Russ Roberts

Bryan Caplan on College, Signaling and Human Capital

EconTalk Episode with Bryan Caplan
Hosted by Russ Roberts
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Postmortem on Cochrane on Educ... Continuing Conversation... Bry...

Bryan Caplan of George Mason University and blogger at EconLog talks to EconTalk host Russ Roberts about the value of a college education. Caplan argues that the extra amount that college graduates earn relative to high school graduates is misleading as a guide for attending college--it ignores the fact that a sizable number of students don't graduate and never earn that extra money. Caplan argues that the monetary benefits of a college education have a large signaling component rather than representing the value of the knowledge that's learned. Caplan closes by arguing that the subsidies to education should be reduced rather than increased.

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0:33Intro. [Recording date: March 20, 2014.] Russ: Our topic for today is education, and part of the conversation I assume will be a sneak preview of your next book. But I'm hoping we'll get into some more general issues related to measurement and empirical work. What we are going to talk about specifically today is the return to education: What's the impact on a person's earning potential or earning power or income after attending college, graduating from college for that person. So, I want to start with some basic empirical measurements. How much more do college graduates earn relative to high school graduates, and how has that return changed over time? Guest: So, in 2011, college graduates made 83% more than high school graduates. And high school graduates, mainly people who have gone to college not at all. How has that amount changed over time? It's gone up quite a bit. So, maybe around 1970 it would have been only about 35 or 40%, so it's something like doubled over the last 40 years, during my lifetime. Russ: And what are some of the standard explanations for why that's happened? So, why is college more productive for people who attend and have graduated? Guest: The usual story is that there has been a lot of psychological change in the economy, globalization as well, and that this has somehow made it more important to be a college graduate. And among most economists, they do tend to focus on the skills that you supposedly receive in school. And so they think of it as: it's more important to have general thinking ability and reasoning skills, as well as different technical skills you might learn in school; and that when the economy is more technologically complex, and also when you are competing in a global market where one person could mess up a big firm, it's more important to have these skills. I'd say that's probably the usual view. Russ: And what do you think of that view? Guest: I think that there is some truth in it, but it's greatly exaggerated and there's a lot of other things that are going on that most people who study education would rather not talk about. Russ: What are a few of those? Guest: Well, one of the main ones, strangely, for economists to ignore is--even though they do--is that people who go to college are not the same even when they start. So, the kind of person who goes to college is different at the beginning. And there are a lot of reasons to think that people who are different in the beginning would have made more money even if they hadn't gone to college. The most obvious one is that people who go to college are generally smarter. It's not popular to say it, but all of the evidence confirms it. And they were smarter before they started. Now, there's also a lot of evidence that-- Russ: We'll get into that later. But why would that have changed over time? This is the reason--this is an incredible change, right? I don't think there is any parallel development in the area of education over any other time period, 30, 40-year time period, a doubling of the returns to education. You are suggesting that--you started by saying that the standard answer, which is, well, the world is more complex, there's all this technology, and so college students are more valuable--you are not convinced of that. I'm not either, by the way. I used to be more sympathetic to that until I started reading you. So, I'm interested: Why would think that would change over time? Guest: Right. Well, again, there's an important distinction to make. You need to distinguish between college graduates being more valuable and college itself being more valuable. Those are two different things. So the main problem that I have with the usual view is that I take a look at what people actually study in school, and I see very little evidence that most students are acquiring any technical skills. And also, surprisingly, when I read educational psychology, there is a lot of question about whether college students are actually learning much in the way of thinking skills, either. So, a more reasonable story is not so much that the skills that college teaches are more valuable than they used to be, but rather the kind of people who go to college are more valuable than they used to be. Which is quite different. Russ: Great. A subtle but important distinction. We're going to get into how that affects the measurement issue, but let's start with a puzzle that you identified in a recent post at EconLog, which is that, given that increase in the return to graduating--which is enormous--you'd think that everybody would want to graduate from college. And in particular we see lots of policy encouragement of people to attend college and ideally graduate. There hasn't been much of an impact, right? You'd think with that increase, that a lot more people would want to graduate from college. They don't seem to be doing that. So what do we know about what's happened to enrollment and graduation over the last 20, 30 years? And how do you explain that? Guest: All right. So, female enrollment has increased a lot. Male enrollment has not increased nearly as much. And then the graduation rate has been almost flat for these two decades. It may have gone up a bit for women, but that--the actual picture, is even though we've seen this very large run-up in the payoff to finishing college, it doesn't seem like there has been that much response. Especially when you realize this increase in women going to college probably has a lot more to do with social norms than it does with the return. Russ: We don't know that, do we? Guest: Well, if you just see all the other ways that gender norms have changed over that period, it seems plausible that this is just another example of women and the role they see for themselves in society has changed, and that's why they are going to college more, rather than the change in the payoff. Russ: Good point. Let's throw in one more piece of data, which I left out. Which is: What's the return to attending college but not graduating? So, the return you say is 83%. By the way, is that an annual difference? Guest: So, this is just a premium. So this says if you just take a look at the average college graduate and his earnings and compare his earnings to the average high school graduate, the average college graduate makes 83% more, in any given year. Or, really, in 2011, the year we are looking at. Russ: What about for someone who has attended college but not graduated? What's the premium for that? Guest: That is about 10%. A lot less. Russ: So, not very good. Guest: Far less.
7:33Russ: Which brings us now, finally, to the question I started with; I apologize for the roundabout way of asking it. Given that big increase in the return to graduating--not much of a return to attending, but a big improvement in your income if you graduate--why aren't people working hard graduating? And why isn't that getting more people to stay in school and finish. Guest: Well, we have probably a lot of what's going on is that for many people, graduation is hard. It's actually hard to pass the classes, hard to keep doing it. The kind of people who write about education are people who have had a fantastic educational experience. They've always been doing well in class; they've been getting their heads patted from kindergarten on. And not only did they have no trouble finishing, but the people they know had no trouble finishing. But most people have a lot of trouble finishing. So, right now, the 5-year graduation rate for 4-year college is only about 55%. So like 45% fall by the wayside during this period. As to why exactly it is they don't finish, part of it is probably just the material is too difficult. A lot of it is that people get really bored. And then, another point is that even if you wouldn't actually fail out, it's just very discouraging to constantly receive Cs or worse. Even if you could get your 4-year college degree with Cs and get something out of the labor market, it's hard to spend four more years being told that you are at the bottom of the barrel. Russ: But the puzzle then is that, while it is hard, enrollment rates haven't even increased for men--I think is what you said. Guest: They've increased a little bit. Russ: A little bit but not very much, given the huge increase in the premium. And so the question you raised in that post is: why aren't more people grasping for the brass ring? And your point was, based on some other folks' research, which was fascinating, was that well, if you don't finish, it's not a very good investment. Guest: That's right. If you were to go and put in 3 or 4 years and then not finish, you might only be getting some of this 10% premium, and that is not very good for all those years you are putting in. It really doesn't pay very much. Here's the key thing to keep in mind. When we say that there's an average graduation rate of like 55%, a lot of that is predictable. So if you have great SAT (Standardized Admission Test) scores, if you are great in high school, then your graduation rate is probably closer to 90 or 95%. On the other hand, if you were in the bottom quarter of your high school class then you are talking about maybe a 10% chance of finishing, something along those lines. So even if you aren't a great student, doing the math actually eventually becomes fairly easy--yeah, I can get an 83% if I finish but I only have a 10% chance of doing that. Even if you don't think in such complex terms or think so quantitatively, just noticing that people like you almost never finish probably does discourage a lot of people from trying. And then a lot of people give up once they see [?] something would be easier, and it's not. Russ: You write--this was a very nice way of capturing it: "For students in the bottom quartile of academic ability, paying a year's tuition is almost as foolish as buying 10,000 lottery tickets." Just that the odds are stacked against them; they have a small likelihood of finishing. Guest: That's right. So the way that some of the researchers that have worked on this topic put it is, for the people with a really high graduation rate, the fact that the college premium went way up doesn't change anything because college was a great deal in 1970 and a great deal now. If you know you are going to finish, you get a 40 or 50% raise and you have 4 good years where you do well and people say that you are a good student. It's a nice experience which then pays off. But then on the other hand, for people who only have like a 10% chance of finishing, the fact that the return has doubled just means that it's gone from abysmally bad to really bad. Still not much of a reason to go. And then the really key people, the marginal people, the people who are just on the edge, the main result of the research is that there just aren't that many people like that. There aren't that many people who are on the border. And so even when the payoff doubles if you succeed, there aren't that many people who then say, Okay, now I'll put in the extra effort to try to do it. Russ: Do we know anything about why those people don't finish? How many of them just were getting good grades and just decided to give up, versus flunked out? Do we know anything about that. Guest: Right. So, literal flunking out is pretty rare just because most colleges, perhaps for financial reasons, don't like flunking people out. It's far better to string people along, let them keep going, taking classes, trying, trying, getting Ds[?] and Cs. So certainly their academic performance is quite a bit worse than people who finish. But it's not clear that--it doesn't seem there's that many that are literally flunking out. It's just more of people throwing in the towel. Russ: Interesting. Now, you point out, which I never thought about--it's just embarrassing but it's true--that colleges don't give refunds. Which is an interesting thing. They let you in. Right? I guess the answer would be: You took the classes, you learned what you learned, so you get your money's worth. But it's an interesting thing. You'd think the main value of going through college is finishing, not finishing what seems to be--you'd think there would be some refunds possible. But there aren't. Guest: Right. Well, if you were the first college that started giving refunds, you would probably have a lot of really marginal students showing