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«Working Paper No. 86 October 2012 b B A M B AMBERG E CONOMIC R ESEARCH GROUP k k* BERG Working Paper Series Bamberg Economic Research Group Bamberg ...»

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Do literacy and numeracy pay off?

On the relationship between basic skills and earnings

Manfred Antoni and Guido Heineck

Working Paper No. 86

October 2012

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B AMBERG

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Bamberg Economic Research Group Bamberg University Feldkirchenstraße 21 D-96052 Bamberg Telefax: (0951) 863 5547 Telephone: (0951) 863 2687 felix.stuebben@uni-bamberg.de http://www.uni-bamberg.de/vwl/forschung/berg/ ISBN 978-3-943153-00-2

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Dr. Felix Stübben  felix.stuebben@uni-bamberg.de Do literacy and numeracy pay off? On the relationship between basic skills and earnings∗ Manfred Antoni† Guido Heineck‡, September 17, 2012 Abstract Is there a reward for basic skills in the German labor market? To answer this question, we examine the relationship between literacy, numeracy and monthly gross earnings of full-time employed workers. We use data from the ALWA survey, augmented by test scores on basic cognitive skills as well as administrative earnings data. Our results indicate that earnings are positively related to both types of skills. There furthermore is no evidence for non-linearity in this relationship and only little heterogeneity when differentiating by sub-groups.

JEL classification: I21, J31 Keywords: Literacy, numeracy, earnings, administrative data, Germany, ALWA ∗ We would like to thank Lutz Bellmann, Alfred Garloff, Thomas Kruppe, Claus Schnabel and Stefan Zagelmeyer as well as the participants of the Annual Congress 2012 of the Verein f¨r Socialpolitik, the 3rd International u Workshop on Applied Economics of Education and the IAB Seminar on Labour Market and Occupational Research (DiskAB) for valuable comments and suggestions. The usual disclaimer applies.

† Institute for Employment Research, Regensburger Strasse 104, 90478 Nuremberg, Germany, email: manfred.antoni@iab.de ‡ University of Bamberg, Feldkirchenstr. 21, 96052 Bamberg, Germany, email: guido.heineck@uni-bamberg.de 1 Introduction Ever since its establishment in the early 1960s (Becker, 1962; Schultz, 1961), research on human capital had a focal interest on the labor market returns to individuals’ schooling, which was considered to represent individuals’ productivity. However, it was soon recognized that the indicator typically used, time spent in education, may not necessarily be a good proxy for individuals’ capabilities, and that the resulting coefficients will be biased if ability cannot be accounted for (Griliches and Mason, 1972).

Though there is a small but established literature on the returns to cognitive ability,1 it might be argued that adults’ basic skills, i.e. literacy and numeracy, are at least as relevant for earnings. Not only may they be considered as better indicators for individuals’ productivity than schooling credentials, but they are also more malleable than innate cognitive abilities. The latter are partly determined by pre-natal circumstanced, are mainly developed in childhood and early youth and cannot be altered easily later on in the life course (Cunha and Heckman, 2007). In fact, numerous policy programs that are embedded in the “lifelong-learning” debate show that the removal of deficiencies in and the enhancement of adult’s basic skills are of high interest to policymakers.2 But similar to the literature on cognitive abilities, there is only little evidence on the role of adults’ literacy and numeracy. This is not surprising since data on adults’ basic skills are rather scarce and have a focus on Anglo-Saxon countries, with only very limited evidence from other countries.

We add to the literature by providing first evidence on the association between adults’ literacy and numeracy skills and individual earnings for Germany. In contrast to evidence on the formation of basic skills in the school student population, for which there has been a surge in research interest after the German “PISA shock” in 2000 (see Klieme et al., 2010), our analysis will shed some light upon the situation of adult workers for whom there is barely any research. To be able to do this, we base our analysis on the ALWA-ADIAB and ALWA-KOMP data, a combination of data sources that is unique in several aspects, even beyond the German context.

