A Question of Signaling
GMU’s latest comprehensive Ph.D. Microeconomics exam included the following question:
If the observed education premium is 100% due to signaling, controlling for intelligence will NOT reduce estimates of the effect of education on earnings.
No one got full credit, and 90% of students incorrectly answered FALSE.
Using these hints, can you compose an answer worthy of full credit?
Try your luck in the comments! I’ll post my preferred answer next week.
This question is pretty tough to translate to English.
So: we're trying to estimate the effect of education on earnings. We have a scenario where the education premium is exclusively created by signaling. What exactly is our education signaling though? Does it signal that I have some set of character traits (ie: commitment and work ethic sufficient to complete a degree), that I have special knowledge (ie: knowledge of my field), or that I have a certain degree of intelligence (ie: more because I went to Brown instead of Arizona State)? Does it signal all of the above?
If the value of my education is due to the fact that it signals I am intelligent, then controlling for intelligence when seeking the effect of that observed education premium on income would certainly reduce the estimate -since it would mitigate the signaling effect, given the well-established connection between IQ and income- making this statement FALSE.
It seems that even in normal circumstances, where even a part of the observed education premium is determined by signaling (which includes signaling of one's intelligence), that controlling for intelligence WOULD reduce the estimate of the effect of education on earnings. I don't see why things would be different in a scenario where 100% of that observed premium is due to signaling -not unless 'signaling' doesn't include 'signaling intelligence', which isn't specified in the question.
I'm obviously not an economist. Does the statement '100% due to signaling' mean something very specific in economics, such that these students would have been expected to know ahead of time? Maybe I'm misunderstanding what exactly the 'observed' education premium is?
If the education premium is 100% due to signaling, then the signal is perfectly correlated with higher levels of productivity (thus income in a competitive labor market), no matter what factors contribute to productivity. That means that controlling for *any* factor, intelligence or otherwise, will not reduce the estimate of the effect of education on earnings.