What has Happened to the Rate of Return after the Expansion?

The simple supply and demand framework specifies that if the relative demand increases faster than the relative supply, then the return to education (wages) will increase, as explained in Section 3.2.4. This part, then, will discuss what has happened to the rate of return after the expansion of education by taking into account empirical studies in the US, the UK, and OECD countries, followed by empirical studies from Indonesia and other similar countries.

Many studies have analysed this expansion and some of them even prove that wages have increased after the education expansion (Katz and Murphy (1992), and Machin and McNally (2007)). On the other hand, other studies also find that wages have decreased (Walker and Zhu, 2008).

Firstly, Katz and Murphy (1992) use a simple supply and demand framework to analyse the change in wage structure in the US from 1963 to 1987. The data used were a series of 25 consecutive March Current Population Surveys (CPSs). The education variable used was years of schooling which is then divided into 4 groups: (1) 8-11 years for dropout group, (2) 12 years for high school graduate, (3) 13-15 years for some college, and (4)

wage of full-time workers within gender-education-experience. The sample includes all individuals who worked at least one week in the preceding year. The study finds the college wage premium increased moderately in the 1960s, decreased in the 1970s and increased significantly in the 1980s. The driving force behind the observed change in wage structure is the rapid secular growth in the demand for more-educated workers as well as female and more skilled workers. In addition, they estimate that the elasticity of substitution between skilled and unskilled labour was significant, around 1.4 – 1.6, which implies that the increased supply reduces relative wages (ceteris paribus). Thus, the differences in the growth rate of the supply of university graduates have an important role to play in explaining the changes in college premium in the US during that period. The demand has outstripped supply; hence, the wage premium increased significantly over this time period despite the large increase in supply.

Machin and McNally (2007) have addressed some issues related to the expansion in tertiary level education: over-supply, over-qualification and skill mismatch. Machin and McNally also estimate the change of returns to education in OECD countries in their study, using the simple relative supply and demand framework. Moreover, they provide empirical evidence for each country. In general, they find that the wage premium has increased in most OECD countries, except for Spain, New Zealand, and South Korea. In South Korea, the decline of wage premium occurred during rapid industrialisation period (1974-1990). Yet, there is still a positive return to tertiary education, even in countries with a decline in return. The strong, positive and increasing returns to higher education suggest that ‘under-supply’ is more of an issue and that continued expansion is justified. For the UK, Machin and McNally (2007) document previous research and assert that the proportion of employees with higher education qualifications in the UK increased from 5 per cent to 21 per cent over the period of 1980-2004. The relative weekly wages also increased from 1.48 in 1980 to 1.64 in 2004 in the UK. This concludes that the pattern of change in the wage structure differs; however, the pattern of change in university wage differentials is fairly clear. There was a significant increase in the 1980s, in terms of the average wage return, which continued to increase at a lower rate in the 1990s; and became relatively stagnant in the 2000s.

Some more debates have emerged in more recent works about certain subgroups and whether there is any evidence of falling returns to education. A number of studies documents rising returns over time from the 1970s to the early 1990s such as: Harkness

and Machin (1999). A number of other studies also find slightly rising or constant returns from the early 1990s to the early 2000s, such as: Chevalier et al. (2004) and Walker and Zhu (2003). In contrast, there is little evidence of declines in return to education such as: O’Leary and Sloane (2005) and Walker and Zhu (2005), even Dickerson (2005) reports no change in return to education using the same data sources. Moreover, reports of falling returns need to be kept in perspective as the size of returns are still substantial in comparison to those with only an upper secondary education. Overall, the UK pattern of change in relative wage and employment was similar to the US in that the relative demand for higher education has outstripped the relative supply.

Particularly for South Korea, Kim and Topel (1995) study the development of wage premium during Korea’s rapid industrialisation, from 1970 to 1990. The analysis is based on the simple supply and demand framework, whilst ignoring capital and assuming the production in industry is homothetic in its labour input. The study find that there were; a very substantial upgrading of skills in the workforce, an increase in the number of university graduates, a positive wage premium, and an increase in the wage premium at the end of that period. Kim and Topel argued that the change in wage inequality can be driven by (at least) three factors, i.e. changes in relative supplies of different skill groups can change their relative wages; expanding industries may be intense users of some employee types which in turn raises the relative demand for those employees; and finally, the pace of technical change may favour certain employee types. As such, there is a shift in relative labour demands over time.

