Image created by ChatGPT
There’s a vigorous debate on social media over whether it’s acceptable for a job candidate to bring an iced coffee to an interview. In his always interesting “Monday Morning Economist” Substack, Jadrian Wooten provides an economic analysis based on the signaling theory of Nobel laureate Michael Spence of New York University and Stanford.
Photo of Michael Spence from gsb.stanford.edu
Signaling can be important in markets affected by the problem of asymmetric information, which occurs when one party to an economic attraction has less information than the other party. As we discuss in Microeconomics, Chapter 7, George Akerlof—who was awarded the Nobel Prize in Economics in the same year as Spence—provided a classic early analysis of asymmetric information in the used car market. The seller of a used car will know whether a failure to maintain the car by, for instance, regularly changing its oil, has caused the car’s engine to suffer damage that even an auto mechanic may have difficulty detecting.
Image created by ChatGPT
Asymmetric information in a market can lead to adverse selection in which one party to a transaction—in this case, a car seller—takes advantage of knowing more than the other party—in this case, a car buyer. For example, suppose you intend to buy a car, and you contact people who have listed cars on Facebook Marketplace or Craigslist. You have no good way of determining whether a car listed has been well maintained, a “creampuff,” or poorly maintained, a “lemon.” If you had full information on the car you would offer to pay $25,000 to buy a creampuff, but only $15,000 to buy a lemon. Because of this uncertainty, you might offer to pay $20,000 for a car of unknown quality. Your offer seems reasonable to you, given your uncertainty about the quality of the car. However, a seller who knows the quality of the car will be reluctant to accept your offer if the car is a creampuff, but happy to accept your offer if the car is a lemon. The result is that cars offered for sale are more likely to be lemons than creampuffs. Or, in other words, because of asymmetric information, the market has adversely selected the cars that will be offered for sale.
Asymmetric information also exists in the job market. When you apply for a job, you know much more about how hard you will work and how developed your relevant skills are than does the company you are applying to. Suppose that the company would pay you a salary of $60,000 per year if the company was sure that you would turn out to be a hard worker, but only $40,000 if the company believed that you would turn out be a slacker. Because of this uncertainty, the company might offer a starting salary of $50,000. That salary would be attractive to slackers but unattractive to hard workers. As a result, the company might find that most of the people applying to work for them are slackers.
Michael Spence argues that in markets in which asymmetric information is important, economic agents will have an incentive to signal that the good or service they are selling is of higher quality than buyers might otherwise think. For example, a firm selling used cars may invest in making their dealership clean and attractive or by offering warranties on the cars they sell. The firms are attempting to signal buyers that the cars they are selling are creampuffs rather than lemons.
One strong signal you can send to employers when you apply for jobs is that you have earned a college degree. There has been a long debate among economists over whether a college degree indicates to potential employers that you have accumulated knowledge and skills in college—in other words, your human capital is higher than for non-college graduates—or whether a college degree is mainly a signal to potential employers that you are likely to be a hard worker because you have completed a task as difficult as obtaining a college degree.
Image created by ChatGPT
The sheepskin effect is often raised by economists arguing that for potential employers your having college degree is more about signaling than about the human capital you have accumulated in college. If you complete three years of college but drop out in your fourth year before earning your degree, you have likely learned almost as much, and have nearly the same level of human capital, as someone who has taken the few additional classes needed to earn a degree. In the job market, though, you are likely to earn significantly less than someone who has a college degree. This result makes it seem that a college degree is primarily a signal to employers that you have the characteristics of a good employee. Note: The sheepskin effect gets its name from the fact that years ago college diplomas were often printed on material derived from animal skins.
This older blog post by Noah Smith, including the responses from Bryan Kaplan of George Mason University, covers the main points raised in the debate over whether the value of a college degree is mainly the signal it sends to potential employers.
So, what signal are you sending when you bring an iced coffee to a job interview? Jadrian Wooten’s Substack post explains.
