A Spillover-Based Theory of Credentialism

This paper studies a large economy in which workers’ productivities are influenced by the skills of their coworkers. Each worker’s skill is the result of an ability-augmenting investment that is made prior to matching with a coworker. These skills are ‘soft’ (unquantifiable) characteristics of workers. In contrast, investments are ‘hard’ characteristics. This feature gives investments a credential quality, since a worker can use their investment attract desirable coworkers. The main result of the model is that, despite the positive externality, there is over-investment in equilibrium. Apart from providing a rationalization for credentialism that overcomes some recent criticisms of signaling models, the analysis provides insights into the relationship between spillovers and productivity, welfare, and inequality. The model offers a different interpretation of returns to education, and demonstrates how modeling spillovers in this way produces conclusions that are dramatically different from standard treatments. I extend the model to a simple dynamic setting and show that the qualitative conclusions of the static model are unaffected when utility is non-transferable, and that efficiency is restored as workers become patient when utility is transferable. ∗Job Market Paper. Thanks to participants in the Development, Institutions, Environment, and Trade lunch at UBC, the 2007 Canadian Economics Association Meetings in Halifax, and the 2006 TARGET UBC-SFU student workshop. Thanks are especially due to Ken Jackson, Patrick Francois, and Mike Peters for valuable discussions. All errors are mine and any further comments are most welcome. †PhD Candidate, Department of Economics, University of British Columbia, 997 1873 East Mall Vancouver, BC Canada, V6T 1Z1. email : [email protected], web : grad.econ.ubc.ca/cbidner