A mismatch made in heaven: a hedonic analysis of overeducation and undereducation.

1. Introduction

Over the past two decades, there has been much concern by researchers and policymakers over the apparent lack of coordination between the labor market and the education system that leads some workers to have educational qualifications in excess of those specified for the job (overeducation) and others to have less (undereducation). Cross-sectional studies using U.S., European, and Asian data sources indicate that between 30% and 40% of workers have educational qualifications that either exceed or fall short of firm requirements at a particular point in time (e.g., Sicherman and Galor 1991; Alba-Ramirez 1993; Ng 2001). Moreover, a meta-analysis by Groot and Maassen van den Brink (2000) shows no significant change in the extent of this mismatch between workers and firms over the past 20 years. Thus, overeducation and undereducation appear to be pervasive and persistent phenomena in industrialized countries.

A large empirical literature treats both overeducation and undereducation as evidence of an imbalance in the supply of and demand for skills (Rumberger 1981, 1987; Manacorda and Petrongolo 2000). For example, short-run coordination failure between worker qualifications and firm requirements could occur if rapid technological advancement draws educated workers into jobs traditionally held by lower-skilled workers who cannot readily acquire more education (Borghans and de Grip 2000). Mismatch in the skills market is supported by a number of empirical wage studies that include years of required education and measures of whether the worker has more or less education than required. These studies find that workers whose qualifications equal firm requirements earn a higher return to education than those who do not (Duncan and Hoffman 1981; Hersch 1991; Vahey 2000).

Recently, two equilibrium rationales have been proposed for the presence of overeducation. First, several papers examine whether worker qualifications might exceed firm requirements due to the substitutability or complementarity between education and on-the-job training (de Oliveira, Santos, and Kiker 2000). Workers might be identified as overeducated if, for example, education and on-the-job training are substitutes in production such that job entrants who possess more than the minimum educational requirements do not require further training. While not explicitly examined in prior work, substitutability between education and on-the-job training can also lead to undereducation if workers can use on-the-job training as a substitute for formal education, whereas complementarity between education and training could imply that human capital differences increase throughout a career because well-educated workers benefit more from training (Sloane, Battu, and Seaman 1996). An empirical paper by van Smoorenburg and van der Velden (2000) finds that substitutability and complementarity between initial education and on-the-job training are both possible and depend on factors such as the match between the job and field of study and the "narrowness" of educational training.

Second, several papers model overeducation as a result of career mobility. For example, Sicherman and Galor (1990) develop a theoretical model in which workers start in jobs for which they are overeducated in exchange for a higher probability of moving up the job hierarchy. They test this hypothesis using data for working-age males from the 1976-1981 waves of the Panel Study of Income Dynamics (PSID) and find that the correlation between the effect of education on wages and the probability of moving to a "better" job is negative and significant. This result suggests that overeducated workers trade off a lower return to education for career mobility reflected in an increased probability of promotion. Nonetheless, an equilibrium rationale has not been put forward for the presence of undereducated workers.

In this paper we develop a discrete hedonic pairing model where worker qualifications do not always match firm requirements in equilibrium. Workers can be overeducated in equilibrium when they start in lower-paying, entry-level jobs in return for the promise of higher-paying future positions that do, in fact, require their educational background. However, undereducated-type pairings can also arise when workers begin in lower-paying jobs for which they are exactly educated but then receive the necessary training for promotion into a higher-skilled and hence higher-paying job. The missing element in most models is time: Workers who now appear overeducated may be waiting for promotion to jobs requiring their level of education, while workers who now appear undereducated may have received training in the past that provided them with the skills they need to perform the higher-paying job. Yet worker qualifications will meet firm requirements at some time in every worker-firm pairing.

An implication of this analysis is that the observed educational match in a cross section or a short panel (used in prior work) will misidentify some pairing types. However, the discrete hedonic pairing process is shown to yield a jointly determined ordered probit model of worker qualifications and firm requirements that can be used to impute the pairing type (i.e., overeducated, undereducated, and exactly educated), which is estimated using uniquely detailed data for British working-age males contained in the Social Change and Economic Life Initiative survey (SCELI). The predicted pairings correctly identify most of the observed overeducated and undereducated worker-firm pairs but also show that many apparent exactly educated worker-firm pairs are properly characterized as overeducated or undereducated types of pairings. Several empirical analyses exploit the forward-looking and backward-looking data contained in SCELI to show that past and future opportunities for on-the-job training and promotion differ across the pairing types consistent with the hedonic pairing model.

We supplement our cross-sectional results with analyses using the British Household Panel Study (BHPS) that permit us to track the career path of respondents over a 12-year period. The BHPS analyses confirm our training and promotion findings from SCELI and permit the estimation of wage growth equations over a career path that show that overeducated and undereducated pairing types have steeper wage profiles than those in exactly educated pairings. Collectively, the results provide some of the first formal evidence that overeducation and undereducation can occur in a labor market equilibrium that is mutually beneficial for workers and firms and that a proper empirical assessment of the pairing process must account for these worker-firm pairings occurring over multiple periods.

2. Empirical Model

Two Illustrations of Career Mobility

By definition, overeducation or undereducation occur when the observed educational qualifications of the worker (Q) do not match the stated educational requirements for the job (R) at a given time. However, a worker-firm pairing often occurs over multiple periods and, thus, may reflect the objectives of the worker and the firm over the course of their pairing and not just for a single period. We develop an empirical model of a hedonic pairing process that shows that an overeducated-type (undereducated-type) pairing yields Q > R (Q < R) over a portion of their employment relationship and results from the fact that, in such pairings, workers move up the job-skill hierarchy with experience. To lay a foundation for the empirical model, it is useful to begin with two simple illustrations where career mobility can yield an overeducated- or an undereducated-type pairing.

There are a number of practical examples of an overeducated-type pairing. For example, most UK police officers enter the force with secondary school qualifications that qualify them to be a patrol officer. However, entrants into the force who have a university degree also begin as patrol officers because this experience improves their subsequent performance when they are promoted into jobs that require their qualifications (e.g., detective). In other words, university-educated patrol officers accept jobs for which they are overeducated in exchange for training and an expected future promotion into a job for which they are exactly educated.

Career mobility can also potentially yield an undereducated-type pairing. For example, whereas many detectives have a university degree, patrol officers with only secondary school qualifications can be promoted to detective if their on-the-job field experience reveals that they have the necessary skills and personal attributes to be a successful detective. These secondary school-educated detectives begin in a patrol officer job for which they are exactly educated but are promoted into jobs for which they may be viewed as undereducated because their qualifications are below those of many detectives who have a university degree. It follows that the experience of these secondary school-educated detectives substitute for the skills and/or a signal of ability provided by a university degree and permit them to move up the job hierarchy (Groot and Oosterbeck 1994; Chatterji, Seaman, and Singell 2003).