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PAGE ONE Economics


Learning the Skills To Pay the Bills?
Scott A. Wolla, Senior Economic Education Specialist

Asymmetric information: A situation in
which one party to an economic transaction has less information than the other
Human capital: The knowledge and skills
that people obtain through education,
experience, and training.
Innate: Something determined by factors
present in an individual from birth rather
than learned by experience.
Opportunity cost: The value of the next-best
alternative when a decision is made; it’s
what is given up.
Productivity: The ratio of output per worker
per unit of time.

“An investment in knowledge pays the best interest.”

—Benjamin Franklin

It’s often said that a college education is the key to success. And the decision to go to college is one of the most important choices young people
encounter. But you might wonder why a college degree makes such a big
difference. Does college really teach valuable skills, or is it all about the
degree itself—the piece of paper that serves as your ticket to success? Or
is it a bit of both?

The Economic Benefits of Education
Economists observe that individuals benefit greatly from education, and
those benefits accumulate into benefits for the entire economy. For the
individual, education increases job opportunities and usually results in a
higher income. This occurs because workers with more education tend to
have higher productivity, which means they tend to produce more output
with the same inputs. Because businesses can sell this extra output to earn
higher revenues, firms are willing to pay highly productive employees a
higher wage.1 In other words, higher productivity increases the value of
these employees to the firm.
So, as noted above, an educated workforce benefits society by producing
more goods and services with the same level of resources. Productivity
gains fuel economic growth, which increases the standard of living in an
economy—for both the highly educated workers and the population
more broadly. In a sense, these are two sides of the same coin: Education
increases productivity, and higher productivity results in higher incomes
for workers and more economic growth for the economy.

How Are Education and Productivity Linked?
In some ways, discussing the relationship between education and productivity is like trying to answer the old question “Which came first, the chicken
or the egg?” On the one hand, education might nurture productivity,
December 2015

Federal Reserve Bank of St. Louis |

PAGE ONE Economics®

Federal Reserve Bank of St. Louis |


Earnings and Unemployment Rates by Educational Attainment
Unemployment rate in 2014 (%)

Median weekly earnings in 2014 ($)
Doctoral degree
Professional degree


Master’s degree


Bachelor’s degree


Associate’s degree


Some college,
no degree


High school diploma
Less than a
high school diploma




Average: 5%

Average: $839

NOTE: Generally speaking, higher education is related to higher median weekly earnings and a lower unemployment rate.
SOURCE: Current Population Survey, U.S. Bureau of Labor Statistics, U.S. Department of Labor.

causing it to grow and develop (like a chick hatching
from an egg). On the other hand, productivity might
already exist (like the chicken) in varying degrees in different people, and the presence of high productivity can
lead to the successful completion of higher education.
Economists usually view this dynamic through one of
two models and can sometimes disagree over which is
really at play.
The first is the human capital model, sometimes called
the “schooling model.” Human capital is the knowledge
and skills that people obtain through education, experience, and training. One way workers invest in human
capital is by pursuing education after high school. This
can be expensive not only in terms of tuition, room, and
board (direct costs), but also in terms of the opportunity
cost, or what is given up. College students give up the
opportunity to work (and earn income), but the knowledge and skills acquired will enable them to earn more
in the future. This is generally a good trade-off. Economic
data strongly suggest that education, income, and success in the labor market are positively related (see the
figure), and studies confirm that the benefits of a degree
exceed both the direct costs and the opportunity cost
for most students.2

One way to discuss the benefits from investing in higher
education is to determine the college wage premium,
which is the percent increase in earnings of those with
a bachelor’s degree compared with those with a high
school diploma. Research suggests that the college wage
premium has risen from 40 percent in the late 1970s to
84 percent in 2012.3 In short, the human capital (or
schooling) model says education raises a worker’s productivity through the knowledge learned and skills
acquired, and this increase in productivity results in
higher wages. In other words, human capital is the chick
that emerges from the egg, which grows and develops
into a productive chicken.
Other economists argue that education primarily serves
as a signal of one’s productivity. And, not surprisingly,
the economic model that captures this is known as the
signaling model. Suppose a business hires two types of
workers: low-productivity workers and high-productivity
workers. Low-productivity workers earn a good wage at
the firm, but high-productivity workers earn much more.
If the firm asks applicants about their productivity during
the interview process, all applicants will claim to be highproductivity workers because they know high-productivity
workers earn higher wages. In this model, employers lack

PAGE ONE Economics®
information about the actual productivity of workers at
the time of the interview. Economically speaking, the
labor market has asymmetric information, which is a
situation in which one party to an economic transaction
has less information than the other party. In this case, the
job applicant knows more about his or her actual productivity than the employer. As a result, the firm will seek
information about a worker’s productivity and often
use education credentials as an indicator, or “signal,” of
Imagine a business seeking a computer programmer.
Several applicants might claim to know how to write
computer code in the interview process, but firms will
likely give preference to applicants with a college degree
in computer science. To the employer, the degree communicates that the worker is cut out for high-productivity
work. The worker has demonstrated his or her talents
and ability while earning a degree, and the college has
affirmed that ability by granting the degree. So, the
degree serves as a signal that the worker has the qualifications for high-productivity employment. Note that
both sides benefit from the signal sent by the degree:
Employees gain access to higher-paying jobs, and employers gain information about a prospective employee’s
Some economists take the signaling model one step
further. They attribute productivity to an innate combination of intelligence and work ethic. While colleges
might teach knowledge and skills, in this model, the
primary role of a college is to serve as a filter to categorize workers. Put differently, the college sets the bar high
enough so that only high-productivity students can clear
the hurdle. This process provides information, which
helps firms separate the low-productivity workers (who

Federal Reserve Bank of St. Louis |


do not go to college or fail to finish with a degree) from
the high-productivity workers (who earn a degree). Along
these lines, the degree both filters and signals the innate
abilities of potential employees.

In the human capital model, education leads to increases
in productivity. In the signaling model, high productivity
leads to successful completion of higher education. In
the end, the results are similar: Those who earn a college
degree tend to be more productive workers and earn
more money. Perhaps blending the models provides
something more complete: People should earn a college
degree because the knowledge gained and the skills
acquired will increase their productivity, and they can
use the degree to signal their productivity to prospective
employers. n


Economic theory suggests that competition in labor markets ensures that firms
reward highly productive workers with higher wages to keep them from looking
for employment elsewhere.


Abel, Jaison R. and Deitz, Richard. “Do the Benefits of College Still Outweigh the
Costs?” Federal Reserve Bank of New York Current Issues in Economics and Finance,
2014, 20(3);


Jonathan, James. “The College Wage Premium.” Federal Reserve Bank of
Cleveland Economic Commentary, No. 2012-10, August 8, 2012;

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