employment probabilities and access to better quality jobs (as measured by the level of formality), converged (Figure 8). Employment in the formal sector of the economy had been declining in the region from 1990 to 2005, but increased by about 5 points thereafter. Country data reveal that, with the exceptions of Bolivia, El Salvador, Mexico and Uruguay, formal employment increased throughout the 2000s (Table A.8). The extent to which this combination of labor market factors generates substitution and income effects will be addressed in Section 4.

# **3.3 Returns to education**

The macroeconomic environment and labor market conditions discussed above are expected to affect household schooling investment decisions mostly through the short run substitution effect related to the opportunity cost of time. In contrast, returns to education may also affect enrollment, but are linked to more structural factors such as the quality of education and the long run rewards to graduating from different schooling levels. Returns to education are normally regarded as a measure of the extent to which the labor market values different types of skills at different times.<sup>34</sup> In this case we expect that higher perceived long-term returns would be associated with higher current school enrollment rates, and vice versa. If education is perceived of low quality or relevance in terms of generating lower future labor market rewards, the marginal benefit of schooling investment will be lower, with consequent higher dropout.

It is important to stress, however, that the returns to education do not only reflect school quality, and the same type of education can be subject to higher or lower rewards, depending on context. In particular, factor endowments determine production structures and therefore the demand for different skill types, which can alter the returns to education, and thus the incentives to invest in it. Substantial natural resources, for example, have been commonly thought to lead to production structures in which returns to broad education are limited, while the returns to some forms of specialized technical education (e.g., mining engineering) may be high. Furthermore, as noted by Spilimbergo, Londoño and Székely (1999), the rewards to education are affected not only by the scarcity or abundance of factors of production in each country, but also by the extent to which each country is exposed to international trade. For example, if a country opens up to trade there will be more incentives to acquire education because trade openness generally involves more rapid changes in technology and in capital, which may have positive effects on the returns to education (e.g. Rosenzweig (1990), and Foster and Rosenzweig (2004)).

Recent qualitative evidence suggests that education’s perceived relevance is in fact strongly related to USE demand decisions among youth in the region. According to self-reported survey data on school dropout by adolescents in 8 LA countries, the first cause of school exit for 33 percent of youth that reach LS and USE age is “lack of interest in attending” –which can be interpreted as being related to perceived lack of relevance and future low returns to schooling (Alfonso et.al.

> 34 As discussed by Murane (2013), the schooling’s value can change through channels including higher productivity, exogenous economic factors, but also changing value of school credentials related to socioeconomic status, etc.

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