Culture and the Labor Market
Author(s): Siobhan Austen
Source: Review of Social Economy, Vol. 58, No. 4 (DECEMBER 2000), pp. 505-521
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Review of Social Economy
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REVIEW OF SOCIAL ECONOMY, VOL. LVIII, NO. 4, DECEMBER 2000
Culture and the Labor Market
Siobhan Austen
Curtin University of Technology
aus tens @ clos. curtin. edu. au
Abstract This paper explores the relationship between culture and labor market
behavior. An attempt is made to clarify, from an economic perspective, the meaning
of culture; to discuss the importance of cultural studies in the economic analysis of
the labor market; and to outline the major theoretical issues that are associated with
adopting a cultural perspective on economic behavior in the labor market.
Keywords: Culture, labor market, labor economics, social norms
Culture is a hermeneutic system, that is, "an interpretative integration of material
objects, behavior, and their meanings" (Jennings and Waller 1994: 1000). Culture
encompasses language, norms, customs, morals, beliefs and conventions, and it
serves to establish a shared understanding among a group of people of the external
world and each individual's relationship to this world.
An understanding of culture should be an integral part of any economic analysis
of the labor market. Culture determines, in large part, the value and significance that
individuals attach to alternative labor market actions and outcomes. Particular
aspects of culture, such as social norms, also help to define the boundaries to the
pursuit by individuals of their culturally defined objectives in the labor market.
The economic analysis of Veblen and Commons embraced a cultural per?
spective on economic life (Jackson 1996). Veblen described individuals as the
sometimes comic creations of their inherited cultures and, following in his foot?
steps, "old-instutiutionalists" have continued to interpret patterns of economic
behavior as being the product of cultural environments that are specific to par?
ticular times and places (Mayhew 1987: 590, 596 and Woodbury 1979).
"Old-institutionalists" have also identified aspects of culture, such as customs,
conventions and norms as legitimate and distinct topics of economic analysis.
Rather than interpreting these aspects of culture as the products of self-interested
individual action, the "old-institutionalists" have sought to describe social norms,
Review of Social Economy
ISSN 0034-6764 print/ISSN 1470-1162 online ? 2000 The Association for Social Economics
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REVIEW OF SOCIAL ECONOMY
customs, conventions and beliefs as autonomous parts of the environment in which
economic action takes place (see Hillard and Mclntyre 1994: 620-621 and Gimble
1991).
However, the neo-classical (and "new-institutionalist") analysis of the labor
market has attacked the notion of culture as a core process (Mayhew 1987). In
neo-classical analysis, human action is typically defined by objectives that are
treated as independent from the culture of the individual. Rather than viewing
human action as the product of culture, aspects of culture (such as language,
norms and morals) are interpreted as the product of an independent set of indi?
vidual interests. As Julie Nelson (1993: 292) explains, Homo economicus "springs
up fully formed, with preferences fully developed, and is fully active and self
contained. . .The [social and economic] environment has no effect on him but
rather is merely the passive material, presented as constraints, over which his
rationality has play. He interacts with society without being influenced by
society."
The dominance of neo-classical model in labor economics over recent decades
has meant that, despite the richness of the "old-institutionalist" heritage, the
important relationship between culture and labor market behavior has been a
relatively neglected field. An important gap now exists in the labor economics
literature.
This paper aims to help fill this gap in the literature by describing and dis?
cussing in broad terms the concept of culture as it relates to some important labor
market issues. The paper also sets out to describe the theoretical controversies that
are associated with adopting a cultural perspective on labor market issues and to
highlight the potential scope of cultural studies of these issues.
The structure of the paper reflects these aims. Section I utilises the classi?
fication of cultural effects provided by Di Maggio (1994) to identify, in very broad
terms, the nature of the relationship between culture and human action. Then, in
sections II and III, two major types of cultural effects are described and discussed
in greater detail, with reference to particular labor market issues. Several funda?
mental theoretical questions emerge from this analysis, especially concerning the
relationship between culture and instrumental reasoning, and these are discussed
in section IV. Section V concludes with a general discussion of the agenda for
further studies of the effects of culture in the labor market.
I. CULTURE AND ECONOMIC BEHAVIOR IN THE LABOR MARKET
The cultural perspective on labor market issues features an understanding that the
behavior of individuals in the labor market is shaped by their culture. It features,
in particular, an understanding that the language, categories, customs, norms and
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CULTURE AND THE LABOR MARKET
other aspects of culture shape an individual's valuation of alternative means and
ends, as well as his or her perception of legitimate and feasible action.
Di Maggio (1994) provides a taxonomy of cultural effects that can be used to
describe the general relationships between culture and economic behavior and to
highlight the difference between a cultural and neo-classical perspective of the
labor market. Di Maggio, first, describes the constitutive effects of culture. These
effects refer to the way in which the economic behavior of individuals is shaped
by the categories, understandings and differential valuations provided by culture.
One clear example of these effects is the influence of culture on an individuals'
perceptions of their self-regarding interest, and, thus, their "preferences" for
alternative labor market activities or outcomes.
Di Maggio also identifies the regulatory effects of culture, whereby aspects of
culture, such as social norms, morals, laws and conventions, impose boundaries to
the pursuit by individuals of their culturally defined objectives. In the context of
conventional models of economic behavior, these effects of culture can be under?
stood especially in terms of their regulation of the individual's pursuit of his or her
self-regarding interest.
This taxonomy of cultural effects has the advantage of simplicity and, thus, it is
a useful starting point for the task of describing and analyzing the relationship
between culture and economic behavior. However, it must be recognised that this
categorisation does not capture the richness and complexity of culture. For
example, it does not reflect the important differences in the concept of class,
organisational and national culture. Furthermore, the taxonomy suggests that
there are distinct elements of the cultural system, whereas White and Dillingham
(1973: 12-13) emphasise that "Culture is a whole. Everything is related to every?
thing else in a cultural system." Thus, although the notions of constitutive and
regulatory effects are discussed separately in the following sections, this is purely
for expository purposes. The two "effects" should not be construed as being
separate entities.
II. THE CONSTITUTIVE EFFECTS OF CULTURE
According to a cultural perspective on economic behavior, individuals' interests
(or their "preferences") are not a priori theirs. Rather, the value and significance
that individuals attach to material objects and different types of behavior have
their origins in the cultural environment, and these are transmitted to individuals
through a process of social learning. Thus, the choices made by individuals, even
those choices that have the objective of maximising their self-interest, are seen to
be shaped by (and can only be properly understood in the context of) the cultural
environment.
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REVIEW OF SOCIAL ECONOMY
The labor market is replete with examples that demonstrate these points about
the cultural specificity of economic behavior. An individual's evaluation of occu?
pational "attributes", such as income, responsibility, caring and creativity, and, in
turn, his or her occupational "choice" clearly reflects prevailing cultural values, as
passed on by schools families and peers (see Dugger 1981: 400 and Chapman
1981). The relationship between cultural values relating to work, leisure, income
and household production, and the formation of "individual preferences" for labor
market participation and hours of work also illustrate the way in which culture
constitutes economic action (see Brown 1985 and Golden 1996).
These constitutive effects of culture are not recognised in the neo-classical
analysis of the labor market. Orthodox economic models typically incorporate
an assumption that preferences are exogenous to the cultural environment of the
choice-maker. For example, Stigler and Becker (1977: 76) argue that preferences
are the same for all individuals and that any observed differences in behavior
between individuals or groups across time or space can always be explained by an
analysis of price and income factors. According to their view, if individuals from
different societies do engage in different types of activities and/or create and
maintain different institutions this is because they associate different costs and
benefits with similar actions (for example, because they have acquired different
types of skills).
In contrast, a hallmark of a cultural (and "old-institutionalist") perspective is
an assumption that individual preferences are endogenous. For example, an
important link is recognised between the culture of an organisation, its organis?
ational structure and workers' perceptions of their own self-interest. The insti
tutionalist analysis of internal labor markets features an argument that the structure
of such markets promotes the internalisation of the norms of the organisation by
its employees, (see Golden 1996: 13) Piore's (1979) work on migrant labor is also
distinguished by an assumption that workers' preferences and, thus, their willing?
ness to accept job offers, are molded by the characteristics of their social and
economic environment.
