Race for Multiple Qualifications: Human Capital Development or Signaling?

28-Mar-2010

By Tharindra Ranasinghe

I was in Sri Lanka last month. While browsing through local Sunday newspapers, I was amazed by the plethora of advertisements placed by “higher education” institutes of various kinds. They were so abundant that some newspapers had dedicated entire sections for such advertisements. Majority of the advertisements promoted numerous ‘degrees’, ‘diplomas’ and ‘masters programs’ with some foreign affiliations. Unfortunately, verifiable information with regard to globally recognized accreditations were missing in majority of them.

More the Merrier?

My conversations with some of the prominent personalities of the private higher education industry revealed that things have changed quite a bit over the past few years. Around nine years ago, at the time I entered the job market, a good university degree or a reputed professional qualification (such as Accounting or Marketing) was considered a satisfactory entry level requirement for a good private sector job with promising prospects. While there were some who could boast of both, it wasn’t the norm. However, it seems that now the bar is raised. Many industry insiders confided me that “multiple qualifications” is fast becoming the norm instead of the exception (for example, an IT degree and a professional Accounting qualification) even at the entry level. As access to local universities is quite limited, a natural demand is created for foreign degrees despite the quality of many of them being questionable.

The rationale behind this phenomenon can be puzzling. For example, if one wants to be an Accounting professional, a good professional qualification or a university degree focusing on Accounting would provide him with basic know how to start his career. It is unclear why such a person should pursue an additional, less related stream such as an IT degree as well. The reverse would hold if one wants to be an IT professional. There seems to be a hint of irrationality in this endless pursuit of education credentials.

Human Capital Theory

To address this issue more rigorously, one needs to identify the purpose of education. Numerous research studies indicate a strong positive relationship with wages and education, which means employers do value education. On average, highly educated employees appear more productive than the ones with lower levels of education (and hence the higher salary). But what is the source of this productivity?

One obvious explanation is that, education is valuable because it enhances human capital. That is, education provides prospective employees with necessary skills to become better at their jobs and increase productivity. To put it more precisely, education augments the students’ productive capacity in later life. Development economists such as Theodore Schultz of the University of Chicago (joint winner of Nobel Prize for economics in 1979) promoted and formalized this intuitive idea of human capital. In his 1963 monograph “The Economic Value of Education”, Prof. Schultz outlines this idea. Under this viewpoint, education is highly desirable for a society as it increases productivity and creates economic wealth. Investments in education are not wasteful at all.

While this theory is consistent, with regard to certain types of education (for example, a prospective accountant pursuing a professional qualification or a degree in accounting), it is unclear whether it can explain the trend seen in Sri Lanka. For example, can we use the human capital theory to explain a prospective accountant pursuing an IT degree in addition to accounting studies? Given that education is costly (both in terms of money and time), would the additional less related degree create sufficient incremental value in terms of human capital? This seems rather unlikely. If Human capital theory is unable to explain this “multiple qualifications” phenomenon, do we have any alternative explanations?

Education as signal

Starting from early 70s equilibrium and game theory, economists have come up with an alternative theory on the demand for education. Another Nobel laureate (2001) Prof. Michael Spence advanced this idea in his 1973 paper titled “Job Market Signaling”. Under the signaling argument, prospective employees use education qualifications as a signal of their existing productivity. Accordingly there can be demand for education even if it does not enhance productivity.

The argument goes as follows. In most job markets, employer is not sure of the productive abilities of a prospective employee, before he is hired. Accordingly, the employer has to make a reasonable assessment about this ability from the characteristics and attributes that are observable. Education can be one of those observable attributes. As we all know, education is costly. However if the relative cost of education is lower for inherently productive people, they can use education as a signal to distinguish themselves from the less productive (in technical terms this is known as creating a “separating equilibrium”). Assuming that inherently productive (intelligent) people do better in exams, it is reasonable to argue that it costs them less to acquire education. For example, since these people would find it easier to pass exams, they will spend less money (lower probability of having to retake), less time, and less intellectual capacity (Prof. Spence terms this as “psychic costs”) to acquire a given level of education.

Is the cost worth paying?

Accordingly, one would expect to see highly educated individuals finding it easier to secure jobs and higher salaries not because education creates human capital, but simply because education is used as a signaling tool to showcase the inherent talents and abilities. Under the signaling theory, the race for multiple education qualifications in Sri Lanka can be easily explained. Since education is merely a signal, people will acquire qualifications that have nothing or very little to do with their profession. As the competition for good jobs intensifies, the demand for all types of degrees diplomas etc. will amplify.

While this type of signaling behavior may emerge as the only rationale response, one needs to keep in mind that the signaling process (acquiring multiple qualifications) is costly. Therefore, how would such behavior impact our society as a whole? Is the price worth paying? Are there further unintended consequences? In a time where an active debate on the nature of education in Sri Lanka seems to be emerging, these come up as intriguing issues with important policy ramifications. We will attempt a rudimentary exploration of some of these issues next week.