Monday, July 17, 2006

Returns to prestige

In my last post I pointed to Greg Mankiw's blog where he discussed returns to education. Prof Mankiw states:

What might well be true is that the returns to education have become increasingly non-linear: The most educated are now getting a bigger return from a marginal year of education than those with moderate amounts of education. In other words, two years getting an MBA from Harvard Business School may increase a person's income more in percentage terms than does two years getting an Associate Degree from Mass Bay Community College. My understanding from my labor economist friends is that some evidence favors this hypothesis of increasing nonlinearity.

To some extent, the returns to human capital are random (as is true of physical capital). Getting an MBA gives you a shot at being CEO, but it is not a guarantee. This may be part of the Lemieux finding that higher levels of education are associated with higher residual variance. And perhaps it can reconcile the differing perspectives of Krugman and Lazear.

Perhaps returns to education are not as "random" as we might think. To add to Prof Mankiw's hypothesis, I suspect that monetary returns to institutional-derived education are becoming nonlinear while (labour wage) returns to prestige are becoming increasingly linear. Prestige in this sense would be measured as a function of the prominence of the educational institute attended, the prestige of a person's relations, society's determination of prestige, and so on.

A criticism that has been expressed of Prof Mankiw's hypothesis is that returns to skill (perhaps as a function of IQ, training, etc...- assuming “skill” could be accurately calculated), contains more information than returns to education. I agree but disagree. If an employer could learn about the skills of the workforce (ie. if it was efficient and affordable to do so), he/she would would likely use this information instead of hiring based on education. However, in a competitive labour market, employers have a good chance of gaining qualified candidates if they simply advertise for graduates from prominent universities. And they do.

I believe that there would be a benefit to looking at more than returns to education. Why? There are too many categories and determinants to entertain, and too many qualifications to make. For example, why should education be measured only in years when two years at Harvard offers greater returns than two years at Bunghole Community College? To put it another way, could you measure returns to gas on the growth of a flame? Not if you knew the difference between oxygen and methane. You could, however, measure the returns to each gas separately. But then, what would be the point in generalizing gas' influence on a flame? Instead, you might want to know what's in the gas that causes a flame to burn higher. Let's leave this bad metaphor. What I'm saying is, it's worth considering what a Harvard graduate and a Princeton graduate have that a graduate from Bunghole College doesn't have.

i) Perhaps they obtained relatively better skills from their education, but (once again), we're assuming that employers are not able to determine which candidates have the most skill. It's not efficient. It's much more efficient for them to hire based on...

ii) Prestige! People who graduate from prominent universities increase their personal prestige. As I see it, this latter point has become increasingly important in the labour market, more so than a general education.

One argument I foresee against my hypothesis would be in the case where a person is prestigious and stands to inherit a fortune. Evidence shows that people who expect to receive a large bequest often work less, perhaps because they have no incentive to work (Douglas Holtz-Eakin et al: 1993). In this case, the (labour wage) returns to prestige would be low; however, such situations would become the outliers. Linearity would surely still be stronger than in the case of measurements of monetary returns to education today.

In sum, I hypothesize that returns to education are becoming increasingly nonlinear and monetary returns to prestige are becoming increasingly linear. Looking at the potential nonlinearity of returns to education is interesting, but I think prestige is what is sucking up the linearity.

I invite criticism and knowledge!

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