Skill Signalling with Product Market Externality

We propose that signalling in professional labour markets creates product market externalities that affect wages, thus establishing a link between the externality and signalling incentives. Due to signalling activity, a free substitute (negative externality) or complement (positive externality) good appears. For negative or mildly positive externalities, the standard result of signalling at the minimum level obtains. When the positive externality is sufficiently strong, separation occurs, in contrast to the literature, at the maximum rather than at the minimum level of signalling. Very strong positive externalities imply the unique maximum pooling equilibrium. The private market solution may involve too little signalling when compared to the social optimum. Copyright © The Author(s). Journal compilation © Royal Economic Society 2009.