Labor Economists vs. Signaling
By Bryan Caplan
From chapter 4 of my book in progress, The Case Against Education.
Signaling has been one of economists’ more successful intellectual exports.After Spence and Arrow developed the signaling model of education in the 1970s, the idea soon spread to sociology, psychology, and education research. While few experts are staunch converts, most grant that the idea is plausible and the evidence suggestive. Yet strangely, there is one body of experts that sees little or no merit in the signaling model: labor economists, particularly those who specialize in education.
In modern labor economics, human capital theory reigns supreme.Most specialists see signaling as an irrelevant distraction.Very few would endorse anything approaching a 20/80 split in signaling’s favor.A high profile chapter in the Handbook of the Economics of Education fairly represents labor economists’ consensus: “Our review of the available empirical evidence on Job Market Signaling leads us to conclude that there is little in the data that supports Job Market Signaling as an explanation for the observed returns to education.”
This is a disquieting intellectual development.Economists have plenty of blind spots, but they spend years studying economic theory.So you would expect labor economists to have a crisp grasp of the signaling model. Who else would better understand what signaling predicts – or whether those predictions are correct? Yet after forty years of research, the experts most-qualified to judge the signaling model turn out to be the least-persuaded. If I denied I was disturbed by labor economists’ disdain, I’d be lying. If they’re right, I’m wrong.
Where precisely do I part company from mainstream labor economics? For the most part, I accept their empirical evidence – especially when they rely on standard, transparent statistical methods. My claim is that mainstream labor economists have an interpretive double standard. When their evidence supports the human capital model, they take the evidence at face value. When their evidence supports the signaling model, they wrack their brains to avoid giving signaling an iota of credit.
Consider the sheepskin effect. Almost everyone senses that big payoffs for graduation support signaling and undermine human capital. As long as the rewards for degree completion were in doubt, labor economists took the sheepskin-signaling link for granted. Once evidence of large sheepskin effects became undeniable, however, labor economists moved the goal posts. In theory, the sheepskin effect could stem purely from selection; maybe students who finish their degrees would have been equally well-paid if they’d dropped out a day before graduation. Sure, the sheepskin effect survives standard ability corrections unscatched. But human capital purists can demur, “You didn’t correct for weird not-yet-measured abilities.” If labor economists consistently enforced this unmeetable burden of proof, their field would vanish.
Or take the cross-national evidence. Signaling predicts that education will be more lucrative for individuals than for countries. This is precisely what researchers typically find. Yet few labor economists even grudgingly admit, “Signaling wins this round.” Instead, they rush to figure out how they’ve erred. Maybe better data or fancier statistical methods would help. No? Then the question’s beyond us. Move along, nothing to see here. My point is not that the cross-national evidence is strong enough to settle the human capital/signaling debate. All I’m saying is that if the evidence supported human capital purism, labor economists would have spent less time second-guessing the results and more time dancing on signaling’s grave.
Labor economists don’t merely misinterpret their own evidence. They also ignore everyone else’s evidence. Psychology, education, and sociology all have useful insight for the human capital/signaling debate, but labor economists rarely read their research – or even acknowledge its existence. It’s classic Not Invented Here Syndrome.
Case in point: Human capital says that education raises income by imparting useful skills; signaling says education raises income without imparting useful skills. To weigh the two theories, then, you must investigate what students actually learn and retain. Psychologists and education researchers are clearly the go-to experts on these matters. Yet labor economists almost never go to these go-to experts. If they did, they would hear lurid tales of a yawning chasm between learning and earning – precisely as signaling predicts.
Labor economists’ root problem, at risk of being uncharitable, is that they fall in love with education years before they study the evidence. When they meet human capital theory, they’re instant converts. It tells them what they want to hear: Two things they love – education and prosperity – go hand-in-hand. When budding labor economists discover signaling, they rush to reject to it. Most latch on to one of the flimsy “signaling doesn’t make sense” arguments from chapter 1 – “Employers would just do IQ tests instead,” “You can’t fool employers for long,” “There’s got to be a
cheaper way.” By the time they examine the scholarly research, it’s hard for labor economists to give signaling a fair shake.
To be fair, however, personal experience would cloud labor economists’ judgment even if love of education did not. Why? Because the link between what academics learn in school and what academics do on the job is eerily close. I call it “intellectual incest.” We sit in class, learn some material, then get jobs teaching the very material we studied. Professors can even “acquire human capital” by recycling our old professors’ lecture notes! The upshot: When academics reflect on our own lives, school almost automatically seems “relevant.” To see the labor market clearly, professors would have to contemplate the alien career paths of the vast majority students who never enter academia.
When I argue with mainstream labor economists, they grow frustrated. “Is everything signaling? I have trouble believing that workers can’t find a cheaper way to certify their quality,” they ask. I’m tempted to sarcastically reply, “Is everything human capital? I have trouble believing that studying Latin makes you a better banker.”
My constructive answer, however, is: Of course everything isn’t signaling. Students definitely learn useful job skills. School lasts over a decade. It would be amazing if students didn’t learn something useful before they left. My claim, as I keep repeating, is that education is mostly signaling. Given all the evidence, a 20/80 human capital/signaling split seems reasonable. I’m happy to debate the exact figure. Until labor economists renounce human capital purism, though, I cannot take them seriously – and neither should anyone else.
 Lange, Fabian, and Robert Topel. 2006. “The Social Value of Education and Human Capital.” In Hanushek, Eric, and Finis Welch, eds. Handbook of the Economics of Education. Amsterdam: North-Holland, p.505.
 See list of references on Lange and Topel, p.493.
 Lange and Topel, pp.492-495, is probably the best-developed example of this denialism. After conceding that, “The existence of diploma effects ranks among the most persistent empirical findings in labor economics,” they claim, “Those least capable to profit from schooling drop out before the completion of degree years.” Lange and Topel then provide a careful theoretical model of their story, but zero empirical evidence.