up. Remember, one of the main things that colleges want to do is preserve their ranking; and being too open does hurt your ranking. So, the kinds of places that would be likely to do this or that would gain the most would be schools that are very unselective to begin with. So, it could work, but probably the problem is there is a large body of people who are not very committed to doing well even by today's standards. So if you did this you might get a lot of students who--if you think currently the bottom half of students currently aren't doing a very good job and putting much into it, imagine how bad students would be if you were offering them a money-back guarantee. Russ: And you also point out, and I think it's important to remind people of this, that one of the major costs of college isn't tuition. It's the foregone income that you give up by not working. You don't get that back, either. Guest: That's absolutely right. You're right that that is more important. One of the things that I've learned writing the book is that even though list prices for tuition have gone way up, still the actual tuition for your main 4-year state universities is not that much. After you adjust for all financial aid and everything else, it's still only in the ballpark of $5000 a year in most places. So actually the foregone earnings could easily outweigh that by a factor of 3 or 4. Russ: $5000? So the list price--this is important, by the way. When people talk about how college is getting so expensive--a small portion at any university pays the full freight. Many people get scholarships. Many people get financial aid. Financial aid, of course, alone, it's not a-- Guest: Right, right. So that $5000 figure, that actually--if it was a loan that would not adjust that number. It's only grants or tuition reductions or other things like that, that would reduce that number. Russ: Wow. That's a low number. Guest: Yeah. So you take a look at the list prices for tuition. And again[?] of course these list prices are probably often being paid, especially for public universities, by the elite people that actually write about education. But when people have actually stepped back and say, well, what about most families; what are most families paying for their kids to go to college? It hasn't risen nearly as much as it seems on the surface. Which is one of the things that surprised me when I started looking at the numbers. Russ: Do you know offhand the average list price? At state universities? Guest: Yes. So, that's more like $10,000, $12,000. For four years, for 4-year universities. Russ: Okay. So, it's a little less than half, is what people actually pay.
15:29Russ: Now, you make an analogy in your post about this issue of the actual return, because it's not the same for everybody. So, another way to say it is that the average return is 83%, but if you have low ability or low ability to finish, not 83%; it's closer to 10%. You make an analogy to marriage, which I found interesting. What is it? Guest: Right. So there is a lot of evidence that on average married couples do a lot better financially. And especially men. So, married men seem to make a lot more money than otherwise very similar single men. And then there are all sorts of other benefits to marriage. One of the main things is you save a lot of living expenses. Just as a side-issue for the book, I wound up looking into how much do people save when they get married. Most estimates are something like, I think it's like 35% off your cost of living. So you take a look at this, and marriage looks like a fantastic deal. But, it can be a fantastic deal for most people, most people who currently do it; that doesn't mean it's a fantastic deal for people who currently don't get married, because they very possibly would have unusually high divorce rates. So, the kinds of people that get married tend to be committed; they are mature; they are ready to settle down. For them, marriage is a great deal. On the other hand, if you are still very immature and impulsive and you just don't feel ready to settle down, then you might think, I'll go get married, I'll have all these benefits, but quite likely you won't really capture them because you are not self-prepared actually to reap the benefits. Russ: And there are very large differences in divorce rates by education, which of course magnifies the return to--it complicates measuring the return to education and marriage independently, right? Guest: Right, right. Now, actually a much simpler analogy that I drew in an earlier post is this: Suppose you are a bank and you lend money out at 10%, and then someone asks you: How much do you actually make? And you say, 10%. Wait a second--does everyone pay back their loans? No, there's like a 3% default rate. Wait a second--you aren't really making 10%. You are making 7%. So that default rate is actually extremely important when you are running any kind of investment fund. Even a very small default rate can completely wipe out the apparent gains you get from the loans that succeed. So imagine if you had a loan at 5% and a 6% default rate, you are actually losing money on average. And what I say is very much goes the same for education. The way that most people talk about education talk, it's as if every time someone tries to get a degree, they succeed. So they only look at the numbers for the successful people. But, that is a lot like looking at the success of a bank by only looking at the money you make on the loans that get repaid. Really what you need to do is count both the loans that get repaid and the ones that don't. And that can easily show that a bank is making a modest profit or losing money. And the same goes for education. You need to look at the educational investments that work as well as the ones that fail. And putting in the ones that fail can have a large effect on the overall profitability of investing in educations. Now, you really have to keep in mind-- Russ: Well, you are saying, taking that crude 55% graduation rate, and let's make it 50% to make it easy, it says that the real premium is 40, and it's 40 because half the people get aid and the other half get closer to zero. Guest: Yeah, yeah, exactly. Russ: 10. Excuse me. 10. Guest: Yes. So that is exactly right. And then of course, oh yeah--as I was saying--it's better to put an average, if the average number is 100%. Right? So right now, when people talk about education, they assume 100% completion rate. Far better to put in the 50%, although even better, of course, is to individually tailor the predictions based upon the performance of the student in high school and SATs and so on, and then you'll see, well for some people it really is very close to 80%, because they are great students, they always have been, and they almost certainly are going to graduate. And on the other hand, as we said, for other people, who have maybe a 10% graduation chance, then they are talking of a real pittance. Russ: Well, I think it's a great example--we'll come back to this a few more times--of heterogeneity. I think the fact that people aren't the same, people are different; and as a result, when you say, well what's the return to going to college? In many ways the average is not a meaningful measure. It captures something. Even when you include--we've talked about two different measures. One would be the assumption that everybody graduated. That's the 83% return. If we talked about the assumption, the more realistic assumption, the returns are closer to, say, 45 or 50%. Because 55% of the people graduate and the 45% who don't only get a 10% premium for attending. So as a result, the real return is much lower. But that return, the measured, sort of okay honest average return of 50-something-percent, that's very misleading, because almost nobody gets that return. There's a bunch of people who have a very good chance, at the high end of graduating. They are going to get 83%. There's a bunch of people at the lower end who have very little chance of graduating. They are only going to get 10%. There are people in the middle who are something like that. But almost nobody gets 50%. It's either you finish and you get something closer to 80%, or you don't. And so, as a result, the average is not a very useful measure of what's actually going on. Guest: Yes. And of course, even to say that college graduates get 83% is very misleading. There's a huge range. One of the main things that matters is your major, where there are your stereotypical high-earning majors, where you are getting a lot more than that. So that would be engineering, computer science, finance. And actually economics. Since this is EconTalk, I was actually very surprised to see that there isn't that much difference in the payoff for getting an econ bachelor's degree versus an engineering bachelor's degree. What I often tell my students is the best-paid of all the easy majors. But I didn't realize quite how true that was until I looked at the numbers and saying, My God, we're getting almost as much as a computer scientist who worked 80 hours a week all through college. Crazy. Russ: 'And I actually learned something.' That's a joke. That was a joke. Guest: A lot of [all our?] students learn a lot, Russ. But yeah, what about those other economics students who didn't learn so much. On the other hand, of course, one of your low-earning majors, like, you know--like, the standard example in the research is actually the education major. Which is not always at the very bottom, but it's close to the very bottom. Russ: Ironic. Guest: Now, [?] in mind, people often make fun of majors like philosophy or political science or education. Although the truth, when I looked into is--as long as you--people who finish on average with those easier, low-paid majors, they still get a substantial benefit on the job market. It's not like they get zero. That's just wrong. But yeah, it is a lot less than they would get if they were engineers or something like that. Russ: Well, I'm going to defend the education, the return to education degree, for a minute here. Not maybe more than a minute. But I don't think that people who study education learn very much that's useful about how to be a good teacher. I want to put that on the table. However, the wage they earn, if they go into teaching, has a large non-monetary component, both in terms of get summers off and you also get the thrill of experiencing young minds coming to the light. Which is really a glorious thing. So, salary is not the only thing we really care about that. Let's make that clear. Having said that, there are large differences in the monetary compensation of different majors of the people who do graduate. Guest: There's a very common view, often associated with David Card and his many students that education is just as lucrative for high-ability students and low-ability students. The way they reached this conclusion is basically saying, look, if you take a look at the graduates of college, high-ability graduates seem to get as large percentage increase in their earnings as low-ability graduates. The main problem with this, again, is that they are only looking at graduates. If you go and look at the fact of ability on whether you graduated all, that's the main way where you very clearly see that the lower-ability students don't get the same return as high-ability students, because they are less likely to get much of a return at all. So, it's one thing to say, if a low-ability student manages to get to the finish line then he'll get a big gain. But what are his chances of getting over the finish line? Pretty bad.
