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potential experience. This means a, will be smaller than one which will cause ß₁ⱼ to be a
downward biased estimate of the return to work experience.
Second, a; may differ across groups, which will bias comparisons between groups. In
particular, dropouts tend to work less than high school graduates, so the downward bias
in ß₁ⱼ will be greater for dropouts. Thus finding lower wage growth in terms of potential
experience for dropouts versus high school graduates may be due to differences in labor
supply rather than differences in the returns to experience. That is for two groups j and
j',
A finding that ß₁ⱼ' > ß₁ⱼ may be due to the fact that aj' > a, rather than Yu' > Y₁ⱼ.
A serious potential problem arises in that actual experience will be positively correlated
with uil if high wage workers tend to work more. In the framework above, this problem
leads one to worry that Eit may be positively correlated with Vit. We deal with this potential
problem in two ways. First, we allow Eit to have a fixed effect Θᵢ,
This partly solves the problem in that by allowing AE to be correlated with Oᵢ we allow
workers who tend to have higher wages to also tend to have higher labor supply.
This is still unsatisfactory. Fixed effects requires not only that AEit is uncorrelated
with Eit, but also essentially assumes that it is uncorrelated with Eit-1. However, actual
experience is constructed from the sum of total weeks worked before t, so assuming that
AEit is uncorrelated with Eit-1 amounts to assuming that weeks worked in period t- 1 is
uncorrelated with Eit-1. When one considers labor supply decisions, this assumption seems
implausible. We would typically expect weeks worked to be positively correlated with the
error term through labor supply decisions.
To deal with this problem we use potential experience as an instrumental variable for
actual experience. This process is suggested by the set of equations above. Since potential
experience is exogenous it seems reasonable to assume that it is uncorrelated with Eit. It
can be interpreted essentially as estimating B and a and using these estimates to form an
estimate of γ.
8
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"ocrText": "JUL-03-2000 12:16\nUMB DEP DIR MGMT\n202 395 6974 P.12/37\npotential experience. This means a, will be smaller than one which will cause ß₁ⱼ to be a\ndownward biased estimate of the return to work experience.\nSecond, a; may differ across groups, which will bias comparisons between groups. In\nparticular, dropouts tend to work less than high school graduates, so the downward bias\nin ß₁ⱼ will be greater for dropouts. Thus finding lower wage growth in terms of potential\nexperience for dropouts versus high school graduates may be due to differences in labor\nsupply rather than differences in the returns to experience. That is for two groups j and\nj',\nA finding that ß₁ⱼ' > ß₁ⱼ may be due to the fact that aj' > a, rather than Yu' > Y₁ⱼ.\nA serious potential problem arises in that actual experience will be positively correlated\nwith uil if high wage workers tend to work more. In the framework above, this problem\nleads one to worry that Eit may be positively correlated with Vit. We deal with this potential\nproblem in two ways. First, we allow Eit to have a fixed effect Θᵢ,\nThis partly solves the problem in that by allowing AE to be correlated with Oᵢ we allow\nworkers who tend to have higher wages to also tend to have higher labor supply.\nThis is still unsatisfactory. Fixed effects requires not only that AEit is uncorrelated\nwith Eit, but also essentially assumes that it is uncorrelated with Eit-1. However, actual\nexperience is constructed from the sum of total weeks worked before t, so assuming that\nAEit is uncorrelated with Eit-1 amounts to assuming that weeks worked in period t- 1 is\nuncorrelated with Eit-1. When one considers labor supply decisions, this assumption seems\nimplausible. We would typically expect weeks worked to be positively correlated with the\nerror term through labor supply decisions.\nTo deal with this problem we use potential experience as an instrumental variable for\nactual experience. This process is suggested by the set of equations above. Since potential\nexperience is exogenous it seems reasonable to assume that it is uncorrelated with Eit. It\ncan be interpreted essentially as estimating B and a and using these estimates to form an\nestimate of γ.\n8"
}