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ISSN 1811-5438


THE LAHORE JOURNAL

OF

ECONOMICS

Lahore School of Economics


Hina Nazli


The Effect of Education,

Experience and Occupation on

Earnings: Evidence from Pakistan
Mete Feridun

Determinants of the Argentine

Financial Crisis: Can We

Predict Future Crises?

Syed Zahid Ali

Does Stability Preclude

Contractionary Devaluation?
Mehboob Ahmad and

Tasneem Asghar

Estimation of Saving Behaviour

in Pakistan Using Micro Data
Bushra Yasmin and Hira Rauf

Measuring the Underground

Economy and its Impact on

the Economy of Pakistan




M. Haider Hussain

On the Causal Relationship

between Government Expenditure and Tax Revenue in Pakistan

Azeema Faizunnisa and Atif Ikram

Determinants of Youth

Development in Pakistan


Salman Ahmad

The Standard of Living in

Pakistan--- Better or Worse?

Imran Ashraf Toor and Rizwana Parveen


Factors Influencing Girls’

Primary Enrolment in Pakistan

Book Reviews:

Qais Aslam

Pro-Poor Growth and

Governance in South Asia:

Decentralisation and

Participatory Development

Nina Gera

Exploration in Development Issues

Volume 9, No.2



July-Dec, 2004



THE LAHORE JOURNAL

OF

ECONOMICS



Editorial Board

Dr. Shahid Amjad Chaudhry Editor

Prof. Viqar Ahmed Editor

Dr. Salman Ahmad Editor

Dr. Sohail Zafar Editor

Ms. Nina Gera Co-Editor




Editorial Advisory Board

Dr. Rashid Amjad

Dr. Pervez Tahir

Dr. Khalid Aftab

Dr. A. R. Kemal

Dr. Moazam Mehmood

Dr. Naved Hamid

Dr. Tariq Siddiqui

Dr. Azam Chaudhry



Dr. Munir Ahmad

Dr. Nasim Hasan Shah

Dr. Sarfraz Qureshi

Dr. Shahrukh Rafi Khan

Dr. Akmal Husain

Mr. Tariq Husain

Dr. Aslam Chaudhry

Dr. Nuzhat Ahmad

Dr. Kaiser Bengali


Editorial Staff: Tele. No: 5714936

Telefax: 0092 - 42 - 5714936

E-mail: nina_lse@yahoo.com
Publisher : Lahore School of Economics, Lahore, Pakistan.
Correspondence relating to subscriptions and changes of address should be sent to The Lahore Journal of Economics, 105-C-2, Gulberg III, Lahore - 54660 - Pakistan

Instructions to authors can be found at the end of this issue. No responsibility for the views expressed by authors and reviewers in The Lahore Journal of Economics is assumed by the Editor, the Co-Editor and the Publishers.



Copyright by: Lahore School of Economics

92004

THE LAHORE JOURNAL OF ECONOMICS




Contents Vol. 9, 2004


The Effect of Education, Experience and Occupation on
Earnings: Evidence from Pakistan

Hina Nazli 1

Determinants of the Argentine Financial Crisis: Can We

Predict Future Crises?

Mete Feridun 31

Does Stability Preclude Contractionary Devaluation?


Syed Zahid Ali 51

Estimation of Saving Behaviour in Pakistan Using Micro Data


Mehboob Ahmad and Tasneem Asghar 73

Measuring the Underground Economy and its Impact

on the Economy of Pakistan

Bushra Yasmin and Hira Rauf 93


On the Causal Relationship between Government

Expenditure and Tax Revenue in Pakistan


M. Haider Hussain 105

Determinants of Youth Development In Pakistan

Azeema Faizunnisa and Atif Ikram 119

The Standard of Living in Pakistan--- Better or Worse?

