The importance of the signalling mechanism in higher education

By Patrick Krassén -

The value of education to the individual can be measured in several ways. The most commonly used method is the ‘human capital theory’, in which education increases the abilities, skills and knowledge – summarised as human capital – of the individual, and thus of the society at large as well. High levels of education in a society also correlate with other positive factors, such as better health, higher life expectancy and more civic engagement.1

Education, however, has another important function: signalling. More specifically, signalling certain features that you have as a person – and in the context of education and skills, primarily signalling those features towards employers (with admissions tutors being another important group). This effect was originally identified in 1973 economics research by Nobel laureate Michael Spence2. The model was subsequently developed further by (fellow Nobel laureates) Kenneth Arrow and Joseph Stiglitz3. It builds on theoretical research regarding asymmetrical information; in this case, the asymmetry in information between the employer and the applicant regarding the applicant’s true skill level. As employers wish to hire as able employees as possible – especially for well-paying positions – this signalling mechanism can play an important role in accurate job-market matching.

Education – and this is especially true for higher education – signals that you are capable of handling and analysing information, sometimes in large quantities (studying); that you are able to complete tasks (passing exams); that you can work with others (group assignments); and that you are able to follow a schedule and can function in a social setting (attending, and showing up in time for, class). Many of these abilities are of course well-developed in high/upper secondary school. But in higher education, entry demands are higher, and the responsibility for passing lies more heavily upon the individual. Completing university and attaining a tertiary-level degree says something about you as a person for potential future employers – regardless of the subject you have studied.

Apart from this, there are also a number of other factors that signal that you are highly productive and have features that employers look for. Good grades for example,  But more importantly when it comes to higher education, what degree you have and at which institution you studied.

But, might one ask, doesn’t having a degree from an elite university show that you have attained the actual skills needed to perform the job in question? Yes – perhaps. An employer cannot be certain of this ex ante when reviewing applicants – and hiring an employee who lacks the skills needed can prove costly. Likewise it is both time-consuming and resource-intensive for employers to perform tests on all applicants that will show to a sufficient degree whether they have the skills or not, or even to interview all applicants.

To lower the timeframes and costs when searching for new employees, employers look for certain features in applications where applicants stand out. Have they studied at a ‘prestigious’ university? Did they also work whilst studying – and if so, was it work that had some degree of qualification, showing that the applicant is highly capable at managing both? Have they studied anything aside from their main degree subject? What extra-curricular activities were they involved in? Have they received any particular honours? Do they have trustworthy and high-level referees?

None of the above points really say anything concrete about the applicant’s ability to perform the tasks required for the job. But they work as signals – telling the employer: “This person is high-achieving, has taken steps to show that they do more than just study, or has studied more than their peers. They do this to signal to employers that they stand out from the rest, and should be hired.” Those applications that actually stand out are the ones that go through to the next round, and are maybe called for an interview.

Signalling thus functions as a remedy to the inefficiency caused by asymmetrical information. If the employer had full information about every applicant’s skills, signalling measures would not be necessary. Some, but not all, students know this – often through anecdotal evidence, such as stories from peers, family or alumni. Therefore, they try to show these signals in their résumés when applying for a job. And, taking it a step further back, some may even have these issues in mind when choosing which university to go to and which degree to pursue.

To summarise: Education increases the student’s human capital – but it also functions as a signalling mechanism.

Now, to the problem. Public investment in education is based largely on its presumed returns to society, in the form of increased human capital. But if education beyond a certain point only has a signalling function in most situations, then investments in education beyond that point will not yield returns to society. There is at that stage a risk of ‘over-education’. If education is subsidised at higher and higher levels for yet more and more students, then employers will have a harder time distinguishing those applicants that really do have higher productivity. The signalling effect becomes distorted, and graduates risk winding up in jobs with skill requirements they are over-educated for – or studying longer than necessary, to regain the signalling advantage. This has negative effects for society (since the marginal returns are weaker than intended), for the individual (who may have invested more time and money in education than necessary, or who is not receiving the expected returns to his or her level of education) and for employers (when the signalling mechanism is distorted, the costs for finding employees to match job requirements increase).

