Michael Spence

Who they are

Spence is an economist. He was awarded the Nobel Memorial Prize in Economic Sciences in 2001 for his work on market signalling. His 1973 paper appeared in The Quarterly Journal of Economics and is the reference point for the economic form of costly signalling.

The paper starts from a hiring problem. An employer cannot see a worker's productivity before the worker is hired, but can see traits that the worker has chosen or can alter, and education is the example Spence develops. Workers decide how much to invest in such a trait, and employers set wages according to what they observe.

Key papers

Spence (1973), Job market signaling, The Quarterly Journal of Economics, 87(3), 355-374. In one of its worked examples education adds nothing to productivity, yet it still sorts workers, because a year of schooling costs a low-productivity worker twice what it costs a high-productivity worker.

Key ideas

The central requirement in the paper is that the cost of signalling is negatively correlated with productive capability, so that more capable workers find the signal cheaper. Spence called this a critical assumption. He also noted that it is necessary but not sufficient, because there must be enough signal levels within the relevant cost range for the signal to separate groups.

The same structure appears in biology in Amotz Zahavi's handicap hypothesis of 1975 and in Alan Grafen's 1990 model, which states that the marginal cost of advertising must be lower for the better signaller. The Elephant in the Brain, by Kevin Simler and Robin Hanson, applies the general framework to everyday life.

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