However, despite the efforts of institutionalist scholars to advance an under?
standing of these constitutive effects of culture, the dominance of the neo?
classical paradigm in labor economics has meant that this important issue has
been relatively neglected in recent decades. The analysis of patterns and changes
in the "choice" of occupation, labor force participation and hours of work has
suffered as a result.
The blindness of orthodox economics to the constitutive effects of culture has
also had implications for the type policy recommendations made for the labor
market. The assumption of exogenous preferences has caused many economists to
measure economic welfare in terms of the satisfaction of the supposedly constant
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CULTURE AND THE LABOR MARKET
preferences that are revealed by the choices made by economic actors. As a result,
policy recommendations have emphasised the importance of minimising any con?
straints on individual choice making, and the role for government intervention has
often been restricted to those cases where it is perceived that individual choice
making has been constrained or has been ill-informed. In turn, these recom?
mendations have typically resulted in sets of policy action that have had the effect
of preserving the status quo.
Jennings and Waller (1994) argue that, by ignoring the possibility that other
sets of cultural arrangements may create different preferences, this approach has
been blind to the possibility that cultural change may be an avenue to real welfare
improvement. It has also been blind to the possibility that, viewed from another
cultural perspective, current patterns of choice making may not be in any sense
optimal (see also Bowles 1985: 32).
The importance of these points about the cultural blindness of the neo-classical
analysis of the labor market can be seen in George's (1997) analysis of approaches
to the issue of revealed working hours preferences. He notes that an assumption of
exogenous preferences has led neo-classical economists to adopt an ambivalent
position on the apparent change in individual preferences towards longer working
hours. However, this assumption and the policy ambivalence may not be justified
and there may be a role for the government in the regulation of working hours. For
example, the change in preferences may have been caused by employers man?
dating the working of overtime which, in turn, created high levels of permanent
consumption. Thus, the longer working hours may represent a sacrifice of indi?
vidual welfare even though individuals are declaring a preference for extended
hours.1
The neglect of the constitutive effects of culture by mainstream economists has
also had important implications for the analysis of the evolution of labor market
institutions. The neo-classical view of labor market institutions emphasises that
there are given conditions that characterise, for example, the natural environment.
Furthermore, because individual preferences are assumed to be exogenous, the
ways that individuals respond to these conditions are perceived to not vary over
time or space.
In contrast, a cultural perspective emphasises that the problems that labor
market institutions are designed to resolve, and the characteristics of the insti?
tutions themselves, will be specific to the cultural environment. Thus, the cultural
perspective on labor market institutions emphasises the need to understand insti?
tutions as constantly evolving and "path-dependent" features of particular labor
1 Gintis (1972) also discusses this issue in the context of the economic analysis of education.
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markets, whereas the neo-classical perspective interprets all labor market insti?
tutions according to the single (and constant) calculus of maximisation of indi?
vidual interest.
The relevance of this cultural perspective has also been highlighted by some
recent work on the labor market. Grief (1994) related the differences in the cultural
values of two trading societies of the late medieval period?the Genoese (who
were highly individualistic) and the Maghribis (who had a collectivist culture)?
to the different nature of principal agent problems that were encountered in each
labor market. Using game theoretic techniques, he demonstrated how the cultural
differences between the two communities influenced the propensity of traders to
share information, as well as their expectations about the behavior of agents. He
went on to identify how these culturally determined patterns of behavior resulted
in the evolution and survival of different wage structures and patterns of wealth
distribution in the two societies, despite the similarity of their material situations.
In summary, culture constitutes economic behavior by providing individuals
with categories of understandings and patterns of differential valuation. Neo?
classical economic models, with their assumption that individual preferences are
exogenously determined and constant across time and space, are not suited to the
analysis of the constitutive effects of culture. The widespread use of these models
has limited the economic analysis of important labor market issues, such as the
participation of women in the labor market, occupational choice and working
hours. It has also resulted in a failure to appreciate the dynamic and culture
specific nature of labor market institutions.
III. THE REGULATORY EFFECTS OF CULTURE
One aspect of culture that has received attention by both neo-classical and
institutional economists is what is known as the regulatory effects of culture.
These effects refer to the way in which the values and beliefs embodied in a
culture, and reflected in social norms, conventions and customs, enjoin the indi?
vidual to regard the interests of others, even if this may involve some sacrifice of
self-regarding interest.
The emphasis by economists on these aspects of culture reflects the apparent
potential to maintain an analytical distinction between norm-guided action and
self-interested behavior. As a result, the interpretation that is often given to culture
is that of an external constraint on economic action. Furthermore, the economic
analysis of culture by neo-classical and institutional economists alike, often
focuses on how social norms result in labor market behavior and labor market
outcomes (such as patterns of wage payments and unemployment) that cannot be
reconciled with the predictions of standard neo-classical models.
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CULTURE AND THE LABOR MARKET
A variety of social norms have been linked to labor market outcomes, the most
important of which appear to be the norms of distribution that relate to shared
beliefs about the legitimate or fair basis for the allocation of labor market out?
comes, such as wages. Norms of reciprocity and co-operation have also been
ascribed an important role in the regulation of labor market behavior.
The norms of distribution are wide-ranging but include four main categories
that relate to the key aspects of the distribution of earnings, namely: The legiti?
mate reasons for differences in individual earnings (norms of equity)', the
legitimate degree of difference in earnings (norms of equality); the legitimacy of
protecting the earnings outcomes for individuals at the lowest end of the distri?
bution (norms of need); and the legitimacy of protecting an individual's current
position in the distribution of earnings (reference level norms).
The norms of distribution all have potentially important consequences for the
wage structure. To illustrate, the results of Kelley and Evans's (1993) study of
norms of equity indicate that there is a broad consensus in a number of modern
industrialised societies that individual contribution should be the primary basis
for wage payments. Their findings indicate that people in such societies generally
believe that workers should be rewarded for their skill, education, training and
effort and be paid a wage that reflects the difficulty, complexity and responsibility
associated with their job. These results are significant because they imply that
wage changes based on factors other than those listed above (for example, wage
changes in response to changes in the level of unemployment) are likely to be
judged as unfair or immoral. Thus, the norms challenge market principles and
may be an important source of wage stickiness.
Kahneman et al. (1986) elaborate on these relationships between norms of
equity and labor market behavior. They explain that employers who share such
norms are likely to resist cutting nominal wage rates because they perceive this to
be unfair or immoral. Employees and third parties, such as customers, are also
likely to sanction any firm that violates the fair wage norm. Thus, norms of distri?
bution have been seen as placing regulatory pressure on nominal wage rates
through a variety of different mechanisms.
Norms of reciprocity are a further group of social norms that have been
identified in a labor market context. These norms enjoin individuals to return
favors done to them by others and gift giving is often regulated by such norms (see
Halparin 1988: 37-38 and Polanyi 1957). Norms of reciprocity are reflected in
Akerlof's (1982) gift exchange model where workers give a gift to the firm in the
form of a level of effort above the firm's work rule. The gift is motivated by the
workers' sentiments for each other (their sense of solidarity) and their sentiments
for the firm (for example, their sense of loyalty). Importantly, the workers expect
that the firm will reciprocate their gift through the payment of fair wages, since the
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REVIEW OF SOCIAL ECONOMY
giving of gifts is codified in terms of norms of reciprocity. In order to keep morale
and productivity high the firm conforms with the norm's requirements.
As Akerlof explains, the norms of reciprocity have potentially important impli?
cations for the relationship between the level of wages and productivity. Further?
more, because such norms promote the payment of high efficiency wages, they
may also have consequences for the level of unemployment. Drago and Perlman
(1989) also suggest that the gift exchange norms may have an important role to
play in explaining the relationship between the level of supervision and the level
of productivity in a workplace. In particular, they note that gift exchange requires
a high level of trust between the employer and the employees. This trust relation?
ship is likely to be undermined by a high level of supervision and, for this reason,
high levels of supervision may have negative effects on workgroup productivity.
Norms of co-operation have also been identified in a labor market context.
These norms enjoin individuals in a group to contribute to a shared objective or
to participate in a group action or activity (see Elster 1989b: 101). For example,
a firm might feel obliged to participate in an industry-based training scheme,
despite the financial incentive that exists for it to free ride, because its managers
feel a sense of obligation to co-operate or participate when other firms in the
industry are doing so. Firms may also contribute to these collective programs
because social pressures (sanctions) are brought to bear on firms to contribute.
