A Spillover-Based Theory of Credentialism

I propose a model in which credentials, such as diplomas, are intrinsically valuable; a situation described as credentialism. The model overcomes an important criticism of signalling models by mechanically tying a worker’s wages to their productivity. A worker’s productivity is influenced by the skills of their coworkers, where such skills arise from an ability-augmenting investment that is made prior to matching with coworkers. A worker’s credentials allow them to demonstrate their investment to the labor market, thereby allowing workers to match with high-skill coworkers in equilibrium. Despite the positive externality associated with a worker’s investment, I show how over-investment is pervasive in equilibrium.