Beyond the Mincer equation: the internal rate of return to higher education in Colombia

Abstract

In order to present an estimation of the internal rate of return (IRR) to higher education in Colombia, we take advantage of recent updates on the methodological approach towards earnings equations. In order to overcome the criticism that surrounds interpretations of the education coefficient of Mincer equations as being the rate of return to investments in education we develop a more structured approach of estimation, which includes more accurate measures of labor income and the role of education costs and income taxes. Our results imply a lower rate of return than the ones found in the Colombian literature, obtained through conventional estimation of Mincer equations, and show that the IRR for higher education in Colombia lies somewhere between 0.074 and 0.128. The results vary according to the year analyzed and the individual's gender.

JEL classifications:

• I28
• J11
• J31

Keywords:

• education returns
• Mincer equation
• internal rate of return
• Colombia

Notes

1. This term also holds as the semi-elasticity of wage with respect to the education level.

2. Average of estimated tuition fees was 3600 USD per year.

3. The costs of investing in human capital involve more than tuition fees. However, whether an individual decides to achieve an education degree or not, both situations imply living costs, which we could assume to be rather similar. In addition, considering that we use an individual decision approach focussed on individual benefits, social costs such as teacher salaries or capital as factor of the education production function. Thereby, we do not consider these issues. For a specific exercise on these matters, see Kara (2010).

4. According to the Colombian Labor Code, pension contribution must be equal to 16% of the wage, from which 12% must be paid by the employer and the remaining 4% must be paid by the worker.

5. Two definitions of wages were built, as follows: before-tax wages consist the sum of reported wages and the share of pensions/retirement fund payment that the employers must provide; and after-tax wages are the above definition with income taxes discounted according National Taxes Directorate (DIAN).

6. In particular, it should be noted that in Colombia the income tax rate is linear and is applied over a specific wage level, which goes around 20 monthly minimum wages. This implies that only 4% of wage earners actually pay labor income taxes.

7. It is important to note that these estimations do have a potential selection bias. However, taking into account that our interest is to estimate the wages, this specification error could lose relevance.