Department of Economics

Manudeep Bhuller (UiO): Signalling and Employer Learning with Instruments

Main content

Welcome to our research seminar with associate professor Manudeep Bhuller (UiO).

Title: Signalling and Employer Learning with Instruments.


Two competing theories in labor economics – the theory of hu-man capital and the signalling theory – try to explain the schooling-earnings relationship. The human capital theory says that education increases worker productivity while educa-tion investments are costly, such that individuals choose an optimal level of schooling in a cost-benefit trade-off to maximize lifetime payoffs (Becker 1964; Mincer 1974). The sig-nalling theory posits that education is used to signal one’s productivity in an environment with asymmetric information where employers don’t observe worker productivity and less productive individuals face higher investment costs (Spence, 1973). Taken together, this im-plies that even after accounting for the standard ability bias, education wage premiums may represent both a human capital component and a signalling component. Although there is an extensive empirical literature that has focused on estimating the causal returns to educa-tion using instrumental variables, little is known about the relative contributions of human capital and signalling. Decomposing these two components is empirically challenging be-cause the two models are observationally equivalent. This paper develops a model of market learning with human capital and signalling where employers gradually learn about worker productivity (Farber & Gibbons, 1996; Altonji & Pierret, 2001). Our key insight relates to the role of instruments in this model of employer learning. In particular, we consider what can be learned about the schooling-earnings relationship depending on whether the instrument is transparent or hidden from the employer. We provide sufficient conditions for point identification of the speed of employer learning and the relative contributions of human capital and signalling over the work career. Using population-level Norwegian administrative data with career long earnings histories for males, we test the model of employer learning by combining information on workers’ IQ test scores and supply-side instruments for schooling. Our preliminary results suggest that the productivity-enhancing human capital returns to schooling are at 6%, while the standard Mincer returns to schooling are at 9.5%.