Why is a College Degree Valuable?

I examine the usual answers to this question in light of the rapid changes in technology and formulate a new theory as to why college is valuable: the Signal-to-Skills theory.

Dueling Theories

One of the major debates in higher education is: “Why is a college degree valuable?” This debate has largely boiled down to one of two arguments. The first, popularized by economist Bryan Caplan in his book “The Case Against Education”, is that graduating from college sends a signal to employers that you are intelligent and employable. Furthermore, this signal is more important than the specific courses you took in school. This is called the “signaling theory” of higher education. This theory predicts that where you attend college is more important than what courses you take, and that graduating is more important for your career than completing individual courses.

The second argument, called the “human capital theory”, is that the knowledge, skills, and tools you acquire in school are what makes a college degree valuable. Human capital theory predicts that each additional course you take makes you more and more valuable to employers. This theory assumes that employers can accurately assess the knowledge, skills, and tools you have, and use this information to determine whether or not to hire you. This theory predicts that taking more courses is better than fewer courses, and some college is better than no college.

One argument in favor of the signaling theory of education is that salaries of students who only completed say, 50% of their college credits, do not get a pay increase that is 50% of what a college graduate makes. This implies that the value of a college degree is based on crossing the finish line, rather than completing any one course. A second argument would be the collective shrug that employers have shown towards students that have “completion certificates” from online education programs, like EdX or Coursera. The “human capital” theory would predict that these courses would have more value in the job market.

On the other hand, the human capital theory is supported by the fact that there is a growing “skills gap” in the world of work. My recent article on the Manpower Group, one of the world’s largest staffing agencies, noted that 45% of employers have difficulty filling roles. Employers cite both the “skills gap” (27%) (a lack of hard and soft skill abilities), and inexperience (20%) as driving factors. Clearly, employers are monitoring the skills that graduates are lacking, and improving these skills through education would increase the value of a student in the job market.

How do we resolve the contradiction between these two theories of college value?

Hiring Managers

My hypothesis is that companies screen job candidates based primarily on either credentials OR skills. Hence, whether “signaling” the possession of a credential is more important than learning individual skills, depends on the way companies have hired historically.

For example, imagine an industry like investment banking, where banks only hire from the Top 20 colleges. In this industry, you won’t be hired without a college degree from a top school, let alone without a college degree altogether. This is a credential-based hiring process. Yes, the bank may give candidates a skills assessment during the interview, such as having them build a financial model. However, since every job applicant has a college degree, the “signal” variable will dominate the analysis: employees who have completed college will have higher wages than non-college graduates.

On the other hand, imagine an industry like photography. In this industry, the hiring process is not geared around where you went to school, or even, if you went to school at all! The hiring managers look at online portfolios of the candidates actual photography. This is a skills-based hiring process. In this industry, whether you went to college or not is largely irrelevant. Hence, the “human capital” variable will dominate in this industry: employees who have the most “skill” at photography will have higher wages than those with less skill, regardless of whether or not they have a degree.

In Caplan’s book, he shows concrete analysis that the “signal” of having a college degree has been more important historically than the “skills” acquired by taking specific classes. This tells us that on average, the job market in the U.S. has been historically dominated by employers that use credential-based hiring.

Signal-to-Skills Theory of Education

But, what if the hiring process was shifting, from a credential-based hiring process to a skills-based process? The implication would be that both the signaling theory and the human capital theory have validity, but their importance is changing over time. Indeed, I have argued that the signaling theory of higher education has more validity today. However, I also see evidence that employers are shifting from valuing credentials to valuing skills. The reason for this change is technology.

I call this idea the Signal-to-Skills theory of education: the higher the level of technical skill required in a specific industry or career, the more important the specific knowledge, skills, and tools, you have will be compared to whether or not you have a degree.

This theory predicts the following dynamic:

s2sedu.png

As technological change increases over time, the value of education will be driven more and more by skills, and less and less by signaling to employers that you have a credential, degree, or certificate.

Signal-to-Skills Theory of Hiring

Interestingly, when we consider the Signal-to-Skills theory at the level of an individual company, we get a different chart:

s2shiring.png

The Signal-to-Skills theory of hiring predicts that as a job becomes more technical, employers will be forced to switch from a credential-based hiring system to a skills-based hiring system. This switch is not gradual. Instead, it happens suddenly as the company changes the way they evaluate job candidates from credentials (e.g. resumes) to skills (e.g. work samples) over a short period of time.

Predictive Power

The reason the ideas above are “theories” is that we can use them to make predictions, and then test the predictions against what actually happens in the future. I will be using this framework to make predictions and testing my own performance over time. On Friday, I will be looking at recent news from Make School, a higher education startup in Silicon Valley navigating these changes, and exploring what the Signal-to-Skills theory predicts about their future performance.

Until then, enjoy your new mental model, and let me know whether it rings true in your school or industry.

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Micah

Micah is the author of Rethink the MBA. He works and lives in Silicon Valley.

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