Are Changes in Education Important for the Wage Premium and Unemployment?

A generalized rise in unemployment rates for both college and high-school graduates, a widening education wage premium, and a sharp increase in college education participation are characteristic features of the transformations observed in the U.S. labor market between 1970 and 1990. This paper investigates the interactions between these changes in the labor market and in educational attainment. First, it develops an equilibrium search and matching model of the labor market where education is endogenously determined. Other important features of the model are a labor market which is segmented by education levels, and the imperfect correlation between skill and education in the labor force. Second, calibrated versions of the model are used to study quantitatively whether either a skill-biased change in technology or a mismatch shock can explain the above facts, and to assess the importance of the links between education and the labor market. The skill-biased shock accounts for a considerable part of the changes but fails to produce the increase in unemployment for the educated labor force. The mismatch shock explains instead much of the change in the four variables, including the wage premium. The endogenous response of education contributes positively to fit better the model's predictions to the data on wages and unemployment, especially so under the mismatch shock.