Signaling and Employer Learning with Instruments
Gaurab Aryal, Manudeep Bhuller, and Fabian Lange
NBER Working Paper Series
We show how we can use instrument to disentangle social and private returns to education, when schooling can increase productivity and also be used to signal productivity. Within the employer learning framework of Farber and Gibbons  and Altonji and Pierret , we show that instrumental variable (IV) estimates of the returns to education among experienced workers identify the social returns to education. What the IV identifies among less experienced workers depends on whether it is hidden from or observed by employers. If the IV is hidden then it identifies private returns to education, but if it is transparent then it identifies social returns to education. We use local variation in compulsory schooling laws across multiple cohorts in Norway as an IV to estimate our model. Our preferred estimates indicate that the social return to an additional year of education is 6.3%, and the private internal rate of return, aggregating the returns over the life-cycle, is 7.9%. Thus 80% of the private return to education can be attributed to education raising productivity and 20% to education signaling worker’s ability. Extending our framework to allow for productive externalities, we find evidence indicating large external returns to education, which suggests that social returns could exceed private returns.