Labor Market Absorptive Capacity and the Employment Effects of Education Across Development Stages

Abstract

This study examines how labor market absorptive capacity shapes the relationship between education and employment across stages of economic development in developing economies. Rather than assuming a uniform relationship, the study argues that the employment effects of education depend on the economy’s ability to absorb educated labor through structural transformation and demand for skilled workers. The analysis distinguishes between lower-middle-income and upper-middle-income countries during the period 2000–2024. A dynamic Panel ARDL framework is employed to estimate short-run and long-run relationships, while the Lind–Mehlum test is used to examine nonlinearities and educational thresholds. The findings reveal significant heterogeneity across development stages. In lower-middle-income countries, the relationship between education and employment follows an inverted U-shape, suggesting that the employment gains from educational expansion decline beyond a certain threshold due to limited absorptive capacity and weak structural transformation. In upper-middle-income countries, education continues to exert a positive effect on employment, although with diminishing marginal returns and without strong evidence of a statistically significant threshold. The study concludes that the employment impact of education depends largely on the structural capacity of economies to create skilled employment opportunities, emphasizing the need to align educational expansion with labor market development and structural transformation.