The chapter shows that as a general rule people with more education earn higher salaries. Economists have offered two explanations of this relationship

Question

The human capital argument says that high schools and colleges teach people valuable skills and employers are willing to pay higher salaries to attract people with those skills. The signaling argument says that college graduates earn more because a college degree is a signal to employers that a job applicant is diligent, intelligent, and persevering. How might you use data on people with two, three, and four years of college education to shed light on this controversy?

Answer 1

If the human capital explanation is correct, then we might expect to find that people who attend college but do not graduate earn salaries that are close to what college graduates earn. Consider the extreme case of people who drop out of college the week before graduation. It is very unlikely that they would have improved their job skills much in that last week. The human capital school of thought would suggest that they should therefore earn roughly the same salaries as college graduates. On the other hand, the signaling school of thought would argue that these people should earn significantly less than college graduates. Employers would interpret their failure to graduate as a signal they are not as diligent or persevering as people who see their college educations through to the end. There is substantial literature on what is often called the "sheepskin effect" (college diplomas used to be written on sheepskin; Notre Dame continued to use sheepskin until 2012). That literature suggests that human capital and signaling both contribute to the returns to education that we observe in the data.
For recent evidence, see the Michael Greenstone and Adam Looney 2013 Brookings Institution study "Is Starting College and Not Finishing Really That Bad?" (http://www.brookings.edu/blogs/jobs/posts/2013/06/07-return-to-some-college-greenstone-looney). They find that people with some college education but who do not graduate from college earn an average of $8,000 more per year than high school graduates who never attend college.