Similarly, individuals might become union members or make a contribution to a
group output, despite the individual costs associated with such actions, because
the participation of others creates a moral obligation for them (see Booth 1985).
One implication of these norms of co-operation is that they may result in a
particular dynamic pattern in the levels of participation in collective programs,
such as training and union action. If one individual's participation in a collective
activity is dependent on the level of participation by others then, unless a certain
level of participation in the activity is reached, the likelihood that new members
will join will be low. However, if there is a high level of community participation
in an activity, then the obligation that this creates for others to contribute or
participate will promote the institution's growth and survival.
The norms of co-operation also have potential relevance to levels of per?
formance and efficiency in the workplace. As Casson (1991) notes, the ability of a
firm's management to establish a culture that is conducive to honesty, initiative
and unsupervised performance of tasks can be vital to its economic performance.
A workplace environment where individuals commit effort and honesty out of a
sense of obligation is likely to be more reliable than any third party enforcement
of contracts (see also Bowles and Gintis 1993). Furthermore, these cultural values
may deliver the level of work performance required without the cost, risks and
inflexibility that can be involved with the design of material incentive structures.
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CULTURE AND THE LABOR MARKET
IV. SOCIAL NORMS AND INSTRUMENTAL REASON
The analysis of social norms is also the subject of methodological controversy in
labor economics. The cultural (and "old-institutionalist") perspective has two main
(interrelated) features that distinguish it from the neo-classical analysis of social
norms. First, social norms are treated as "real" features of the economic environ?
ment, in the sense that they are autonomous from and cannot be reduced to self
interested action. Second, although social norms are viewed as a part of culture,
they are seen as being no more (or less) "cultural" than is economic behavior. As
was explained in previous sections of this paper, self-interested action is also seen
to be constituted by culture. Thus, social norms are simply seen to be a particular
aspect of culture that has evolved in response to the inevitable tensions that arise
between different, culturally defined values and action, including self-interested
action (see Jennings and Waller 1995: 1004).
Neo-classical economics (and "new-institutionalism"), on the other hand, denies
the reality of social norms. The importance of norms is rejected either by way of
an argument that individuals will only be motivated by their self-interest, or by an
argument that the norms themselves can be explained by the self-interest of
the relevant parties. It is a viewpoint that has been summarised by Sahlins in the
following terms:
.. .Culture is taken as an environment or means at the disposition of the 'manipu?
lating individual,' and also as a sedimented [sic] resultant of his self-interested
machinations. The characteristic resolution of culture is thus solipsistic in form.
Only the actors (and their interests taken as a priori theirs) are real: culture is the
epiphenomenon of their intentions.
(Sahlins 1976: 102)
Schumpeter (1954: 888) made a similar point when he noted that neo-classical
analysis is based on a view that "all social phenomena resolve themselves into
decisions and actions of individuals that need not or cannot be analysed in terms of
super individual factors."
The neo-classical argument against the importance of culture in the labor
market proceeds along these general lines. A common theme is that labor market
"actors" simply are not motivated by anything other than their self-regarding
interests. This is evident in Hicks's (1963: 80) analysis of the use of fairness argu?
ments in wage disputes. He alleged that employers' expressed concerns for fair?
ness was not the real reason why particular wage rises were paid. He argued that:
Demands for a rise in wages come, in the first place, because a rise appears to be
'fair'. And the principle motive in an employer's mind when he concedes such a rise
may be a desire that his wage-policy should not appear to be an 'unfair' one. . .But
although this appears to be the motive for a very large proportion of wage changes,
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REVIEW OF SOCIAL ECONOMY
it is not the real reason. These rules of fairness and justice are simply rough-and
ready guides whereby the workings of supply and demand are anticipated.
(Hicks 1963: 80)
Another variation on this theme is the argument that social norms are "merely a
cloak" for self-regarding interests. Workers, unions and employers are seen to use
norms flexibly and only to invoke those norms that support their particular bar?
gaining position. For example, Hyman and Brough (1975: 39) commented that in
industrial relations in the UK "the process of comparison [which relates to the use
of reference level norms] in many respects is characterised by inconsistency and
arbitrariness." The participants in the industrial disputes were often selective in
type of norms they utilised and in the types of comparisons that they brought
forward to support their arguments about fair wages (see also Wootton 1962).
Yet another type of argument that is levied against the importance of social
norms is one that attributes an individual's decision to conform with the require?
ments of a norm to the nature of his or her self-regarding interest. For example,
much of the orthodox analysis of employers' actions in the presence of social
norms is based on the assumption that employers do not share the norm in
question (they are only concerned with profits). Instead, employers are seen as
conforming to the norm's requirements due to a concern for the sanctions (costs)
that non-compliance entails. For example, in Akerlof's (1980) model of fair wages
firms avoid low or unfair wages only because these would threaten a loss of moti?
vation, effort and, thus, profits (see also Brown and Sisson 1975).
A more sophisticated, neo-classical argument against the importance of social
norms in the labor market posits that the origins of the norms themselves can be
explained in terms of the self-regarding interests of the relevant parties. This is the
functionalist perspective which sees social norms as little more than tools that
have been devised to promote the self-regarding interests of the labor market
actors. For example, the use of reference level norms has been linked to the
savings in information and bargaining costs for employers, and to the measure of
success for union wage negotiators, that such wage comparisons provide (see
Ross 1948: 51-52, and Marsden 1986: 136). In a similar vein, Lindlbeck and
Snower (1986) explain the existence of norms against the employment of new
workers at lower wage rates in terms of the self-regarding interest that workers
have in maximising their monopoly power.
Another important variation of this argument is that social norms develop
because they deliver benefits to individuals in an indirect way. In this case it is
accepted that social norms may impose losses on individuals in the immediate
term, but the social norms are still interpreted as being the product of an en?
lightened form of self-interest. For example, Arrow (1971) linked the existence of
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CULTURE AND THE LABOR MARKET
ethical and moral codes to the mutually beneficially co-operation that such codes
support. He argued that market action to ensure the functioning of economic
relationships that require trust and/or co-operation among individuals would
entail a high level of costs, with the result that "many opportunities for mutually
beneficial co-operation would. . .be foregone" (1971: 22). Therefore, as a cost
saving alternative to the price system, "society may proceed to the internalisation of
norms to the achievement of the desired agreement on an unconscious level."
This neo-classical perspective on social norms in the labor market can be
challenged on several levels. First, there is the empirical evidence of economic
actors behaving in ways that indicates that self-interest is not the primary or
singular goal of individuals. Workers who have bargaining strength often do not
take advantage of this power to advance their relative wage position (see Hyman
and Brough 1975: 8, and Hobsbawm 1964: 351). Evidence of high paid workers
or their unions advancing the wage claims of low paid workers also is not
generally consistent with interpretations of behavior based solely on self-regarding
interests. The survey evidence provided by Reynolds (1951) and Kahneman et al.
(1986), that some firms apply fair wage policies even in situations where there is
no risk of external sanctions also contributes to the argument that social norms
have a separate (non-individualistic) impact on labor market outcomes.
There are also several logical flaws with the argument that social norms are
reducible to individuals' externally defined self-interest. For example, explan?
ations of social norms in terms of their direct or indirect instrumental effects suffer
the important deficiency that they offer no reason as to why socially useful norms
do not develop. The neo-classical perspective also does not explain why the bene?
ficial or optimal nature of particular aspects of social norms is often controversial.
Furthermore, as Field (1979: 58) argues, explanations of culture in terms of "enlight?
ened self-interest" typically rely at some point on the existence of beliefs that are
not related to self-interest. For example, explanations of the willingness of indi?
viduals to co-operate rather than free ride depend on the existence of beliefs that
other individuals will also co-operate, and these beliefs themselves cannot be accounted
for by the self-interest of the relevant parties, (see also Sugden 1998: 76)
The argument that, because social norms are sometimes used flexibly or to
support bargaining positions based on self-regarding interest, they are, at best, a
weak influence on the behavior of labor market actors, can also be countered. As
Hyman and Brough (1975: 65) comment, social norms cannot be re-interpreted at
will to suit some bargaining claim or other. The ability to make use of a norm
depends on the general acceptance of its legitimacy and this legitimacy depends on
the sincere use of the norm. Indeed, it can be argued that the fact that it is possible for
norms to be used to further an individual's self-regarding interests is evidence of the
reality of the norm rather than of its insignificance (Elster 1989a: 128).
