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Signalling and For-Profit Colleges February 2, 2009

Signalling in economics is the idea that, given imperfect information and a cost to disseminate that information, there are ways for high-quality agents to show (signal) others of their high quality.

This fellow doesn’t know it, but he’s trying to break signalling theory. Can he succeed? I don’t think so. My reasoning (second-order signalling) and a haiku behind the cut.

Given a homogeneous market (say, the job market for entry-level positions in a given industry), some candidates will be high-quality and some will be low-quality. It is in the hiring firm’s best interest to be able to differentiate between high- and low-quality job applicants, but it is not in the low-quality applicants’ best interest to communicate that they’re less than the best applicant for the job. As a result, it can be quite difficult to differentiate them.

In the same way, it is in a hunting lion’s best interest to pursue the slowest, least fit gazelle on the savannah, rather than the fastest, fittest gazelle. (This is a stock example and I think it comes from Charles Wheelan’s Naked Economics.) Obviously, the slow gazelles want to discourage lions from attacking them, and the fast gazelles want to discourage the lions from pursuing the fast gazelles. The best way to accomplish this is by showing that the gazelle can make a sacrifice and still be in better position than the others. Gazelles do this by stotting or pronging, a behavior in which the gazelle leaps high into the air several times before taking off in earnest. The gazelle sacrifices a head start from the predator, essentially showing that it can waste time and energy but still outrun the predator.

That example is a tad anthropomorphic, but the analogy holds. Signalling (or signaling – both spellings are common) is a way of undertaking a costly method of showing fitness as a way to differentiate oneself from the unwashed masses. The classic example, and the one used in Hal Varian’s Intermediate Economics: A Modern Approach, is “the Sheepskin Effect,” in which education is used as a signal of fitness for employment. Education is costly; not only is tuition required, but finishing a bachelor’s degree requires either that time be taken away from the workplace (by taking a less desirable job to get off-shift work to attend school during the day or by not working at all) or that school be attended part-time while working (siphoning resources to work from education while full-time students can devote more time and effort to their studies). Education is also selective; it’s much more difficult for a subpar student to finish a degree than for a talented student to do so. Education also serves as a sorting mechanism; generally speaking, it stands to reason that higher grades show higher levels of ability.

For this reason, many employers require college degrees for positions that don’t necessarily warrant them, and as a result, people who might not be interested in attending college do so anyway in order to avoid being signalled out of the market. For example, this gentleman attempted to signal his fitness for employment by pursuing a college degree at a for-profit institution.  My argument is that low-quality, for-profit colleges represent a method by which students attempt to circumvent the signalling mechanism of requiring degrees, and that the status of these colleges represents a second-order signalling mechanism by which these students can still be signalled out of the market.

The importance of signalling, as stated above, is that signalling is costly, selective, and a valid way of sorting. For-profit colleges are certainly costly, but they are not selective and are not a valid sorting mechanism. The signals provided by different colleges and universities are differentiable: a degree from Stanford, MIT, or the University of Chicago shows that the student had the ability to stay competitive at one of the top schools in the nation. A degree from a state school, such as the University at Buffalo, is less valuable but still signals that the student was either willing to put in a base level of effort or had a certain degree of intelligence necessary to get a degree.

A degree from the DeVry Institute or Everest College shows several things, none of which are very flattering. It shows that the student:

• is not aware of the reputation of for-profit schools (or else the student wouldn’t be representing the for-profit degree as equivalent to a standard degree);
• has trouble valuing the degrees (since many for-profit degrees are far more expensive than equivalent coursework at a community college), and either
• lacks research skills (since the reputation of the school and the extra costs associated with for-profit schools are readily determinable), or
• has poor judgment (knew these factors but decided to go with a for-profit school anyway).

As a result, this second-order signalling allows students like the subject of the video to be crowded out of the market due to his inability or refusal to understand the system by which he’s signalling his lack of true higher education. He essentially paid a tax in the form of higher tuition for his inability or unwillingness to research his options. He claims that the ease with which he could pass his New England Institute of Art courses shows that the United States can’t compete on the global stage; I think that perhaps his expense of $30,000 on a for-profit degree as opposed to spending a smaller amount on the same associate’s degree shows why he, personally, is unfit to compete.

Overpriced degree
Failed attempt at signalling
Sheepskin effect holds