The Effect of Labor Market Regulations on Educational Attainment

A recent OECD study highlighted the fact that those with tertiary education had significantly higher earnings on average than those with less than upper secondary or post-secondary non-tertiary earnings.[1] In a frictionless and costless world, therefore, all individuals should aim to attain the highest level of education possible in order to maximize the return from schooling. However, patterns of educational attainment across countries show widely differing levels of enrollment in higher education (though enrollments in primary education are fairly uniform). In this paper, I argue that labor market frictions in the form of employment protection laws are responsible to a degree for these observed differences.

Theoretical models of labor markets with employment protection legislation (EPL) conclude that the effect of such legislation is to reduce job turnover, reduce productivity, increase the duration of unemployment and under certain circumstances, increase unemployment.[2] The model employed in this paper argues that the reduced job reallocations that result as a consequence of labor market rigidities have negative effects on investments in education. Reduced job reallocations, measured as the sum of job creation and job destruction rates, imply that workers have fewer vacancies to which they can apply for jobs.[3] This reduces the return to education in two ways. The “job creation” effect is that even with an education, the likelihood of finding a job through search, and earning a productive wage, is reduced. The “job destruction” effect is that since firings are reduced, workers with jobs will face fewer opportunities to search for re-employment. Therefore, they will have less “use” of education as a signaling device to secure their next job.[4] With flexible labor markets and higher job mobility, these conditions are reversed. Job reallocations are higher leading to more vacancies per unemployed worker. This yields a higher expected return to job search for educated workers since the likelihood of finding a job is higher. Further, workers are either fired or they quit more frequently (i.e. job destruction is higher) leading to a greater “use” (or need) of education as a signaling device. Job flows in the model are synonymous with worker flows. Higher worker flows or reallocations, measured as the sum of worker hires and separations, are similarly lower in rigid labor markets. This, in turn, leads to lower worker investment in higher education in these markets relative to freer labor markets.

This paper is available as an Adobe Acrobat PDF.

Aparna Mathur is a resident fellow at AEI.


  1. For instance, OECD’s Education At a Glance (Table A.9.1a) reports that those with tertiary education had significantly higher earnings on average than those with less than upper secondary or post-secondary non-tertiary earnings.

  2. Empirical studies using annual cross-country data flows, have however, not been able to document this link. A recent paper by Wolfers (2008) however, argues that this lack of empirical results may be partially due to the frequency of the data examined. Using quarterly household employment survey data, the paper finds a significant effect of employment protection on job flows. Another NBER working paper by Autor, Kerr and Kugler (2007) finds that wrongful-discharge protection laws in U.S. states reduce employment flows and firm entry rates and also lead to declines in total factor productivity. For papers on the political economy of employment protection, see Saint-Paul (2002) and Acemoglu and Robinson (1998). For effects on job turnover, see Bertola and Rogerson (1997).

  3. This follows the definition of job reallocations employed in Davis and Haltiwanger (1999).

  4. For papers discussing the signaling effect of education, see Jaeger and Page(1996), Olneck (1977), Hungerford and Solon (1987), Belmen and Haywood (1991) and Card and Krueger (1992).

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