Education: Signaling Model vs Human Capital Model

I was going to selectively quote from this article by Bryan Caplan, but I ended up copying and pasting the whole darn thing. Just read the article; it's pretty short.

Bryan Caplan is a economics professor who writes a lot on the "signaling model of education": the idea that education is valuable not because of the knowledge and skills it teaches (as per the "human capital model") but rather because of the certification and fancy initials you get to put after your name (B.A., MBA, LL.D., Ph.D, etc.). In other words, education is valuable as a "signal" to others of your supposed abilities, regardless of whether you actually have them or whether said abilities are even relevant.

This isn't a new idea in and of itself, but it's become increasingly relevant as youth unemployment remains high, tuition costs remain unaffordable, federal student loans are reexamined and student debt reaches record levels.

Bryan points to a lot of strange distortions due this signaling effect dominating the pure intellectual effects of education. For example, if human capital model were correct and education's true value lay in its transfer of knowledge and skills, then everyone should audit.

The best education in the world is already free of charge. Just go to the best university in the world and start attending classes. Stay as long as you want, and study everything that interests you. No one will ever "card" you. The only problem is that, no matter how much you learn, there won't be any record you were ever there.

So why doesn't everyone do this? One theory could be that everyone actually really wants to, but the physical difficulties of being in the right location (geographically near a top university) and free at the right time (class hours are usually at daytime on workdays) are prohibitive. Fortunately, these are the problems that online courses (or if you prefer, MOOCs) try to tackle.

Thus, if the signaling model were false, instead of going to a real universities, online courses (of the same academic caliber and rigor) should be a perfect substitute. In my ideal world, they would be, but of course, that's not actually the case. Otherwise, why would online courses be trying to move into the certification business?

Has this always been true? More specifically, has the signaling effect always dominated the pure intellectual effects of education? I would argue no. Then why has it changed? Very simply, the price of knowledge has significantly decreased. This is due to technological advances and the democratization of information. In fact, the existence of sites like Wikipedia shows that knowledge is practically free (free as in free beer, not free speech). It doesn't make sense that as the price of knowledge decreases, the cost of education hasn't gone down (rather, it's gone up).

The final question remains: even if you're right, so what? As long as rational employers are fully conscious of the signaling model and completely cognizant of the fact that their hiring decisions are based on possibly nothing more than fluff and air, why should we care? If they choose to hire an ignorant Harvard grad over a more capable state school grad because they're too lazy to do their due diligence and look beyond credentials, then that's their loss. They'll fully bear the costs of their own decisions, as they are forced to pay for employee training programs to teach the skills that universities never did.

However, the reason that we should care - that everyone should care - is because of the negative externalities this imposes on the system. This is visible in the higher degree treadmill process observed in the US labor market: today we have so many bachelor's degree holders that job seekers are increasingly jumping to master's degrees. This has reached the point where jobs previously only requiring bachelor's degrees now require master's degrees, despite no obvious increase in job difficulty or worker aptitude. These inefficiencies incur costs that will eventually be born by everyone.

Of course, the real world is rarely this black and white. Most realistically, education displays both effects of the signaling model as well as the human capital model. There are still people who care about learning for learning's sake and there are still industries which select candidates on a more meritocratic basis (programming and investing are two examples). Unfortunately, this seems to be the exception rather than the rule.

Automation and Labor

FT Alphaville recently had a thought experiment on how things would have gone if "the US, rather than taking advantage of cheap labour in China, had kept things at home and heavily invested in automation".

This is one of my favorite themes: the rise of automation in manufacturing and its effects on the global economic balances. Recently, over the past year or so, multiple research publications and journals (such as the FT, The Economist, GS, BofA, BCG, Gavekal, ISI) have featured this supposed inevitable renaissance as robotics and 3D printing revitalize manufacturing in the US.

It's an exciting and sexy theme I will probably cover in greater detail in the future. Today, however, I am interested in very specific component: labor.

Luddites

Low-cost production techniques could soon become so advanced and so low cost — thanks to developments like 3D printing — that even the tiniest salaries in Africa will not make it worthwhile to employ human beings at all.

In the 1800's, the Luddites were a group of disgruntled skilled weavers who displayed their discontent by destroying the automated looms that made it possible to hire unskilled (and cheaper) labor in their place. Of course, in hindsight, these productivity-enhancing machines were a good thing: it freed up future generations of educated men and women towards more interesting work, e.g. as innovators of new industries. In other words, would-be weavers became engineers, inventors, thinkers, etc. instead.

Are we falling prey to this Luddite fallacy today? It's clear that on its own, automation cannot be said to be a job-killer. Generally, as the prices of goods fall with the productivity gain made possible by automation, demand for goods increases, which results in increasing demand for labor. This gives us more employment, rather than less.

However, the current round of automation (the third industrial revolution, as The Economist likes to put it) is potentially different.

source:

This is unlike the job destruction and creation that has taken place continuously since the beginning of the Industrial Revolution, as machines gradually replaced the muscle-power of human labourers and horses. Today, automation is having an impact not just on routine work, but on cognitive and even creative tasks as well. A tipping point seems to have been reached, at which AI-based automation threatens to supplant the brain-power of large swathes of middle-income employees.

