Increasing Returns to Education and the Skills Under-Investment Trap

32 Pages Posted: 21 Jul 2005

See all articles by Alison L. Booth

Alison L. Booth

Australian National University (ANU) - Research School of Social Sciences (RSSS); Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics

Melvyn G. Coles

University of Essex - Department of Economics; Autonomous University of Barcelona; IZA Institute of Labor Economics

Date Written: July 2005

Abstract

We model educational investment and labor supply in a competitive economy with home and market production. Heterogeneous workers are assumed to have different productivities both at home and in the workplace. We investigate the degree to which there is under-investment in human capital, and examine the deadweight losses that accrue via distortionary taxes. We show that there are increasing returns to education at the participation margin, and that deadweight losses are most severe for workers located here. Although the social planner's optimum implies the worker should choose a high level of education and participate in the market sector, instead the worker chooses not to invest in human capital and either non-participation or partial participation in market-sector work. A severe deadweight loss is generated by this substitution effect. Those individuals most likely to be in this trap are those types with large enough home productivity, who are likely either to be involved in home production or to be characterized by a strong preference for other non-market sector activities.

Keywords: home production, labor supply, returns to education, income tax

JEL Classification: H24, J13, J24, J31, J42

Suggested Citation

Booth, Alison L. and Coles, Melvyn G., Increasing Returns to Education and the Skills Under-Investment Trap (July 2005). IZA Discussion Paper No. 1657, Available at SSRN: https://ssrn.com/abstract=760726

Alison L. Booth (Contact Author)

Australian National University (ANU) - Research School of Social Sciences (RSSS) ( email )

Canberra, Australian Capital Territory 0200
Australia
+61 2 6125 3285 (Phone)
+61 2 6125 0182 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Melvyn G. Coles

University of Essex - Department of Economics ( email )

Wivenhoe Park
Colchester CO4 3SQ
United Kingdom
+44 1206 873333 (Phone)
+44 1206 872724 (Fax)

Autonomous University of Barcelona

Plaça Cívica
Cerdañola del Valles
Barcelona, Barcelona 08193
SPAIN

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

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