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REVIEW OF SOCIAL ECONOMY
Furthermore, it is a misunderstanding of social norms and other aspects of cul?
ture to suggest that they are inflexible and not open to different interpretations. As
Jennings and Waller (1995: 1006) note, culture is flexible, in that "individuals
with different locations within the [cultural] matrix can experience and interpret
even identical processes in different ways without thereby rupturing the cultural
web."
Culture is also a dynamic system, whereby changes in social norms and other
aspects of culture do occur as a result of the introduction of new knowledge,
government action, social movements, or the small changes in the routines and
habits of a society's members. (Jennings and Waller 1995: 1006, 1009) Thus, the
possibility that the content of social norms will be influenced by prevailing social
and economic conditions is also not ruled out by a cultural perspective on
economic behavior. Indeed, it is widely recognised that the material environment
has an important influence on the evolution of culture (see Jackson 1996). Hence,
norms of equality are likely to be influenced by changes in the actual pattern of
earnings dispersion (Atkinson 1997). At another level, the obligation to recipro?
cate the giving of a gift, or to be trustworthy, or to sanction violations of norms of
equity or equality, will be bounded, to a significant degree, by the extent of an
individual's social network (see Granovetter 1985).
Rational behavior is also not ruled out in this cultural analysis. Instrumental
reasoning is viewed as a universal but not singular feature of human behavior.
Thus, the argument is that it should not be elevated to the status an elemental
human strategy, according to which all behavior and institutions can be reduced
(Mayhew 1987).
Furthermore, although it is accepted that individuals attempt to act rationally,
the importance of instrumental reasoning in explaining patterns of production and
distribution is seen to be limited. Rather, the cultural perspective emphasises that
social institutions are not simply the product of the "the excellency of man's genius",
but rather they owe more to "the length of time, and the experience of many
generations" Mandeville (1974: 142).2 Traditions and customs, as much as indi?
vidual reason, underlie the 'design' of social institutions, and these traditions and
customs are grounded in unreflected thought and ideas that are beyond our recall.
By denying the reality of social norms and other aspects of culture, neo?
classical economics has been blind to the content and internal arrangement of
these cultural objects. Customs, norms and beliefs, have been given (to borrow a
phrase from Sahlins 1976: 76) a "bath of sulphuric acid" that has stripped them of
all their meaning and significance apart from their purported instrumental effect.
2 See also Hayek (1948: 6-7).
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CULTURE AND THE LABOR MARKET
Much more could be gained in terms of understanding these aspects of culture and
their role in the labor market if they were referred to as social facts and their
relationship to other social and economic structures explored.
V. SUMMARY AND CONCLUSION
The focus of this paper has been on the idea of culture as an integrative
hermeneutic system that encompasses language, custom, norms, moral, laws,
values and beliefs. The importance of understanding the way in which culture
constitutes economic actors and defines the boundaries to the legitimate pursuit of
self-regarding and other interests has been emphasised. An argument has been
made that this cultural perspective is relevant to a range of important labor market
issues, including the participation of married women in the paid workforce, occu?
pational choice, aspects of the wage structure and levels of effort and motivation.
This cultural perspective has been identified as a vital component of any under?
standing of the way labor markets work, especially the dynamic aspects of the
growth and survival of labor market institutions.
This paper has focused primarily on describing the meaning of culture and on
the identification of the major theoretical controversies that surround the topic.
Few comments have been made about how studies of the effects of culture can and
should be carried out. However, the discussion in the previous section indicates
that the argument that culture is an autonomous source of labor market institutions
is likely to be greeted with skepticism by many economists. Alternative
(efficiency) explanations for any cultural phenomena are likely to be forth?
coming, and it is unlikely that empirical evidence alone will win any argument
about the reality of culture.
This is not to say that empirical studies of the effects of culture have no value.
The opposite is true. For example, there is a pressing need for further analysis of
the way in which social norms regulate the pursuit of self-regarding interest by
individuals in the labor market. However, the comments made above do imply
that many studies of culture in the labor market will feel obliged to address
the counter-claim that differences in behavior reflect the material interests of
the actors involved. Kelley and Evans's (1993) evidence that significant cross
national differences in attitudes to inequality persist after differences in material
conditions have been taken into account provides a good example of the type of
approach that will be required. Kahneman et a/.'s (1986) use of counter-factual
propositions to test whether individual's normative reactions to reductions in
nominal wage rates accord with self-interested explanations offers another
approach (see also Yaari and Bar-Hillel 1984).
However, the idea that aspects of culture, such as social norms, are "social
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REVIEW OF SOCIAL ECONOMY
facts" specific to particular times and places implies that the broad scale empirical
studies (and the drawing from these of general conclusions about the behavior
of populations as a whole) may have limited relevance to cultural studies. Case
studies that pay attention to the specifics of the institutional environment and the
processes at work in particular labor markets are likely to be more in keeping with
the description of culture that has been advanced in this paper.
Cultural studies are complex. As Jennings and Waller (1994) explain, human
action and the cultural web that relates to it are multifaceted. For example, culture
can be described across a number of dimensions, such as at the level of class,
organisations and nations. The nature of the social norms that apply to human
action in each of these dimensions is likely to differ, and in many cases the norms
that apply in one dimension may not apply in another. Indeed, one important form
of research question is how the tensions between the social norms that apply to
behavior in the various parts of an individual's working life are resolved and
how these various norms together constrain the set of feasible choices of action
available to an individual.
There is a need for further development of models of human action to guide the
study of culture in the labor market. Keeping in mind the above comments about
the ability to assume a high level of generality in the nature of cultural effects,
studies of the constitutive effects of culture may benefit from the development of
the analysis of preference formation, especially models that emphasises cognitive
limitations and the way in which cognitive development is molded in the social
environment (see Manski 1993; Witt 1996; Casson 1993; George 1996 and
Jonsson 1994). Studies of the regulatory effects of culture may benefit from the
further development of models of human action that depart from the convention of
a single utility function. Models, such as those developed by Sen (1977), Margolis
(1990), Etzioni (1988), O'Boyle (1994) and Casson (1991), offer the potential to
explore at an abstract level the 'trade-off' between their self-regarding and other
regarding interests and the possible implications of, for example, social norms on
economic behavior.
The large number of labor market issues that are potentially within the scope of
the regulatory and constitutive aspects of culture suggests that labor economists
should pursue the complex and challenging task of pursuing the study of culture.
Such studies offer the opportunity to improve our understanding of how the labor
market works. They offer the potential to learn from and contribute to research
on labor market issues in other disciplines, and they have enormous policy
relevance.
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CULTURE AND THE LABOR MARKET
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ECON343_W2020_Assignment 1
Read the research article “Culture and the Labor Market” by Siobhan Austen to answer the
following questions:
1. What is the primary argument of the research article?
2. Do you agree/disagree with the arguments of the author? Provide a rationale for your
choice.
3. What is the Old-institutionalists’ view about the association between culture and labor
market?
4. How is the view of new-institutionalists differ from the perspective of Oldinstitutionalists about the association between culture and labor market?
5. What taxonomy Di Maggio (1994) used to describe the relationships between culture
and economic behavior? Explain.
6. What are the limitations of the taxonomy used by Di Maggio (1994)?
7. What are the implications of ignoring the constitutive effects of culture by mainstream
economists?
8. In light of the article, explain the following terms:
•
Norms of equity
•
Norms of reciprocity
•
Norms of cooperation
•
Norms of equality
9. What are the neo-classical arguments against the importance of social norms?
10. How did the author challenge the neo-classical perspective of social norms in the
labor market?
Journal of Economic Perspectives—Volume 9, Number 4—Fall 1995—Pages 133–154
Human Capital vs. Signalling
Explanations of Wages
Andrew Weiss
W
orkers with higher levels of education and more work experience tend
to have higher wages. For some years, the most common explanation
for these correlations has been that time spent in school or on the job
increases wages by directly increasing the worker's productivity. This learning explanation is usually associated with human capital theory.