24:02Russ: So, let's shift gears. Let's talk about the underlying explanations for why there is any premium at all. Over the years, since I've been studying economics, the two approaches that fight against each other are the human capital model and the signaling model. Talk about what the differences between those two models are, and which you think has, if you can, more weight than the other. Guest: Sure. So, the human capital model and the signaling model are both stories about how education successfully increases earnings. They are not disagreeing about whether education actually raises earnings. Rather they are disagreeing about why. The human capital story says that you go to school; they actually teach you a bunch of useful jobs skills; you then finish and the labor market rewards you because you are now able to do more stuff. The signaling model says, no, no, no, no; that's not what's going on. What's going on is that people go to school; they don't actually learn a lot of useful stuff; however, the whole educational process filters out the people who wouldn't have been very good workers. So people who are lower intelligence, lower in work ethic, lower in conformity--those people tend to not do very well in school. They drop out. They get bad grades. And that's why the labor market cares. It's not that the school actually transforms you to a good worker from a bad worker. It's that the schooling, the school puts a little sticker on your head--you know, Grade A student, Grade B student, Grade C student. A very simple way of explaining it is think about two different ways to raise the price of a diamond. One way is by cutting it very beautifully so that it is actually a better diamond. Another way, though, is you put on that funny monocle thing and you look at it and you appraise it. These are both ways that you can raise the price of a diamond. So, cutting the diamond can raise the price. But also a very credible appraisal can raise the price as well. And the human capital story basically says that schools take these diamonds-in-the-rough and it cuts them very nicely and then that's why they are more valuable. And signaling says, no, no, no: what's going on is students show up to school basically as well as they are going to be, and then what the school does is it puts them through a bunch of tests and it makes them jump through a lot of hoops, and then it certifies them and certifies their quality. And that's why employers actually care. Now of course, any sensible person will say: Well, there's some truth to both stories. But, so the real question is not: Is it all human capital or is it all signaling? The question is: What's the balance? The general view among most active labor economists is that signaling is basically irrelevant[?]; it's maybe 5%, 10%; it's something that we can pretty much forget about. My view, though, is signaling is more like 80%, and that labor economists-- Russ: It's a slight difference. Guest: Yes. Most labor economists are ignoring a lot of relevant evidence or they are disqualifying a lot of evidence that seems to be very credible on strange methodological grounds. [?] We should take a different, a fair look at all the evidence. Don't just look at the kinds of evidence that economists like. Look at what's going on in educational psychology, look at what's going on in sociology. And of course also remember what school is like. Everyone who is talking about these issues spent well over 10 years in school. So, like, does the human capital story even fit with your own experience? What I generally found is what I argue with mainstream labor economists face to face. They make a lot of concessions, that, yeah, signaling does fit everything I saw, but it can't really be. There has to be something misleading about everything that I ever experienced. And I say: Well, why don't we take what you experienced more seriously and think about whether the evidence that you have is even inconsistent with the signaling model? Because I don't think it is. Russ: So, let me push back a little bit. I've always been troubled by the signaling model. And I agree with you--it's an interesting--the sociology of labor economists is a fascinating thing. Because I agree with you; I think most labor economists don't like the signaling model and would be prone, as I am, to dismiss some evidence in favor of it. So I'm going to let you make the case in a second. But let me let the listeners understand why I have a natural skepticism about it. And I think a lot of labor economists do as well. And the reason is that it's an extremely expensive signal. So, you are saying, for 4 years, I give up the chance to work; I pay this tuition, whether it's $5000 or $10,000, or $30,000, or $40,000--at a private university. And for that enormous amount of money, I prove that I am a good worker and I get a sticker on my head. Wouldn't there be an easier, cheaper way to get the sticker? If all it's doing is measuring ability, this 4-year slog that's extremely expensive? That's the best way that people have come up with to get the sticker? Guest: Uh, right. Well, there's so many things to say. First of all, when you say, Is that the best way we've come up with? It's the best way we've come up with given that government showers a trillion dollars a year on education. So, it's not that it is somehow [?]-- Russ: Only a trillion? Guest: Yes. [?] and a fair contest. This is a very heavily subsidized way to evaluate [?], is that government doesn't just have a hand on the scale. It is a truck on the scale in favor of the status quo. So this is the first thing to keep in mind. Now the next thing to keep in mind is, there are many different kinds of ability, and school seems to actually be weeding people out on almost all the ones you can think of. So, it's not just intelligence. Intelligence is something, yeah, you can just give people, like you test something like that, and that seems to be a much cheaper way. But what if what you are trying to find are workers who are hard-working, and especially workers who are conformist? Now there it is a lot easier to see, well, why does it have to be so expensive and go on for so long? Well, suppose that someone came along, here's the way I'm going to certify the people who are hard-working but it only takes a month. Now, who are the first people who are going to be in line for this one-month certification? They are going to be people who aren't very hard-working. The people looking for an easy way out. Russ: But Bryan, if you are arguing that the average college student is proving how hard-working he or she is, you've got a tough task there. It's really not-- Guest: Prove you are hard-working compared to the competition. You know the old story about two guys in the woods and they see a bear and one starts putting on his running shoes? You can't outrun that bear. I just have to outrun you. That's a lot of what's going on in education, is that, you know, 55% of people are finishing; they are showing that they are better than the 45% who don't. I will say it is puzzling, like, why is it that people are, like, you know, don't finish when they don't have to do that much work. And when you say, well what tells is showing that they weren't even wanting to do the little the college asks of them. So that is a problem. Russ: Well, I think they are different. Maybe a better answer for your case is for the majors that do pay a premium, a significant premium above the average, the 83% premium for those who graduate, there are some who really do have to work for it very hard. Engineering, in the sciences. Guest: Oh, yeah. Russ: Even economics, you have to work pretty hard. Guest: But there's actually a more fundamental answer to your question, and it says, look, not only can signals be expensive, but they really have to be if there is a valuable prize at the end. So, think about this. Suppose that somebody came up with a chemical process to make diamonds as cheaply as plastic. How much longer would people continue to give diamond engagement rings? I say, like a minute. This would be the end of it. Why? Because the engagement ring just has to be expensive, otherwise it does not show commitment. Russ: Yeah, fair enough. Guest: So, I say the same thing goes with education. If someone figured out a way to make the current process happen in a year, this would mean that a whole lot of people would put in a year; they'd finish; and then it wouldn't really show that much about you. It's got to be a long, drawn-out, painful process or else it doesn't really separate you from the pack. And according to signaling, that's the key point, is to separate yourself from the pack. So the easier it gets, or the more subsidized, the more you have to do to show, Hey, I am at the top of the pack. Russ: Yeah; I guess the next question would be: Why isn't it six years, or why isn't it three? It is interesting that there is--and of course, there is some movement toward three. The movement toward 3 is the Advanced Placement [AP] phenomenon. Which is making it-- Guest: Although there is a lot more movement toward 5 or 6. Russ: Yeah. Is that true? Guest: Yeah. So a lot--it is very common for students to not finish in 4 years. Very common. So that's why these graduation rates, when they are reported, are usually 5- or 6-year graduation rates for 4-year programs, because so many people, even those who finish, don't actually finish on time. Russ: And of course--we've talked about this before on EconTalk--there's a third part of college, which is exploring life and finding out who you are and all that. The social part of college is a huge part, I think, of why people are willing to spend large sums of money to go through the experience.
32:53Russ: But, going back to the signaling versus human capital argument: So, playing in the armchair, when I think back to the numerous college courses that I took that didn't change my life or didn't appear to have made me more productive or more interesting or more thoughtful or whatever. Many of them did. I think we can all--that's a silly debate, but I take your point, that when you think about it that there are some majors and some classes that didn't seem to have much productive value. But we can debate that for a long time. I'm curious what evidence--besides armchair theorizing--you point to that labor economists ignore. That you say is in other fields, etc. For the signaling theory. Guest: So, in terms of the research, one very well-established fact that gets very little play is what's called the 'Sheepskin Effect'. So, we've sort of been touching on this point on how not finishing, starting college without finishing seems to raise earnings by only 10%, whereas it raises earnings by, seems to raise earnings by 83% if you do finish. So, this is actually part of a much more general fact, which is that a lot of the payoff for education comes from getting your degree. It comes from crossing the finish line. Right now, in the early decades of the signaling model, this fact was not well-established. And so there was a lively debate: Is there a sheepskin effect? Is there not a sheepskin effect? But until the sheepskin effect was well-established, when it was still in debate, almost everyone took for granted that a large sheepskin effect would show that signaling was important. Because otherwise, why would it be so important to just get over that finish line? So, in terms of the human capital model, it's really puzzling. What is it, the last class that teaches you-- Russ: The capstone. It's the capstone class. The whole idea. Guest: Yeah, the capstone class. So, like, why is it the person one [?] class short of graduation is only getting 10%, whereas if you finish that class you would get 83%? Russ: Well, hang on. Two things. First of all, for those who are--I don't know if this is a universally understood name, but a 'sheepskin' is another word for graduating college. 'Getting your sheepskin.' I don't know the origin of that. Do you know it, Bryan? Guest: Yes. Yes, I do. So, it's another word for 'diploma.' And the reason is diplomas used to be written on sheepskins, actually. Russ: Oh, which is called, like, is it vellum? What's it--there's a name for sheepskin. What's another name? Guest: Yeah, that sounds right. Russ: I'm not sure that's right. But I see what you are saying. It's a form of ancient paper-like stuff. Um, so-- Guest: Yes. So, anyway-- Russ: Hang on. My question is: Is 10%--you said the return is 10% if you don't finish. Is it 10% if you go for-- Guest: Yeah, the premium. Russ: The premium. Sorry. The premium over high school students is over 10% if you don't graduate. That is, attending college makes you a little more money relative to a high school graduate. Is that true if you go for one year, two years, three years? What you are claiming is, you might be claiming--if you go for 3 and a half semesters and you are 1 course short of graduation, you still only get 10%? Is that true? Guest: It's a little more complicated than that. So, if you go and take a very close look at the data for college, you'll see something like for the first year of college, that might increase, if you [?] essentially finish that, that might increase your earnings by 5-10%. Then year 2, maybe another 5-10%. Year 3 seems to give you nothing. And then it's year 4 that gives you the remainder. Which is huge. Russ: I guess the question would be-- Guest: And we see that's very similar for high school as well. So, like, 9th grade seems to give you a bit, 10th grade a bit; 11th grade seems to give you nothing at all; and then 12th grade, finishing that, getting a diploma, that's what gives you a very big raise over what a high school dropout would earn. Russ: Yeah. I guess the complication is that the people who do get, say, three and a half years into their college degree or one course short, why don't they finish? And what does that tell you. Guest: [?] Exactly. Now you're thinking like someone who believes in signaling. Now you're saying, [?] asking, why didn't this person finish? What is wrong with that person? Maybe they just had some bad luck. But also it suggests, look, in our society it's expected that you finish; you [?] finished; there are a lot of different ways that you could have made up whatever problems that you had; so I'm nervous about you as an applicant. But let me go back to how the debate played out. So there was a long period when economists just weren't sure if there was a sheepskin effect or how big it was. During that period everyone took for granted that a large sheepskin effect would show that signaling was important and the lack of one would at least undermine that. Now, in the late 1980s, early 1990s, it became totally clear that there were huge sheepskin effects--better data came along and several papers were published and they've never been challenged successfully. Not even challenged successfully--no one's even tried to challenge them. The