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December 18, 2012

31

Why Does More Education Increase Income?

by Jeremy Arnone

We reviewed the higher education bubble in two previous posts (see here and here).  Today’s post is looking at the fuzzy thinking driving the bubble, as well as the larger issue of which the bubble is merely a symptom.  But first things first – I need to congratulate my Duke Blue Devils for assuming their rightful place atop the college basketball rankings!  And a preemptive apology to my thesis adviser at Northwestern, who may not care much for this post.

At its core, the bubble in higher education is being driven by the belief that a college education teaches skills that are vital to building a successful career, and that higher levels of education are tied to increased worker productivity.  In other words, skills learned in school lead to higher productivity, which is rewarded by employers in the form of higher earnings for the well-schooled.  Here’s the assumed relationship:

Screen Shot 2012-12-16 at 10.27.32 PM

In Economics there’s the concept of asymetric information, where one party to a transaction has better information than the other party.  Virtually all job markets have imperfect information.  To cope with this asymetry, buyers look for shortcuts – ways to infer quality – using a process called signaling.  In the case of the job market, employers look at both the level (how much) and quality (where) of education to signal the quality of the applicant.

In my professional career, I’ve seen consistently that higher levels of educational attainment lead to higher levels of income.  This is especially true with workers under 40, who matured professionally as the higher education mania spread in earnest.  We see this relationship in the chart below, based on 2010 Census data:

Screen Shot 2012-12-16 at 10.38.08 PM

There’s a clear correlation between levels of education attainment and higher incomes.  The more interesting questions involve causality – does higher education cause higher income, and if so, how, why, and should it?

An Important Distinction:  Correlation vs. Causation

One of the more prevalent learning disabilities in organizations today is confusing correlation with causation, the notion that umbrellas cause rain or diet soda causes weight gain or even that a rock keeps away tigers.  In a professional setting, I’ve seen this confusion lead companies to mistakenly justify expensive marketing campaigns, brand overhauls, even major changes to their strategic positioning.  Let me share just one example.

Several years ago we were asked to optimize the Marketing performance of a large multi-channel business.  The most successful marketing channel was catalog, with more than 100 million copies being sent to millions of customers every year.  Like many direct-response companies, the team tracked if someone received a catalog and then placed an order online or in a store.  Based on that key assumption, more and more catalogs seemed the way to go.  But, we asked, did the catalog really drive the sale, or was it the umbrella that happened to be around when it was most likely to rain?

There happens to be a very easy way to figure this out (though surprisingly few companies do).  We split the customer file into 2 groups.  One group received the normal series of catalogs; the second group received no catalogs.  Here’s what we saw in terms of sales and profit between the two groups (numbers disguised but directional).

Screen Shot 2012-12-16 at 11.09.16 PM

Turns out nearly every customer who received the catalogs and ordered would have ordered without one.  The company had mistakenly focused on one variable (received catalog) and seen a correlation with the desired action (bought something).  But when we controlled for the impact of the catalog, we saw it was largely unnecessary.  Could the same thing be happening with higher education and the job market?

The Assumptions Linking Education & Income

We saw that the relationship between education and income is tied through the assumed impacts of greater skill development and then higher productivity.  Turns out, researchers have begun questioning these assumptions.  One study showed that a majority of students gain few to no job-related skills while in college.  A second study (one of many) showed that there was a negligible impact on worker productivity from higher levels of education.  Finally, a Princeton study showed that when you take a student’s inherent skills into account, universities have minimal impact on future earnings.  The first 2 studies challenge the assumption that higher educational attainment causes skills and productivity, respectively.  The last study severs altogether the assumed causal link between educational attainment and higher income.

Screen Shot 2012-12-17 at 9.22.18 PM

The chart above makes this point – there are causal factors related to the “level-of-education decision” which are also related to someone’s level of “skill.”  For example, ambition is a causal factor that may lead both to greater consumption of education and to a job-related skill such as hard work.  This is where the signalling function, unable to make such fine distinctions within causal factors, mistakenly attributes a skill to more education.

This isn’t to say that higher educational attainment doesn’t cause higher incomes; it does.  But the assumptions underlying that relationship are wrong.  We’ve assumed that something we can easily measure – educational attainment – is a handy proxy for the thing we really want to measure, productivity.  But shortcuts can sometimes lead you astray.  If we found ways to identify and measure actual causes of productivity, we might, among other things, stop wasting money on unnecessary education.

Why the Higher Education Bubble Isn’t THE Problem

At first glance, what’s driving the bubble is demand from students.  However, the real driver is employers adding, “Degree required, advanced degree preferred,” willy nilly to every job description.  If employers modified or severed the relationship between hiring and college education by better understanding the impact of a degree on what they care about – productivity – we could arrest the dangerous spirals of higher costs and poorer returns within the higher education market.

