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It’s no secret that college graduates earn more than their peers (although the extent and size of the lifetime financial payoff has recently become ground for debate). As authors of a new National Bureau of Economic Research working paper explain it, employers, provided with limited information about potential or new hires, often rely on easily observed characteristics -- race and diploma earned, for instance -- and determine pay in part based on average ability of people with the same level of education.
Conventional wisdom says that the more employers learn about the ability of workers, the less they typically rely on education in setting wages.
In “Beyond Signaling and Human Capital: Education and the Revelation of Ability,” (the full version of which is available electronically for $5) three Duke University economists argue that education plays more than just a "signaling" role in the determination of wages. Graduation from college, the report says, allows individuals to directly reveal key aspects of their ability to potential employers.
Having identified a method of quantifying a person's ability early in his or her career, the authors studied the first 10 to 12 years of work for both white and black men who are high school or college graduates. They found that from the very beginning of their careers, college graduates are "paid in accordance with their own ability." In other words, financial returns are immediate for college alumni first seeking employment, and that typically doesn't change with labor market experience.
The authors note that college students are often rewarded right away because their resumes include information on grades, majors, standardized test scores and college attended -- all of which allows employers to sort individuals by background.
On the other hand, individual ability is revealed to the job market much more gradually for high school graduates, whose wages are initially "completely unrelated to their own ability," the report notes. Their financial returns rise steeply with experience, in part because employers at first have limited data on their ability to perform.
This dichotomy, the authors note, "has a great deal of power in explaining racial wage differences." Among college graduates entering the job market, the report finds no measurable differences in wages or opportunity to cash in on professional ability across races.
But the report estimates that, comparing people of similar ability, black high school graduates initially earn 6 percent less than white high school graduates. "These results are consistent with the notion that employers use race to statistically discriminate in the high school market but have no need to do so in the college market," the report says.
