), pages 307-339.
  4. Jacob A. Mincer, 1974. "Schooling, Experience, and Earnings," NBER Books, National Bureau of Economic Research, Inc, number minc74-1, May.
  5. Malcolm Keswell & Laura Poswell, 2004. "Returns To Education In South Africa: A Retrospective Sensitivity Analysis Of The Available Evidence," South African Journal of Economics, Economic Society of South Africa, vol. 72(4), pages 834-860, 09.
  6. Siphambe, Happy Kufigwa, 2000. "Rates of return to education in Botswana," Economics of Education Review, Elsevier, vol. 19(3), pages 291-300, June.
  7. Francis Teal, 2001. "Education, incomes, poverty and inequality in Ghana in the 1990s," Economics Series Working Papers WPS/2001-21, University of Oxford, Department of Economics.
  8. repec:fth:coluec:9596-13 is not listed on IDEAS
  9. Francis Teal, 2004. "Education, incomes, poverty and inequality in Ghana in the 1990s," Development and Comp Systems 0409006, EconWPA.
  10. Jacob Mincer, 1996. "Changes in Wage Inequality, 1970-1990," NBER Working Papers 5823, National Bureau of Economic Research, Inc.
  11. Jacob A. Mincer, 1974. "Introduction to "Schooling, Experience, and Earnings"," NBER Chapters, in: Schooling, Experience, and Earnings, pages 1-4 National Bureau of Economic Research, Inc.
  12. Nielsen, Helena Skyt & Westergard-Nielsen, Niels, 2001. "Returns to Schooling in Less Developed Countries: New Evidence from Zambia," Economic Development and Cultural Change, University of Chicago Press, vol. 49(2), pages 365-94, January.
  13. James J. Heckman, 2010. "Building Bridges Between Structural and Program Evaluation Approaches to Evaluating Policy," NBER Working Papers 16110, National Bureau of Economic Research, Inc.
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