Spence's Model of Education
Why pursue higher learning? Seventy five years after Veblen, Michael Spence proposed an alternative explanation for higher education.
Like Veblen, Spence viewed education as a signal. But while Veblen argued that higher education signals membership in the leisure class, Spence proposed that education provides employers with information about otherwise unobservable characteristics of potential employees. In his 1973 paper "Job Market Signalling," Michael Spence developed a mathematical model of the signalling function of education; for this and related work he eventually shared a Nobel prize with George Akerlof and Joseph Stiglitz in 2001.
Spence's model is elegent in that it is as simple as possible while still capturing the essence of educational signalling. Spence imagines a hypothetical labor market with two kinds of employees, highly productive "type A" individuals and less productive "type B" individuals. Despite the considerable benefits associated with hiring A's instead of B's, employers are unable to observe a worker's type directly. Workers can obtain education prior to going on the market, but in Spence's simple model, this education has no effect on productivity. Why then would workers seek education and why would employers pay higher wages to educated workers?
Spence shows that education can serve as a reliable signal of the worker's type if the ease of acquiring an education is correlated with worker productivity. When type A individuals are able to obtain education at lower financial and psychic cost than are type B individuals, a game-theretic equilibrium exists in which employers pay higher wages to individuals with a threshold level of education, and in which only type A individuals obtain this level. Doing so is a worthwhile investment for type A workers, because the benefit of increased salary exceeds the cost of acquiring this extra education. For type B works, the costs of acquiring this level of education are so high that the extra salary does not compensate. Thus type A workers acquire more education and receive higher wages than do type B workers.
In Spence's model, education is useless in and of itself as a means of increasing worker productivity. This is not because Spence believes education is truly useless, but rather because his model aims to highlight the indirect signalling role that education can play.