Introduction
The link between
unemployment and
returns to education:
evidence from
14 European countries
Bernhard A. Weber
The author
Bernhard A. Weber works as a Researcher for the
State Secretariat for Economic Affairs and the University
of Berne, Berne, Switzerland.
Keywords
Unemployment, Education, Human capital theory,
Labour market, Europe
Abstract
There is strong empirical evidence that unemployment
rates decrease as the educational level rises. The present
article attempts to take explicit account of this when
estimating educational rates of return. Three models that
differ with respect to their degree of simplicity and data
requirements are developed herein and applied to the
empirical data. The estimates for 14 European countries
suggest that standard estimates that do not account for
unemployment are substantially downward biased.
Differences in unemployment probabilities at different
educational levels, and youth unemployment, both appear
to be important for a better understanding of the
incentive structure behind educational decisions.
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Education + Training
Volume 44 . Number 4/5 . 2002 . pp. 171±178
# MCB UP Limited . ISSN 0040-0912
DOI 10.1108/00400910210432059
171
There is quite a lot of empirical evidence on
private rates of return to education for many
countries (Harmon et al., 2001; Ashenfelter et
al., 2000; Asplund and Pereira, 1999;
Psacharopoulos, 1994). However, little is
known about the link between standard
estimates of private rates of return and
unemployment. This is rather striking given
the strong empirical evidence that
unemployment rates systematically vary with
the educational level. It seems quite obvious
that a rational investor will take into account
not only his or her earnings potential, but also
the probability of this potential being realized
in the labour market. In other words,
investors will base their schooling decisions
on their anticipated life income stream, taking
into account their expected future earnings
and the probability of their being employed.
In this paper we outline two empirical models
in which standard estimates of private rates of
return to education are adjusted for
differences in unemployment probabilities
between educational levels. This enables us to
estimate how much the level and structure of
unemployment changes the incentive
structure for educational decisions in 14
European countries.
Previous work
Explaining unemployment differences
The literature evaluating the incidence and
duration of unemployment has always found
education to be a key factor (Nickell, 1979;
Mincer, 1991a, b; Hoynes, 1999). One
explanation for the lower unemployment
incidence of skilled employees is that their risk
of being laid off is reduced by their greater
accumulation of firm-specific human capital
compared to unskilled workers. A second
explanation that is often given is ``crowding
out'' or ``over-education'', i.e. the replacement
of less skilled workers by those who are better
The work was carried out under a European TSER
program on public funding and private returns to
education (PURE) (http://www.etla.fi/PURE).
Financial support from the Swiss Federal Office for
Education and Science is gratefully acknowledged.
The author would also like to thank his colleagues
at the PURE project for their excellent input. All
correspondence should be sent to:
bernhard.weber@gmx.ch
 The link between unemployment and returns to education
Bernhard A. Weber
educated and/or have more experience
(Muysken and Ter Weel, 1998, 1999). In
addition, technological change is skill-biased in
the highly developed countries. Since labour
markets are not perfectly flexible, the reduced
relative demand for unskilled labour can lead
to increased unemployment, especially in the
low-skilled group.
Unemployment and schooling enrolment
A second line of research addresses the
question of how unemployment affects
schooling enrolment decisions, i.e. the
demand for education. There are three main
lines of reasoning to be found in the literature.
The first one is that when conditions in the
labour market are bad, leaving school to enter
the market becomes less attractive because
new entrants have fewer job opportunities and
receive lower wage offers (the ``discouraged
worker effect''). Thus high unemployment,
and high youth unemployment in particular,
reduces the opportunity costs of further
education and should have a positive impact
on enrolment. However, a second line of
reasoning argues that there is an ``added
worker effect'' that operates in the opposite
direction. According to this hypothesis, an
increase in unemployment reduces household
income and this can encourage early school
leaving. A third argument for how
unemployment affects the demand for
schooling states that the unemployment risk is
not constant across educational levels, that
groups at higher educational levels typically
face less unemployment risk and this
increases their expected earnings relative to
less educated people.
