How Responsive Is Investment in Schooling to Changes in Returns? Evidence from an Unusual Pay Reform in Israel's Kibbutzim. NBER Working Paper No. 17093

This paper uses a novel dataset to test the important theoretical prediction that the level of investment in schooling is increasing in the rate of return to education. We exploit a unique episode where different Israeli kibbutzim shifted from equal sharing to productivity-based wages in different years, resulting in sharp increases in the return to education. We use a difference-in-differences approach comparing educational outcomes of high school students in kibbutzim that reformed early (the treatment group) and late (the control group), before and after the early reforms (but before the late reforms). The treatment group is shown to be nearly identical to the control group in observable characteristics and pre-reform mean outcomes. We find that students in kibbutzim that reformed early increased their investment in education, as reflected by outcomes such as whether they graduated high school and their average matriculation scores. This effect is stronger for males, and is mainly driven by students whose parents have lower levels of education. It is also stronger for students in kibbutzim that reformed to a greater degree. We use various falsification tests to support our identification strategy and to show that our results are not driven by other factors such as differential time trends or differential exit rates. Our findings support the prediction that education is highly responsive to changes in returns, especially for students from weaker backgrounds.