Michael Spence’s 1973 paper “Job Market Signalling” tackled a thorny problem: how do employers figure out which job candidates are good when they can’t directly observe their abilities?
His breakthrough was showing how education works as more than just skill-building—it’s a way for talented people to prove themselves. The logic is elegant: getting a degree is harder for less capable people, so those who complete more education are sending a credible message about their abilities.
What makes this work is that the signal must be expensive—in time, money, or effort—and crucially, it must be more expensive for less productive people. When high-ability workers find it easier to get degrees than low-ability workers, education becomes a reliable sorting mechanism.
This creates what Spence called a “separating equilibrium” where different types of workers make different choices about education, allowing employers to make better hiring decisions based on credential levels.
The irony Spence pointed out is that education might work perfectly as a signal even if it taught nothing useful for the job. If it just helps employers identify talent, society might spend enormous resources on credentials that don’t actually boost productivity.
For a signal to work properly, it needs three things: it must cost something significant, it must cost less for truly qualified people, and employers must be able to easily verify it.
While Spence focused on education and jobs, his insight revolutionised how economists think about information problems across many markets—from warranties signalling product quality to companies using dividend policies to signal financial health.
This elegant theory helped explain puzzling real-world patterns and became a cornerstone of the economics of information.
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