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Toshimitsu Suzuki

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Economics of Education & Academic Background

Toshimitsu Suzuki
Assistant Professor (Term) of Labor Economics, Faculty of Economics, Chuo University

1.Introduction

In March 2011, the Ministry of Health, Labor and Welfare (MHLW) released survey results regarding official employment obtained by students who were scheduled to graduate in 2010. The overall percentage of university graduates who found employment before graduation was 77.4% (a 2.6% year-on-year decrease). 78.9% of male students found employment (a 1.2% year-on-year decrease) compared to 75.7% of female students (a 4.2% year-on-year decrease). This level of official employment obtained by students was the lowest for the second-lowest result since the survey was started in 1996.

Among such a severe employment environment, the form of university education is being questioned by society. This essay uses economic theory to provide a simple explanation regarding how education can be understood and the benefits of education.

Figure 1 Difference in official salary (salary issued in June 2009; excludes overtime pay, etc.) by academic background)
(Vertical axis: Official salary; Unit: 10,000 yen (total for men and women)
Note: Created based on the FY2009 Basic Survey on Wage Structure (MHLW)

Figure 2 Difference in executive positions held by all workers by academic background
(Unit: %; male workers; corporations with 100 or more employees)
Note: Created based on the FY2009 Basic Survey on Wage Structure (MHLW)

In order to consider education from an economic standpoint, I will begin with a simple examination of recent statistical data on the effect of education on salary and promotions. Figure 1 shows the difference in salary by academic background for all age groups. Although salary differs by only several 10,000 yen for workers in their 20s and 30s, this difference increases to approximately 200,000 yen for workers in their 50s. Figures 2 shows the difference in executive positions held by all workers by academic background. It is clear that university graduates and graduate school graduates compose the highest ratio of senior manager, manager and assistant manager positions. As the executive position becomes higher, there is a greater difference in the ratios between workers by academic background. How can the differences caused by academic background be explained by economics?

2.Basic philosophy of the theory of human capital

Education research within economics consists of two major theories. The theory of human capital was proposed by Schultz (1963) and Becker (1964), while the signaling theory was proposed by Spence (1974). Although both of these theories address the issue of education, they take total different views on the effects of education.

The theory of human capital states that education increases productivity due to the accumulation of knowledge and skills within a person. This in turn results in higher salary. The term "capital" within the theory of human capital is used differently from the "capital" in ordinary society. When used in ordinary society, the term capital is recognized as possessing a financial meaning that refers to funds required for conducting corporate activities. Conversely, economics defines capital as assets which have been produced or accumulated by people over a long period of time and which bring long-term benefit. When applying this definition, roads, airports, hospitals and schools are all examples of capital. Indeed, such facilities are referred to using terms such as social capital. Other typical examples of capital are factory facilities and machinery, which are referred to as physical capital.

As opposed to physical capital, human capital is knowledge and skills acquired through education. When a person obtains employment that allows them to be utilized, the knowledge and skills accumulated through education enable that person to receive long-term benefits in the form of salary. Such knowledge and skills are therefore referred to as capital.

One issue within this theory is to specifically define the essence of knowledge and skills which are accumulated through education. This question was addressed by the previously introduced Schultz (1975), one of the economists to propose the theory of human capital. Schultz proposes that distributive ability is one of the main forms of knowledge and skill accumulated through education. When leading daily life, people distribute the limited resources of time and money. For example, people decide how much time to spend studying and how much time to spend on leisure. They also decide how much of their salary to spend on living expenses and how much to save. Put in the context of corporate activities, these decisions are akin to deciding what projects to expand and what projects to downsize. Furthermore, when broadening our discussion to the level of operating a national government, there is a similarity to the policy decisions of where to allocate an increased budget and where to enact budget cuts. Schultz defines distributive ability as being able to recognize relevant conditions, make an appropriate assessment of those conditions and distribute resources appropriately. The distributive ability which Schultz says can be acquired through education is an important ability in every aspect of life, from daily living to the operation of government.

3.Basic philosophy of the signaling theory

The theory of human capital espouses that education raises individual ability. Conversely, the signaling theory states that it is not important whether or not education increase individual ability. Instead, the theory states that academic background is merely a signal for classifying individual ability (potential ability). For example, assume that a certain person possesses the same productivity as a university graduate. If that person is not an actual university graduate, then a corporation will not evaluate his (her) productivity as being high. Therefore, individuals with high productivity enter university in order to acquire a signal which shows the extent of their productivity. I will explain this point by using the example of hiring of new employees by corporations.

During the hiring of new employees, the prospective employees that apply to a corporation consist of individuals with high productivity and individuals with low productivity. It is difficult or impossible for corporations to accurate assess the productivity of each applicant. Conversely, compared to the corporation, the applicant has a more accurate assessment of his or her productivity. Corporations possess insufficient information regarding the productivity of each applicant, while applicants themselves possess a large amount of information. This existence of a gap in information is referred as asymmetric information. Since asymmetric information exists during the hiring of new employees, the signal of academic background serves as criteria for determining the productivity of each individual. In summary, corporations make decisions by assuming that high productivity is possessed by applicants with a high academic background.

