Bryan’s breakdown on my break down

by on July 12, 2013 at 11:59 am in Economics, Education | Permalink

Re: my post immediately below on signaling, Bryan thinks I haven’t answered his question about the importance of signalling.  But I have, he is just confused because I don’t use the exact same normalization as he does.   In any case, I postulate the wage return to signalling as going away within five years, in say a career of forty years, then with the measure adjusted for the presence of capital and resource income.  You can express that in terms of totals, variations, percentages, as you wish but the point remains that signaling is only a temporary factor, and overall only somewhat of a marginal factor (5-10%?) in explaining the overall evolution of wages.  That is why it has lost ground to human capital approaches, all the more so with increasing inequality.  (One can believe all of that and still think, as I do, that we could organize current education more efficiently and at lower cost.)  I also stand by my points that insisting on the break down is missing the more important points about indeterminacy and nestedness and those points too can be applied to any normalization of the units.  It would be more useful if Bryan would outline where he disagrees with my assessment, as the entire chain of reasoning is laid out pretty explicitly.

By the way, the easiest way to boost the contribution of signaling is to invoke the “you got your first job by signaling and then from that job quickly gained persistent extra human capital” argument, but even then that increment can, under traditional measures, be assigned to human capital.  (You don’t want to rule out all human capital influences, on the grounds that signaling helped create them, any more than you wish to classify gains from signaling as human capital, if the human capital helped you get into the position to signal.  But if that doesn’t convince you, revisit the earlier point about indeterminacy, as you can see that the marginal products for human capital and signaling will sum to well over one hundred percent.)

1 derek July 12, 2013 at 12:20 pm

If you use the counterfactual, a smart kid without the signalling that doesn’t get into the door. How much would he make over a lifetime compared to the one with the signals? Getting into the door is extremely valuable.

And yes, after 5 years even if you do have some sort of prestigious degree, it is what you have accomplished while working that means a bit more. But you still get into the door based on the signalling, unless you spent 5 years drying out from a habit gained at some university.

2 JasonL July 12, 2013 at 12:25 pm

My take is the Cowenian formulation underestimates the value of signalling in getting your foot in the door at the right firm / wage level that then sets the parameters for the rest of your lifetime earnings (assuming no disruptive events such as dramatic change in career or long term unemployment). My sense is that it is very very valuable to set that initial wage as high as possible, and it is also my sense that people hiring college grads into certain positions are terrible or unwilling to deliver high starting salaries to anyone other than the elitely credentialed. (I’m sure that sentence could be better constructed …)

After entry, I suspect the trajectory of wages becomes dominated by applied knowledge within the industry. Experience becomes dominant over formal education whether you view education as a signal or an acquisition of skills.

3 somaguy July 12, 2013 at 1:36 pm

“My sense is that it is very very valuable to set that initial wage as high as possible, and it is also my sense that people hiring college grads into certain positions are terrible or unwilling to deliver high starting salaries to anyone other than the elitely credentialed.”

I’ve felt this way too but thinking about it, I’ve never had to reveal my past wages. If you’re slightly clever I think you can bluff yourself to market salaries (or above…) without relying on your past wages, at any point where you decide to switch jobs.

(Disclosure: I work in the tech industry as a software & hardware engineer)

4 Geoff Olynyk July 12, 2013 at 12:25 pm

I’m trying to think of what an experiment to empirically test the signalling vs. human capital gains from education would look like. You’d have to basically get a bunch of schools that have different amounts of signalling value and human-capital value (how do you measure either?) and then track students of the same innate ability as they go to the different schools, and see how their eventual earnings turn out.

Ideally you’d have schools A and B that have identical human-capital value (same quality of faculty?) but different signalling value. And then schools B and C that have the same signalling value but different human-capital value. But these things seem almost impossible to pin a numerical value to. It’s even worse because the quality of your classmates can influence the human-capital value of the education.

In these threads on signalling vs. human capital here and on Bryan Caplan’s blog, and elsewhere, I always see a lot of talk but not a lot of data. Is it because there haven’t been any studies? Or because the studies show conflicting results and so you can take from the data what you will?

We are talking about something here that is at least in principle measurable, right?

5 Dan S July 12, 2013 at 12:32 pm

I think a good thought experiment to separate the signaling vs human capital effects is this: if you took half of the entire incoming freshman class at Harvard this year, pulled them out of the school, sent them to a terrible school instead (I mean really bad, with little in the way of actual teaching and learning happening), and then sent them out onto the job market with the stipulation that employers KNOW that they all got into Harvard but got thrown into the bad school instead as part of some odd involuntary experiment, how would they do on the job market? If they did just or almost as well as the half that stayed at Harvard, you have strong evidence for signaling over human capital. If they do as well as community college grads, you have evidence for the human capital model. Somewhere in between, then somewhere in between.

