Education Expansion, Sorting, and the Decreasing Wage Premium

Abstract

This paper studies the interplay between education expansion and workers and firms sorting in Portugal between 1987 and 2017. The Portuguese labor market is characterized by three facts: a decreasing high school wage premium, a dramatic increase in supply of high school graduates, and an increasingly unbalanced distribution of high school graduates across industries. To quantify the impact of the latter two on the former, I build a model of one-to-many matching where workers sort with firms based on their own preferences, their relative productivity within the firm, and substitution patterns with other workers. Using tool from the optimal transport literature, I solve the model and structurally estimate it on matched employer-employee data. Estimates suggest changes in sorting are mainly driven by heterogeneous increase in relative productivity of high school graduates relative to non graduates across industries. It acts as a mitigating force on the decreasing high school wage premium, but does not fully compensate for high school graduates’ rise in relative supply.