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Sending The Right Signals

Fergus McCormack analyses the signalling role education plays in the labour market.

Education is commonly seen as an effective method of improving one’s productivity by boosting one’s ‘human capital’. It can also be construed as a signalling method; a means of demonstrating to employers one’s innate productivity.

Education as a signalling tool was first identified by Nobel Prize Laureate, Michael Spencer, in 1973. Due to asymmetric information in the labour market, whereby students have information about their employability that employers do not, prospective employees use education as a signal to employers that they are hard-working and intelligent. A useful illustration of this is the perceived desirability of hiring students from prestigious universities, with their stringent entry requirements and high ranking. Acceptance to, and graduation from, such universities signals to prospective employers that the student is the ‘cream of the crop’, somehow more hardworking, self-driven and focused than other applicants.

However, it could be argued that as labour markets become saturated with graduates (47% go on to higher education in the UK), education becomes inefficient as a signalling mechanism. Having a degree no longer gives a competitive advantage; students must obtain higher and higher levels of education to differentiate themselves in an education arms race. This also limits the potential of skills-based courses, as not having a degree in itself becomes a negative signal to employers.

In addition to the increased financial burden on the state and the student, this also raises questions about the relevance of education. Students want access to the best job opportunities, so they choose the universities with the best reputations. Universities must therefore maximise their ranking to signal their merit and attract the best students. Employers interpret these rankings as evidence that these students represent the ‘best catch’ in the labour market. However, as rankings are based primarily on research, academic rather than vocational skills are emphasised in the development of programme curricula. As an example, in my own Business course, the focus is on the theory of leadership and innovation rather than their practical application.

Clearly signalling in education creates significant waste, much of which is financed by the taxpayer. But how can education be used to increase both students’ employment prospects and their future productive capabilities? Switzerland, and other countries such as Germany, Austria and Norway, opt for a ‘dual’ Vocational and Education Training (VET) system, which combines traditional classroom learning with on-the-job training. Around 70% of students in Switzerland opt for this route (Eurostat, 2014), contributing to high student satisfaction rates and one of the lowest youth unemployment rates in the developed world. The fields covered vary from high-tech industry and finance to retail and care services, attracting the best students wishing to work in industry. The vocational system is therefore not prone to the same negative signalling effect as that in the UK. Moreover by offering direct entry into the labour force it reduces the need for education as a signal, and by affording students the opportunity to apply their learning on their placements it resolves the issue of classes being too theoretical. In addition to providing networking opportunities and improving employability, the system also reduces the financial strain on the state (and indeed the future debt burden for students) by providing students with an apprenticeship salary of $600-$800 per month.

As economists we care a great deal about efficiency, and clearly our current system is not optimal in this regard. By focusing excessively on research, we fail to properly prepare our students for the workplace and waste significant time and money on over-education rather than resolving the problem of information asymmetry in the labour market. Perhaps we would be better served by the Swiss system, as it provides a clearer signalling mechanism for both students and employers. It offers students practical experience and helps them to secure employment through placements, while providing employers with an appropriately skilled workforce. However, there are benefits to an education that trains students to think critically and challenge existing norms. The VET system does represent a more streamlined approach to education, which might inhibit innovation by teaching people to think linearly. Which approach yields maximum utility to society? Time will tell.

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