Schooling Investment in Frictional Labor Markets

Abstract

This paper studies how and to what extent labor market friction affects workers schooling decisions. We use a standard on the job search model with schooling decisions that highlights the roles of employment-to-employment transition rate, job finding rate and separation rate in schooling through two channels: opportunity cost of college education and employment duration. While higher opportunity costs reduce the incentives for schooling, higher employment duration can help agents enjoy higher skill prices for a longer time and lead to more investment in schooling. Consistent with the data, our model economy predicts that higher employment-to-employment transition rates decrease the share of college graduates, while higher job finding and separation rates increase it. Unlike the previous literature, we find that market equilibrium generates over-investment in schooling in the U.S., which can be resolved by enhancing the quality of higher education.