Human capital investment, Signaling, and Wage differentials

In the real world, two types of education investment may exist. One of these contributes to labor skills, and the other does not, corresponding to human capital and signal invest- ment, respectively. The question is how individuals determine the ratio of these alternative investments. In response, we formulate an overlapping generations economy where the rich and the poor invest in both types of education. We argue that the ratio of human capital to signal investment is a U-shaped function of the wage differentials between the rich and the poor. Moreover, we identify three patterns of stable steady states for these wage differentials, namely, no-inequality, high-inequality, and multiple steady states. Using these results, we conclude that exogenous factors, such as skill-biased technical change, may switch the steady state from no-inequality to high-inequality, and as a result, the ratio of human capital to signal investment changes in a U-shaped form during the transition to the new steady state.