To be clear, the set of basic skills as given in our data will neither allow us to separate innate abilities from literacy and numeracy skills, nor can we disentangle causal mechanisms that might lead to differences between the returns to educational attainment and to basic skills. We primarily aim at providing evidence on whether literacy and numeracy adds to the explanation of variation in earnings beyond individuals’ educational attainment or whether It is worth noting that the available evidence is far from conclusive: On the one hand, there is a large number of studies that reveal substantial returns to cognitive abilities (e.g., Bronars and Oettinger, 2006; Cameron and Heckman, 1993; Green and Riddell, 2003). On the other hand, there are as many studies suggesting that cognitive abilities have barely any additional effect on earnings (Bound et al., 1986; Murnane et al., 1995) and that they are a poor predictor of earnings compared to a direct measure of education, family background, and environment (Cawley et al., 2001; Zax and Rees, 2002).





See, for example, Recommendation 2006/962/EC of the European Parliament and of the Council on key competencies for lifelong learning.

potential effects are fully absorbed by educational credentials. Despite its more descriptive character, our analysis is relevant for both economists and policy makers as it furthers our understanding of the returns to education and skills beyond formal schooling.

The remainder of our paper is as follows: We review prior research on the returns to basic skills in section 2, introduce the data sets in section 4 and provide results in section 5. Section 6 draws conclusions.

2 Background and Previous Research As noted above, interest in individuals’ abilities is nothing new in the empirical literature on human capital. Where available, researchers used information on individuals’ cognitive abilities for technical reasons, i.e. in order to remove potential issues caused by omitted variables.

Researchers are also interested in the labor market value of cognitive abilities – and along the same line of argument, of basic skills – as they may reflect individuals’ productivity as good as formal schooling, if not better. If so, implications from human capital theory would predict that such a set of skills will pay off.

It is therefore not surprising that the interest in adults’ basic skills has also been around for some time, and particularly so in the political spheres. Faced with the challenges of increasing demands for a skilled workforce in knowledge based societies, it was only in the more recent past, that the OECD implemented two comparative studies, the International Adult Literacy Survey (IALS), that was conducted in three periods between 1994 and 1998 and covered 21 countries, and the 2003 Adult Literacy and Lifeskills Survey (ALL) that covered six countries.

Some of the studies that examined the returns to basic skills are based on either ALL or IALS data. Yet, before looking at findings in more details, it is useful to first address the concepts of numeracy and literacy which are, as Dougherty (2003, p. 512) puts it, “...

susceptible to definitional variability”. It furthermore is necessary to distinguish basic skills measures as given in the database we use from cognitive abilities as included in, for example, the National Longitudinal Survey of Youth (NLSY). Such measures are typically used as proxies for individuals’ innate abilities and are mainly taken from a common cohort and when individuals are still in education.

We however use data drawn from basic skills tests conducted during a survey with adult respondents. Our measures therefore are mainly from individuals who have completed their educational and vocational training and are of different age. Beyond that, and more importantly, the tests aim at capturing skills that are needed in individuals’ everyday life. Since the basic skills scores in our data are based on tests that were included in ALL, we follow its definition

for prose literacy and numeracy (Statistics Canada and OECD, 2005, p. 16):

Prose literacy: “the knowledge and skills needed to understand and use information from texts including editorials, news stories, brochures and instruction manuals.” Numeracy: “the knowledge and skills required to effectively manage the mathematical demands of diverse situations.” Since the data do not contain actual measures of innate ability, our basic skills measures should be interpreted as a compound measure of an individual’s innate abilities, educational gains, and post-education experiences of the individual in both her working and private life.

As outlined above, there is only little evidence on the association between workers’ basic skills and labor market success, measured by either employment participation or earnings. While there are a few studies from the 1970s (see Dougherty, 2003), we concentrate on more recent studies to allow some comparison to the current German setting. As most of the research on the association between adults’ basic skills and labor market success focuses on Anglo-Saxon countries, we outline first a few relevant studies the North Americas and the UK before we look at other countries, including Germany.

