The Increase in College Premium and the Decline in Low‐Skill Wages: A Signaling Story

Abstract

AbstractThe increase in the college premium over the last 30 years in the United States is to a large extent driven by a reduction in noncollege wages. We show that the signaling effects triggered by an improvement in the incentives to attend higher education can explain this fact, as well as the increase in the number of college graduates. Under imperfect credit markets and wealth heterogeneity, higher education is not only a signal of ability but also of individuals' (parents') wealth. General conditions on the distribution of wealth guarantee that after an increase in incentives to attend higher education, the absence of a college degree becomes a more evident signal of low ability. This results in a reduction in low‐skill wages but not necessarily in increased high skill wages. The increased incentives to enroll in college can either arise from a skill‐biased technology change or an improvement in access to higher education. An important difference is that while skill‐biased technology change always results in an increase in the college premium, that is not necessarily the case when the increased incentives to enroll arise from improved access to higher education.