Salman Ahmad 135
Factors Influencing Girls’ Primary Enrolment in Pakistan
Imran Ashraf Toor and Rizwana Parveen 141

Book Reviews:


Pro-Poor Growth and Governance in South Asia:

Decentralisation and Participatory Development



Qais Aslam 159

Exploration in Development Issues Nina Gera 163


The Effect of Education, Experience and Occupation on

Earnings: Evidence from Pakistan

Hina Nazli*

I. Introduction

The theory of human capital posits a significant and positive relationship between earnings and work experience. This theory assumes a continuous increase in wages with employment experience at different levels of schooling. Several studies have established that earnings rise rapidly as the level of educational attainment improves. Similarly increase in work experience adds to skills, makes an individual more productive and hence leads to higher earnings. Education provides not only an initial labour market advantage, but also cumulative benefits over the working life. Therefore, it is misleading to assume a uniform rate of return to experience at different levels of education.

In order to examine the impact of education and experience on earnings, Mincer (1974) in his seminal article introduced an interaction term of education and experience as an explanatory variable in the earning function to account for the cumulative effect of both these variables. He found a negative and significant coefficient in estimates based on US data and concluded that more educated workers attain peak earnings with less experience. However, the opposite impact is generally estimated and is extensively documented in the literature1. There are however, some exceptions; for example, using data for Morocco, Psacharopoulos (1981) did not observe any significant impact of this interaction on earnings. For British data, Psacharopoulos and Layard (1979) found that the value of the interactions terms increases with either increase in education or experience for different levels of both these variables. More recently, Connolly and Gottschalk (2003) have found that the returns to tenure increase with education, but that returns to experience decrease with educational attainment in the US. This indicates that the less educated have higher returns to education. In examining the role of ICT technology in the UK, Kirby and Riley (2004) found that the return to an extra year of schooling is greater relative to an extra year of job-specific experience. The overall conclusion of the international studies examining the returns to education2 is that higher levels of education lead to higher earnings as the employment experience lengthens.

While studies examining the effect of education on earnings are manifold for Pakistan, no study has used the education-experience interaction variable. This study seeks to fill the gap.



Acquired skills through education and training play an important role in the choice of occupation that in turn affects individual earning as different occupations require different characteristics of workers. In order to get a suitable reward, educated individuals look for such jobs that match with their education. On the other hand, the uneducated want to enter jobs that match with their skills and where rewards are higher. By using an “occupation production function”, Knight (1979) demonstrated that certain levels of education are ‘necessary’, ‘appropriate’ or ‘excessive’ for a particular job. In other words, a worker with a certain level of education may be more productive in one occupation than the other and would thus receive higher wages. For Tanzania and Kenya, Beyer and Knight (1989) and Knight and Sabot (1990) found a positive relationship between human capital variables and the level of skills an individual has. They concluded that by introducing occupation in the earning function, one can better understand the mechanism by which the returns to education fall; and, more generally the way in which the labour market operates. Using data on U.S. engineers and the position of engineering jobs within firms, Ferrall (1997) observed that most of the returns to experience and to assignment to higher hierarchy levels within firms are caused by skill accumulation and self-selection rather than technological differences across hierarchy levels.

The role of occupation in determining earnings has been highlighted by several studies3. For Pakistan various studies have observed that workers belonging to different occupations receive significantly different returns4. Khan and Irfan (1985) found differences in earnings based on interregional as well as occupational differences. The expected average earnings for urban areas were found to be 18 percent higher than those for rural areas whereas clerical, sales and service workers were expected to earn 6 percent lower than the blue-collar and agricultural workers. Another important factor that the authors captured in explaining the earning function of the earner was the effect of the income of the first earner (usually father) on the second earner (off spring). Their results indicated that the income of the second earner was positively related with that of the first earner and that the effect was strongest for the administrative and professional group of workers. Hence the income of the first earner affected that of the second earner through occupational status. Fafchamps and Quisumbing (1998) using data from the International Food Policy Research Institute report that increase in earnings associated with an increase in human capital are partly due to the increase in productivity and partly to the reallocation of labour from farm to non-farm activity. Hence increase in education induces households to shift labour away from low productivity farm activities to high productivity non-farm activities; which results in a greater increase in earnings. Malik and Nazli (2003) found a significant poverty reduction effect of skilled occupations both in urban as well as rural areas.

This paper attempts to explain the effect of education, experience and occupation on individual earnings in Pakistan. The exploration of this interlinked connection is of considerable importance at the academic as well as policy levels. From the academic point of view, it highlights the importance of the collection of data on years of schooling and past and present employment history of work experience. These data are sadly lacking in most of the household surveys. At the policy level, it highlights the importance of education and training expansion, and brings to light the very important issue of uneven employment opportunities in different regions of Pakistan.