Dougherty (2003) uses data for the US from the NLSY which provides test scores from the Armed Services Vocational Aptitude (ASVAB) test. Rather than using the composite AFQT score that can be derived from the ASVAB scores, the author employs numeracy scores, based on the individuals’ arithmetic reasoning attainment, and literacy scores, a joint verbal composite based on word knowledge and paragraph comprehension. The results suggest that numeracy is strongly related to earnings, working indirectly via its effect on college attainment but also directly, controlling for educational attainment. While the effect is small in absolute terms, it appears to increase over the 1988-1996 period covered in the analysis. Compared to that of numeracy, the literacy earnings gradient is smaller and less significant.

Ishikawa and Ryan (2002) use only the prose literacy measures from the 1992 National Adult Literacy Survey (NALS) for the US and examine both the formation of basic skills and their association to earnings. They attempt to disentangle basic skills that are learned in school from those acquired in the post-school periods and conclude that it is the “substance of learning in school [...] that counts” (ibid., p. 241), which emphasizes the need to account for both schooling and basic skills. Their results further suggest that compared to their white or hispanic counterparts, black workers do not benefit from basic skills acquired in school.

McIntosh and Vignoles (2001) use data from the 1991 British National Child Development Study (NCDS) and data on the UK from the 1994 IALS.3 The authors focus on individuals in the bottom part of the skills distribution, and their findings for numeracy imply that low skilled individuals are substantially more likely to be employed, and, if employed, earn some 16-21% more than the lowest skilled. The results for literacy are more heterogenous and there are large differences between results based on either data set, so that the authors avoid a concluding answer.

This is interesting on its own, since the authors compare the methodological strengths and, above all, weaknesses of both data sources. The authors in fact conclude that both data sets “... suffer from significant, but different, measurement problems” (McIntosh and Vignoles, 2001, p. 474).

Another recent study for the UK is by Vignoles et al. (2011) who use data from the British Cohort Study (BCS) for 2004, and, for comparison over time, NCDS data for 1995. Similar to the study by McIntosh and Vignoles (2001), the authors find that both numeracy and literacy skills measured at age 16, 21, and 34 are positively related to the earnings of 34-year old workers.

The earnings premia are at about 11% for a standard deviation increase in numeracy, and 14% for literacy, respectively, with no substantial differences between men and women. These results are robust to a range of different specifications. The findings further imply that despite numerous policy efforts to increase the supply of skills over the period 1995 to 2004, the value of basic skills has remained stable in the UK.

Evidence for full-time working male Canadians is provided by Green and Riddell (2003) who use the country component of the 1994 IALS. They employ the average of test scores on document, prose and quantitative skills and run quantile regressions in order to examine whether basic skills vary across the wage distribution. Their results however suggest that this is not the case, but they too find a strong association between their skills measure and the earnings of male workers.

The analysis of Shomos (2010) complements the overall picture of the positive relationship between adults’ basic skills and labor market success as measured in earnings. Using data from the Australian Adult Literacy and Lifeskills Survey (ALLS)4 for 2006, his results suggest a 14 percentage points increase in wages for an increase in skills, which are measured in categories, from the lower to the next higher skill level. Separated by gender, there are somewhat stronger effects for men than for women.

One of the few studies on non-Anglo-Saxon countries is by Denny and Doyle (2010) who use the 1998 IALS components for the Czech Republic, Hungary, and Slovenia. The authors employ semi-parametric econometric techniques and find that returns to basic skills are significant in Slovenia and the Czech Repulic, but to a lesser extent in Hungary. Based on the flexible semi-parametric part of their analysis, the authors conclude that the returns vary considerably between numeracy and literacy as well as across the countries in their sample.



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