However, the bubble in higher education is caused by a bigger problem; a misunderstanding of what drives productivity and innovation.  For example, an increasing amount of research (see here and here) shows the outsourcing of manufacturing has a direct impact on our capacity to innovate.  This shift from “sweating” to “thinking” sounds compelling individually, but taken collectively is perhaps the biggest factor driving the oversupply of higher education.  As I mentioned in my recent posts on strategy (here and here), high-level strategy (thinking) is founded on a lot of messy digging (sweating).  If you don’t get your hands dirty (literally and figuratively), you won’t capture the insights that lead to long-term innovation and productivity.

This is an issue increasingly being studied and given attention.  With the direct and opportunity costs we face, the sooner we confront and address these issues, the more confident we can be that our education dollars are being wisely invested, that our kids and grandkids aren’t being saddled with debt they can’t hope to repay, and that the asset that is our workforce – regardless of collar – is properly utilized.

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31 Comments Post a comment
  1. Rachel Pollack
    Dec 18 2012

    Amen. I once asked a Yale graduate I know, “Did you learn anything in school you didn’t know before?” He said no.

    Requiring a degree for every job needs to stop! And we do need our workers to do their own work in order to innovate. If you don’t do the work yourself, you won’t see ways to improve. Think of Henry Ford walking through his factory.

    Great article!

    Reply
    • Dec 18 2012

      Good points! I believe the value that many get from higher education (teamwork, independence, responsibility, critical thinking, etc.) can often be acquired in less expensive, more productive ways. If I could distill all the research, it would be this: The value of higher education is inversely correlated with the “quality” of the environment in which you grew up. The students with the most disadvantaged upbringings are the ones who get the most value from higher education.

      Reply
  2. Melfisher1
    Dec 18 2012

    Make universities guarantee 50% of all student loans and watch the results of a free market.

    Reply
  3. Brad D.
    Dec 18 2012

    Also, I am college professor at a small, regional university in the midwest. I teach five to six courses per semester and my annual take-home pay is around $45,000/yr. The bloated costs of higher ed at my institution come from bloated bureaucracy, overpaid staff surrounding the various administrative bureaucrats, and all the money that has to be spent to meet every new state and federal regulation that comes down the pike. Not all of us academics are paid a lot…nor are all of us Leftists either. Higher Ed, like public education, is broken for sure…and I should know as I see it every day!

    Reply
    • Dec 18 2012

      Your perspective on what’s driving the rise in tuition is spot on with what I’ve heard/read from other educators.

      Reply
  4. Allison Hunter
    Dec 18 2012

    I don’t understand why college tuition is so high these days. The buildings and land are DONATED by weathy families or corporations who sponsor research. The only “expense” the school has is for salaries. Time for a pay cut or force these overpaid professors to teach four classes a day and fire all the assistants.

    Reply
  5. Hank J.
    Dec 18 2012

    Up at mighty University of Michigan – the G&A (General and Administrative fees or Overhead costs) charged to a Government won Grant are OVER 50%. That means that when a prof wins, for example, a Cancer research grant of $10,000,000 from the NIH – over $5,000,000 goes to the Administration for mowing the lawn, waxing the monkey, etc. The Federal Government dolls out Billions in grants each year – and HALF of that simply props up the University Administrations.

    Reply
  6. Citizen.Jerry
    Dec 18 2012

    Colleges and universities may be offering too many Bushwood-like luxuries, but perspective students demand them. If one college doesn’t offer them, students will go where they are offered.

    Maybe all this will change when kids realize they can get pretty much the equivalent of a college education through no-cost and low-cost online sources.

    Reply
  7. Joseph White
    Dec 18 2012

    Percentage of Americans between the ages of 18 and 24 attending college in 1980: 40%

    Percentage of Americans between the ages of 18 and 24 attending college in 2010: 68.6%

    There’s your bubble, right there.

    Reply
  8. Noel T.
    Dec 19 2012

    College is not for everyone. There are other legitimate paths to successfull careers. We need to make sure high school students are aware of the alternatives rather than continuing the mantra of college or would you like fries with that. In education, it is extremely important to learn the new skills that are part of today’s society, but we cannot focus only on those to the detriment of classical learning. If we produce a society full of texting whizzes and computer geniuses who have never read Beowulf or have never heard of Wuthering Heights, it will be a great loss of richness. We cannot exchange the great literature and learning of the past for technology of today. We have to achieve a balance of both.

    Reply
  9. Gate Keeper
    Dec 19 2012

    This article is a good example of why some looking at high tutition and overall cost of college should take a serious look at a trades education. Even is it’s a back up to a university one…People will ALWAYS NEED a plumber, electrician, mechanic, builder, landscaper, mason, etc.

    Reply
  10. Santa Elf
    Dec 19 2012

    I think this article is somewhat misleading.. the majority of the statistics show that people with degrees will go to make more money than those without it.

    Reply
    • Anonymous
      Dec 19 2012

      That’s what the article says: college grads earn more. ?? But the inference is that even though college grads make more money, that doesn’t mean that they are any smarter or more skillful than people without degrees.

      Reply
  11. Romavicta
    Dec 19 2012

    Higher Education is a for profit business, . . . .1/4 of the students attending higher education do not have the intellectual or educational abilities that are required but that does not stop colleges and Universities from taking their money. We have all drank the Kool-Aid when it came to buying the idea that everyone needs a college education. We need to model our educational system after the German model. In their high schools students have to chose either a technical or a college route. Our country needs more skilled blue-collar laborers! Now, you can write your own ticket if you have a learned skill.