4.The adverse effects of "diplomaism" as seen from the signaling theory

Diplomaism refers to focusing solely on academic background. It has been asserted that diplomaism results in the hiring and promotion of individuals with low productivity over individuals with high productivity. The adverse effects of diplomaism are evident in the signaling theory which assumes that education is not linked with an increase in skills.

In the signaling theory, the signal shown when an individual graduates from university is not that individual's true ability. Instead, it is shown that the individual possessed the academic ability to enter that university at the time of examinations. Hiring and promotion decisions should be made based on true ability. However, they are instead made based on what university the individual graduated from, a signal which only shows academic ability at the time of examinations. This is the adverse effect of diplomaism.

5.Diplomaism during the hiring of new employees

During the hiring of new employees, the actual function of diplomaism is considered to be the screening of application documents as performed by major corporations. Corporations do recognize academic background as one indication of ability. However, due to a decrease in the birth rate, the rate of students entering university is extremely high in current society. Therefore, corporations also recognize that academic background alone is not a sufficient indicator of ability. Corporations have a limited amount of time and money to spend on the hiring process. Therefore, it is realistic for corporations to use academic background to screen applicants and then to conduct hiring based on information obtained through interviews and aptitude tests.

In this case, the academic background used as criteria during the hiring process is not the content of material studied at university or the vertical academic background of bachelor's degree, master's degree and PhD as used in Western society. Instead, it is a horizontal academic background which emphasizes graduation from a university which is difficult to enter. In order to pass the entrance examinations of such exclusive universities, an individual must possess the potential ability required to solve difficult problems and the perseverance to endure many hours of studying for examinations. In other words, the horizontal academic background of graduating from an exclusive university is a signal which shows corporations that the applicant possesses a certain level of potential ability and perseverance. It is one criterion for screening new employees from among a large number of applicants.

Of course, when using horizontal academic background as criteria, there is the adverse effect that outstanding university graduates who didn't graduate from exclusive universities will not be hired by corporations. However, diplomaism within the hiring process possess a certain level of rationality when assuming that this adverse effect is outweighed by the costs incurred by corporations in order to discern outstanding applicants from among a large number of prospective applicants. Still, the issue of fair employment opportunities remains for outstanding university graduates who were cut during the screening process. What kind of measures can be proposed in order to solve such problems?

6.Measures for diplomaism

It may be difficult to completely eliminate the adverse effects of diplomaism. However, several measures can be proposed. Firstly, corporations could stop the traditional batch hiring of new graduates, instead implementing a hiring system effective after a certain period of test employment. The discrimination based on academic background during the hiring of new university graduates occurs because of asymmetric information between the corporation and applicant. Therefore, if a test employment period was established, then corporation could determine hiring based on an accurate assessment of the applicant's ability without being misled by academic background. Applicants would also be able to decide on whether or not to accept employment after assessing information such as work duties and human relations within the workplace.

Secondly, a more realistic proposal would be to increase the proportion of mid-career employment within corporate hiring policies. In the case of mid-career employment, the applicant's ability is made clear by past work performance and letters of recommendation from the former employer. This makes it possible to alleviate asymmetric information to a certain extent. Invigoration of mid-career employment would also present a merit to new graduates who were unable to enter their desired company during the initial hiring process. Such graduates could obtain employment at another corporation within the same industry, establish a career and record of performance, and then apply to their desired company once again in the form of mid-career employment.

7.Conclusion

Even more severe employment search activities are forecasted as the result of the East Japan Earthquake which occurred on March 11th, 2011. I would like to present a short message to students who will be searching for employment in the near future. Even if your employment search does not proceed smoothly, do not take a negative view of yourself or society. Instead, work as hard as possible to acquire knowledge and skills related to your desired profession. I believe that the majority of students searching for employment are in their teens or 20s. If you miss the opportunity to receive education and acquire knowledge and skills while you are young, it is a great loss that will affect the rest of your life.

Additionally, it is necessary for corporations and educational institutions to cooperate in an effort to eliminate the adverse effects of a new graduate hiring system that creates significant differences in employment conditions due to diplomaism and economic trends at the time of employment searching.

Related Literature
  • Becker, G.S. (1964) Human Capital: A Theoretical and Empirical Analysis with Special Reference to Education, The University of Chicago Press.
  • Schultz, T.W. (1963) The Economic Value of Education, The University of Columbia Press.
  • Schultz, T.W. (1975) "The Value of the Ability to Deal with Disequilibria," Journal of Economic Literature, Vol.13, No.3, pp.827-846.
  • Spence, M. (1974) Market Signaling, The University of Harvard Press.
Toshimitsu Suzuki
Assistant Professor (Term) of Labor Economics, Faculty of Economics, Chuo University
Born in Miyagi Prefecture in 1981. In 2004, graduated from the Department of Economics at the Faculty of Economics, Chuo University. In 2006, completed the Master's Program in Economics at the Graduate School of Economics, Chuo University. In 2010, completed the Doctoral Program in Economics at the Graduate School of Economics, Chuo University. Holds a PhD in economics. Has held his current position since 2010. Specializes in labor economics.
Current areas of research include the adjustment of employment by corporations at the time of mergers and acquisitions, as well as the influence of labor unions on the working conditions of non-permanent employees. Recent major essays include "The effect of M&A on complementary and alternative relationships between laborers" (published in Economic Policy Journal Vol. 63; Keiso-Shobo Publishing 2010; edited by Japan Economic Policy Association).