Unobserved Ability, Comparative Advantage, and the Rising Return to Education in the United States 1979-2000

This paper quantifies the change in the causal effect of education on labor market earnings in the United States between 1979 and 2000. In absence of valid instrumental variables for schooling, a causal model for earnings and schooling that incorporates heterogeneity in absolute and comparative advantage across individuals is used to impose some structure on the observed relationship between schooling and earnings. A simple intuition arises from the model: if individuals with higher returns to schooling acquire more schooling, the relationship between log earnings and schooling will be convex in the population. Likewise, for a fixed cohort of individuals, the degree of convexity will rise over time if the causal return to education rises. Differences across cohorts in the mapping between schooling and ability will lead to permanent differences in the profiles of the earnings-schooling relationship. Changes in the observed relationship between schooling and earnings can therefore be decomposed into year-specific and cohort-specific factors corresponding to causal and confounding components. Using CPS data for cohorts of men born between 1930 and 1970, I find that the causal return to education increased by 30% between 1979 and 2000, after controlling for the confounding effects of time-varying ability and comparative advantage biases across cohorts.