Estimating the returns to education for Australian youth via rank-order instrumental variables

This paper employs the rank-order instrumental variable (IV) procedure of Vella and Verbeek [Vella, F., Verbeek, M., 1997. Using rank order as an instrumental variable: an application to the return to schooling, CES Discussion Paper 97.10, K.U. Leuven.] to estimate the returns to education for Australian youth. The attraction of this approach is that it can account for the endogeneity of schooling in the wage equation via the use of instrumental variables without the use of exclusion restrictions. We find, after accounting for the endogeneity of schooling, that an additional year of schooling is associated with an increase in wages of approximately 8%. Furthermore, we find that the rank-order IV approach is able to identify the presence of endogeneity in this particular empirical example. However, despite this, the adjusted estimate of how schooling affects wage is close to the ordinary least squares (OLS) estimate.