Quite a lot of empirical evidence has been
gathered using time series (e.g. Whitfield and
Wilson, 1991; Betts and McFarland, 1995;
Rice and McVicar, 1996; Fredriksson, 1997;
Card and Lemieux, 2000) and cross-sectional
regional data (e.g. Rice, 1987, 1996; Card
and Lemieux, 2000) that points to a positive
relationship between total unemployment and
enrolment. But there are also studies that
show the relationship between the two as
being weak, insignificant or negative (e.g.
Micklewright et al., 1990; Kane, 1995).
Studies that take account of relative
differences in unemployment usually find that
high unemployment at lower skill levels has a
positive impact on enrolment (Kodde, 1988;
Fredriksson, 1997). Two recent studies have
shown that students expect job stability to
172
Education + Training
Volume 44 . Number 4/5 . 2002 . 171±178
increase as the level of schooling rises (Manski
and Straub, 2000; Guiso et al., 1998).
Unemployment and rates of return to
education
A third issue addressed in the literature is the
link between unemployment and rates of
return to education. Nickell (1979) adjusts
the rates of return by introducing
unemployment and finds that standard
estimates are slightly downward biased. Groot
and Oosterbeeck (1992) extend the standard
human capital model by adding the
unemployment probability. The theoretical
implication of introducing unemployment
and unemployment benefits into the latter
model is ambiguous. However, their
empirical findings for The Netherlands and
the USA show that unemployment increases
the rates of return in almost all cases, while
narrowing slightly the differences in the rates
of return between different educational levels.
Asplund et al. (1996) reformulate the earnings
function and define earnings as expected
working hours multiplied by a wage rate.
Differences in unemployment are interpreted
as differences in expected working hours.
Ashenfelter and Ham (1979) proceed in a
similar way. Wolter and Weber (1999)
introduce unemployment and the
characteristics of the Swiss unemployment
insurance system in an educational cost-
benefit analysis. Barceinas
et al. (2000) apply a similar method to
European data. The present article can be
viewed as a contribution to this third stream
in the literature.
Method
The basic model (model 0)
As our point of departure we take a very simple
model for estimating the private rate of return
to education called the ``short-cut method''
(Psacharopoulos, 1987). When direct costs for
education are ignored (i.e. when schooling is
entirely publicly funded), the rate of return
corresponds to the relative wage differential
between two consecutive levels of education,
divided by the additional years of schooling
necessary to attain the higher degree. If
estimated using an ordinary least squares
regression, the schooling coefficient in a
Mincer earnings function corresponds
approximately to this rate of return.
 The link between unemployment and returns to education
Bernhard A. Weber
With unemployment introduced (model 1)
Estimates of rates of return to education are
usually based on wages observed in the labour
market. The presence of unemployment can
lead to biased estimates for two reasons. First
of all, observed wages may not be
representative of the earnings potential of
unemployed people. If the probability of
being unemployed depends on individual
characteristics that correlate with the
unemployed person's earnings potential,
problems of selection bias arise.
Second, unemployment spells result in
earnings losses. In the absence of any
unemployment insurance system, earnings of
the unemployed should be zero. An
unemployment insurance system or some
other system of social security typically
replaces only part of former earnings.
In the following analysis we will ignore
problems of selection bias and try to take
account of the second source of bias by using
education-specific standardised
unemployment rates ui as a proxy for an
individual's unemployment probability. Thus
for an individual with educational level h who
participates in the labour market, the
employment probability is Ph-1 = 1±uh. By
weighting the average earnings of persons
with educational level h and h±1 in model 0
with their corresponding employment
probabilities ph and ph±1, we obtain an
estimate for rates of return that takes
unemployment into account.
According to model 1, rates of return are
unbiased when employment probabilities p are
identical for two consecutive educational
levels, because the relative wage differentials
remain unchanged. If the probability of being
employed increases with the level of education,
as is usually the case, the relative wage
differential also increases and the conventional
rates of return should be corrected upwards.
