Over-education for the rich, under-education for the poor: A search-theoretic microfoundation

This paper studies the efficiency of educational choices in a two sector/two schooling level matching model of the labor market where a continuum of heterogenous workers allocates itself between sectors depending on their decision to invest in education. Individuals differ in working ability and schooling cost, the search market is segmented by education, and there is free entry of new firms in each sector. Self-selection in education causes composition effects in the distribution of skills across sectors. This in turn modifies the intensity of job creation, implying the private and social returns to schooling always differ. Provided that ability and schooling cost are not too positively correlated, agents with large schooling costs - the 'poor' - underinvest in education, while there is overinvestment among the low schooling cost individuals the 'rich'. We also show that education should be more taxed than subsidized when the Hosios condition holds. (C) 2010 Elsevier B.V. All rights reserved.