Does the returns to education literature really test the signaling model?

Here is a comment by Matt, and also by ArnoldBryan’s response argues that the returns to education tests consider “ability bias” but not “signaling.”  For a lot of the tests that is a distinction without a difference, and indeed you can see this on the first two pages of Angrist and Krueger, which discuss “omitted variables that are correlated with educational attainment and with earnings capacity.”  The tests still discriminate against the signaling model, even if signaling and ability bias differ in other regards.  In a nutshell, artificially or randomly elevated workers fare better in the longer run than the signaling model predicts.

Here’s a parable to illustrate.  Imagine a market situation with wages and different education levels observed for two classes of workers — call the locale Honduras.  Now compare that to another setting — Nicaragua — where education is handed out on some subsidized, randomized basis.  In the latter case some of the low ability group will be induced to get more schooling, and the pool of the educated will contain more low ability individuals in Nicaragua, compared to Honduras.

Now measure the long term earnings and compare.

If the signaling model is correct, the average long-term wage rates of return for the subsidized/elevated group in Nicaragua will be noticeably below the average wage rates of return of the educated group from the separating equilibrium in Honduras.  After all, the subsidy-elevated group adds many more “low ability individuals” to the Nicaraguan mix of the educated than one would find in Honduras.  According to the signaling model, in Nicaragua eventually the lower skill level of the elevated group will be discovered and their wage rates of return won’t stay so high forever.

But the wage rates of return for the elevated groups do not plummet back to earth and generally they are robust over time.  That measures the real learning which went on in school, or so it would seem.  Education is good for more than getting a good first job offer right off the bat.

The modern liberal interpretation (which may or may not be true) is that these poor people were waiting for a helping hand up the ladder, and then they took good advantage of it when it came.  And if the elevated group in Nicaragua has higher long-term wage rates of return than the educated Hondurans (a result which does sometimes pop up in the data), that is because their lower initial margin of education made them an especially potent investment.

The actual tests are more complicated than this, and I use the country names to make the example easy to follow, not out of verisimilitude.  But this example is one way to see some of the intuitions behind why the data do not treat the signaling model so kindly.

One empirical implication is that crude OLS measures of the return to education are much better than they may at first appear.  These results are also one reason why most modern labor economists might object to the arguments of Charles Murray.

Here is a recent Brookings piece on the return to education, I have not had time to go through it.


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