However, it seems unlikely that learning explains all the wage differences associated with schooling and work history. Better-educated workers are not a random
sample of workers: they have lower propensities to quit or to be absent, are less
likely to smoke, drink or use illicit drugs, and are generally healthier. It is unlikely
that employers make full use of differences in propensities to quit or to be absent
or sick when hiring workers. These characteristics are often not directly observed,
and the Americans with Disabilities Act precludes firms from using either poor
health or the likelihood of future sickness as a hiring criterion unless it is directly
related to job performance.1 However, if low levels of education are associated with
these unfavorable employee characteristics, and employers are allowed to take education into account when hiring workers, we would expect employers to favor
better-educated workers as a means of reducing their costs of sickness and job
turnover. In turn, students will take these hiring criteria into account when deciding
how long to stay in school. Students will choose a length of schooling to "signal"
their ability to employers, and employers will demand a minimum level of schooling
1
The American Lung Association has found that a smoker costs his employer up to $5000 more in
annual health insurance costs. However, in 29 states it is illegal to refuse to hire smokers (New York Times,
May 8, 1994, p. E5).
• Andrew Weiss is Professor of Economics, Boston University, Boston, Massachusetts.
134
Journal of Economic Perspectives
from applicants in order to "screen" their workers. Both signalling and screening
serve to "sort" workers according to their unobserved abilities. This paper will use
the term "sorting" to refer to both signalling and screening of workers.2 We shall
focus on the way in which individuals are sorted according to a measure of ability
that improves productivity across all jobs.
"Sorting models" of education can best be viewed as extensions of human
capital models. However, while human capital theory is concerned with the role of
learning in determining the return to schooling, sorting models, while allowing for
learning, focus on the ways in which schooling serves as either a signal or filter for
productivity differences that firms cannot reward directly. Sorting models extend
human capital theory models by allowing for some productivity differences that
firms do not observe to be correlated with the costs or benefits of schooling.3 (Sorting models can also include ability differences that are observed by firms but which
the firms cannot use in making employment decisions. Both these extensions of
human capital theory have the same qualitative implications.) In sorting models,
schooling is correlated with differences among workers that were present before
the schooling choices were made; firms make inferences about these productivity
differences from schooling choices, and students respond to this inference process
by going to school longer.
If the sorting extensions of human capital theory are important, the marginal benefits from schooling or work experience for an individual could
greatly exceed the expected value of the effects of those activities on productivity, even ignoring taxes, subsidies and externalities. An accurate measure of
the change in wages for a person who goes to school for 12 years instead of 11
would not measure the effect of that year of education on his productivity, but
rather the combined effect of one additional year of learning and the effect of
being identified as the type of person who has 12 rather than 11 years of schooling. Because individuals will react to their private wage gains, rather than to
the social gains from greater productivity, schooling and employment decisions will be distorted.
The remainder of this paper discusses whether various empirical regularities
are better explained by learning or sorting considerations. It first examines the
positive correlation between wages and education and then turns to the relationship
between wages and job tenure. The bottom line is that labor economists should
take into account the distortions induced by signalling or screening when estimating social rates of return to schooling and job experience. Meanwhile, policymakers
2
In signalling models the informed (students) move first In screening models the uninformed (firms)
move first. Signalling models often have multiple equilibria; screening models suffer from the opposite
problem of nonexistence of equilibrium. Realistic dynamic models combining signalling and screening
have not been well studied.
3
The relationship between wages and education could be the outcome of either students choosing an
education program to signal their ability, or students choosing education levels in response to the relative
wage offers of firms, in which case wages would serve to screen workers.
Andrew Weiss 135
should be cautious about using "consensus" estimates of rates of return to schooling in considering policies designed to reduce dropout rates or when allocating
resources across primary, secondary, and postsecondary schools.
Explaining the Connection Between Education and Wages
Interpreting the Coefficient on Education in a Wage Equation
There have been literally thousands of published estimates of rates of return
to education. The estimates are generally derived using least squares regression,
where the dependent variable is the logarithm of wages or earnings, and the independent explanatory variables include a constant, observed demographic characteristics such as schooling, race, sex, and experience, and other observed variables
that are deemed relevant by the researcher. This method of explaining wages is
often known as a Mincerian earnings equation, after Jacob Mincer. Since the coefficient that appears in front of the schooling term describes the percentage
change in wages associated with each additional year of schooling, it has been interpreted as the private rate of return to schooling. This interpretation is accurate
as long as there are no ability differences that are not included in the wage equation,
but that are observed by the firm. If such ability differences did exist, an individual
who graduated from high school but who did not look like a typical high school
graduate would not get the wages of a high school graduate, and so that individual's
return to schooling would differ from the estimated regression coefficient.
With less justification, the coefficient on education in the log wage regression
has also been interpreted as an estimate of the productivity-enhancing effects of
education. The assumptions needed for that interpretation are far stronger. Not
only must wages be proportionate to productivity, but also all attributes that are
not observed by firms and that affect productivity must be uncorrelated with schooling, or else firms must be irrational.
One frequent test of the extent to which education is directly affecting individual productivity is to measure the effect on the education coefficient when additional right-hand variables intended to capture ability differences—such as IQ—
are included in the wage equation. The usual finding is that the coefficient on
education is not strongly affected by the inclusion of additional right-hand variables.
These results have been (mis) interpreted as suggesting that unobserved ability differences do not have important effects on productivity.
However, in sorting models, firms do not directly observe the attributes that
are omitted from a standard wage equation and that affect worker productivity.
Rather, firms use education choices to draw inferences about unobserved attributes.
The coefficient on education is fully capturing the effects of that inference process
and would not be affected by the inclusion of additional explanatory variables that
are not observed by the firm. Even if the researcher knows the results of accurate
tests of attributes like intelligence, perseverance or a taste for additional learning,
if the firm does not have that direct information available, then the sorting model
136
Journal of Economic Perspectives
predicts that including these variables in the wage equation will not affect the coefficient on schooling.
Because there has been some misunderstanding of the differences between
human capital and sorting interpretations, it is worth reemphasizing the point that
sorting models subsume all the features of human capital models. In particular,
both approaches allow for learning in school (and human capital models require
it). In both approaches, profit-maximizing firms compete for utility-maximizing
workers, and the expected lifetime compensation of a worker with a given set of
observed characteristics is equal to the expected lifetime productivity of a randomly
selected worker with those characteristics. Both human capital and sorting models
assume that individuals choose a length of schooling that equates their marginal
return from schooling to their cost of schooling. The models differ in that sorting
models allow for attributes that are not observed by the firm to be correlated with
schooling.
Much policy-oriented research has been devoted to calculating returns to education, by adjusting for all traits that are observed by firms. This is often done by
expanding the set of attributes that are observed by the researcher and assuming
that everything the researcher observes is observed by the firm. When policy is being
formulated, these estimates of private returns are frequently used as estimates of
the social return. From a policy viewpoint, the key difference between human capital and sorting is that in sorting models, even after correcting for all traits that are
observed by the firm, the coefficient on education may be a very biased measure of
the effects of either schooling or experience on productivity. If sorting considerations matter, the coefficient on education offers a good estimate only of the private
return to education, not the social return to education.
If the sorting approach is correct, the outcome of the market is inefficient,
since the private and social returns differ. However, it is not clear whether there
will be too much or too little education. On one side, individuals may pursue too
much education as a means of signalling their love of learning, or firms may demand more education than is required for a job to deter applications from people
who have difficulty succeeding in school. In these cases, the private return to education would exceed the social return. On the other side, as Stiglitz (1975) pointed
out, an indirect effect of sorting may be to improve the match between workers
and jobs, in which case the social return from schooling may exceed the private
return. For instance, suppose people for whom schooling is unpleasant have an
absolute advantage in unskilled jobs, and people for whom schooling is relatively
pleasant have an absolute advantage in skilled jobs, and employers cannot directly
observe the productivity of workers nor identify the different types. Then, when
workers for whom education is relatively pleasant choose more education to separate themselves, average productivity and wages at the low-skill job rises. The resulting increase in wages of people with low levels of education leads to an underestimate of the social return to education. (Note that the Stiglitz argument departs
from the usual assumption made in sorting and human capital models: that abilities
that are correlated with schooling positively affect productivity on all jobs.)
