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Unobserved Ability and the Return to Schooling

  • Belzil, Christian

    ()

    (Ecole Polytechnique, Paris)

  • Hansen, Jörgen

    ()

    (Concordia University)

We estimate a structural dynamic programming model of schooling decisions with unobserved heterogeneity in school ability and market ability on a sample taken from the National Longitudinal Survey of Youth (NLSY). Both the instantaneous utility of attending school and the wage regression function are estimated flexibly. The null hypothesis that the local returns to schooling are constant is strongly rejected in favor of a convex wage regression function composed of 8 spline segments. The local returns are very low until grade 11 (1% per year or less), increase to 3.7% in grade 12 and exceed 10% only from grade 14 to grade 16. The average return increases smoothly from 0.4% (grade 7) to 4.6% (grade 16). The convexity of the log wage regression function implies that those who obtain more schooling also experience higher average returns. We strongly reject the null hypothesis that unobserved market ability is uncorrelated with realized schooling attainments, which underlies many previous studies that have used OLS to estimate the return to schooling. The correlation between realized schooling and market ability is found to be positive and is consistent with the existence of a positive “Ability Bias”.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 508.

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Length: 27 pages
Date of creation: May 2002
Date of revision:
Publication status: published in: Econometrica, 2002, 70 (2), 2078-2091
Handle: RePEc:iza:izadps:dp508
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  1. Belzil, Christian & Hansen, Jörgen, 2002. "A Structural Analysis of the Correlated Random Coefficient Wage Regression Model," IZA Discussion Papers 512, Institute for the Study of Labor (IZA).
  2. Douglas Staiger & James H. Stock, 1994. "Instrumental Variables Regression with Weak Instruments," NBER Technical Working Papers 0151, National Bureau of Economic Research, Inc.
  3. Belzil, Christian & Hansen, Jörgen, 2002. "Unobserved Ability and the Return to Schooling," IZA Discussion Papers 508, Institute for the Study of Labor (IZA).
  4. Eckstein, Z. & Wolpin, K.I., 1997. "Youth Employment and Academic Perfomance in High School," Papers 24-97, Tel Aviv.
  5. Charles F. Manski & John V. Pepper, 1998. "Monotone Instrumental Variables: With an Application to the Returns to Schooling," Virginia Economics Online Papers 308, University of Virginia, Department of Economics.
  6. Christian Belzil & Jörgen Hansen, 2001. "Heterogeneous Returns to Human Capital and Dynamic Self-Selection," CIRANO Working Papers 2001s-10, CIRANO.
  7. Richard Blundell & James Powell, 2001. "Endogeneity in nonparametric and semiparametric regression models," CeMMAP working papers CWP09/01, Centre for Microdata Methods and Practice, Institute for Fiscal Studies.
  8. Kenneth I. Wolpin & Mark R. Rosenzweig, 2000. "Natural "Natural Experiments" in Economics," Journal of Economic Literature, American Economic Association, vol. 38(4), pages 827-874, December.
  9. Keane, Michael P & Wolpin, Kenneth I, 1997. "The Career Decisions of Young Men," Journal of Political Economy, University of Chicago Press, vol. 105(3), pages 473-522, June.
  10. James Heckman & Edward Vytlacil, 1998. "Instrumental Variables Methods for the Correlated Random Coefficient Model: Estimating the Average Rate of Return to Schooling When the Return is Correlated with Schooling," Journal of Human Resources, University of Wisconsin Press, vol. 33(4), pages 974-987.
  11. Whitney Newey & James Powell & Francis Vella, 1998. "Nonparametric Estimation of Triangular Simultaneous Equations Models," Working papers 98-16, Massachusetts Institute of Technology (MIT), Department of Economics.
  12. Narayana R. Kocherlakota, 1996. "The Equity Premium: It's Still a Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(1), pages 42-71, March.
  13. Lang, Kevin, 1993. "Ability Bias, Discount Rate Bias and the Return to Education," MPRA Paper 24651, University Library of Munich, Germany.
  14. Rust, John, 1987. "Optimal Replacement of GMC Bus Engines: An Empirical Model of Harold Zurcher," Econometrica, Econometric Society, vol. 55(5), pages 999-1033, September.
  15. Christian Belzil & Jörgen Hansen, 2001. "Estimating the Intergenerational Education Correlation from a Dynamic Programming Model," CIRANO Working Papers 2001s-20, CIRANO.
  16. Audrey Light & Wayne Strayer, 2000. "Determinants of College Completion: School Quality or Student Ability?," Journal of Human Resources, University of Wisconsin Press, vol. 35(2), pages 299-332.
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