Rates of return to education give synthetically a measure of the net benefits associated with investment in education. Costs and benefits from that investment depend on the increased earnings obtained in the labour (employment) market when the individual attains a higher level of education. Therefore, expected wage would be a crucial part of the individual?s decision. However, in situations of high unemployment, like is the case with most developing countries that expected wage should be weighted by employment expectations. Casual evidence but also survey results seem to show that employment expectations play a nontrivial role in the educational investment decision. Moreover, under conditions of low wage flexibility, unemployment differentials should play a more important role in the formation of the individual expected wage.
If individuals internalize unemployment in their decisions on further education, this implies that rates of return to education should be adjusted by employment expectations and unemployment benefits, if we are to explain the demand for further education. The core is to analyze the impact of including unemployment on the estimated rates of return.
A wide empirical literature exists showing a significant effect of unemployment on educational demand both in macro and micro models. Nonetheless, the work addressing the effect of unemployment on the rate of return is rather scarce. In this context, some contributions should be mentioned, though.
Nickell (1979) adjusts rates of return by introducing unemployment because ?we shall be underestimating the private rate of return to the extent that the individual will only be in receipt of those earnings for some proportion of the time where the proportion is directly related to schooling? ( Nickell 1979, S126).
Groot and Oosterbeeck (1992) and Wolter and Weber also estimate the effect of unemployment on the level of rates of return to education, while Asplund et al. (1996) reformulate the earnings equation to allow for the introduction of unemployment.
In all these cases, when unemployment differentials are taken into account, returns to education increase, in general, at all levels. In fact, it is quite surprising that, while the number of papers devoted to the calculus of rates of return to education is really impressive, studies of the impact of unemployment on it are so scarce. A contribution to further the discussion on the relationship between unemployment and education by using an approach in line with that of Nickell, Groot and Oosterbeek, Wolter and Weber, and Asplund et al.; that is, by introducing the employment probability and unemployment benefits as determinants of the level (and relative position) of the marginal rate of return to schooling. The effect cannot be determined theoretically. Most of the empirical evidence, however, gives support to the idea that unemployment increases the return to education.
For a long time, the cost benefit analysis in education has been taking little regard of the rate of unemployment. Developing countries have the highest rates of unemployment despite the massive investment in education. There is a serious conflict amongst different administrations of different countries pertaining social and education investments. Thus, a look into the effects of unemployment on returns will highlight how the two levels of investments (social and education) are complimentary. To understand this, a critical measure of benefits to the earnings adjusted for differences in the rates of employment and labour force participation of workers with different levels of education must be understood. Again, estimates must be made of the average rates of employment for workers of different ages in each educational category, so that the benefits of education can be measured in terms of earnings weighted by the probability of employment for educated workers.
A number of considerations have been fronted by Economists:
First, adjusted returns result from the behaviour of unemployment differentials. This aspect should be expected to influence the schooling decision of individuals. Given individuals? imperfect foresight, it seems adequate to assume that expectations about future earnings are likely to correlate with current economic conditions. From this point-of-view, the rates of return that individuals or households take into account when making decisions on schooling investment are those adjusted by empl