In previous industrial revolutions, machines replaced our "hardware", that is, our bodies and our physical labor (bad analogy, but let's roll with it). This was fine, because as long as our ideas added value and machines couldn't automate our thought processes, we could remain employed in an intellectual capacity. However, machines are now able to simulate many of our thought processes - and not just the purely computational ones - with the industrial implementation of artificial intelligence and machine learning techniques. Machines are now replacing our "software", that is, our minds and our intellectual labor.

Modern Luddites like to point at today's unprecedented levels of long term unemployment as evidence for this. However, if this were true, why is there continuing high demand for skilled workers?

source:

Nearly 60 percent of survey participants expect to increase their workforce (compared to 50 percent in the fall), but finding qualified workers to fill open positions continues to be a concern for the industry – an unusual dichotomy, given that national unemployment rate remains high," said Kurek. "The need for a skilled workforce could be one of the greatest impediments to growth for U.S. manufacturers and distributors, and makes it difficult to compete in the global market."

source: 

For many manufacturers, finding the best people to fill these new positions is far from assured. Respondents to ThomasNet.com's IMB lament the skilled labor shortage, and are vocal about what needs to be done to fill the gap. One noted that we need to "improve the attitude within the U.S. regarding the desirability of manufacturing for the next generation." And many respondents want to see education reform with the aim of giving America's youth the skills needed to join the manufacturing workforce.

Usually, automation draws labor demand away from the high-skilled towards the low-skilled. So what is going on here?

Perhaps it's simply a matter of perspective.

Skills and Training

In the long term, it may be true that we are on the cusp of a post-scarcity world of maximal leisure and obsolete labor thanks to the ever increasing intelligence of machines. In the short term, however, human intellectual capital is very much in demand.

[In the 1990s] the US went for massive outsourcing. However, Germany and Northern Europe in general went for automation. The reason why the latter region went for automation is that they were already fighting high labour costs as early as 1980, so they already were well on the path to automation.

At least in Northern Europe, the big automation revolution that we saw starting around 1980 seems to be coming to an end. The reason is the full exhaustion of engineers/skilled technical workers.

This is why some have proposed working hour limits, e.g. instead of a few investment bankers working 100 hour weeks, twice as many bankers working 50 hour weeks are hired. Of course, the policy's track record isn't that great (consider France's 35 hour/week limit and look at their economy) and furthermore, it falls victim to the lump of labor fallacy. However, this perhaps helps us in understanding the liberal's curious characterization of an ambitious overachiever taking excessive overtime for himself as somehow "greedy" due to his theft of his fellow man's labor hours. Compare with a conservative's view that all hard work is deserved and efficiently allocated to those who are most deserving.

However, considering the theory that we are on the cusp of a post-scarcity world, perhaps the liberal is right.

We live in a world were there is too much work for highly educated workers and not enough work for low educated ones. This at a time of general decline in education standards as demonstrated by many PISA studies. The forces of the market would have it that wages of the educated will rise and wages of the non-educated will fall.

This is why we need cheap, effective and widely available STEM (science, tech, engineering, mathematics) training (and retraining) opportunities in the US. This is both for new entrants to the labor force as well as for existing workers who have been displaced. A "liberal arts" education may be more intellectually pure, but for the majority of the population, it's simply irresponsible. The German education system, which emphasizes vocational schools alongside industry apprenticeships, is a good model (already these are starting to pop up in the US). This would also serve to help students avoid taking on excessive student debt as costs are lower than traditional research universities, and full time offers are often made by the employer to their apprentices upon graduation. Businesses would also be more willing to hire new graduates (as opposed to experienced hires) as job-specific training has already been completed (avoiding expensive on-the-job training programs as in the US).

However, the fundamental problem remains that the exponential pace of technological progress may simply be too fast for the skills mismatch gap to close. This is why I am optimistic about online education opportunities such as Udacity, Coursera, Codecademy, iTunes U, which meet many of the above requirements for good STEM training: cheap (it's free), effective (taught by professors, some of whom are at Ivy League universities) and widely available (anyone with internet). Recently, Udacity announced that they will offering certification exams in Pearson testing centers in conjunction with their job placement program. Unlike inflexible bureaucratic universities, online education is subject to the free markets: courses are offered in the subjects where the demand is, course demand goes where the opportunities are. This should go a long way towards minimizing the skills mismatch gap.

Future

Demand for unskilled labor will disappear or at least be significantly diminished. Although AI, robotics and 3D printing may have the potential to completely eliminate labor as a factor of production, as some modern Luddites claim, in the short term, the modern day equivalents of machine-operators (programmers, engineers, technicians) will be in high (and probably increasing) demand.

As the ultra-low labor costs in emerging markets no longer matter, jobs may initially come back to the the developed world. However, this job reshoring may be limited in impact as the emerging markets will seek to rapidly catch up (look at the growth of India's IT talent), especially as knowledge becomes freer and more easily available (such as through online courses). Thus, the most sustainable way for developed markets to compete will probably be through superior education and training.