    Reply
  12. Guest
    Dec 19 2012

    Here’s the problem I see, if one looks through a newspaper, searches on the internet or even goes to a temporary service agency the first thing 90% of listings requires “4 yr degree”. When I was laid off in 2005, I had over 10 yrs of administrative work under my belt (Executive Assistant). I was turned down over and over and over again because I didnt have a degree regardless of excellent credentials and references.
    Its not the kids who think they have to have a degree to make it in this country but lets ask the hiring mangers why they require degrees? I wasnt aware a 4 yr degree was needed to be a receptionist or assistant or even file documents in a law firm. But this is the “job requirements” that we see.

    Reply
    • Cliff65
      Dec 19 2012

      The BA and now the MBA is the arbitary cut of device they use to not have to interview every job applicant and have a cut off that will be a CYA on the legal front if someone wishes to suggest illegal preferences are at play. Once you have to CYA on EEOC issues and the like and not allowed to hire whom the heck you want to for what ever reason you want to, things like college degrees become the only safety value for employers.

      Reply
      • Dec 27 2012

        What a pleasure to find someone who thinks through the issues.

    • Pedro M.
      Dec 19 2012

      Unfortunately a college degree.or absence of one is the best way for HR to get rid of 1/2 of the job applicants without reading a single resume.

      Reply
  13. Anonymous
    Dec 19 2012

    I agree with this completely. I spent my time in the Corps instead of on a campus and I’m doing better in the tech field than 3/4s of the people that I graduated with that went on to college. It’s all about what you put into it and are able to bring to the table. A degree just says I can read a book and listen to someone talk for hours on end. As long as you’re competent at what you’re doing and can perform all of the duties of your job, what does it matter if you have a degree for it.

    Reply
  14. David R.
    Dec 20 2012

    Very original approach to the education question, haven’t seen this angle before. We always hear that more education is the solution to joblessness and underemployment, but you seem to be saying the opposite. Reviewed your background on Linkedin – Northwestern, Duke, McKinsey…wouldn’t expect someone with that background to have this perspective. Your readers might appreciate this article. http://www.reuters.com/subjects/income-inequality/massachusetts

    Very well done.

    Reply
    • Dec 24 2012

      David, thanks for the link to your story. Re: my academic/work background, I hope it has helped facilitate a desire to dig deeper.

      Reply
    • Dec 28 2012

      Thinking like that is really impressive.

      Reply
  15. Scott Wilkerson
    Dec 20 2012

    Face it. A college degree gives a employer a legal and instantly way to discriminate against an applicant for a job. Some of the dumbest, least motivated, lacking in imagination, and work ethics people I know have college degrees (myself included). Some of the most intelligent, hard working, and motivated people I know have a HS diploma. Education level is an easy way to discriminate in salary compensation and career development.

    Reply
  16. Anonymous
    Dec 23 2012

    I don’t understand what you mean by causal factors. Can you clarify?

    Reply
  17. Dec 25 2012

    I have been checking out some of your stories and i must say nice stuff. I will surely bookmark your website.

    Reply
  18. Feb 16 2013

    Its like you read my mind! You seem to know so much about this, like you wrote the book in it or something. I think that you could do with some pics to drive the message home a little bit, but other than that, this is great blog. An excellent read. I will definitely be back.

    Reply
  19. Will B.
    Feb 21 2013

    The Ponzi must be fed.

    Mo-money, mo-money, mo-money.

    The dream factory and related industries must be fed.

    The dream of an illusory tomorrow is the only way to maintain the fantasies of today.

    Reply
  20. Mediocratis
    Feb 21 2013

    Universities are dying a slow death.

    Excepting hands-on experience (physical manipulation of lab equipment for example), universities are not able to offer ANY paid-for content that is not already freely accessible on the internet. Even if they can, decent content quickly makes it up onto the web a short time later, it just takes a little effort to look.

    Courses are massively overpriced and drawn-out over years because dragging it out means pulling in more tuition fees. It’s a total rip-off because any person with sufficient motivation (and that’s the key to learning) can teach themselves off the net in a fraction of the time with only minimal guidance (if needed at all).

    The only thing that’s keeping universities going is prestige and status. People still think having a degree from a top-tier university is something to be admired, even when it means being totally incompetent. Youngsters still yearn for the social life on campus without sparing a thought towards a future of debt.

    The universities will dig in and fight this one out for years, all the way to the bitter end, but the web will ultimately win as youngsters wise up. As that happens, employers will also evolve to value competence over “education”.

    Expect it to be a long fight because universities are sitting on truly massive hoards of wealth in the form of things like real estate and art works. Perhaps some form of them will always be around because all the really rich kids still want to party with the other rich kids while justifying it to their parents, and they DO love to have titles.

    Reply
  21. Major Minor
    Feb 21 2013

    I’m sure glad I got my degree in the 80s. I hope this bubble pops before 2018 when my daughter starts college.

    Reply

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