The Role of Education Signaling in Explaining the Growth of College Wage Premium

Abstract

This paper incorporates an explicit education signaling mechanism into a dynamic model of production and asks if "higher education as a signal" helps explain the simultaneous increase in the supply and price of skilled relative to unskilled labor, as is observed in the US since 1980. The key mechanism is that if college degrees serve as a signal of unobservable talent and talent is productive at the workplace, then improved access to college will enable a higher fraction of the population to signal talent by completing college, resulting in degrees being a better signal about talent. In a dynamic environment with skill-biased technical change, as college becomes more accessible along the growth path, the signaling mechanism helps generate part of the increase in the skill premium. When I assess the contribution of signaling from the model for the US economy from 1980 to 2003, I find that a moderate but sizeable 15% of the observed increase in the skill premium can be attributed to the signaling mechanism. This is achieved after adjusting for the potential decline of the quality of college graduates.

Keywords: College wave premium, education signal, skil-biased technical change, skill premium, compositional change

JEL Classification: D3, D8, JT