data are now so clear. But almost as soon as the evidence came in very strongly that sheepskin effects were very real and very large-- Russ: Let me guess-- Guest: Then labor economists moved the goal posts and said, Well, that doesn't really prove anything. Russ: Of course not. Guest: And then they came up with some very sophisticated mathematical models where it wouldn't have to prove anything. So, yes, well, you can come up with a model where it doesn't prove anything, but that doesn't mean that it doesn't. In order to show that it--basically, in order to say that it doesn't mean anything, you have to say, well, there's got to be some totally unmeasurable difference between the people who just finish and the people who just don't, and I can't tell you what that thing is; and none of the things we actually measure worked; but that's my story. Right? And when you know that these people making these arguments have been through the entire educational process; they finished at least three different degrees. To be a researcher on this, you finished your high school degree, you finished your bachelor's degree, your master's, probably your Ph.D. And for people like that to say, I'm totally unconvinced that it matters whether you actually get your degree and cross the finish line, to me it's just insane. Like, you know very well, you were a student, you know that if you didn't finish that would ruin your life and prevent you from getting this job. You know that. Everyone around you knew that. If you were to go and deny that to your fellow students and say, I'm not showing up for the final exam because what difference does it make? It makes a lot of difference. And it makes a lot of difference because people who don't finish are quite different from people who do, and employers will hold it against you. Russ: Yeah, it's fascinating. Any other empirical evidence you want to cite that's relevant besides the sheepskin effect? Guest: Sure. Well, so there is some abstruse research evidence that I could go over, but actually I'd rather focus on some arguments that--in a way I think there should be research on them although in a way they are too simple and clear to get a paper out of it. Like, here is one fact that I've often noticed. What do students do when a professor cancels class? They are happy. They cheer. And from a human capital point of view this is bizarre. Basically, the rest are saying, you know how you [?] for me to train me to be a better worker so you can do better in real life? Yeah. Well, I'm going to keep your money and I'm not going to give you the training. See ya'. That is effectively what the human capital model is saying is happening when a professor cancels class. On the other hand, so the signaling model says, well why don't the why are the students happy? Because the employers will never know that you canceled class. What they are learning they are probably going to never need to know again. It's not going to show up on their transcripts. If everybody learns less then this is not going to change the distribution of grades in all likelihood. So then students get an extra afternoon off and then it's not going to affect their future. So, this is something that my 11-year-old sons who are fanatical about doing their homework, yet they are delighted with every snow day, say, why are you delighted? Well, it doesn't disadvantage us compared to anyone else. Aren't you worried you are going to need to know the stuff you didn't learn? Even 11-year-olds, they're cynical enough to go, yeah, right, like that's ever going to happen. Kid, you appear deeply in the system and [?] Russ: I fight off the urge to say, Well, Bryan, in your classes they cheer, but in my classes they weep. But I'm going to leave that out. I'm not going to say that. That would be cruel. Guest: Or here's another one of my favorite debating points. Claim: Right now you can get the best education in the world for free if you want it. What am I talking about? Well, suppose you think Princeton is the best education in the world. You don't need to apply; you don't need to get admitted. All you do is move to Princeton and start attending classes. And in my experience, no one will stop you; no one will card you. If you go to the professor and say, I'm not a student here but I'm interested in your class, most professors get a tear in their eye: Someone actually wants to learn from me. But if you go and get this totally free Princeton education for four years, there is one thing you won't have at the end: any proof you ever did it. Right. And if you consider--Deal A is you go to Princeton and you get a Princeton education with no record you ever did it, or you go to a much lower-ranked school where you admit you are getting a worse education but there is a record, which one is going to do more for your career? Almost everyone says, well, obviously the second one. The first one may make you an interesting person, may be a great experience, but employers aren't going to care. They won't believe you if there is no sign you were ever there. Whereas getting a bachelor's degree by the book from Podunk State on the other hand, that actually, that gives you--it doesn't give you nearly as much as getting a bachelor's degree from Princeton but it gives you something that is real and tangible.
42:44Russ: But your point is even stronger than that. You're saying even if I could prove I was there, even if you gave me the tests that showed I understood the material, because I didn't go through the ordeal of writing, doing the homework or the tests, I still wouldn't help my employment chances. And that's where it gets a little more complicated, right? I recently talked with John Cochrane about MOOCs (massive open online courses), and we've talked with others about MOOCs here, the online educational opportunities. Which is what I thought you were going to talk about. I thought you were going to say, a person gets a great education for free. They can listen to EconTalk; they can go to Udacity. Don't laugh, Bryan. You can laugh. They can go to Udacity and take free classes there. Guest: It's a fantastic education; it's just not education in the sense that the labor market cares about. Russ: There's Khan Academy. There are all these wonderful resources, and a lot of them, including EconTalk, are trying to think about ways to help people feel better about what they've actually learned or give them feedback on what they've learned. But none of them right now give a certificate. Although Udacity is trying to move in that direction and some of the online courses are as well. And that's going to be one of the challenges. But the question would be, if a person did not go to school, did not go to university, but instead stayed home for four years, lived with their parents, and took these extraordinary classes that were out there--and let's say did all the work but couldn't prove it. Okay? So, in certain fields, I don't think it would matter that they didn't get the sheepskin. They might have trouble getting in the door. I agree with that. But they would have learned something very, very useful. Say, for example, if they study computer science at many of these places that are available online, many of these classes--you can teach yourself many of these things without going to university. What's true is, you can't certify that you've done that. And is there a test that employers could give? And the answer is, well, maybe, maybe not. It's expensive. It's much easier to take the person with good grades who has gone through a standard university program. But of course many of these people don't go to college and become very successful. They start their own businesses, etc. So it seems--I don't know. Your thought experiment there--it's a little more complicated. Guest: That foot in the door point that you made is spot on. So, I've often had this argument with Tyler Cowen about signaling. He says, Look, Bryan, you don't know what you're talking about. I actually have a job where I have to hire people and fire people and I know how things work. And he says, And I say within three months we know whether a worker is good or not, so it's crazy to think you have to go and spend all these years signaling in order to get the job. But I say, Wait a second, you are looking at this the wrong way. What has to happen before you can evaluate someone for three months? You have to hire them. What has to happen before you hire them? You have to interview them. What has to happen before you interview them? Well, you have to go and pull their application out of a giant stack of other applications. And any time someone has 300 applications for one job, what are they going to do? They are going to go and start thinning it by throwing away applications from people that don't seem like they are worth giving an interview to. So, if you have an unconventional transcript, an unconventional background, so maybe you don't have any proof that you did it or maybe it's just something weird that you did or unusual that you did, this is something where employers quite reasonably don't give you a chance because they are not in the business of giving chances. They are trying to run a business. To go and actually give everyone out of 300 applicants a full interview would be enormously costly. So it's very natural that they actually throw most applications away before they even give the person much of a chance. Russ: I'm going to give you a little more evidence on your behalf. And maybe I stole this from you; maybe you've already thought of it. It's hard to believe I could come up with something you haven't thought of on this because I know you think about it a lot and you are a very clever man. I have a lot of respect for your creativity, especially as a debater. But here's an interesting example. Sometimes someone turns out to have lied about their qualifications for a job. They don't have a degree from Harvard. They didn't get a Master's in such-and-such. And they are immediately fired. And they are not fired because they can't do the job well. They are fired because they lied. Not because they are incompetent. Which would seem to suggest that the piece of paper itself is maybe not so important. Guest: Well--there is a reason to be concerned about having con artists in your employment, right? Russ: No, I'm not saying it's wrong. I'm just saying that it-- Guest: I'm saying as a business decision, saying look, this guy is perfectly able to do the job, but he's a con artist. I would fire that person-- Russ: Of course-- Guest: and I think it's a smart business decision. Russ: No, I agree. I'm agreeing with you. I didn't say it well. What I'm saying is that actually attending university didn't have any impact on whether they were good at the job or not. It's not like the people say, oh, the person didn't attend this university, doesn't have the degree--obviously they can't do the job. They've been doing the job. So it's really just the piece of paper as a signal that matters. When they are fired it's not because they don't have the skills. They are fired because they were dishonest. Which is fine. I understand that. But it seems to be consistent with your theory.
47:38Russ: Let's talk about how signaling and human capital models in terms of thinking about and measuring the return. And the thing I think is most valuable about it, for me, is forcing you to think about the role of ability, underlying ability and unobserved variables. Because I think a lot of labor economists--I like your sociological observation that we are all graduates of universities and therefore we tend to be sympathetic to this idea that we were transformed by them; we didn't just jump through a bunch of hoops. I like that point. But I think most people are sympathetic to the ability idea--excuse me, at the transformational idea, the human capital argument--because they look at the data. And look, going to college makes you more productive. Because you make more money. But your point really is that the people who go and don't go aren't the same. It's where we started. So let's come back to that and talk about how that affects how people measure the return to education and why it's so important. Is there anything you can do about it? Guest: Sure. So, like during this whole conversation we've been talking about the observed education premia. So, this is just taking a look in the world and seeing how much does the average college graduate make, how much does the average high school graduate make, and then they say, okay, so 83% advantage for the college graduate. Now, if you are a terrible statistician, you will then say: getting a college degree raises your earnings by 83%. And I'm actually a little bit nervous that if you go through the transcript of our conversation, one or both of us has said that at some point. It's just a simplification[?] Russ: It's tempting. Guest: Yes. It's tempting, but wrong. So I think as I said at the beginning, when you see that college graduates are earning 83% more than high school graduates, you have to ask, well there's one thing that's different about them and that the college graduate has--went to college and finished. But is that the only thing that's different about college graduates versus high school