01 December 2011

Signaling and the College Bubble

From Bryan Caplan:
Many educators sooth their consciences by insisting that "I teach my students how to think, not what to think."  But this platitude goes against a hundred years of educational psychology.  Education is very narrow; students learn the material you specifically teach them... if you're lucky. 
Other educators claim they're teaching good work habits.  But especially at the college level, this doesn't pass the laugh test.  How many jobs tolerate a 50% attendance rate - or let you skate by with twelve hours of work a week?  School probably builds character relative to playing videogames.  But it's hard to see how school could build character relative to a full-time job in the Real World.
At this point, you may be thinking: If professors don't teach a lot of job skills, don't teach their students how to think, and don't instill constructive work habits, why do employers so heavily reward educational success?  The best answer comes straight out of the ivory tower itself.  It's called the signaling model of education - the subject of my book in progress, The Case Against Education. 
According to the signaling model, employers reward educational success because of what it shows ("signals") about the student.  Good students tend to be smart, hard-working, and conformist - three crucial traits for almost any job.  When a student excels in school, then, employers correctly infer that he's likely to be a good worker.  What precisely did he study?  What did he learn how to do?  Mere details.  As long as you were a good student, employers surmise that you'll quickly learn what you need to know on the job.
In the signaling story, what matters is how much education you have compared to competing workers.  When education levels rise, employers respond with higher standards; when education levels fall, employers respond with lower standards.  We're on a treadmill.  If voters took this idea seriously, my close friends and I could easily lose our jobs.  As a professor, it is in my interest for the public to continue to believe in the magic of education: To imagine that the ivory tower transforms student lead into worker gold.
What makes the college bubble so problematic is that it is essentially inflationary.  College degrees can be considered a form of currency in the labor market, wherein one purchases a salary with not only one’s labor but one’s college education as well.  Obviously, this mechanism is not as direct as, say, buying milk at a grocery store, but the effect is similar.

The labor market, then, relies on college degrees to indicate a prospective employee’s fitness for the salary being offered.  Certain types of degrees generally pay better than others, certain colleges’ degrees pay better than others, certain grade point averages are worth more than others, etc.  Someone who receives an MBA from Harvard while maintaining a GPA of 4.0 will generally earn more than someone who receives an Associate’s degree from ITT Tech while maintaining a 2.0 GPA.  This should make sense, as the quality of student varies by institution, degree, and grade, and there are ways to sort this.  The college bubble, then, serves as a form of inflation because it distorts the signal that a college has in the labor market.

Basically, as is well known, the college bubble is the result of massive governmental interference in the post-secondary education market.  The federal government offers direct subsidies of education costs (e.g. the Pell Grant), and also makes college loans a very enticing offer to lenders by guaranteeing the loans.  With direct subsidies and easy credit, prospective students have a very strong incentive to go to college.  Furthermore, with this much money on the line, colleges have a very strong incentive to accept more students.

The effects of this bubble, as noted before, are seen primarily in signal distortion.  This occurs because employers now have a larger labor from which to select workers.  This generally seems like a good thing, since employers can now offer lower wages, but this is not always the case because some potential workers are perhaps not as well-qualified for their position as others.  The problem with using college degrees as a qualification is that, at this point, there isn’t enough data to sort the good from the bad.  When there were a limited number of college-educated labor candidates, the quality was considerably better since colleges had an incentive to maintain quality control.  This is no longer the case because the federal government is paying colleges, indirectly, to simply pass out degrees to young adults with no regards for their qualification.

Thus, the lower wages that have resulted from the increased pool of labor applicants can be thought of as a risk premium.  Because there are more college-educated people in the labor supply coupled with increased variance of abilities without there being an increase in the sharpness of the signal generally associated with a college education, and because American labor is tightly regulated with regards to discrimination (particularly as it pertains to firing employees), there is consequently more risk associated with hiring someone because the chance that person a company hires turns out to be a bust, as it were, is considerably greater.  Given the costs associated with firing incompetent workers, particularly if they are in a union or minority, employers have an increased incentive to mitigate that risk by offering lower wages.

As such, the most problematic aspect of the college bubble is the consequences that come with signal distortion.  Because the supply of college educated labor has increased with a matching increase in demand for said labor, and because a college degree isn’t nuanced enough as a single, there will be an increase in the number of people who are overpaid and an increase in the number of people who are underpaid.  This happens because the signal sent by a college degree is roughly the same for everyone who has one.*

Some people will be underpaid because their aptitude is such that they would ordinarily deserve more pay than they are currently receiving but, because it is now more difficult to tell who has what levels of aptitude, they must take a pay cut.  The reverse is true for those who are overpaid.  Basically, the inflation in the number of students undermines meritocracy, thereby distorting the pay scale.  Thus, the current bubble has introduced not only distortion, but market failure on a large scale.

The irony of the current college bubble is that its existence is largely predicated on the belief that a college education makes one more intelligent.  This claim is laughable on its face because it does not begin to account for the self-selection bias inherent in this sort of activity.  Do students learn because they go to college or do they go to college because they like to learn?  This is a crucial question because if the answer is the latter, then it seems likely that those who do go to college would become just as knowledgeable if they lived in a library for four years.

At any rate, the college bubble has had the nasty effect of giving diplomas to those who have no desire to learn, and have undermined the meritocracy that once was a college education, thereby depriving those who are truly above average from an income that would properly reflect this fact.  This, then, is the lamentable effect of the college bubble:  The attempt to make everyone equal in education has only led to a diminution of standards.  We are all idiots now.

* Obviously, a Harvard diploma is still more valuable than an ITT Tech diploma. However, if Harvard’s business school doubles the number of graduates, year over year, the value of a Harvard degree will decline assuming that there is not a corresponding increase in demand for Harvard grads.

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