This Productivity Commission staff working paper (by Matthew Forbes, Andrew Barker and Stewart Turner) was released March 2010. Human capital theory supports the view that people with higher levels of education and lower incidences of chronic illness should have higher labour productivity. Hourly wages can be used as an indicator of labour productivity. While wages are likely to be a reasonable indicator of the effects of education on labour productivity, statistical issues and the way that labour markets function in practice mean that using wages as an indicator could lead to results that under- or overstate the negative effects of ill health on labour productivity. In this paper, higher levels of education are estimated to be associated with significantly higher wages. A second objective of this paper is to estimate the potential productivity of people who are not employed or not in the labour force. These people tend to have characteristics that are systematically different to people who are employed. For example, they tend to have less education and work experience, and also to be in worse health. Because of this, they are more likely to be targeted by government programs. The views expressed in this paper are those of the staff involved and do not necessarily reflect those of the Productivity Commission.