New research in the Bank of Israel: The Return to Education-The Causal Effect of Education on Wages in Israel

25.2.2007

New research in the Bank of Israel: The Return to Education––The Causal Effect of Education on Wages in Israel

The views expressed in this paper do not necessarily reflect those of the Bank of Israel

	The return to education in the past decade has settled down at a high level – raising education by one year had the effect of raising wages by 8.6 percent in 2004–05, similar to the effect in 1996–97.
	The research found that wage gaps between the educated and uneducated was wholly explained by the level of education, thus rebutting the claim that wage gaps stem from other variables such as differences in IQ or motivation between the groups.
	In order to examine the relationship between education and wage we examined the effect of the Free Secondary Education Law. The law that came into effect in 1979 increased the number of years of education for second-generation Israelis of Asian and African origin. It was found that extending education by one year, as a result of the law, increased wages by more than 8 percent.
The Bank of Israel today published a new study by Roni Frish of the Research Department, in which the author finds that the addition of one year to education raises wages for the individual by 8.6 percent. The research used two methods commonly found in literature to estimate the relationship between education and wages. The first method used environmental conditions of the individual and, indirectly, also his IQ; as we had no direct measure of the individual's IQ, we used proxy variables of his family––his mother's education, his father's wage and his siblings' education. It is acceptable to use such variables not only to teach us about the individual's environmental conditions but also as a measure of his abilities.
The second method of measuring the relationship between education and wages is to identify an extraneous event that resulted in the individual’s educational level being raised. The event examined in this paper was the coming into effect of the Free Secondary Education Law in 1979 and its raising of the upper age limit for compulsory education by one year (up to Grade 10). This event raised the number of years of education for children born to parents who immigrated from Asia and Africa and who were still in secondary education when the law came into effect. Using this law has an obvious advantage; it extended the education of an entire population group, and not necessarily only of the talented among them. Comparing wages of the generation affected by this law with the previous generation would therefore allow us to isolate the contribution of education to wages. It was found that the return to one year of education among young workers of Asian and African descent (who had reached secondary school age after the new law came into effect) was, on average, 8 percent in the period 1996–2005 and 12.4 percent in 1995; the 1995 sample was based on the population and housing census of that year and which included 20 percent of the population.
The findings of this research strengthen the recognition of education's contribution to wages found in earlier studies, despite the fact that the previous research ignored features such as IQ and motivation (and this despite the fact that the educated usually have higher abilities and motivation on average than the uneducated). This conclusion does not contradict that found widely in literature elsewhere. We can therefore also learn from the experience of the Free Secondary Education Law that return on state investment in education is not lower than the return on private investment and that state investment in education does contribute to reducing economic inequality.

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