Ability, education choice and life cycle earnings

This dissertation consists of two chapters. In the first chapter, I explain changes in the life-cycle earnings profile for different birth cohorts. The second chapter assesses the quantitative importance of federal aid for college education in explaining college premium.

In the first chapter, I document the life-cycle earnings profile for the 25-year- old college- and high school-educated white men in 1940, 1950, 1960 and 1970. I find that later cohorts have flatter average life-cycle earnings profile. Using a version of the Ben-Porath model, I propose an explanation based on the composition effect. In my model, all individuals have a high school diploma and are differentiated by their ability. They must decide whether to work or go to a four-year college. There is a threshold ability above which individuals choose to attend college and below which they work. All cohorts face the same ability distribution and an exogenous sequence of wage rate per unit of human capital that grows at a constant rate. A higher initial level of wage rate increases college attainment implying that the average ability is lower for both college- and high school-educated individuals. From the Ben- Porath model, lower ability individuals have less steep increment in their earnings. This implies that the average college (and high school) life-cycle earnings profile for the 1970 cohort will be flatter than that of the 1940 cohort. My model is able to quantitatively explain 67 and 35 percent of the flattening in the average life-cycle earnings profile for college and high school-educated individuals, respectively.

Since the late 1970s, there has been a strong increase in the college premium. While most papers focus on skill-biased technical change, the second chapter explores the role of federal aid as a possible source of inequality. I build a model where all individuals have a high-school diploma but are heterogeneous with respect to their innate abilities and initial human capital. They decide whether to attend college to accumulate more human capital before working, or to start working right away. The production function for human capital in college requires two inputs: human capital and goods. In this context, two mechanisms are key for the behavior of the college premium. First, federal aid makes it easier to afford the goods input in the human capital technology. This induces college students to accumulate more human capital and consequently, they have higher earnings. Second, as more individuals attend college due to rising income, the composition of college graduates changes: more low- ability individuals attend college, implying a decrease in average college earnings. A calibrated version of the model accounts fully for the rise in the college premium. Federal aid alone accounts for about 70 percent of the rise.