This paper examines the causal effect of education on earnings in Israel. The Ordinary Least Squares coefficient of earnings on schooling (the "Mincer" coefficient) is likely to be biased upwards because it ignores the unobserved 'ability' which is correlated with schooling and has a positive effect on earnings. We use two methods to estimate the causal effect of education on earnings: The first is to use proxy variables - variables that are correlated with the unobserved "ability" of the individual, such as his mother's education and his brother's wage. The second method is to use the "Free High School Law" as an instrumental variable, a Law which also raised the minimal age limit for compulsory education by one year. This Law increased the years of schooling of students whose father was born in Asia or Africa. We find that the causal effect estimated by the instrumental variable was not different from that obtained using Ordinary Least Squares regressions: the return to one year of education (among Asian-Africans) obtained using the instrumental variable was 12.4 percent in 1995, and 8 percent in the years 1996-2005. These estimates are not significantly different from those received using the OLS regression, 9.5 percent. Thus, the additional wage earned by receiving an extra year of education with government support is no less than that earned without such support.
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