Home > Economics, Education > College Degree Wage Premiums: Signaling vs. Human Capital Accumulation

College Degree Wage Premiums: Signaling vs. Human Capital Accumulation

The general consensus in the sub-field of education economics is that college graduates command a wage premium because of two separate effects: human capital accumulation (a.k.a. learning) and signaling (a.k.a. getting a piece of paper for being a good little monkey and jumping through the hoops). Every study I have read on the subject comes to a different conclusion about how much of the premium comes from human capital, and how much comes from signaling. The general consensus, from what I remember from the survey course I took in 2008, is that the majority of the effects come from signaling.

This recent study done at Georgetown, that specifically looks at wages and how they are effected by college degrees and other factors such as demographic identity and occupational choice, doesn’t really tell us anything that is new. It does have some surprising figures about proportions of relatively uneducated people who hold “highly respectable” occupations such as executives and legislators, but all in all it isn’t paradigm shifting or even a surprise to anyone who is already familiar with the subject.

This article makes the claim that signaling makes up most of the wage premium. The article is a commentary on the aforementioned study, and more anecdotal than empirical in its analysis, but it does make interesting implications about the supposed bubble in higher education.

It is hard to measure a bubble in higher ed. Most of the models would compare job openings to the number of people with degrees qualified for those jobs, and then would discount the future projected earnings of the graduate back to a comparison with the cost of attaining the degree itself. The issue I have with this approach is that a college degree has value beyond the wage premium that its holder can command. If it is a signal to employers of your aptitude, it is also a social signal to friends, peers, colleagues, strangers, and prospective mates that you are “college educated” and in some ways a more worthy person. The social benefits can be measured in dollar terms with regressions and analysis, but I maintain that most of them are intangible or too sensitive to noise variables for such measurement to be of much use. That still leaves us with the benefits of human capital accumulation that don’t necessary make their way into your wages. It seems reasonable to assume a person with an education in history or the arts will have a different, and probably greater, appreciation for life and the world around them than someone without a commensurate level of education, whether that education is formal or informal. Then of course there is the entire undergraduate college experience; the parties, access to social groups and mating partners, clubs, associations, the existential joys of being somewhere between adolescence and full blown adulthood.

So in so much as you can’t calculate the non-economic benefits of a college education, it is hard to say whether or not there is a bubble. It is certainly true that there are more people with degrees and less jobs for them to fill, but the cultural importance we place on higher ed makes it seem like there will be no shortages of college applicants in the coming years.

I personally don’t think that a general bubble in higher ed is possible. There may be smaller, mini-bubbles within certain subsectors of the industry, such as online MBA’s or vocational training certifications offered by for-profit institutions, but that is because these degrees are presented primarily as preparation for a job. You do get a certain amount of human capital accumulation by earning one of these degrees, but it is of the type that will only be helpful to you within your prospective vocation. To a large extent, you also miss out on the “college experience” that I described earlier.

The question I find myself wondering about is whether signaling is economically valuable, and if so, to what extent. It certainly has value to employers, who use it as a sorting mechanism when hiring (so it decreases the costs of the hiring process), but if we consider how much productivity a graduate adds to a firm, it would seem that the human capital element is the main value driver.

The extension of this line of thought would lead one to believe that there is a huge inefficiency in the labor market. Ultimately, the signaling part of the premium doesn’t give employers a very good return. People without signals, or with suboptimal signals (a state college degree instead of an Ivy League) are very likely be undervalued by a firm, and people with signals but without the human capital to match (think of the George W. Bush’s of the world, with their Ivy League graduate degrees bought with equal parts daddy’s money and “hard” work) are most likely overvalued. The amount they are overvalued would be the amount of their wage premium attributed to signaling, less the hiring cost savings of the signaling mechanism itself. I am not sure how to calculate the hiring cost savings; perhaps the best way would be using a replacement cost method, such as the costs of testing the general and technical aptitude of job applicants. I would imagine this cost is generally small, and most if not all of it could be passed onto the applicant. Passing the costs onto the applicant creates another signaling mechanism; high ability people will self select their way into the applicant pool and low ability people will be discouraged from applying. Why don’t more employers do this?

I sympathize with employers making hiring decisions: how do you weed out the “phonies” with low human capital but strong signals, from the high human capital applicants? Maybe the process is easy for some managers, but the costs of hiring the wrong employee are staggering. To me, it seems that there is a severe underinvestment in methods of differentiating signaling from human capital accumulation for job applicants.

I recently submitted my resume to a staffing service and had to take a battery of tests to prove my proficiency in certain software applications and general accounting knowledge. I scored highly on the tests, and was happy to have taken them. Not only does it dispel ambiguity for employers, it takes the burden off of me to exaggerate my own signaling efforts in an interview.

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Categories: Economics, Education
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