Human Capital vs. Signalling Explanations of Wages 137
Ability Differences and Educational Choices
People choose different levels of schooling. One reason for their different
choices might be that some receive a higher benefit from a given amount of schooling, perhaps because they learn more readily than others, or because they value
future earnings more highly, or because they enjoy learning.
Human capital models do not naturally generate a positive correlation between
ability differences and education (Weiss, 1971). If higher-ability people are more
productive at every schooling level, they will have a higher opportunity cost of
schooling, which would lead them to leave school sooner. They would, however,
stay in school longer if they cared more about the future, or enjoyed school more
than the average student, or learned more rapidly. These preferences make workers
desirable employees: they would be less likely to quit or be absent (both quits and
absenteeism involve short-term benefits and long-term costs) and more likely to
participate successfully in training programs. Of course, if people with desirable
preferences go to school longer, firms would use education in their hiring criteria
as a means of selecting workers with these desirable traits.
Leaving aside differences in preferences, more able people may go to school
longer because they derive greater benefits from schooling. The positive correlation
between the ability to learn and the length of schooling chosen is central to sorting
models such as Weiss (1983) and Cho and Kreps (1987).
The available evidence suggests that the benefit to schooling is greater for more
able individuals, so that we would expect education to sort by ability. In the Netherlands and Singapore, for example, outcomes on a certification exam have large
effects on the earnings of school-leavers (Liu and Wong, 1982; Hartog, 1983). Altonji (1995) has shown that in the United States, a composite measure of aptitude—
based on grades in secondary school, scores on standardized tests, and the student's
own self-appraisal of ability—is correlated with returns to postsecondary education.
High-ability men have more than twice the return to postsecondary education as
do low-ability men.4 The effect of this composite measure on rates of return to
postsecondary education appears to be due to high-ability people being more likely
to complete a course of study. The aspects of ability included by Altonji are not
usually directly observed by firms (or researchers) and are likely to be correlated
with other unobserved attributes such as perseverance. Altonji (1995) also finds
that students who take more courses in high school have more years of postsecondary schooling. This relationship holds both within and across high schools. However, when the high school a student attended is used as an instrument to predict
courses taken then this instrument is uncorrelated with postsecondary schooling.
These instrumental variable results suggest that the relationship between high
school courses and postsecondary schooling is not due to learning in school, but is
rather a consequence of the same unobserved attributes that lead some people to
take more courses, also leading them to stay in school longer.
4
High-ability students have scores that are one standard deviation above the mean for this composite
measure, while low-ability students have scores that are one standard deviation below the mean.
138
Journal of Economic Perspectives
One indirect implication of sorting models is that the ratio of the wage paid
to people who succeed in school to the wage paid to workers who failed in school
will increase with schooling (Weiss, 1983). In the Netherlands this effect is quite
pronounced at high education levels (Hartog, 1984) and could be causing the
positive correlation between years of schooling and the variance of earnings
(Mincer, 1974).
Direct Evidence of the Effects of Learning on Earnings
If the positive relationship between wages and years of secondary schooling is
due to learning in secondary school, then the higher wages of better-educated
people should be due to skills that were learned during those years of additional
education. Altonji (1995) examines the effect of course work in school on earnings
using data from the National Longitudinal Survey of the High School Class of 1972
and various follow-ups, including earnings in 1986. Everyone in the sample graduated from high school. However, not everyone took the same number of courses,
making it possible to estimate the effects on future earnings of taking an additional
course. Altonji estimates the increase in earnings associated with particular courses,
holding years of education fixed.5
If the return to education is due to learning in secondary school, and learning
in one course does not decrease learning in other courses, and course selection is
uncorrelated with the error term of the wage equation, then the sum of the individual effects on earnings of each course in the standard curriculum should equal
the usual estimates of the effect of a year of schooling on earnings—that is, 7 to 10
percent. Altonji addresses the following question: if an individual was to take seven
periods of lunch and recess instead of a standard curriculum, what would be the
effect on his earnings? He finds that taking the average high school course load,
rather than registering and getting a "social promotion," either has no effect on
wages or actually decreases wages. Course work fails to have a significantly positive
effect on wages even 13-years after individuals have graduated from high school.
By that time employers would have had considerable opportunity to observe the
productivity of workers. On the other hand, course work (and ability) does affect
returns to postsecondary education. Thus while secondary schoolwork may not directly affect productivity, it may be complementary to learning in postsecondary
school.
In an earlier paper, using a different data set, different estimate techniques,
and only sampling high school graduates who did not continue their education,
Rang and Bishop (1986) also found that academic courses had insignificant effects
on wages. Their estimates imply that a year of a full academic curriculum of mathematics, English, foreign language, social sciences and science is, holding all other
courses fixed, associated with $.11 lower hourly wages. The only academic courses
5
Altonji's (1995) results are robust to the inclusion of controls for measures of family background and
scores on aptitude and achievement tests.
Andrew Weiss
139
that had a statistically significant effect on hourly wages were social science courses,
which were associated with $.12 lower hourly wages.
Altonji's (1995) results (and to a lesser extent the results in Kang and
Bishop, 1986) provide a serious challenge to explanations of the relationship
between secondary schooling and wages that are based on learning in secondary
school. The small or negative returns to course work are especially striking, since
they include both the learning and signalling effects of those courses. These
results are a strong refutation of the huge literature that interprets the correlation between wages and secondary schooling as due to learning in secondary
school.
Of course, there are ad hoc explanations of these results that are consistent
with learning in secondary school generating the relationship between wages and
schooling, although these explanations are far from compelling.
First, perhaps adding courses subtracts from the effort in other courses. If the
courses from which effort is being drained are the ones with the high returns for
the individual, then adding courses could decrease earnings. Under this scenario,
the value of what is learned in a year of schooling could rise or fall with the number
of courses. For instance, taking a foreign language could decrease the amount of
time a student spent on vocational subjects and thus might decrease wages. We
don't know if students who are induced to take additional courses spend significantly less time on courses in which the marginal units of effort are having large
effects on personal productivity, but such behavior would surely seem irrational if
productivity was observed by firms. In addition, students report spending on average
less than one hour per day on homework, suggesting that for most students crowding out effects are not very important—most of their learning is taking place in
school.
A second objection to the Altonji-Kang-Bishop results is that students who took
different courses in school, even if they had the same number of total years of
schooling, are likely to differ in other ways. Since returns to postsecondary schooling are higher for people who took more courses in high school, the cost of quitting
school is higher for those students. Thus, we might expect students who took more
courses in high school to have higher reservation wages and thus higher wages
conditional on leaving school. This effect would cause an upward bias in the measured effect of secondary school courses on wages. On the other hand, a student
who is guaranteed a highly paid job upon completion of high school (perhaps with
a parent's union?) may take few courses, introducing a downward bias in estimates
of returns to courses. These biases offset one another, and I would expect their net
effect to be small.
A third possibility is that the curriculum results are due to omitting high school
dropouts from the samples. However, this sample bias would only explain the results
if people who complete high school derived less benefit from their course work
than do high school dropouts. This seems unlikely.
A fourth possibility is that less able students take more courses because they
must repeat those courses. However, Altonji (1995) found a positive correlation
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Journal of Economic Perspectives
between hours of science, foreign language, English, and math and both grades
and achievement test scores.
While the previous four explanations seem implausible, if one is willing to give
up on the estimated coefficient on secondary schooling as a reasonable estimate of
returns to that schooling, there is a reasonable way to resurrect learning as the
cause of the relationship between secondary schooling and wages. It is implausible
that learning in secondary school is generating the relationship—since courses are
not affecting wages even 13 years after graduation, by which time the learned skills
will presumably have been observed by employers. However, learning in primary
school may be generating the positive correlation between secondary schooling and
wages. In primary school children are taught to cooperate, to persevere, to delay
gratification. Children who learn these affective skills are likely to stay in school
longer. So the positive correlation between schooling and wages could be due to
the correlation between schooling and the earlier acquisition of affective skills in
primary school. If employers do not observe what workers have learned in primary
grades, schooling decisions later on will be distorted in the ways implied by sorting
models.6
Consider the types of jobs taken by people with no more than 12 years of
schooling. Few of those jobs require a knowledge of chemistry, algebra or trigonometry, or history or geography. On the other hand, punctuality, perseverance,
self-discipline, good manners, literacy, and the ability to perform simple calculations accurately are all valuable for a wide range of jobs—and all are skills that are
primarily taught in the early years of school. Schooling also affects preferences,
including the preference for present versus future rewards.
