Lower and Upper Bounds of Returns on Schooling : An Exercise in IV Estimation with Different Instruments

Many recent studies that were based on "exogenous" sources of variation in education outcomes' IV estimates of returns to schooling were substantially higher than the corresponding OLS estimates. Card (1995a) suggests that these results are explained by the existence of heterogeneity in individual returns and by the fact that these studies are based on instruments that influence only the educational decision of individuals with high marginal returns due to either liquidity constraints or to high ability. This conclusion is consistent with the Local Average Treatment Effect (LATE) interpretation of IV (Imbens and Angrist, 1994) according to which IV identifies only the average returns of those who comply with the assignment-to-treatment mechanism implied by the instrument. We show evidence for Germany suggesting that returns to schooling are heterogeneous, instruments matter and the LATE interpretation of IV makes sense. With an appropriate choice of instruments we also show how IV can be used to approximate the range of variations of returns to schooling in Germany