graduates? Saying, well, of course not. So the average college graduate is probably going to be smarter; he's probably going to be harder-working. He's probably going to be more conformist, less impulsive, have many other advantages. And that 83% is capturing all the advantages that the college graduate has. Not just the single advantage of the education. It's capturing the benefits of a lot of advantages he had before he ever started school. So if you really want to find out how much did the education raise his earnings, you need to correct for or adjust for all these initial advantages. So there is a big research literature that tries to do this in economics. If you do this the simple way, namely you try to go and measure the pre-existing advantages and then re-do the statistics, then you generally find that the true education premium is a lot less than the observed one. So, basically just putting in, just correcting for your measured IQ before you start college, that will usually bring the payoff down by about 30%. It's not 30 percentage points, but 30%. So, bring it down from like 80 to like 55, something like that. So that is one very important adjustment. And then once you put in that adjustment you say, well, there's a lot more going on than just intelligence. There's work ethic, conformity. Some of these things there aren't very good measures for, but you can still say it seems plausible that this actually--there are other abilities that are accounting for this. So, in my book, after going over all of the evidence that I could find and just weighing it all, I say, well, my best guess is that only about 55% of the gain that you seem to get is genuine. And the rest is what college graduates, the extra amount college graduates would have actually earned if they hadn't even gone to college. So, that is my story. Now, there's a lot of very technical statistical work that actually has higher status than the research I'm talking about, where they try to say, no, no, no, the 83% is genuine. We can talk about that if you want, but my view is that the simple, standard method gives the obvious answer. And probably as a result, researchers have turned to a much more complicated approach that gives the answer that they are more interested in hearing. Which is: What you see is what you get. Russ: Let's talk about this general issue in empirical work. Sometimes we are just stuck with variables that are produced by the data sets that we have access to. So, for example, one I've always found strange is: years of schooling. Right? We have seen lots and lots of statistical analyses that use years of schooling as a predictor of, say, income or something else. And of course a year of schooling at one place is not the same as a year of schooling somewhere else. We had Lant Pritchett on recently talking about education in outside, in poorer countries. And it's tragic. A year of education--forget this human capital/signaling thing. In a lot of places, and of course this is true in the United States as well, a year of schooling doesn't mean you've learned anything. Guest: And yet actually if you look at earnings in countries where they have really crummy school systems, it seems like a year of education pays as much or more as it does right here. Russ: Is that true? Guest: Yeah. Russ: I'm a skeptic about that, Bryan. Tell me about that. Guest: Right. So there's been a lot of effort to measure the international return to education, look at different countries. And the very standard result is that actually in poor countries that generally have, as Lant Pritchett points out, these very crummy educational systems, the payoff in the labor market of getting another year of education or getting more degrees seems to still be on the order of like 10% per year. Again, in terms of what they are teaching them, it's crazy. But in terms of saying, look, people who are willing to jump through these hoops and endure this horrible process where they don't even learn anything, it still seems to say something about you as a worker and it makes employers in those countries more willing to hire you, and you do actually get an advantage. Even though you don't seem to be learning much of anything. Russ: I'm skeptical about that. I guess, you know, if you are in a school where the teacher doesn't show up most of the time, which is one of the examples that Pritchett was talking about, you are telling me that you get a premium just for the ability to show that you can sit there? I don't know. It's hard to believe. It could be. Guest: So, you really can take a look at [?] countries and see that people with more education make more money there, just like they do here. The premiums are very similar to here or actually a bit higher. So--again, the main thing to remember is of course employers don't know the details. So you might have gone to the school where the teacher never showed up, and maybe they wouldn't have considered that to be much of a signal, but if teachers show up two thirds of the time and yours didn't show up at all, they may still be willing to give you a big pay hike because they are just playing the odds. Which is what all employers are doing all the time, is just playing the odds. If you have 300 applications, you don't go and hire people based upon the truth. You do it based upon your best guess. Russ: Because you can't know the truth.
54:25Russ: But the other example I wanted to mention which I think is always fascinating is, there is always a debate in the economics profession in the last few years about whether the minimum wage reduces employment or not, and if so, by how much. And of course one of the challenges of that literature which I don't think it does a very good job of dealing with is the fact that most workers aren't affected by the minimum wage. So when you are going trying to look at a country of hundreds, a few hundred million workers, a hundred-plus million workers, most of them are not going to have any effect. So it's very difficult to tease out that measure. It fascinates me to think about the challenges of actually attributing causal relationships here. These things are poorly measured and there's a lot of heterogeneity. Guest: Right. So my view of course is everything you are saying is true. I still am a firm believer that some numbers are better than no numbers. It's better to do a very stripped down, oversimplified version than to just say: do whatever you want to do. And especially, when you start with some numbers, however crummy, then you can say, all right, here's our first product; it's a beta, it's a prototype; now how can we improve this? Like one of the main things that I'm doing in the chapter that I'm writing right now is trying to put together all of the evidence on all of the different ways that education is supposed to improve your life, and try to go and get a very complicated list of like anything anybody's ever said, anything that seems plausible, put it all in. Now, like, are there going to be problems with this estimate? Yeah. Basically at every single stage in this problem. But still, just to get a ballpark idea of what's going on. When I think about hiring a contractor--the contractors are never, I absolutely never hire the ones where I say, how long will this take, and they say, I can't tell you. Those people have no chance in my book. Someone who says, like, maybe 6 weeks--those people have a chance in my book; at least they are giving me some kind of a number. We all know it's not the exact truth. But at least be willing to stick their necks out and tell me something, something I can work with; that's where I can say, so, you're like way over what you said you were going to do, or if there's a delay, I can say I can understand a delay of a week, but why are you delayed by three weeks? It's taken 9 weeks? It should have been maybe 7 based upon the guy who worked for you being sick for a week. So, what's up with that? So I would always rather have some evidence rather than no evidence, and just try to do the best we can. And then at the end--it's always fine to--it's like--so here's like a fudge factor. So, if we go and correct for every ability we can measure, we see that the payoff for education seems to go down by 35%. Well, what about all the stuff we haven't put in? Maybe that changes it to like 45%, something like that. Just seeing if all the stuff we can think of and measure easily brings the return down by 30 or 35%; then if we go and tack on the other stuff we haven't seen, 45% sounds good. [?] Is that like a hard fact? No, it's just a reasonable judgment that reasonable people will make. Russ: Yeah, I don't disagree with you, by the way. I don't think--I have no problem with the idea of arguing that some data is better than none. As long as it's relevant. My general skepticism is toward sophisticated empirical work. Meaning multiple regression analysis, which struggles, I think, to prove anything that's reliable, I find often. And I think what's fascinating--your example is a good example, right? Here you have all this evidence that should have convinced all these labor economists. It hasn't. Either they have a terrible confirmation bias problem, which I'm willing to entertain. Or you do. And the information is not quite as decisive as it appears to you. I like your point though which I think is extremely relevant--and you'd have to document it to make it strong--which is, well, gee, before the evidence came out they did seem to say that it wouldn't be found. So when they did find it, they should have had some adjustment to their priors. But that's hard for people. So that's probably confirmation bias. Guest: To me, what is most impressive is that when I actually talk to people who officially don't believe in signaling, their actual experiences are so similar to mine. So, similar to what the signaling model would predict. So, I was talking with one very, very eminent labor economist about his experience as a bank apprentice in Germany, and I say, so did you consider just going on and being a banker? And he said, no, no, you have to get college for that. And he actually laughed at his own sentence, because he realized that what he was saying fit with my story so much better than his; and yet that was his spontaneous reaction to what he saw with his own eyes. Russ: It's interesting.
59:16Russ: Well, we're almost out of time. Let's close with an issue that comes up now and then. Well, it's actually a perennial issue. Which is the case for subsidizing education. A lot of people argue that because the returns are so high, even if they are only 40 or 50%, the returns are high. And since students have difficulty accessing capital, frequently to borrow to get that, to make that investment, capital markets for human beings are not very effective. I can't promise you my future returns so it's hard for me to use that as collateral. So people use that along with the alleged externalities, positive externalities of having an educated public, to justify public subsidies to education, either in the financing of education or the provision of it. What's your opinion on that? And we'll close on that. Guest: Well, really what's so important about the signaling model is that it says, look, you are correct to believe that education increases the earnings of the individual who gets the education. You are wrong, though, to think that it's socially valuable for everyone to get a lot more education. Because all that will do is raise the bar for how much you need to have in order to get a job at the same level. The heart of the signaling model is saying there actually is a big negative externality of education. That every time you get more, you are making everyone else who didn't get the, didn't jump through the same number of hoops look worse. So really what the signaling model is saying-- Russ: It's an arms race. Guest: Yes, it's an arms race. And the fact, if it is a fact, the private return is high is really a very bad argument for pouring more money on. Now, the other point, as we were saying, the return that you should be looking at in terms of this argument of not being able to borrow against your future earnings--what you are looking at is return for the marginal people who are just on the edge of going or not going. And as we've seen, the return for those people is actually not, is actually quite mediocre. And then finally if you adjust for ability and everything else, really I would say that once you appreciate signaling you realize that, so we have subsidized education way past the point of [?] returns. So by my calculations, actually, the social return to education is now quite negative. And it would be a much better policy to drastically scale it back, so rather than encouraging more people to go, I think it's better to discourage them from going or at least to encourage them less. So in fact--so, the biggest policy implication that's going to come out of my book is we just have way too much education. I call this the white elephant in the room. There are way too many people going to school, maybe not from their own selfish point of view, but certainly from a social point of view to go and pour more money on this really is just throwing gasoline on the fire. And we need to do less of it.

