Reconciling Theoretical and Empirical Human Capital Earnings Functions

To interpret estimates of empirical earnings functions, and to resolve sample selection problems such as tenure bias, the wage determination process must be specified. This paper shows that an earnings function can be interpreted as a wage offer in a labour market auction in which the worker accepts the highest offer received. The elasticity of the wage is one with respect to general human capital, and less than one for specific capital. There is a sample selection problem because only accepted offers are observed. This causes underestimation of the return to specific capital in a cross-sectional earnings regression.