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Unbiased Estimates of the Wage Equation When Individuals Choose Among Income-Earning Activities

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Unbiased Estimates of the Wage Equation When Individuals Choose Among Income-Earning Activities A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Vyverberg, Wim P. M. Working Paper Unbiased Estimates of the Wage Equation When Individuals Choose Among Income-Earning Activities Center Discussion Paper, No. 429 Provided in Cooperation with: Economic Growth Center (EGC), Yale University Suggested Citation: Vyverberg, Wim P. M. (1982) : Unbiased Estimates of the Wage Equation When Individuals Choose Among Income-Earning Activities, Center Discussion Paper, No. 429, Yale University, Economic Growth Center, New Haven, CT This Version is available at: http://hdl.handle.net/10419/160353 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle You are not to copy documents for public or commercial Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich purposes, to exhibit the documents publicly, to make them machen, vertreiben oder anderweitig nutzen. publicly available on the internet, or to distribute or otherwise use the documents in public. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. www.econstor.eu ECONOMIC GROWTH CENTER YALE UNIVERSITY Box 1987, Yale Station New Haven, Connecticut CENTER DISCUSSION PAPER NO. 429 UNBIASED ESTIMATES OF THE WAGE EQUATION WHEN INDIVIDUALS CHOOSE AMONG INCOME EARNING ACTIVITIES .Wim P .M. Vijverberg -December 1982 ·Notes: Support from :NIH Training Gr_~_nt 2-T32-HD07146-05 and__ The William and Flora Hewlett FoundatiQ!Jis gratefully acknowledged. I would like to thank those who made valuable comments during the course of the work'that led to this paper: Frank Anscombe, John Beggs, Paul Schultz, Ken Wolpin, and participants of the Labor and Population Workshop. Center Discussion Papers are preliminary materials circulated to stimulate discussion and critical comment. References in publications to Discussion Papers should be cleared with the author to protect the tentative character of these papers. UNBIASED ESTIMATES OF THE WAGE EQUATION WHEN INDIVIDUALS CHOOSE AMONG INCOME-EARNING ACTIVITIES * 1. Introduction One of the most stable relationships in economics is the human capital wage determination equation. Numerous studies, using data from the U.S. as well as low income countrit:~· have found that education raises the individual's wage rate, and that experience affects wage rates in a non-linear way, peaking in the age cross-section generally at around thirty years of experience. The "wage rate" is an aggregate concept, in that it represents the returns per hour of work regardless of the type of work performed. This paper is a first step toward a disaggregation of wages according to income- earning activities. The activities distinguished here are work in the wage labor market, and work in self-employment. The motivation for this paper is threefold. First of all, an issue that has not been well analyzed is whether the wage equation is stable across different types of income-earning activities. Instability in this sense may be due to three reasons. First, wage may be affected differently by exogenous variables, if the labor market does not work sufficiently smoothly. Workers cannot always switch readily b etween act1v1t1es· · · in· response to t h e wage d'1screpanc1es. · l) Second, wage are only a part of the returns to work. If non-pecuniary benefits are affected by the same set of exogenous variables as pecuniary benefits (or a subset of it), wage equations are expected to differ between activities. In this light one could explain the common finding that the marginal return to -2- education appears to decrease with the level of education. Third, the pecuniary benefits of work in different activities may include different kinds of returns. This is quite obviously the case when, as is the focus of this paper, one distinguishes between labor supplied to the wage labor market and labor engaged in self-employment. By dividing total self-employment earnings by self-employment hours of work', one obtains a so-called self- employment wage rate. One may expect that the impact of wage determinants on market wages differs from their impact on self-employment wages, since, in addition to labor income, self-employment earnings include returns to supervisory and management skills, and returns to assets owned by the individual and used in the ptoduction process. The second motivation for this paper is that little is known about self- employment wages. In most wage studies it is recognized, that self-employed workers are.different from market workers, but the most common treatment of individuals reporting self-employment earnings is to omit them from the 2 sample and to estimate wage equations for employees only. ) As Table 1 indicates, this is not the optimal solution to the problem. In low income countries up to one half of the labor force is self-employed, and even in industrialized countries 10 to 15 percent adds up to a sizeable group in absolute numbers. Restricting the sample to employees is likely to introduce self-selection bias in the estimates: often the proportion of self-employed in an age group increases with age, due, e.g., to inheritance and asset accumulation. If one widens the analysis to all (market and self-employed) workers, such self-selection bias can be avoided and insights are gained into self-employment wages, providing a more complete picture of the distribution of income. Moreover, knowing or being able to impute self-employment wages ,.