Learning and Wage Dynamics

TL;DR: This paper developed a dynamic model of learning and wage determination, which predicts that the role of schooling in the labor market's inference process declines as performance observations accumulate, and the estimated effect of schooling on the level of wages is predicted to be independent of labor-market experience.

Abstract: We develop a dynamic model of learning and wage determination. Education may convey initial information about ability, but subsequent performance observations also are informative. Although the role of schooling in the labor market's inference process declines as performance observations accumulate, the estimated effect of schooling on the level of wages is predicted to be independent of labor-market experience. The model also predicts that time-invariant variables correlated with ability but unobserved by employers should be increasingly correlated with wages as experience increases and that wage residuals should be a martingale. We present evidence from the National Longitudinal Survey of Youth that is generally consistent with the model's predictions, but a chi-squared goodness-of-fit test does reject the martingale prediction for wage residuals even after accounting for classical measurement error. We investigate alternative specifications and find that a modification of the learning model that allows for worker ability to evolve as an AR1 process fits the data quite well.