Introduction

The discussion of educational investment presented in chapter 2 was based on the assumption that an increase in education was associated with an increase in potential (permanent) income. While this remains true from an individual perspective (that is, families take this to be a stylised fact, as in any partial equilibrium model), in this chapter we look into why this may be true in the aggregate. We face competing explanations here, and will review them in turn, starting from the aggregate evidence supporting the view that human capital raises firms' productivity (in line with the human capital approach). We then proceed with a more recent view, according to which education is associated with non-cognitive abilities. Next we present the credentialist approach, where education is just a signal of unobservable ability. The remaining part of the chapter is devoted to the problem of measuring the return on education, from both theoretical and econometric perspectives.

The productivity of human capital

While the positive correlation between education and earnings at the individual level is one of the most established facts in economic literature, the existence of a causal relation between the two is not yet widely accepted. The strongest doubts arise from the consideration that earnings and schooling could both depend on additional factors not observed by the researcher, thus constituting a patent case of spurious correlation.