Model 1 provides an idea of the magnitude
of the bias of rates of return to education.
However, several simplifying assumptions have
been made. One of them is that employment
probabilities are stable over the life cycle. As
we know, this is not the case ± in many
European countries, youth unemployment is a
particularly severe problem.
With youth unemployment introduced
(model 2)
We again take model 0 as our point of
departure and introduce employment
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Volume 44 . Number 4/5 . 2002 . 171±178
probabilities. This time, however, we
decompose employment probabilities at the
lower educational level into two periods, one
for the youth and one for the adult
population. The youth employment
probability is used to weight the earnings of
young persons who remain at the lower
educational level. In doing so we get an
estimate for the true opportunity costs of
education, costs that are reduced as youth
unemployment rises. The adult employment
probabilities are used to adjust the earnings
differentials between two consecutive levels of
education.
As was the case with model 1, we find that
conventional rates of return should be
corrected upwards if the average employment
probability at the higher educational level
exceeds both the youth and adult
employment probabilities at the lower level.
The question of whether high youth
unemployment has an impact on the rates of
return cannot be answered in a general
manner and has to be tested empirically.
With unemployment benefits introduced
(model 3)
An implicit assumption of the above models is
that unemployed persons have no earnings at
all. This assumption is certainly unrealistic
given that all European countries have an
unemployment insurance system. In order to
take this factor into account, we assume that
unemployment benefits correspond to a
country-specific, fixed proportion of previous
earnings r, called the replacement rate, and
introduce this rate by extending the
employment probability term pi to pi + (1±pi)
r.
This implies that an individual i earns yi with
probability pi (i.e. when employed), and yi
r
with probability 1±pi (i.e. when unemployed).
The data
The first ingredient in our analysis consists of
estimates of standard Mincer human capital
earnings functions that use the log of hourly
gross or net earnings as a dependent variable.
We chose to use hourly instead of annual
earnings in this context because the latter may
be influenced by hours of work and
unemployment spells. On the right-hand side
of the earnings function, we use dummy
variables for the highest level of education
attained (primary or lower secondary, upper
 The link between unemployment and returns to education Education + Training
Bernhard A. Weber Volume 44 . Number 4/5 . 2002 . 171±178

secondary, or tertiary education), years of unemployed according to the ILO definition

potential labour market experience, and the
square of the latter. The earnings functions
were estimated by the teams involved in the
PURE project using national labour force
survey data for a year as close as possible to
1995. The educational dummy variables are
defined in accordance with the Eurostat
classification, and their coefficients
correspond approximately to the relative
earnings differential.
As the second element we use age- and
education-specific standardised
unemployment rates. This information was
available from Eurostat in the form of a table
showing the unemployment figures for 1992-
1999 broken down by gender, age group, and
educational level. Table I gives an overview of
the level and structure of unemployment in
the 14 countries in our sample.
The third element of our analysis consists of
the characteristics of the 14 countries'
unemployment insurance systems.
Internationally comparable replacement rates
can be found in OECD (1999). In our
analysis we use net replacement rates in the
first month of unemployment for both youths
and adults, with married persons serving as
representative of adults. Furthermore, we
assume that two-thirds of those who are
receive unemployment benefits. We thus
multiply the replacement rates by the factor
0.66. The rates used in our analysis are
reported in Table I. They range from 0 to 50
per cent for the youth population (country
mean: 24 per cent), and from 28 to 55 per
cent for the adult population (country mean:
43 per cent).
Results
In what follows we will compare standard
estimates of rates of return with the results of
our three models. Tables II and III
summarise the results for 14 European
countries. We have Mincer equation
estimates using gross hourly wages as the
dependent variable for 11 of these countries,
and net hourly wages for three of them. The
results for upper secondary and tertiary
education, and for men and women, are
reported separately.