To sum up: the most plausible explanation for the Altonji-Kang-Bishop results
is that employers do not observe transcripts and thus do not use course work as a
signal. They do observe years of secondary schooling, which is an unbiased predictor
of productivity. Courses taken in school do not significantly improve the predictive
value of merely persevering through four years of high school.
Grades, Test Scores and Earnings
If the focus shifts from curriculum to measures of schooling like test scores,
there still seems to be little connection between these measures of education and
the earnings of high school graduates. There is a long history of researchers failing
to find an economically significant relationship between scores on achievement
tests and wages.
Altonji (1995, Table A-2) finds that while vocabulary, reading ability, and basic
competence in math are positively correlated with log wages, the correlations are
neither economically nor statistically significant. Kang and Bishop (1986) found
6
If, on the other hand, the productivity differences associated with different levels of secondary schooling
are due to learning in primary school that is directly observed by employers, standard estimates of rates
of return to secondary education would bear little relationship to the productivity-enhancing effects of
learning in secondary school.
Human Capital vs. Signalling Explanations of Wages 141
that a one standard deviation increase in math, reading, and vocabulary test scores
was associated with a $.003 fall in hourly wages, a $.001 rise in hourly wages, and a
$.002 increase in hourly wages, respectively—and none of these changes was statistically significant. (A one standard deviation differences in achievement test scores
is usually associated with three years of schooling, so these effects are trivial compared with the usual estimates of the effects of three years of schooling on wages.)
Meyer (1982) reports that a shift of one standard deviation in a variable he labels
as "test" (a composite of various test scores) increases earnings by up to 4 percent—
again this finding is not statistically significant. Bishop (1990b) finds similar results.
All of these studies reject the hypothesis that cognitive learning in secondary school
classrooms is making a substantial contribution to the positive relationship between
schooling and earnings at the individual level.
Researchers have also looked at possible effects of secondary school grades and
class rank on wages (Kang and Bishop, 1986; Meyer, 1982). In some regressions,
small results are found some of the time. But the main message from studies on
course work, test scores, and grades is that learning in high school does not seem
to be a significant factor in explaining the correlation between secondary schooling
and wages.
These small or statistically insignificant results are especially striking since these
estimates are almost certainly upwardly biased estimates of the effects of test scores
on wages. Individuals with high test scores and good grades are likely to have some
other traits that are observed by employers and are directly rewarded in the labor
market.
Taken together, these estimates suggest that courses, test scores, and measurable learning in secondary school can explain at most one-quarter of the increased
earning associated with completion of high school, and probably substantially less.
A Sorting Explanation
If less than one-quarter of the higher earnings of high school graduates is due
to learning in secondary school, what accounts for the other three-quarters of their
higher earnings?
One possible explanation is that some individuals have (unobserved) traits that
make schooling less costly to them. We can call these traits various aspects of perseverance. Individuals with more perseverance are likely to have lower quit rates
and rates of absenteeism after leaving high school, as well as being more likely to
graduate high school. Along these lines, Klein et al. (1991) found that individuals
who had more education than would be expected from their observed demographic
characteristics were likely to have unexpectedly low propensities to quit a job. Along
similar lines, Weiss (1988) presents evidence and a simulation study suggesting that
substantially all of the relationship between high school graduation and earnings
can be explained by the lower quit propensities and lower rates of absenteeism of
high school graduates. If perseverance is not directly observable by firms, then high
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Journal of Economic Perspectives
school graduation will be rewarded because of the lower rates of absenteeism and
lower quit behavior of high school graduates. Students need not be consciously
"signalling" these traits. The sorting explanation only requires that some students
have unobserved traits that lower their cost of schooling and that these traits are
valued by firms.
An important empirical study that bears on the relative usefulness of the sorting
and learning approaches for understanding wage determination is Card and Krueger (1992). That study finds that individuals who were born in states with small
class sizes and high relative teacher salaries had higher rates of rate of return to
education as well as more schooling. They also found that increases in those school
inputs were associated with lower wages for students who fail to complete high
school and higher wages for students with more than 12 years of schooling. The
increase in schooling associated with small class sizes and high relative teacher
wages generated higher wages at every percentile of the population.
Card and Krueger (1992) present their findings as evidence that learning in
school is generating the correlation between schooling and wages, but there are
several problems with this interpretation. First, it is hard to see why better instruction in primary and secondary school would cause a fall in wages for people with
no postsecondary schooling. (The schooling inputs they measure are inputs into
primary and secondary education.) At the education levels chosen by most of their
sample, increased school inputs either had no effect or a negative effect on wages.
Second, if increased learning is causing the wage-education locus to become
steeper (pivoting roughly around its midpoint), it is surprising that length of school
term has no effect on this slope when they control for other characteristics of the
state-cohort.
Third, relative teacher wage is likely to be highly correlated with the ratio of
college wages to the wages of high school graduates—and thus with returns to
education in the state of birth. Card and Krueger (1992) attempt to control for that
problem by using differences in the returns to education of a state's emigrants and
the residents of the state in which they reside to estimate returns to school inputs.
However, since the change of wages conditional on emigrating affects the probability of migration, we would expect that the rates of return to education for migrants to be highly correlated with the return in the state from which they migrated.7 Thus, the Card and Krueger focus on migrants does not avoid the problem
that relative teacher salaries are highly correlated with returns to education in the
state of birth.
Fourth, the teacher/pupil ratio may also be correlated with the relative demand for skilled workers in the state, which may in turn be correlated with per
capita income. To test this hypothesis I added the natural log of per capita income
in the worker's state of birth when the average worker in a cohort was 23, as an
additional explanatory variable in the Card and Krueger regressions estimating
7
Speakman and Welsh (1994) treat this issue at some length.
Andrew Weiss
143
effects of school inputs on rates of return. With that specification, the coefficient
on the teacher/pupil ratio becomes insignificant while the coefficient on per capita
income is both economically and statistically significant.8
A sorting explanation for the Card and Krueger (1992) results is that states
with high per capita income will tend to spend more on instruction and also build
more schools and provide better transportation, which would reduce differences
in access to schools. Those expenditures would reduce the noise in the relationship
between unobserved ability and schooling. In addition, in more prosperous states
fewer students are likely to leave school because of family financial pressures—
further reducing the noise in the relationship between ability and schooling. To
the extent that schooling decisions are governed by random factors rather than
observed ability differences, the coefficient on schooling in a wage equation will be
biased toward zero—reflecting the zero correlation between those random factors
and productivity. This is the usual problem of measurement error of a right-hand
variable. As the noise in the relationship between unobserved ability and schooling
is decreased, this bias will also decrease, and the estimated coefficient on schooling
in the wage equation will rise, reflecting the true relationship between unobserved
ability differences and wages. Thus the sorting model predicts that controlling for
per capita income reduces the effect of school expenditures on rates of return to
schooling.9 The actual results are quite striking. The effects of every schooling input
is eliminated once we control for per capita income at the time the students were
in school. The t–statistics for pupil/teacher ratio and term length are both near
zero. The t–statistic for relative teacher wage is 1.40, and thus the borderline significance; but, as we've argued, that variable is capturing the relative demand for
educated workers. (These calculations are available from the author.)10
Many other studies purport to measure the relative importance of sorting and
learning for explaining returns to education. Typically these studies can only do so
if they make strong auxiliary assumptions. Space limitations preclude a discussion
of all these studies. Instead, we shall discuss three of the most influential approaches—the Angrist and Krueger (1990) study of the effect of birthdate on returns to schooling, studies of the relationship between wages and schooling for
identical twins, and studies of returns to schooling in different occupations. Angrist
and Krueger find that those people who are forced to continue in school because
of the interaction between their date of birth and the school attendance law in thenstate get the same increase in wages from that education as do people who voluntarily continue their education. It might seem that this result supports a learning
8
The coefficient on In (per capita income) is 1.94, with a t–statistic of 4.78.
Prediction of novel facts is perhaps the most widely accepted criterion for evaluating competing scientific research programs. This criterion has been used, for example, to explain the success of Copernican astronomy, of the Newtonian theory of gravity and its replacement by Einstein's theory, and the
supplanting of classical physics by quantum mechanics. See Lakatos (1978).