With regards to Indonesia and other East Asian countries, Gropello and Sakellariou (2010) estimate skill and wage premium at the national and sectoral levels in seven East Asian countries: Indonesia, the Philippines, Vietnam, Cambodia, Thailand, China and Mongolia. For Indonesia, the study used a 2-digit industry classification, and the data used are from SAKERNAS surveys from 1994 to 2007. Slightly differently, the method used is the linear regression with employees’ characteristics (including age and gender), type of labour (skilled or unskilled), industry indicators (dummies) and the social return to education (skill premium) as the independent variables; and wage premium as the dependent variable. The study confirms that there is a decrease of workers with primary and below primary school qualifications. In contrast, there is an increase (expansion) in workers with high school and university qualifications.

Gropello and Sakellariou (2010) findings are summarised in Tables 3.4, the base (reference) education level is completed primary or lower education level; except that the presented return estimates for education levels higher than primary are given in comparison to primary. Returns to education decreased in most education levels, with the largest decline during 1994-2007 period being the junior and senior high schools (relative to primary school). Meanwhile, the lowest decline was the university level. In addition, the study separates the sample within senior education and finds that most declines in premiums were associated with the vocational-technical education. One possible reason for this is that the demand for higher education workers is on the rise but only moderately, or that the supply of labour outstripped the demand for labour.

For other Asian countries, the Philippines had an increasing trend for senior and tertiary education in basic regression but turning negative when the study adds a control variable and industry dummies. It also seems that Thailand had similar trend to Indonesia, as explained previously, a negative growth in return to education for most of education levels. In contrast, Vietnam and Cambodia had a positive trend or an increase return to education in all education levels. Finally, China had a positive return as well, except for the primary school qualifications, as shown in Table 3.5. Gropello and Sakellariou (2010) argue that those evidence combined with stable or increasing education/skill wage premiums (in regressions with only basic controls) indicate a generally increasing demand for skills in the region (and that education also leads to increasing inequalities in several countries).

Table 3.4: Return to Education by Education Level (Relative to Primary Education) in 1994, 2001 and 2007

1994 2007 Change (%)

1994-2007 Basic controls only

Primary 0.213 0.242 13.6

Junior/Primary 0.234 0.128 -45.3

Senior/Primary 0.596 0.508 -14.8

University/Primary 1.125 1.084 -3.6

Basic controls + Industry dummies

Primary 0.195 0.243 25.1

Junior/Primary 0.235 0.126 -46.4

Senior/Primary 0.61 0.498 -18.4

University/Primary 1.137 1.07 -5.9

High school

general/primary 0.527 0.486 -7.8

High school

vocational/primary 0.663 0.547 -17.5

University/Primary 1.123 1.084 -3.5

Basic controls + Industry dummies High school

general/primary 0.545 0.479 -12.1

High school

vocational/primary 0.678 0.526 -22.4

University/Primary 1.139 1.056 -7.3

Source: Gropello and Sakellariou, 2010.

Note: Return to primary school relative to below primary school graduates.

Table 3.5: The Change of Return to Education by Education Level in Several Asian Countries

Education Level

Indonesia The Philippines Thailand Vietnam Cambodia China Change

1994-2007 1998-2006 1990-2004 1999-2006 1997-2007 1999-2005 Basic control only

Primary 0.029 0.093 0.113 0.154 0.036

Junior/Primary -0.106 -0.058 0.227 0.135 0.105 Senior/Primary -0.088 0.185 -0.033 0.385 0.277 0.274 University/Primary -0.041 0.101 0.196 0.648 0.722 0.351

Basic control + industry dummies

Primary 0.049 0.032 0.098 0.038 -0.019

Junior/Primary -0.109 -0.092 0.206 0.056 0.111 Senior/Primary -0.112 -0.209 -0.141 0.318 0.061 0.290 University/Primary -0.067 -0.141 -0.017 0.487 0.411 0.392

Source: Gropello and Sakellariou, 2010.

Similar to Gropello and Sakellariou’s (2010) conclusion, Purnastuti et al. (2013) confirm that there was a decline in the return to education in Indonesia. The estimation uses the standard Mincer equation with log of monthly earnings as dependent variables; education variable is in dummy of education level from primary to master level (relative to below primary school) and the control variables are: experience, marital status, gender and residential, by comparing IFLS1 (year of 1993) and IFLS4 (year of 2007) data. In addition, the study also uses the cohort effect since changes in the pay-off to education over time can reflect both cohort and age effects. The study finds that the returns to education tend to increase as the level of education increases. Also, gender affects the difference in return to education. Returns to education appear to be a less profitable investment in 2007 than returns in 1993, except for university degrees, but the

profitability of this education level increased between 1993 and 2007, for both males and females. The study argues that the decreasing trend could be attributable to the large-scale expansion of education in Indonesia, or to a rate of expansion in the number of jobs requiring higher educational attainment which lagged behind the expansion of education and the increase of average education attainment.