·. -..:. ~-. -3- is beneficial in studies on a variety of other problems, in which wages are a crucial price variable, e.g., fertility, migration, technological change (labor- versus capital-saving). The third motivation is related in part to the data set used for this study, the Malaysian Family Life Survey. The Malaysian government has recently enacted programs aimed at improving the economic well-being of the Malay population relative to the Chinese. The question asked is to what extent the Chinese - Malay wage gap, observed to be 37 percent in the data set used, is due to an unexplained purely ethnic wage differential. Similar problems in other studies of wages abound: if one could identify choices that have a influence on observed wages, those choices will have implications for the size of any wage gap. This paper proposes a simple two-stage procedure to compare m~rket and self-employment wages, incorporating the individual's choice between self- employment and market work. In the first stage one P.stimates the parameters of the ~~derlying st<ucture of the choice facing the individual. This structure is an example of the now familiar index function framework (see the survey by Heckman and Macurdy (1981)). While in this paper the choice is restricted to two alternatives, the index function framework can in principle handle choices between three or more alternatives. The second stage of the empirical analysis uses the information gained in the first stage in order to obtain consistent estimates of the wage equation in each activity. The empirical analysis in this paper distinguishes regional, ethnic and human capital variables as well as unmeasured differences in wages. Among workers in Malaysia, the effect of race and human capital variables on market and self-employment wages appear to differ, but evidence that region affects -4- these two sources of wages differently is ambiguous. With respect to the 37 percent Chinese - Malay wage gap, it is found that about one quarter is due to an unexplained purely ethnic wage differential. The rest is explained by, among others, choice of activity and human capital differences. In section 2 there is a short survey of the literature. The model analyzing the choice between merket and self-employment is described in section 3, and estimated relationships are derived. Data and variable definitions are given in section 4, and the empirical results are reported in section 5. Section 6 summarizes, and examines the new evidence in a broader perspective, considering issues raised in ·this introduction . ... - .: .~-. -5- 2. Overview of Existing Evidence To the basis of the human capital wage determination equation lies the work of among others Becker(l975), Ben-Porath (1967) and Mincer (1970,1974). The underlying idea is that individuals incur expenditures and forego earnings in order to accumulate skills (human capital) that increase earnings at a later stage of the lifecycle. Investments in human capital take the form of full~time or part-time education, on-the-job training or any type of skill accumulation that increases future prodictivity. Since the 1960's a large number of studies have been devoted to a test of the human capital hypothesis. Although sceptics may say that the estimated parameters vary quite a bit across these studies, the hypothesis has received strong support. As the surveys by Blang (1976), Mincer (1970, 1976), Rosen (1977) and Psacharopoules (1973) indicate, the rate of return to education appears to lie in the range of 7 to 12 percent, with some studies reporting rates of return in excess of 15 percent. Rates of return in developing countries tend to be a little higher than those found in the high income countries. Little attention is paid to the difference in the sources of income. Most studies using data from developing countries, where, as argued in the introduction, the problem may be more severe, ignore self-employed workers and estimate wage equations with a sample of employees.3) One could easily avoid this issue by assuming that self-employed workers are merely workers who happen to work in the entreprise they founded themselves.
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