In column A in both sections of Tables II
and III, we report the coefficient estimates of
the Mincer earnings function. Column B
shows the magnitude of the change in rates of
return when we account for differences in
unemployment probabilities between levels of

Table I Unemployment and replacement rates for men and women

Unemployment rate
By educational level Net replacement
Primary and Upper By age group rate 0.66
lower secondary secondary Tertiary 15-24 15-64 Youths Adults
Austria 7.8 4.5 2.6 7.3 5.1 5 40
Denmark 10.1 7.8 4.3 10.2 7.6 24 44
Finland 21.8 15.7 6.6 39.0 15.3 38 46
France 15.6 11.1 7.0 24.9 11.8 11 48
Germany 12.6 8.3 5.1 9.1 8.3 36 40
Greece 7.5 14.0 6.6 22.7 9.4 31 31
Ireland 19.8 10.4 5.5 22.7 13.1 21 32
Italy 12.1 12.1 6.5 31.1 11.4 0 28
The Netherlands 10.5 5.5 4.4 10.7 6.3 50 55
Portugal 6.2 7.9 3.0 11.4 5.9 0 51
Spain 21.8 22.4 16.0 36.9 20.4 17 48
Sweden 12.2 10.0 4.2 20.5 9.0 38 48
Switzerland 5.6 3.1 2.9 6.1 3.6 40 48
UK 11.6 8.6 4.3 18.8 8.7 30 40
Country mean 12.5 10.1 5.6 19.4 9.7 24 43
Notes: Figures are percentages. The unemployment rates shown are the average rates for the following years and
countries: 1992-1999 for Spain, France, Italy and Portugal; 1992-1998 for Denmark and Greece; 1992-1997 for
Germany, Ireland, The Netherlands and the UK; 1995-1999 for Sweden; 1995-1998 for Austria and Finland; and
1996-1999 for Switzerland

174
 The link between unemployment and returns to education Education + Training
Bernhard A. Weber Volume 44 . Number 4/5 . 2002 . 171±178

Table II Rates of return to education and the impact of unemploymen for me

Upper secondary education Tertiary education
Men A B C D B+C+D A B C D B+C+D
a
Austria 10.6 2.8 0.0 ±0.8 1.9 5.3 0.4 0.1 ±0.1 0.4
Denmark 3.1 1.0 0.2 ±0.5 0.7 7.3 0.8 0.3 ±0.3 0.7
Finland 3.7 2.5 2.1 ±2.7 1.9 6.6 2.6 1.7 ±2.1 2.2
France 6.9 3.9 1.5 ±1.8 3.6 7.6 0.7 1.2 ±0.2 1.6
Germany 11.1 4.4 ±0.2 ±1.7 2.5 6.1 1.1 0.1 ±0.5 0.7
Greecea 5.5 ±0.8 0.6 0.1 ±0.1 8.3 1.7 1.9 ±1.4 2.3
Ireland 10.8 5.6 2.7 ±2.7 5.7 13.4 2.5 1.0 ±0.9 2.6
Italya 5.5 0.2 1.6 0.2 2.1 7.8 1.4 2.7 ±0.2 3.9
The Netherlands 6.1 1.8 0.2 ±1.1 0.9 11.3 0.3 0.4 ±0.4 0.4
Portugal 8.4 ±0.2 0.4 0.4 0.6 18.0 1.5 2.0 ±0.1 3.3
Spain 8.5 0.5 3.1 ±0.3 3.4 7.5 1.9 2.1 ±1.0 3.0
Sweden 4.0 0.4 0.3 ±0.3 0.4 4.6 2.2 0.4 ±1.3 1.3
Switzerland 9.3 0.8 0.0 ±0.3 0.4 9.1 0.2 0.3 ±0.2 0.3
UK 22.1 7.2 1.5 ±3.3 5.4 11.5 2.1 0.9 ±1.1 1.9
Country mean 8.3 2.2 1.0 ±1.1 2.1 8.9 1.4 1.1 ±0.7 1.8
Percent of 100 26 12 ±13 25 100 16 12 ±8 20
column A
Note: aNet wages. Figures are percentages

Table III Rates of return to education and the impact of unemployment for women
Upper secondary education Tertiary education
Women A B C D B+C+D A B C D B+C+D
Austriaa 12.3 2.1 0.5 ±0.4 2.2 4.1 0.4 0.0 ±0.1 0.3
Denmark 1.1 1.8 0.3 ±0.9 1.2 5.0 1.3 0.1 ±0.6 0.9
Finland 2.8 2.6 0.6 ±1.8 1.4 6.5 2.3 1.9 ±2.1 2.1
France 7.2 2.3 3.2 ±1.2 4.3 10.2 2.6 2.2 ±1.1 3.8
Germany 13.9 2.2 ±0.5 ±0.6 1.0 7.3 1.4 ±0.2 ±0.5 0.7
