Dundee Discussion Papers in Economics 114: A hedonic analysis of overeducation and undereducation

Prior work suggests coordination failure between the labour and education markets leads some workers to have educational qualifications in excess of those specified by the firm (overeducation) and others to have less(undereducation). This paper theoretically models and empirically tests the hypothesis that overeducation and undereducation arise out of a common equilibrium matching process that maximises net benefits to workers and firms over the life of the match. The theoretical model predicts that the overeducated begin in low-paying, entry-level jobs early in their career that train them for higher-paying future positions that require their educational background, whereas the undereducated start in low-paying, exactly-educated jobs that can signal the worker has the necessary skills for promotion. This result suggests that prior comparisons of overeducated, undereducated, and exactly-educated workers in a cross-section or short panel may be misleading because all workers are exactly-educated during some portion of their career. However, the theoretical model predicts that the type of education match can be identified in a cross section by differences between predicted and observed qualifications of the worker and predicted and observed requirements of the firm. This hypothesis is tested using data on British, working-age males to identify overeducated and undereducated workers and confirm that these workers trade off a lower return to education for training and a promotion return.