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Carl Petersen writes:

Thank you for the great discussion and topic. I have two young kids and one more on the way and have formed some opinions about the value of attending college based on my experiences. I am even considering homeschooling. So how I guide my children in these decisions will have a real impact on their lives. So, a few clarifying questions:

- is the population sample used in calculating the wage disparities controlling for immigration? I think the ideal population for comparison would exclude wage earners who did not graduate from a US high school.
- what is the average annual wage of the person who does not attend college? 83% by itself is only half the story ...
- could the increase in disparity over the last 30 years partially be the result of increased ability to pay for necessities out of government funds that do not show up in wages?
- what is the average indebtedness of a person who does not attend college vs someone who attends some years vs graduating?
- is the 83% statistic the average difference across every year of life over the 40 years after graduation, controlling for number of years after graduation? I have to assume that the disparity increases greatly 5-10 years after graduation as degree holders move up the corporate ladder?
- does any data exist around small business owners and degrees and their earnings?

Julius writes:

The discussion of signalling reminded me of a scene in the film Good Will Hunting (1997). Matt Damon stars as a self-taught polymath. He and his working class friends drop by a student bar, and he sees a history student acting pretentiously, palming off as his own views which Damon's character recognizes as being plagiarized from academic work he has read. After pointing this out, Damon's character says to the student that one certainty in life he'll realize in 50 years time is that:

'...you dropped a hundred and fifty grand on a ******* education you could'a picked up for a dollar fifty in late charges at the Public Library.'

The student replies:

'But I will have a degree, and you'll be serving my kids fries at a drive through on our way to a skiing trip.'

My heart is with Damon's character, but my head is forced to acknowledge that the student has a point.

Miles writes:

Apologies - a few unrelated points all in one comment here:

1. I'd be curious to hear Prof Caplan's thoughts on human capital improvements vs signaling earlier in the education process. I did my last 3 years of high school in a prestigious boarding school, for example, and I have a child who tested into a "gifted and talented" kindergarten spot. I know that 5 year old really does need to learn some skills, for example :)

2. I work in technology (web sites) and just FYI we certainly do hire people without degrees if they have the right skills. I've also seen this for visual designers. The key might be that we can easily assess the skills of the potential hires. But I'll admit, the challenge is getting the first interview if you don't have the credentials.

3. Not to be too cynical, but a lot of white-collar jobs really do just require a person be smart enough, willing to work hard on something with no personal or social relevance, and just stay focused week after week on getting the job done. As you guys discussed, the four year college program does a GREAT job of identifying those people!

Thanks - really enjoyed this episode.

Walter Clark writes:

There's another aspect to the "signaling" effect of college. It lets through people who have an extraordinary ability to memorize. It is well known among the not-so-politically-correct engineering profession that Indian PhDs have a reputation for knowing a lot of formulas but having zero gut feel for engineering.
My own prejudice for superb engineers are those that tend to have engineering as a hobby; something that seems to be not associated with those who pride themselves on IQ.

Walter Clark writes:

There's a flaw in the "signaling" effect of college. It lets through people who have an extraordinary ability to memorize. It is well known among the not-so-politically-correct engineering profession that Indian PhDs have a reputation for knowing a lot of formulas but having zero gut feel for what to do with them. This is often missed by non-engineering managers.
My own prejudice for superb engineers are those that tend to have engineering as a hobby; a characteristic which takes time and interest away from getting good grades. High IQ foreigners have no such distraction.

