Skill, parental income, and IV estimation of the returns to schooling

Recently, attention has moved away from using parental background variables, such as parental education, in favour of using institutional features of the education system as instruments when estimating the return to schooling. In this paper, these possible instruments are revisited. Using the National Longitudinal Survey of Youth, several specifications of the wage equation are estimated and three types of instruments used - parental education, quarter of birth, and college proximity. It is shown that under some specifications - in particular, by including parental income and individual skill in the wage equation - parental education appears to be a valid and useful instrument. On the other hand, when using the institutional instruments, the weak correlation between the instruments and years of schooling produces imprecise and likely biased estimates of the return to schooling.