Greecea 8.2 ±2.7 2.2 0.2 ±0.3 9.9 5.8 4.1 ±4.3 5.6
Ireland 13.9 8.8 4.1 ±4.3 8.6 23.9 4.3 0.9 ±1.4 3.9
Italya 7.3 0.4 2.6 0.6 3.6 8.7 2.6 3.7 ±0.2 6.0
The Netherlands 4.0 1.6 0.0 ±0.9 0.7 10.2 1.0 0.0 ±0.5 0.5
Spain 10.3 ±0.6 4.1 1.1 4.6 7.6 4.2 2.7 ±2.0 5.0
Sweden 2.1 1.1 0.0 ±0.5 0.5 3.8 1.9 0.6 ±1.2 1.2
Switzerland 12.1 1.6 0.0 ±0.7 0.8 7.9 ±0.5 0.1 0.2 ±0.1
UK 21.1 2.3 1.6 ±1.3 2.7 13.2 1.5 0.5 ±0.7 1.3
Country mean 9.0 1.8 1.4 ±0.8 2.4 9.1 2.2 1.3 ±1.1 2.4
Percent of 100 20 16 ±9 27 100 24 14 ±12 26
column A
Notes: aNet wages. No data for Portugal. Figures are percentages

education using the method applied in model (represented by model 3) as compared to

1. In column C, we see how the rates of return
change relative to model 1 if youth
unemployment is also taken into account as is
done in model 2. These figures can be
cautiously interpreted as an estimate of the
impact of youth unemployment on the rate of
return to education. Column D shows the
impact of the unemployment insurance
system on the rates of return to education
175
model 2. The last column (B+C+D)
summarises the total impact of all three
factors.
As our results show, the rates of return
change substantially if the structure of
unemployment is accounted for. According to
model 1, the rates of return should be
corrected upwards on average by 1.4 to 2.2
percentage points. The country means of
 The link between unemployment and returns to education
Bernhard A. Weber
rates of return therefore increase from
8.3-9.1 per cent to 10.3-11.3 per cent, which
corresponds to a relative increase of about
15-25 per cent over standard estimates
reported in column A. When we also add in
youth unemployment in model 2, the rates of
return increase by another 1.0 to 1.4
percentage points or 12-16 per cent, which
suggests that youth unemployment is an
important factor. The inclusion of
unemployment benefits as is done in model 3
reduces the impact of unemployment on the
rates of return by 0.7 to 1.1 percentage points.
Thus the total impact of unemployment on
the rates of return amounts to between 1.8
and 2.4 percentage points, or 20-27 per cent
on average.
At the upper secondary level of education,
Ireland, the UK, France and Spain experience
the highest shifts in their rates of return in
absolute terms, with a plus of between 2.7
and 8.6 percentage points. In relative terms,
i.e. relative to the initial level of rates of return
shown in column A, there are high increases
of 35-62 per cent for Finland, France,
Ireland, Italy and Spain, and of more than
100 per cent for Danish women. There are
very small shifts in absolute terms of less than
one percentage point for Denmark, Greece,
The Netherlands, Portugal, Sweden and
Switzerland. Greece and Portugal are very
special cases: in these two countries, the
unemployment probability is higher at the
upper secondary than at the lower level, and
the impact of the unemployment structure on
rates of return is therefore negative.
