Labor Earnings, Misallocation, and the Returns to Education in Mexico

59 Pages Posted: 25 Apr 2017

See all articles by Santiago Levy

Santiago Levy

Inter-American Development Bank (IDB)

Luis López-Calva

World Bank

Date Written: February 2016


Over the last two decades Mexico has had an open trade regime, experienced macroeconomic stability, and made substantial progress in education. However, average workers' earnings have stagnated and earnings for workers with more schooling have declined, compressing the earnings distribution and lowering the returns to education. We hypothesize that these developments are explained by large and persistent of distortions that misallocate resources towards less productive firms, since these firms are substantially less intensive in educated workers than more productive ones. We show that at the same time that the relative supply of workers with more years of schooling has increased, misallocation of resources toward less productive firms has persisted. These two trends have generated a widening mismatch between the supply and demand for educated workers. We decompose worker earnings into observable and unobservable firm and individual worker characteristics, and simulate a counterfactual earnings distribution in the absence of misallocation. Under the counterfactual, earnings differentials across schooling levels would increase, as would the returns to education. In parallel, earnings differentials, rather than narrowing overtime, would widen. We conclude arguing that the persistence of distortions that misallocate resources toward lower-productivity firms impedes Mexico from taking full advantage of its investments in the human capital of its workers.

Keywords: Earnings, Misallocation, Returns to education, Human capital

JEL Classification: J23, J24, L11, O17

Suggested Citation

Levy, Santiago and López-Calva, Luis, Labor Earnings, Misallocation, and the Returns to Education in Mexico (February 2016). IDB Working Paper No. IDB-WP-671. Available at SSRN: or

Santiago Levy (Contact Author)

Inter-American Development Bank (IDB) ( email )

1300 New York Avenue NW
Washington, DC 20577
United States

Luis López-Calva

World Bank

1818 H Street, NW
Washington, DC 20433
United States

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