Say you walk into Brooks Brothers and the staff ignore you. Why would this happen? Although the staff have no concrete information about your budget, they can examine your age, style, and demeanor to assume that you certainly cannot afford anything in the store, except for maybe a single sock. We see social experiment videos showing this type of behavior all the time. Ugh, these filthy salespeople and their brazen judgment. This rather scandalous judging, though, can be applied to help solve the information asymmetry problem. We say that information is asymmetric whenever one person involved in a transaction knows more than the other.
So is it really true that you can win a Nobel prize just for observing that some people in markets know more than others?
Yes. Yes, you can. That was the question a journalist posed to Michael Spence, who along with George Akerlof and Joseph Stiglitz, was a joint recipient of the 2001 Nobel prize for their work on asymmetric information. This insight may sound #basic, but the idea was novel to mainstream economists and disrupted many models. Inequalities in access to information upset the normal market for the exchange of goods and services.
Mr. Spence’s contribution is one we can all relate to, which is signaling. Whether we are aware of it or not, we send signals about ourselves constantly. Our social media profiles are a compilation of our life’s best moment to send the message that we are happier, fitter, and having more fun than everyone else. The books we read, cars we drive, and restaurants we frequent all send a signal about Who We Are. As millennials, we understand that we need to be on #brand, all the time. Especially when it comes to our professional image.
When we go to a job interview, we put on our best power suit to show our potential employers that we are SO job ready. We might even follow the company on Twitter beforehand to show that we really care. But how effectively do these signals reach our potential employers? Spence was interested how employers can sort out the best workers from the wannabes and wrote about this in his seminal paper, “Job Market Signaling.”
As it turns out, top workers tend to signal their talents to firms through education, which brings us to an important point about signals. In order to be effective, they have to be more costly for one individual/party to send than another. So if a college education is more difficult for some individuals to complete than others, then it functions as a strong signal for employers. What this signal represents, though, is up for debate.
In his upcoming book, The Case Against Education, Bryan Caplan of George Mason University argues that the primary function of education is not to enhance students’ skills but to certify their intelligence, work ethic, and conformity. In other words, degrees are signaling devices rather than certifications of particular skills gained. On the other hand, education may be important not as a signal, but because learning itself matters. Completing the curriculum necessary to graduate with the piece of paper builds tangible skills making us productive humans.
Regardless of what side you fall on of the signaling versus human capital debate, we see examples of costly signals in many contexts. My neighbor’s Chanel heels? These send a signal that she is a chic woman with impeccable taste. This is literally a costly signal because I cannot afford those on a graduate student stipend. Maybe you want to impress your date, who likes bro-country music, by telling them that you are also into bro-country music. This imposes an incredible cost on you if you continue spending time with this person and they start playing songs about attractive young women, beer-drinkin’, partyin’, and pickup trucks because they think that you like it (Note: the lesson here is to never date someone who likes bro-country).
As effective as signaling may be in getting us closer to solving the problem of asymmetric information, it is not perfect. There are still many uncertainties that one may run into, such as:
· What is an appropriate amount of time, money, or effort to put into sending an effective signal?
· How can I trust that the information I am getting from someone is credible?
While there is no secret formula for sending a perfect signal, results tend to emerge over time. Effective signals often involve multiple encounters such as hiring managers finding out after 90-days that their college-educated employees are, indeed, more productive than their non-college educated employees. Or, that people who dress “well” and walk into Brooks Brothers stores, do end up spending more than the flip-flops and khaki type of person (although this signal is increasingly watered down as Warren Buffet and the Silicon Valley tech folk rock this look).
Next time someone is trying to convince you that they are a “good” type and not like all those other “bad” types, look at the signals they are sending. How difficult is it for them to convince you of the validity of their claims? Play that bro-country music and make them suffer if they are sending false information.