At the tertiary level, the rates of return
increase the most for Italy, Spain and Portugal
(3.0 to 6.0 percentage points). For Greece,
France and Ireland, there are substantial
increases in the rates of return for women of
between 3.8 and 5.6 percentage points. Only
small changes are observed for Austria,
Denmark, Germany, The Netherlands and
Switzerland.
If we take a closer look at the role of
youth unemployment, we see that it plays
a particularly important role in Greece, Italy,
Portugal and Spain, countries in which it has
a stronger impact on the rates of return than
does the relative difference in employment
probabilities between educational levels.
Youth unemployment is also relatively
important in France and Finland compared to
the remaining eight countries in our
overall sample.
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Volume 44 . Number 4/5 . 2002 . 171±178
The impact of the unemployment insurance
system on the rates of return is largest in
Finland and The Netherlands. In these
countries, more than half of the increase in
the rates of return induced by unemployment
differences and youth unemployment is offset
by unemployment benefits. In Denmark,
Germany, Sweden and the UK,
unemployment benefits reduce the potential
increase in the rates of return by about
35-45 per cent. On average, such benefits
offset about one-third of the increase.
Conclusions
We can draw several conclusions on the basis
of these results. First of all, unemployment
would seem to be an important element for
estimating rates of return to education. We
find that conventional estimates of private
rates of return are almost always downward
biased when unemployment is not taken into
account because education usually does not
just increase someone's earnings potential,
it also makes it more likely that this potential
will be realized in the labour market.
According to our models, it is not the absolute
level of unemployment but relative youth
unemployment, and the relative
unemployment differences between
educational levels, that determine the bias of
standard rate of return estimates. There is
unquestionably a large effect in countries
where the rate of unemployment is high, but a
high rate by itself is insufficient to cause a
substantial bias in the rate of return.
As our empirical results show, rates of
return to education are altered, sometimes
substantially, when differences in
unemployment probabilities, youth
unemployment, and the characteristics of the
unemployment insurance system are
accounted for. In our sample of 14 countries,
the standard rates of return were shifted
upwards by about 25 per cent on average.
Since the impact of unemployment on rates
of return varies considerably between
countries, it would appear to be particularly
important to include unemployment in rate
of return estimates when making cross-
country comparisons.
Another finding of our research is that
youth unemployment can play an important
role in estimations of rates of return to
education: on average, it accounts for about
 The link between unemployment and returns to education
Bernhard A. Weber
one-third of the total increase. In some
countries, its impact even exceeds the effect of
the relative unemployment differences
between levels of education. In other words,
high youth unemployment can increase the
economic incentive to pursue an education
quite substantially and sometimes even more
than differences in unemployment between
educational levels. There are mainly two
explanations for this:
(1) youth unemployment has an immediate
impact on the opportunity cost of an
investment in education; and
(2) in cost-benefit analyses, earnings and
earnings losses that occur early in life
have a greater impact on the rate of
return, which means that youth
unemployment is more important than
adult unemployment.
Finally, the present results help to explain the
findings in the literature on educational
enrolment. Since unemployment can have a
substantial impact on rates of return to
education, it seems plausible that it would
influence decisions about educational
enrolment. Our models, however, suggest
that one should focus on relative employment
probabilities between levels of schooling and
youth unemployment rather than on the total
level of unemployment. If the risk to be
unemployed is independent of age and level of
education unemployment does not alter the
cost-benefit relation of an educational
investment. According to human capital
theory, enrolment in education should
therefore not be influenced by unemployment
as such. Still a positive correlation between
the level of unemployment and educational
enrolment, quite often found in the empirical
literature, is consistent with human capital
theory and our model because the overall level
of unemployment is correlated with youth
unemployment, which has a positive impact
on the rate of return to education.
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