The education system in Pakistan is still under-developed. Extremely low levels of adult literacy, low enrolment and high drop out rates at the primary level, high student-teacher ratios, wide gender and regional disparities, and low levels of public investment are both symptoms and indicators of the very dismal performance of the education sector5. The literacy rate for the population 10 years and above was 45 per cent in 2001-02; 58 percent for males and 32 percent for females. Despite many efforts and various government programmes, no change in the literacy rate has been found between 1998-99 and 2001-02 [for details see PIHS (2001-02)]6. This not only indicates that a large proportion of the population is still illiterate but also highlights the significant differences between genders. This situation is far worse if regional disparities are taken into account as gender differential is more pronounced in rural areas [see Arif, Nazli, and Haq (2000)]. The gross enrolment rate showed a remarkable improvement during 1951-1991. This rate increased to 98 percent by 1998-99. It has sadly declined to 91 percent in 2001-02. Rising trends in poverty during the 1990s may be the one major cause for this decline since for several parents, especially in rural areas, it has now become more difficult to send children to school. In addition, high drop out rates also indicate the poor quality of education. PIHS (2001-02) indicates that 13 percent of children of ages 15-19 years who have enrolled in primary school, drop out before completing primary (class 5). However, the largest drop out rate is at the end of the primary level, with 28 percent dropping out before reaching the end of class six.

Due to the poor performance of the education sector, Pakistan’s labour market has remained dominated by less educated and unskilled manpower. In this situation, it becomes important to examine the role of education, experience and occupation on earnings. Because of the non-availability of data on the years of work experience, there is no literature available in Pakistan that examines the returns to experience. The recently conducted nation-wide survey, Pakistan Socio Economic Survey (PSES) has information on various economic and socio-economic variables including the years of employment experience. This information permits an examination of the effect of education, experience and choice of occupation on individual earnings.

The rest of the paper is organised as follows: section 2 presents an outline of the methodology used in the empirical estimation and section 3 describes the data and variables in the model. Results are presented in section 4. Conclusions and policy implications are presented in the last section.

II. Methodology

The simple human capital model developed originally by Becker (1964) and used by Mincer (1974) can be written as:



(1)

Where lnY stands for natural logarithm of monthly earnings, S represents completed years of schooling, and E is the labour market experience of the ith individual. The experience-earning profile indicates that earnings rise rapidly in the first years of work life, reaches a peak, and then tends to fall after the mid-career; implying that the increase in earnings in the early years of work life is due to the increase in productivity that is gained through the level of education, technical training and experience of work. The age at which earnings are maximum depends on the level of schooling. If we say that education plays an important role in enhancing productivity and efficiency of individuals then the more educated should have a steeper age-earning profile than the uneducated. Therefore, as already mentioned, in order to examine the joint effect of education and experience, it is important to incorporate the effect of education in the age-earning profile by specifying the interaction term between schooling and experience. In order to test the interaction effect we will estimate the following equations:

(2)

(3)

(4)

(5)

Where Si and Ej are is the sets of four dummy variables indicating different levels of education and experience respectively. These levels are:



S1 = No education.

S2 = Primary education (1–5 years).

S3 = Middle education (6–8 years).

S4 = Matric and above.

E1 = Employment experience 1–4 years.

E2 = Employment Experience 4–8 years.

E3 = Employment experience 8-12 years.

E4 = Employment experience 12 years or more.

Zk = Vector of other explanatory variables. In our model, this vector includes dummies for technical training, sex, and provinces.

Equation 3 examines the joint effect of education and experience. A positive coefficient of interaction term implies that the joint effect of these two variables is stronger than their individual effects at given values. Equation 4 explains what the returns to education are and experience at different levels of these two variables. Equation 5 introduces the interaction terms of different levels of education and experience and examines the effect of different levels of experience (education), keeping education (experience) constant. Another way of looking at the joint effect of education and experience on earning is to examine the coefficient of education in the earning equation that is stratified by the length of experience or to examine the coefficients of experience and its squared term in the earning equation that is stratified by the levels of education.


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