Fred Kavanaugh writes:

On the issue of signalling. . .The employer can't use intelligence testing, etc. . under the anti-discrimination laws and court cases - those tests are illegal and will create endless legal tangles. If the applicant absorbs all the costs of the sorting process (getting the degree) . . the employer can't get a better deal for finding employees.

The human capital argument would be a lot more compelling if the students sent to the universities were randomly selected. If Harvard could turn a drooling heroine and/or crack addict into a stellar employee, we should all put our trust in the human capital theory. But if Harvard turns promising young men and women at 18 into promising young men and women at 23 (after five years of hard institutional effort). . .there's not a lot causal "umph" to consider.

Thomas writes:

What is the difference between education for the people and an education for the person?

Zachary writes:

After listening to this episode I found myself wondering why Caplan hasn't connected his data on student performance and the signaling vs. human capital debate.

If good students tend to continue to be good students, as his data would suggest, then shouldn't exceptional grades in high school be a strong enough signal to employers to capture a good portion of the wage premium a university graduate would command.

Caplan seems to suggest that student who do well in highschool are very likely to graduate university. So one could imagine an experiment where you compared the wages of exceptionally high performing high school students that attend university vs. wages of exceptionally high performing high school students who didn't attend university. For these students completing university would be a weak signal (as it is already a forgone conclusion that the students who didn't attend university would've passed if they had bothered to enroll). If a 90th percentile student has a .95 chance of graduating university you should see a highschool 90th percentile student wage premium that's ~(.95 x university graduate wage premium).

I don't think you would see this play out in market and the data. If I'm right it would seem to suggest to me that human capital development is at least a large part of the wage premium that university graduates command.

Granted this all hinges on employers being aware that highschool performance is the best indicator of university performance. My gut tells me that most probably aren't, but at lease we have Caplan out there educating people.

D Broberg writes:

Thanks for another interesting and thought provoking topic on the podcast. Every time I hear this topic discussed by academics, I hear so much confirmation bias I cringe. Of course those vested in the higher education system will be swayed to see the maximum value in that system, but not so fast... Based on my own experience in the job market over the past 35 years as an employee as well as a hiring manager I can say you’ve missed several key factors. Please consider the following points:

1. Might there be a third (often unstated) value in the sheepskin? I’m thinking of what I might call the networking premium. By this I mean the hiring preference given by managers to alumni of the same university. I saw this time and time again during my career. You might say that it falls into the “signaling” effect, but it is really something more like a nepotism effect.

2. The discussion repeatedly made the point that the reason people don’t finish college is because they lack ability, drive or aptitude. There are numerous other reasons that are neglected by such studies including financial and economic reasons. In my own case I attended college but never completed a bachelor degree. The reasons are complicated, but in summary I was upwardly mobile and promoted to income levels far ahead of others at my age with the degree in the same field. This was combined with numerous job relocations that had the effect of setting back my part-time college plans since every university required my residence for the last two years of their programs to graduate. Every job-related move increased my earning potential and widened my income gap over recent college graduates, erasing any economic advantage in spending more money and time to complete the degree. At one point in my career, I was even accepted into a highly respected graduate program (MSMoT), which was to be fully paid for by my employer, but I declined the offer to maintain my “free-agent” status, not wanting to be tied to that employer by golden handcuffs.

3. There are also quite a few people who don’t have traditional jobs or traditional careers where their earnings can be counted as a simple annual salary. Most of these are entrepreneurs or self-employed. I suspect there is a larger portion of people who never finished college in these careers. If the bulk of college graduates end up as regular salaried employees and those who don’t finish college end up working for themselves, and you are trying to measure the income difference between these two, your numbers are going to be distorted. This is because an entrepreneur will often forgo some or all of his own salary to see the value of the business increased. This is a type of deferred income that doesn’t measure so well with simple comparisons.

4. Finally, there is the question of timing. I would like to better understand the timing of when these income comparisons are made. At what point in a person’s career do you make these comparisons? In many fields a 4-5 year head-start with experience takes a very long time to overcome. I suspect there are many fields where the gap also diminishes over the length of the career. In my own case, my salary (without the sheepskin) exceeded many of those with PhD’s in the same field after 20+ years of experience. This could be due work ethic, natural ability, passion, productivity or any number of reasons, but as a rule I’ve found those in technical fields who lack the formal credentials end up being more passionate about staying current through life-long learning than those who have already reached their educational goals. As an employer, I’d say any additional human capital that may have been provided by the college degree is at or near zero 10 years after graduation in most technical fields. At that point, job experience is a far better indicator of applicable skills and productivity and salaries often reflect this.

Thanks again for another interesting podcast.

netsp writes:

Maybe it's because I don't understand the methods, but I'm extremely suspicious of the words "correcting for".

Can we really control for a whole mess of interacting factors like income, upbringing, schooling, aptitude, discipline, career focus and everything else that influences a person's decision or ability to finish attend and complete college? Can your methods really yield two lists which could have been selected by random draw. I don't know if this is ignorance, but it seems unlikely to me.

I still am a firm believer that some numbers are better than no numbers.

We have a tendency to avoid the conclusion "I don't know" even if it is the rational one. Human weakness. If having "Some Numbers" helps us to avoid that conclusion, then no numbers might be better than some numbers.

This is an interesting topic just dues to the speculation about possible explanations for the discrepancy in earnings but there is a lot of uncertainty here and what seems to be guiding people's conclusions is 40% common sense, 45% bias & 4% data. 11% in unaccounted for.

My favorite econtalk meditation is the drunk economist and the streetlight:

A policeman sees a economist searching for something under a streetlight. He says he lost his keys and they both look under the streetlight together. After a few minutes the policeman asks if he is sure he lost them here, and the economist replies "no". The policeman asks why he is searching here, and the economist replies, "this is where the light is."

So lets extend the meditation with a koan:

Where should an economist search for his keys?
emerich writes:

The best Econtalk episodes are when guests (like Bryan) shred conventional wisdom but convince. In the end I was surprised that his estimate of the return to college education was as high as 45%. On the externalities of education subsidies: with all the silliness that college students study and do, can there be any doubt that they are negative? Just check out what Dartmouth students have been protesting about.

mark e writes:

Things are changing at near-light speed in the education domain these days, and while this podcast does a great job of explaining the current system, I do hold hope that soon things will change.

I almost totally agree with Bryan's postulates and, in fact, his arguments don't really even seem *that* insightful to anyone who has really thought about them with anything more then a passing interest. Meta-learning, social connections, and behavioral conditioning *must* represent a huge percentage of the value of "higher" education because, obviously, these are the exact skills that help modern businesses make money.

It's interesting that Russ had this podcast the week after the one on MOOC's, and I think an important connection has been left out. The primary problem with MOOC learning is the almost total lack of any signalling benefit to an employer, which is why trying to use MOOC credit as a real-world employment aid isn't really helpful at all. For a relatively small fee, you can hire an offshore surrogate to take the course for you, and pretty much everyone knows this, so what value could an employer ever really give online learning?

Dan Hanson writes:

Great podcast. However, I was surprised by the omission of promotion as evidence for signaling vs human capital.

When trying to determine whether the gains of a college education are due to signaling vs human capital, the conversation seems to stay focused on hiring. Wouldn't it also be useful to look at promotion rates within a firm for degree holders vs non-degree holders?

It's easy to see the value of signalling when the employer has nothing else to go by in evaluating you. But once you're in the firm and subject to employee review and build up an internal resume of accomplishments, you would think that the value of your college 'signal' diminishes or vanishes because the employer no longer needs a proxy for achievement.

To do this analysis, you could look at the problem several ways. One would be strictly by degree, another would be to look at promotion rates compared to the signaling value of the school you went to (do Harvard grads get promoted faster than State U grads?).

And, you could also look at people who have degrees unrelated to the field in which they are working. For example, one of our senior executives has been working as an engineer in the company for decades, and his formal education is a degree in political science. A political science degree brings almost no advantage to an engineer.

In computer engineering and software development, there are many ways to get your foot in the door. We'll look at the resume of a person who went to a 2-year college, and hire him right alongside another person with a masters in comp-sci from Harvard. And once they're in the door, their education no longer matters. That 2-year college grad may find himself leading a team of Harvard guys, because all we care about is who performs the best.

Find companies with formal policies of promoting on merit (as opposed to those who have strict degree requirements for positions - often government works that way), then look for a correlation between promotion and education level, school ranking, and whether the subject's educations align with their work.

In general, I would try to control for organizations that have strict degree requirements and those that don't. In my job, we have people without degrees running large divisions.

On the other hand, my wife is just finishing a Masters because she works for the government, and the level of employment she's trying to move up to requires one. Interestingly, the requirement doesn't state what the Masters must be in - just that you have a Masters in something. That's evidence for a signalling model in this particular government agency.