With this in mind, it should be noted that it is of course difficult to assess the exact proportion of education that functions as signalling. It is also difficult to measure which individual returns to education are based on signalling rather than actual skills. This perspective also, of course, only looks at the financial benefits of education; there are many other benefits4. For policymakers, however, the signalling effect perspective is important to keep in mind, for several reasons. There is an opportunity cost to investing in education, and the negative effects of over-education – through lower marginal returns, distortion of the signalling mechanism, and the “bumping-down” effect on lower-educated job seekers5  – can be highly problematic from an economic perspective6. There is, however, little empirical evidence available on what role signalling plays in job application and hiring situations. For some sectors, the ’diploma effect‘ (sometimes called the ’sheepskin effect’7) is especially significant; the marginal financial reward of having finished a degree are substantial. Having a degree becomes a minimum requirement to even be considered when employers are looking at job applications in such fields (i.e. law).  The existence of so-called ‘fake universities’ or ‘degree mills’8 might in itself be viewed as evidence of the role of the signalling mechanism. The same goes for university rankings, which fuel reputation as a differentiation tool – an obvious kind of signalling.

What are the relevant policy implications? Broadening participation in higher education is a much-embraced goal for governments across the world – and in many cases education is important for economic growth9. But more education is not always the answer, and there needs to be awareness that the marginal returns to education can be weak, or even negative.  Over-education, ‘bumping down’ and skills mismatch effects need to be taken into account when considering the quantitative expansion of higher education, as well as the opportunity cost, prevailing signalling effects and, not least, the quality of the education being offered. In Sweden, as in many other comparable countries, a focus on significant quantitative expansion of university places during the last decades has led to a weakened focus on the quality of education provided and the actual learning outcomes, as well as the level of knowledge of students entering university10. If university education fails in providing students with the skills needed in the job market, the solution should perhaps not be looked for in yet more and longer education, but in reforming existing education systems.

Patrick Krassén is an Education Policy Analyst at the Confederation of Swedish Enterprise.

The Confederation of Swedish Enterprise is Sweden’s largest and most influential business federation representing 49 member organizations and 60 000 member companies with over 1.6 million employees.

  1. Desjardins, R. and Schuller, T. (eds.), Measuring the Effects of Education on Health and Civic Engagement. Proceedings of the Copenhagen Symposium, OECD, 2006.
  2. Spence, A. M., “Job Market Signaling.” Quarterly Journal of Economics (The MIT Press), 1973, 87(3): 355-374. Cf. also Spence, A. M., Market Signaling: Informational Transfer in Hiring and Related Screening Processes, Harvard University Press, 1974.
  3. Arrow, K. J., “Higher education as a filter.” Journal of Public Economics, 1973, 2(3): 193-216; Stiglitz, J. E., “The Theory of ‘Screening’, Education, and the Distribution of Income”, The American Economic Review, 1975, 65(3): 283-300.
  4. Oreopoulos, P. and Salvanes, K. G., “Priceless: The Non-pecuniary Benefits of Schooling”, Journal of Economic Perspectives, 2011, 25(1): 159-184.
  5. Nicaise, I., “The Effect of Bumping Down on Wages: an Empirical Test” in Borghans, L. & de Grip, A. (eds.), The Overeducated Worker?, Edward Elgar Publishing, 2000.
  6. Cf. i.e. OECD, Trends Shaping Education 2013, OECD Publishing, 2013: 60-61.
  7. Jaeger, D. A. and Page, M. E., “Degrees Matter: New Evidence of Sheepskin Effects in the Returns to Education”, The Review of Economics and Statistics, 1996, 78(4): 733-740.
  8. Contreras, A. and Collin, G., “The Real and the Fake: Degree and Diploma Mills”, Change, March-April 2009.
  9. Cf. i.e. World Bank, The Road Not Traveled, 2008: 40-43.
  10. Cf. i.e. Arum, R. and Roksa, J., Academically Adrift: Limited Learning on College Campuses. University of Chicago Press, 2011.

 

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