Do you need a degree?

Our parents’ generation extol the benefits of getting an education. Perhaps it is because education is a valuable good during their days. Both my parents did not finish their secondary school education because their family could not afford giving them one. I studied to a diploma and also A levels level. Now I’m in the process of getting my basic degree qualification.

However, is a basic degree necessary? From an economics viewpoint, does a basic (or advance) degree maximise our utility (satisfaction, welfare, etc)? Using the model of indifference curves (or utility curves), we can plot a diagram between “wages” and “the number of years spent getting a degree”. Assuming wages is a “good” good and “years spent studying” a “bad” good.  The diagram will look like this:

Map of utility curves plotting between wages and years of education

The utility curves tilt away from “Years of Education” because it is consider a “bad” good. Therefore, the higher the utility, the nearer it moves towards “wages” (i.e. U2 is better than U1 and U1 is better than U0).

For a low-ability person (not academically inclined), the utility curves will tilt even more away from years of education than a high-ability person because of the harder work they might have to put in the education.

Assuming that a low-ability person will have a starting salary of $2,000 and a high-ability person will have a starting salary of $4,000 (after 3 years getting a degree). If either type of person do not waste time getting a degree, the market will pay them an average of $3,000 since the market cannot differentiate between high or low ability. They both will be better off (on a higher utility plane) than if the high-ability person spend 3 years on education.

Higher utility (in red) for both types of person if they don't waste time on studies

U(L)0 and U(H)0 are the utility curves if the low-ability person starts work at $2,000 (pt. L) and high-ability person starts working after 3 years of school at $4,000 (pt. H). The red utility curves, U(H)2 and U(L)2 illustrate the higher welfare they will receive if they forego any degree education and start work at $3,000. U(H)2 is obviously better than U(H)0 and similarly, U(L)2 is better than U(L)0. It is not pareto-efficient if they stick to the original arrangement (2k and 4k)

So why don’t we all start working without going through the hassle and costs of obtaining a basic degree? Because the market will not offer $3,000 to bet on whether the new hire is a diamond or a dud.

Asymmetric information regarding the recruitment of new workers adds to the list of reasons for not offering a standard salary rate for all new hires.

Mark Spence’s signalling model explains the need for a basic degree to “signal” the ability of a potential hire. It is one of the common ways to signal if the person is a “lemon” or a “plum”.

This is one of the reasons why I am pursuing my basic degree now. That is also why my good friend, Martin would be enrolling in a degree programme soon. We want to be seen as plums, not lemons. Whether we are genuinely plums or not, you have to ask our employers. I will like to think that I am a real plum, not just seen as one.

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When I just graduated with a diploma, my former lecturer told me that I’ll be fortunate if I could get about $1,800 to $2,000 in my first and second year of employment. That was in early 2006 where the job market is in a boom. If not it will probably be closer to $1300 to $1,500. She said that most diploma holders do not command salary higher than that amount in the first two years.

She predicted wrongly. I got much more than that after a year. Does that mean that there is no asymmetric information for my employer when they hire me? Is that why they are paying me more than a normal diploma holder should get?

So do I still need a degree to earn more? The answer is; it depends.

I’m changing industry and the career that I’m targeting requires a good basic degree (actually, the norm is a good advance degree), therefore I’m enrolled in a university now. Moreover, a degree programme may not just signals ability, but also increases ability. As economic history proves, an educated society benefits more than an uneducated one. Finally, I’m also deriving utility from studying itself (except during exams)

So, do you need a degree?