ECON 381
Signaling in Education
Signaling in education
Suppose there are two types of workers – low productivity
workers and high productivity workers.
Individual workers know their own type, but employers
cannot costly observe a workers type
What will employer do? Hire workers and pay them a
wage equal to their average productivity. If high
productivity workers make up half of the population, the
wage will be (MPh+MPl)/2
This will be nice for low productivity workers, but high
productivity workers will not like it. They will have an
incentive to try to signal to employers that they are in fact
high productivity workers.
Signaling in education
How could they do this?
What if they could take some action that would be visible
to employers? For example, they could all get their hair
dyed pink. Would this work?
No, because all the low productivity workers would dye
their hair pink and then they would all look the same to the
employer
For high productivity workers to signal their type, they need
to find some action that they can take that low productivity
workers will choose not to imitate
Signaling in education
Some people have suggested that this is the primary
function of formal education
Let’s see how this could work. In order to make a nice
diagram, let’s assume that high productivity workers are
exactly twice as productive as low productivity workers.
Productivity is innate. Education does not increase
productivity.
Signaling in education
$
Education does not
increase productivity.
h types productivity is
twice as high as l
types
MPh=2MPl
MPl
Years of education
Signaling in education
Now let’s make some assumptions about costs. Suppose
it costs a low-ability person $C to complete a year of
education, but it costs a high ability only $C/2.
For example a low ability person might have to duplicate
courses to raise their GPA, spend more time studying, etc.
Suppose the high ability decide that they will get a degree
in order to signal to firms that they are high ability. Will the
low ability people imitate them?
It depends.
Signaling in education
$
Firms can tie wages to
education levels. If they
promise to pay Wh=MPh
to workers with a given level
of education, the benefit to
workers of getting that level
of education is
MPh-MPl=MPl.
Note that the magnitude of
this benefit does not depend
on the worker’s type.
What about the cost?
C
C/2
MPh=2MPl
MPl
Years of education
Signaling in education
C
$
Suppose the firm says it
will pay Wh=MPh to all
workers with an education
level of e0<e*.
C/2
MPh=2MPl
High ability workers will go
to school because the benefit
(=MPl) is greater than the cost.
MPl
But so will low ability workers.
So this won’t work.
e0
e*
Years of education
Signaling in education
C
$
Suppose the firm says it
will pay Wh=MPh to all
workers with an education
level of e1>e**.
C/2
MPh=2MPl
High ability workers will not go
to school for this long
because the benefit
(=MPl) is less than the cost.
MPl
So this won’t work
e** e1
Years of education
Signaling in education
But, for any level of
$
education such that
e*<e2<e**, the benefit to
high ability workers exceeds
their cost, and the benefit to
low ability workers is less than
their cost.
C
C/2
MPh=2MPl
MPl
So high ability workers get
the signal, and low ability
workers choose not to.
Firms will pay wages that
depend on education levels,
even though education does
absolutely nothing to make
workers more productive.
e* e2 e**
Years of education
Empirical evidence
A number of studies have tried to test the signaling
hypothesis. It’s not easy to do.
One example of an empirical test:
Consider three types of workers, and three levels of
schools (high school dropout, high school completion and
college).
Now consider two towns. Town A has a college nearby,
and Town B is a long way from any college
The costs of attending college in Town A is therefore lower
than the cost of attending college in Town B.
Empirical evidence
When the cost of attending college is lower, more people
choose to attend college.
The marginal person who attends college in Town A is not
as smart as the marginal person in Town B who attends
college.
This means that the marginal person who completes high
school but does not continue on in Town B is smarter than
the same person in Town A.
Empirical evidence
Now consider the decision of someone who is at the
margin of dropping out or completing high school.
If education acts as a signal, he will earn a wage equal to
the average productivity of workers who complete high
school but don’t go on to college.
This average ability level is higher in Town B, because lots
of smart people in Town B don’t go to college (because
it’s so far away).
So the really low ability guys have a greater incentive to
complete high school in the Town B than Town A.
Empirical evidence
A prediction of the signaling model is that high school
drop-out rates will be lower in communities that are a
greater distance from colleges.
This seems counterintuitive. It’s hard to think of any other
theory that would predict this.
When researchers went out to test this hypothesis, they
found it was supported in the data: drop-out rates are
higher when the costs of attending college are lower and
vice versa.
Empirical evidence
Other empirical evidence is less supportive of the
signalling model.
Role of signalling may differ at different levels of education.
e.g. the return to a high school diploma may reflect a
signalling components, but the return to a medical degree
likely reflects valuable human capital.