Department of Economics

This paper examines the causal association between family background characteristics--parental education and family size-and returns to schooling using data from the Occupational Change in a Generation Survey. I first develop a formal model of schooling and earnings, with heterogeneous returns to education. Family environment is shown to influence the marginal return to schooling through its effects on the marginal benefit and the marginal cost of an additional year of education. Using two types of exclusion restrictions, I find that men raised in larger families have substantially lower returns to education, while the combined effects of parental education on the returns to education are more modest. I also examine the difference between OLS and TSLS estimates of the return to schooling. Like other “supply-side” IV studies of the causal effect of education, this paper documents TSLS estimates that are larger than the corresponding OLS estimates. The results of this paper provide an alternative explanation for this phenomenon: constant marginal returns to schooling, combined with a negative ability bias and a positive self-selection bias (i.e. non-hierarchical sorting).