Ken from Ohio writes:

Another great podcast.

I look forward to the book.

I propose that there are two types of College degrees

1) "Signaling degrees" where there are minimal real world job skills such as business administration, communications, sociology, philosophy

2) "Human Capital degrees" where significant real world job skills are learned - as well as the standard amount of signaling - these would be the STEM degrees.

STEM graduates earn more. The implication of this is that signaling is the lowest common denominator for an income benefit from a college degree, and any added human capital is a bonus....literally.

Chad Skeeters writes:

In the government defense sector, the contracting companies operate like temp companies; they win a contract and then hire the people to do the work. Usually, the contract, written by the government, defines roles that include a requirement to have a degree which varies by role. If not, the each person would fall into "Labor Category" often by level of education that would dictate how much the contractor could charge the government. My guess is that if you add up all of the people that are influenced by the government incentives in the labor market, it would be enormous. How many other sectors does the government have a say? I mention this because it furthers Bryan argument about the government distorting the market for higher education. It's at least two dump trucks on the side of the scale for education.

Erik writes:

Great episode and interesting insights from Chad Skeeters, D Broberg and many others. I'll add an observation from where I live.

Germany has long had a model of aggressive early tracking (splitting by pupil achievement) together with well-respected vocational training.

This means that non-academically inclined people are offered shorter, less scholastic educational packages at age 12, with a real chance at decent jobs with decent benefits if they finish.

The pressure to get more bodies in university lecture halls is reduced and the students who do get into college are the kind who will finish their degrees.

It's pretty brutal, and not just for any potential late bloomers who get put on the vocational track at a young age, but also for college presidents who get paid a lot less than their American colleagues.

Alan Clift writes:

Does college, as done today, signal employers the student is interested in their field of study?

Is a component of college education the student paying someone to 'show me what it's like to be an economist, and tell me if I have the skills needed'?

Kevin Johnson writes:

I will take a look at Bryan's book. However, I believe that the overall college graduation rate of 55% counts students who transfer to another college as though they haven't graduated from their first college because there's no mechanism for tracking them further. I suspect that in the Common Data Set data a graduated student who transferred once would be counted twice, once by the college she transferred from as one of the 45% that didn't graduate, and once by the college she transferred to as a graduated student. One third of students transfer at least once according to http://chronicle.com/article/A-Third-of-Students-Transfer/130954/. I know a student who will transfer three times. I therefore suspect that graduation rates are significantly underestimated, especially among the students described here as less likely to graduate at the start.

Alessandro Sisti writes:

Thanks for an excellent podcast. Bryan’s argument is extremely compelling, but it leaves me wondering something: if so much of education is about signalling, would there not be a huge incentive for employers to hire workers at lower than average pay who do not hold a degree but, as other signals than holding a degree might reveal, are likely to have the ability to do the job?

For instance, if high school grades are such a strong predictor of college performance, why not just hire an 18-year-old with a 95 percent average? Or for the employers with the resources to do so, why not devise a test that could tell good applicants apart from bad ones in a way at least as accurate as discriminating based on educational credentials would do? This is already happening in call centres. Why not elsewhere?

There would certainly be potential workers willing to take a pay cut in order to start earning money sooner and forego the drudgery of formal education. Many of these workers can already signal their desirability as employees through means other than educational credentials. Why is no one hiring them?

Seth writes:

We shouldn't underestimate the human capital improvement that comes from organizing, marketing and mingling at a good party or mud volleyball drinkfest.

Luke J writes:

Caplan said, "we just have way too much education."

I agree, but only if you limit education to a college or university. There are other non-degree education opportunities that should be encouraged.

Contrasting examples of my wife and I:

My wife went to a State University immediately after high school, attended 5 years, and graduated with two B.A.s. Scholarships paid her full cost years 1 - 4, and we paid year 5 out of pocket. Now she is in medical school borrowing $36K/year. She has no work experience, but she will be a doctor in another 5 years (when she turns 30).

I skipped college and got a job in the transportation industry driving a forklift at 18. I am now 30, earning $63K/year as a manager in the same industry. I have professional certification in export compliance. I have taken some college courses through a community college, but the cost/course is too high for the education service provided.

My wife's future earnings will exceed mine, but even without her income, I will be ready to retire at 45, giving me more time with my two daughters.

The labor market is incorrect to presume that lack of a degree = lack of effort/willingness to put in the time, etc. Some of us just prefer to make a little less and have more time for Econtalk.

Patrick Jones writes:

I am just left with the impression that people with degrees are given jobs by people with degrees only so that the people hiring won't feel that they wasted their time and money going to university. I also feel that there is a CYA aspect to employers wanting people with degrees. This is not to say there is no value in attending university, there obviously is, but its not in the education. The value is checking that box on the application that filters out those without a degree.
I have worked in high tech fields (engineering, bio tech, health care)for 25+ years and its been my observation that specific job training (med school, vendor training, etc.) is good but still most learning is on the job. The rest (AS, BS, MS, or PhD) has so little to do with on the job performance it can be ignored except for that box. Hiring managers are happy to let some other organization vet their potential employees. This way when it goes bad, they can use their out by saying "I thought he/she would be a good employee, because they graduated from blank university"

Peter H writes:

For those interested, the Good Will Hunting scene is here, starting about 2 minutes in. Also an interesting little dissertation on the historical economy of the pre-revolutionary colonies.

https://www.youtube.com/watch?v=QnZ0Y4rvz6E

Can we have an Econtalk about the pre-revolutionary economy? That sounds interesting.

Ak Mike writes:

I done a fair amount of hiring over the years for office jobs ranging from file clerks and secretaries to lawyers. I've then had to work with the persons hired. Pretty much across the board, people with more formal education were better employees (including for the nonprofessional positions). They had better language skills, were more reliable and stable, and were better at handling unusual situations. I would not say the more educated had better characters, but in other respects the educated seem to be superior. Thus the signal of a degree conveys real information; of course I cannot say whether the educated are better because they are educated or are educated because they are better

David Zetland writes:

The pure signalling model probably doesn't exist, since there's likely to be SOME learning/skills at any given university, BUT grade inflation dilutes the human capital argument. I wouldn't be happy to hire a "qualified" graduate if I was getting someone who didn't learn the material "required" for graduation at a given university and department. (I'm seeing this now at my uni.)

BW Blasser writes:

One interesting yet marginal indicator that can demonstrate how robust the human capital argument is how many students AUDIT a class. For instance during college I was curious about languages but didn't need the credits or have to pay additional fees but I was registered as having audited the class. Also, getting a degree with a 3.0 GPA is a basic requirement to apply for an office job in many cases. So I think signalling gets you in the door but it is human capital which gets you the job.

I'm delighted that EconTalk is looking to facilitate a more interactive learning process.

After listening to this episode, I got inspired to create my first website! It's a form for exploring expected value of future earnings, taking into account the likelihood of graduating.

My form allows users to take responsibility for most of the assumptions; I did put in 4% per year wage increases for graduates and non-graduates alike, which is probably way too high, come to think of it.

Something that wasn't really covered in the interview was the social capital afforded by "some college." It's easy to think of famous entrepreneurs and friends who dropped out of college and went on to successful careers/ventures with the aid of connections gained at college.

Jim Vandiver writes:

The purported down side of not having ed creds for an employer after living at home four years and getting a "free" online degree is offset by being able to offer employers a year of free work to prove your value -- and have this cost you and your parents less than the current $40 - $200K in education costs.

Jeff Potter writes:

I'm more curious about Medians than about Averages.

For instance, the 1%'ers of Occupy fame all have college degrees. Their pre-existing ownership of the world might tend to skew the value of a typical college degree. Signaling relates to Class, which we should sort out as atypical. Typical degree value should be disconnected from the value of "heritage" graduates of class-based Ivy schools who go on to banking regardless of coursework.

For realistic degree value, I'd pull out all banking, Wall Street, and 1%'er sorts of income so that an average is more meaningful.

For non-degreed average earnings I'd pull out populations that might skew that sample as well. Until the recent push for everyone to get a college degree, the non-degreed population might be significantly Trades and Small Biz. Sorting for different descriptions of this Average might be illuminating. We could take out the unemployed or skill-less and see what we get. We could see what an average looks like without the min-wage sectors (teenage turnkey or exploiteds), tho these sectors might be looking more typical, a la WalMart and much retail/restaurant.

Rob Toutkoushian writes:

Last year I published a study (co-authored with two colleagues) in the Journal of Education Finance where we explored this very topic. The paper is titled "Accounting for Risk of Non-Completion in Private and Social Rates of Return to Higher Education" (JEF, vol. 39, no. 1, pp. 73-95). We found that accounting for the risk of dropping out of colleges reduces the average return on investment, this average return is still fairly sizable.

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