10
The per capita income measure may, however, be measuring the effects of school inputs, rather than
differences in demand conditions; that is, if the model is misspecified the income measure could be a
better measure of school inputs than are the inputs themselves.
9
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Journal of Economic Perspectives
explanation for returns to schooling. However, sorting also generates that result if
employers are paying workers according to their observed characteristics and level
of schooling, without adjusting for the effects of school attendance laws on individual education choices.11 The human capital model, on the other hand, can only
generate that result if there are no aspects of individual productivity that are omitted from the wage equation and that are correlated with schooling. However, as
we've discussed, postsecondary schooling is correlated with courses taken in high
school, with grades on those courses, and with scores on both achievement and
intelligence tests, thus it seems unlikely that schooling would be uncorrelated with
all other unobserved variables. In addition, in the absence of unobserved ability
differences, it is difficult to explain the discontinuous changes in earnings associated with completion of high school and college.12
Twin studies use the relationship between wages and education levels across
identical twins to isolate the effect of education on earnings, holding ability differences constant. The most recent and sophisticated study of twins, by Ashenfelter
and Krueger (1992), finds that returns to education across twins may be as large as
that across the population as a whole. However, even leaving aside the issue of why
identical twins would choose different levels of schooling, it is clear that a sorting
model would generate that result, as long as employers did not observe the education choices of both twins. The reasoning is the same as for the birthdate problem.
In a sorting model, if employers don't know the education level of the worker's
twin, they infer a worker's unobserved ability from the education choices of the
individual worker: recall that in the sorting model employers are using schooling
as a proxy for unobserved characteristics, so that the twin with more schooling
would receive the wage associated with his level of schooling—not with his unobserved abilities. Thus for the Ashenfelter and Krueger results to confirm sorting
models, it is only necessary that employers do not know the education choices of a
worker's twin. One check of whether the twin studies are confirming the sorting
models is to see if wage differences of twins with different education levels decline
over time. If the sorting model is correct we would expect the return to schooling
across twins would decline over time compared to the return for the population as
a whole. Using the Ashenfelter and Krueger data we found some evidence of this
decline, but the data were not sufficient to measure it accurately.
Finally, if screening is important, then workers who look the same to the researcher should look the same to the firm, and hence get the wages predicted by
a correctly specified model in which the right-hand variables only include observed
11
This lack of adjustment is perhaps not surprising given that labor economists studied rates of return
to education for almost half a century before Angrist and Krueger (1990) thought of using school
attendance laws as an exogenous instrument.
12
Hungerford and Solon (1987) found the following percentage changes in wages were associated with
completion of different grades: 11th grade +0.7%, 12th grade +8.6%, 15th grade –4.9%, 16th grade
+ 17.6%. Heckman et al. (1994) also found discontinuous changes in wages associated with completion
of grades 12 and 16. Jaeger and Page (1994) find that returns to the 12th and 16th years of schooling
more than double when those years are associated with graduation from high school or college.
Human Capital vs. Signalling Explanations of Wages 145
characteristics such as education. Testing this implication, Riley (1979) finds that
a standard wage equation fits much better for people who are in occupations in
which screening seems to be important. Riley also finds that rates of return to
education are higher in the unscreened occupations (see his Figure 3). This second
result is also a consequence of the distortion of schooling decisions in sorting equilibria. Since almost every type of worker in the screened occupations is increasing
schooling to separate itself from lower-ability types, ability will increase more slowly
with schooling in occupations in which screening is important. Given some reasonable assumptions about the production technology and preferences, wages will also
increase more slowly with schooling in those occupations.
Answering Objections to the Sorting Approach
The evidence presented thus far seems to support the idea that sorting considerations are playing an important role in school choices. However, there are several
objections to this point of view.
Why Not Other Sorting Mechanisms?
The most strongly voiced objection to the sorting approach is: "There must
be cheaper ways to learn about workers!" The implicit complaint is that if unobserved differences were important, firms would test for them directly, or workers
would test themselves.
Such a solution poses several difficulties. For starters, it is hard to think of costeffective tests of affective traits. For instance, a high score on a test of perseverance,
given to those who have dropped out of school to take the test, might suggest a
particularly low level of perseverance, since this individual performs well on tests
and yet wishes to quit school. Moreover, if those tests have disparate impact by race
or sex, the firms would have to prove that the tests are valid and that there is no
other equally valid test which would have less of an adverse impact on minority
groups or women.
It is also difficult to see how such a test would be introduced. The first firm
that substituted tests for education as a hiring criterion would have monopsony
power over its workers; that is, workers who quit school to take the test would be
bearing the risk that their employer would fire them because of a fall in demand,
and no other firm would recognize the test score. In addition, firms might well
have unfavorable expectations about the first worker who appears at its door with
high test scores and a low level of education and even doubt the integrity of that
particular test score. In general, testing by either a worker or a firm is an out-ofequilibrium move, and assumptions of rationality are not sufficient to predict responses to such moves.
The Cross-Country Correlation Between Education and Productivity
A second general objection to the sorting explanation of the relationship between wages and education is that countries with high levels of education tend to
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Journal of Economic Perspectives
have both high levels of per capita GDP and high growth rates. The magnitude of
these cross-country relationships suggest that education is directly affecting
productivity.
However, such correlations can be interpreted in many ways. For example,
wealth may be affecting schooling, and the same factors that affect growth may
affect schooling. Wealthier countries tend to supply better access to schooling and
to enforce child labor laws more strictly. Thus, the cost of schooling would tend to
be lower in those countries, leading to more schooling. In addition, if education is
a normal good, richer people will consume more of it. Finally, in more highly
developed societies, a greater proportion of jobs seems to be in occupations in
which productivity is not directly observed. As we noted, the sorting model predicts
that those occupations will be associated with higher levels of education.
Turning to the relationship between schooling and future growth in productivity, people with low rates of time preference will have more schooling. Low time
discount rates will also lead to more savings and investment, and thus greater future
growth. Even in agrarian societies, many components of private investment, such
as whether to plant crops that often do not generate positive cash flow for many
years (like citrus or olives), are strongly affected by rates of time preference. Thus,
looking across countries, the choice of high-return, long-term investments may be
highly correlated with schooling choices. Despite these caveats, I find the relationship between literacy and growth to be the strongest evidence of a close relationship
between learning (or at least primary schooling) and productivity.
Finally, even if school learning is the cause of the wealth of nations, sorting
models may still provide the best explanations of the relationship between wages
and education within countries. If the ability to learn is correlated with the nonpecuniary costs of education, the length of schooling could serve as a signal of how
much was learned per year of school, and schooling choices would be distorted in
the ways predicted by sorting models.
Job Tenure and Wages
Labor market economists distinguish between experience, which represents
overall time in the labor market, and tenure, which represents the time on a particular job. Along with the relationship between education and wages, the second
major set of facts that human capital theory and sorting models have attempted to
explain is why wages rise with tenure at a particular job, holding the effect of experience on wages fixed.
Many explanations of the wage-tenure relationship have been proposed, including the idea that longer tenures represent better "job matching," agency models in which rising wage-tenure profiles are intended to induce more effort or reduce the probability of an individual worker quitting, and psychological models in
which people prefer steep wage-tenure profiles. All of these approaches have considerable validity. However, the discussion here will focus on human capital theory
Andrew Weiss
147
and sorting models, because the human capital model is most commonly used, and
because one purpose of this paper is to show how sorting models can be extended
to situations other than education choices. In the particular sorting models discussed here, firms offer wages that are conditional on observed performance or test
results. These conditional wages are designed to deter applications from workers
who have bad private information about their own ability.
The Human Capital Explanation for Wages and Tenure
In standard human capital models, wages rise with the length of time spent on
a job because workers learn on the job. Learning occurs either through on-the-job
training or learning-by-doing. These models commonly divide human capital into
two categories: general and firm-specific. General human capital includes skills that
are valued by many firms. In an economy with perfect information, it has the same
effect on a worker's wage whether or not that worker continues to be employed at
the firm where those skills were acquired. Thus, general human capital affects returns to experience, regardless of whether that experience happens at one job or
many. However, human capital that is applicable only at a worker's current employer—that is, firm-specific human capital—affects the correlation be...
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