Personally I suspect that if you ran that experiment, the result would lean heavily but not entirely in favor of the signaling model.

6 Brian Donohue July 13, 2013 at 10:20 am

What about the (prolly STEM) kids who Hoover up the material at community college themselves?

7 Andrew' July 12, 2013 at 12:33 pm

If you postulate that, then you are wrong, out of hand.

8 Andrew' July 12, 2013 at 12:36 pm

Put simply, I had my last job at year 5 only because I got the degree that got me the job at year zero.

9 Andrew' July 12, 2013 at 12:44 pm

You can assign that 0% at year 5, but I consider it still 100% because you make the marginal product of the job you are allowed to hold and the other guy can never make me unget the job 5 years ago and they won’t train someone to replace you.

10 mulp July 12, 2013 at 1:43 pm

Your value as a laborer is basically zero because the unemployed worker can consume what you produce far beyond your own consumption if you give him money to consume your excess production, but my guess is you are thinking he should get the money from the government to buy all your excess production, plus enough more in consumption to create his own job.

Or maybe not…

If he were really innovative and worked hard, he could produce what you do cheaper so you would buy what he produces, which would then put you out of a job. Then you would get money from government to buy all his excess production plus more to create yourself a job. Or you would sell your stocks and house so you can consume without income from your unneeded labor to consume all the production beyond what the guy who put you out of a job can possibly consume.

All labor is just a liability and ideally is eliminated from an economy.

11 Andrew' July 12, 2013 at 1:56 pm

I’m basically assuming that the employed and unemployed are nearly identical except for the degree and the job, which is also a signal.

12 mulp July 12, 2013 at 1:02 pm

The signalling of the past thirty years is “labor is a liability” and “consumers are not laborers” and “only capital deserves income and capital thus always gains value by accumulating money”.

And “consumers exist for the benefit of capitalists because capitalists demand consumers so they can profit and accumulate money, and if the government gets out of the way and the Fed prints money, an infinite supply of consumers will materialize”.

The dismal economy is nature’s way of signalling that the only consumers are laborers and laborers can not consume more than they earn from their production, and by arguing that capitalists get to have all the gains from increased productivity without the burden of consuming every bit of the excess productivity themselves, economists have tried to argue an economy is not zero sum: consumption equals income equals production.

And we no longer live in the world of Adam Smith and Locke where most people live off the land, either their own, or off public land as migrant hunter-gatherers and herders. 99% in North America consume only what the buy with income.

No matter what your education, you can’t get a job is all the labor jobs are filled by people who produce far more than they consume, and the capitalists see no reason to hire nor no reason to buy five times as many burgers and fries as they did last year to create jobs, so they bid up the price of stocks of companies like Disney which owns the embodied labor of Walt Disney, Sonny Bono, and other dead laborers which are generating more income than when they were alive.

13 sam July 12, 2013 at 1:04 pm

The question isn’t “what determines life time income”.
The question is: “Why do people go to university?”

If you say signalling is important in the first 3-5 years then you agree with Caplan.

14 Ray Lopez July 12, 2013 at 1:31 pm

That’s very astute reformulation of the question, though I think both TC and his opponent are talking about lifetime income. But you and Derek (1st post) raise an important point: how the temporary affects the permanent in economics. I think the effect is small, because on-the-job experience dwarfs signaling and ‘first job’ experience. That is, your first job out of college can be a dead end (mine was) yet you move on, get a better job, and thereby defeat your bad initial conditions. Then again, there is a persistence bias to having a degree from CalTech and a good first job, so you do have a point, but I think, based on how many CEOs from mediocre schools exist, that such a bias is small.

15 allan July 12, 2013 at 1:36 pm

Like most marginal economic theories this one offers no evidence to support the theory. Such evidence should be easy to gather. Just identify the “signalling,” say degrees from Harvard, Yale, Stanford, U. Chicago, etc., then compare the salaries from those schools at 2, 5, 7, 10, 15, 20 yrs, etc. and see if there is any correlation between the “signalling” and income (“human capital?”).

Or, you could come up with an imaginary graph and call it the signalling demand curve.

16 Andrew' July 12, 2013 at 2:55 pm

That’s part of the indeterminacy, which I take as motivation to find more determinacy. Those top schools try to “recruit” the top students. In fact, the students even do all the recruiting work themselves.

