Interpreting Sheepskin Effects of Investment in Schooling

In the last few years, significant amount of research has produced evidence in support of the signaling, credential or “sheepskin” effects in rates of return to schooling for studies of the developed as well as developing countries. An example of the former is the seminal empirical work by Hungerfold and Solon (1987) as well as more recent research for the U. S. [Park (1999) and Flores-Lagunes and Light (2007)] and other developed countries [Mcguinness (2003) and Antelius (2000) for Europe, for instance, and Bauer et al. for Japan (2004)]. Examples of such work for developing countries include Shabbir (1991) for Pakistan, Schady (2003) for the Philippines, and Mora (2008) for Colombia.Testing the sheepskin or credential hypothesis is tantamount to ascertaining if the marginal rate of return to education increases discontinuously for the years when completion diplomas (or degrees) are awarded to the individual.Despite the existence of sheepskin effects, very few attempts have been made either for developed or developing countries to specifically try to identify the possible channels by which such effects may exert themselves. Notable exceptions are Flores-Lagunes and Light (2007) for the U. S. and Riddle (2008) for Canada..This paper tries to address this neglected yet important question by empirically exploring this question in the case of Pakistan. Specifically, this paper explores the above question of interpretation of sheepskin effects in the case of Pakistan. Using the IFPRI-sponsored, 1987 Pakistan Survey of Rural Education, Migration and Employment (PSREME), it tests the hypothesis whether observed sheepskin effects are signaling individual innate ability and/or family background. Thus understanding more fully the sheepskin mechanism, will allow us to better appreciate the role of schooling and degree completion in determining earnings.According to the results of this paper, the sheepskin effects prove to be robust both to an inclusion of measures of innate ability as measured by Raven Progressive Matrices and ‘cognitive’ ability that is based on specially administrated tests of literacy and numeracy as well as measures of family background.This is an important finding with significant policy implications for the debate on the social vs. private returns to schooling investments. The present paper shows that the sheepskin effects as observed in this sample are particularly robust and are not mediated via individual’s innate ability as measured by the Raven Progressive Matrices or measured family background. Thus we will need to continue to explore