Higher Schooling Investments and Poverty in the Indian Economy

The Government of India has historically placed a relatively high weight on higher schooling, presumably because of its correlation with economic growth. Because credit constraints forge a close dependence of schooling attainment on household income, this pattern disproportionately favors wealthy households. The likely impact could be mitigated through the labor market, if the increase in the supply of highly schooled skilled workers generated an increase in the demand for poor unskilled labor, and in unskilled wages. However, there appears to be no correlation between the stock of skilled labor and unskilled wages in the urban Indian economy. This paper argues that the lack of correlation between higher schooling investments and the wages of the poor reflects the imperfect functioning of labor markets. Descriptive statistics on schooling and public sector employment are provided, as well as data on the importance of public sector employment in the urban Indian economy. A theoretical framework is then sketched, which shows how labor market distortions, specifically public sector employment rules, affect the availability of skilled labor to the informal sector and, through this, the wages of unskilled labor. I use this framework to show the wage effects of a schooling policy which increases investments in higher schooling only, thereby keeping fixed the number of the unskilled. Regression results suggest that reductions in public sector wages would significantly increase the spillover benefits from government expenditures on higher schooling for the poor.