17 Steve Sailer July 12, 2013 at 1:50 pm

Academic background is quite important for getting into certain very high compensation job tracks, such as Wall Street, consulting, or Big Law. How you do once you’ve been hired by Goldman Sachs or McKinsey doesn’t have much to do with your academic background, but it’s hard to get your foot in the door if you don’t have the right kind of diploma.

18 Andrew' July 12, 2013 at 1:58 pm

They also like physics et. al., indicating the actual instruction is not an issue. I know someone will say something about programming in physics or something, but come on. The answer is so obvious, just hard to nail down.

19 Steve Sailer July 12, 2013 at 4:07 pm

Sure, if you are rocket scientist … but if you are an economics major with a 1400 SAT and you played a little ball in high school and you want to be a trader on Wall Street, you had better have gone to an Ivy League college rather than your homestate’s flagship public U. You’ll have a much easier time getting a job interview at Wharton than at the U. of Arizona.

20 Andrew' July 12, 2013 at 4:54 pm

Do even economics majors really study finance or anything remotely like what they do on Wall Street? Or is Wall Street just using those as proxies for ability?

21 Jeff L July 12, 2013 at 6:10 pm

There may be one or two relevant classes in the degree for a career in finance (accounting, for some jobs), but mostly it is just a proxy that they are somewhat comfortable dealing with numbers and calculations in their day to day work.

22 Jason Sorens July 12, 2013 at 2:21 pm

What’s lifetime income for the average college grad? Let’s be conservative and say $2.5 million. Now let’s be conservative and say signaling accounts for 5% of that, below what Tyler wanted to concede in his last post on this. That’s still $125,000. You should be willing to pay up to that amount for a good-quality signal. And people are paying that for higher ed.(*) Nothing in Tyler’s analysis is inconsistent with the claim that the bulk of the value that people get from higher ed is the signal.

(*)They’re also paying in opportunity costs, which are low at that time of life, and they’re also getting a little bit of human capital development and consumption good from higher ed. And you shouldn’t expect colleges to get all the surplus on the contract curve. Still, the basic conclusion holds.

23 dirk July 12, 2013 at 6:06 pm

BC and TC are arguing past each other. BC mistakenly attributes the average total returns in column *degree* to the initial door-opening signalling. It is a mistake because in the *no degree* column human capital growth doesn’t have the same multiplier. But isn’t this multiplier part of the point? No, it is double-dipping, because we are no longer talking about signaling but the value of this vs. that career track. TC, on the other hand, mistakenly divides the value of the signaling by (value of signaling + value of human capital growth) reducing the value of signaling proportional to the value of human capital growth! Wrong. All we want is the value of the signaling. So, say the signaling value of a particular degree from a particular school is worth $70K a year with an expected 3% annual raise and the same person without this degree is worth $25K a year with an expected 3% annual raise. That’s the total signaling differential. Cases where people go on to make $500K a year should be attributed to human capital growth and therefore should be eliminated from both BC and TC’s formulas.

24 Jeff L July 12, 2013 at 6:20 pm

So it sounds like you are just defining things differently than him.

You are saying signaling allows you to get human capital later. And he thinks the additional human capital is the product of signaling (and he might mention that a significant portion of the human capital gained is actually from the signal of experience at a prestigious job).

Either way, when you highlight the importance of human capital formed at the first jobs (jobs initially gained by signaling) it sounds like you are backing away from your previous stance that the human capital development from college is much more significant than the signaling in college.

25 Chris H July 13, 2013 at 11:18 am

I was thinking something similar.

Please correct me if I’m wrong, but Bryan’s point is about human capital formation in school itself whereas a point that human capital becomes more important than signaling after about 5 years doesn’t seem to address that question. After 5 or so years one would expect that experience on the job has enhanced human capital (something Bryan certainly doesn’t seem to deny). The key point being that it wasn’t human capital formation from education providing most of the gains.

Perhaps economists have been able to separate out human capital from education gains and human capital from job experience gains in people five years plus after leaving school and if so I’m curious how that was done.

26 V July 13, 2013 at 4:39 am

Agree that Caplan’s formulation is at times extreme but even though I am almost a Cowen supporter in these types of discussions, I think Tyler is significantly underestimating the importance of the first 5 years of one’s career. With the bonus that signalling gives in those years, the parameters of future income is set (in many cases, independent of any human capital advantage) and after that employer risk aversion (and inertia) can combine to give one a very stable trajectory (without any significant human capital accumulation).

27 Andy July 13, 2013 at 2:18 pm

Two attempts at a pithier conclusion:

1. Partial derivatives are not total derivatives. Confuse at your own risk.

2. Accounting exercises are impossible when you ignore complementarities.

Corollary from 2: Ceteris paribus calculations should be used for counterfactual construction and not accounting decompositions.

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