SummaryIn this LP we cover the implications of asymmetrical information, looking at the most important examples. We start by looking at adverse selection, then we learn more about moral hazard.
Signalling is similar to screening, except it is the agent with complete information who decides to move first to mark themselves out as a ‘good’ agent, as a cherry. The most cited example is generally in the job market. When we examine most qualified positions, we realise that those carrying out those jobs generally have some form of higher education. However, except in fields like science and medicine, the qualifications these employees hold are often unrelated to the work they are carrying out: for example, a financial analyst with a degree in philosophy. Until recently, it was assumed that a degree could be wholly unrelated because the point is that it offers some form of unspecified human capital that can be useful in any field, like a greater capacity for analysis which was derived from logical thinking and problem solving applied throughout their higher education.
Be this as it may, newer currents specify that a degree is simply a form of ‘signalling’: that is, a way of showing that you have certain qualities, be they innate or nurtured, that have allowed you first to reach that level of education and then to complete it. It is a question of ‘what came first’ – whether your degree has made you employable, or whether you already were but needed to prove it. In this scenario, a degree is merely a piece of paper proving you know a lot about philosophy but nothing about finance, but it does prove certain things: that you have a certain level of intelligence, that your background is probably at least lower middle class (which may be important to corporate culture) and that you have enough perseverance to have been able to stick out a three year course.
Most HR specialists will admit that hiring graduates for white collar jobs is at least a combination of both what your degree affords you and what the fact you have a degree says about you. The point is that most people didn’t (just) choose to do a degree based on their innate love for philosophy. Rather, they knew they ‘had’ to get a degree in something (based on family pressure, expectations, peer pressure and future employability, as well, of course, as an insatiable curiosity for knowledge) and then narrowed the field to something they hoped they could stick out for the duration. It is the same as the art of constructing a CV: you choose hobbies to detail that you know are acceptable and hopefully interesting (something reasonably risky like rock climbing balanced with something intellectual and cosy like poetry writing!) and you detail other, absolutely unrelated achievements. Being captain of the chess club or having published numerous articles on dog breeding won’t have prepared you for stock trading or designing bridges, but it does say a lot about who you are, marking you out as a cherry rather than a lemon: a ‘good’ agent, capable of advanced financial analysis, rather than a lemon, someone who will slack off from the first day and lead the company to bankruptcy.