Schooling as a Signal

1. Schooling as a Signal

2. The Schooling Model we saw in a previous section assumed that education really increases a worker’s productivity. Here we will study an alternative idea – schooling does not increase productivity, but sends a “signal” that a worker can handle a certain type of work. Table of info Type of worker proportion in population lifetime earning Low-productivity q $200,000 High-productivity 1-q $300,000 In the table here low-productivity workers make up q percent of the population and earn $200,000 over their lifetime (in present value terms), while high-productivity workers make up 1-q percent of population and they earn $300,000 over their lifetime. The problem for a firm in this is that it is not cheap to figure out if a worker can handle a job or not. So, the firm would prefer the workers send signals about their ability to do the work. Low productivity workers may not even know they are low productivity, so they would probably say they should get the $300,000 jobs!

3. If there is no signal the firm will not know which worker is which and will thus pay an “expected wage” to both and that wage is q(200,000) + (1-q)(300,000) = 300,000 – 100,000q. Now, since q can range from 0 to 1, the earnings will range from 200,000(like when q =1) to 300,000(when q = 0). When the firm can not distinguish between the types of workers the firm just “pools” them and pays the one wage to all. As an example, say q = .5. Then all would make $250,000. The low-productivity worker would like this because of being paid more than what they should be paid. The high-productivity workers will not like this because of getting paid too low. The firm will not like it either because they would find they are mismatching workers with jobs and this would lead to lower efficiency. So the high-productivity worker has an incentive to send a signal and the firm has an incentive to require that a signal be sent. It helps both. When you think about it the low-productivity workers are helped as well because if they get into high-productivity job they will not perform and they will get fired.

4. Let’s say that the signal required is for workers to reveal their level of schooling and the firm requires ybar years of college to get the high-productivity job. Major assumption: high-productivity workers and low-productivity workers do not have the same cost of getting a year of education. The tuition and fees are the same, but the logic is the low-productivity worker will have to spend more time studying and may have to buy tutors, study guides and special classes. Let’s say the high-productivity worker can get a year of schooling for $20,000, while the low-productivity worker can do it for $25,001. A low-productivity worker will make $200,000 (over their lifetime in present value terms) if they get less than ybar years of school. If they get ybar years of school they will make $300,000, but they will have to pay 25,001 per year to do it. The net income then would be 300,000 – 25,001ybar The low-productivity worker will not go to college if 200,000 > 300,000 – 25,001ybar, which means if ybar >100,000/25,001= 3.999 So, if the firm requires more than 3.999 years of schooling the low-productivity workers will find it too expensive to get the high productivity job and will in fact not go to college at all because even some college will not change earnings.

5. If the firm requires more than 3.999 years of schooling the low-productivity workers will “signal” to the firm their low-productivity skill level. The high-productivity worker will go to college if 200,000 < 300,000 – 20,000ybar, which means if ybar < 100,000/20,000= 5 So, high-productivity workers will go to college as long as they do not have to get too much schooling, here less than 5 years. So when firms say the signal for schooling is not less than 3.999 but not more than 5 the workers will be separated into their own groups.

6. Public Policy The human capital model suggested education increased productivity and thus accounted for the higher income of more educated people. The signaling model also says more educated get more income, but for a different reason – it signals the worker’s innate ability that is otherwise difficult to see. The human capital model would suggest government intervention in the form of educational assistance can lift people to higher wages, whereas the signaling model indicates the education won’t really change the wages of workers, but will just get the right workers into the right jobs.