Scand. J. of Economics 110(4), 755–775, 2008 DOI: 10.1111/j.1467-9442.2008.00560.x Signalling or Human Capital: Evidence from the Finnish Polytechnic School Reform Ulla H¨ am¨ al¨ ainen Social Insurance Institution, FIN-00250 Helsinki, Finland ulla.hamalainen@kela.fi Roope Uusitalo Government Institute for Economic Research, FIN-00101 Helsinki, Finland roope.uusitalo@vatt.fi Abstract We use data from the Finnish polytechnic reform to distinguish between human capital and signalling theories of the value of education. We find that the reform increased the earnings of polytechnic graduates compared with those graduating from the same schools before the reform, as predicted by both the human capital and the signalling models. However, we also find that the relative earnings of vocational college graduates decrease after polytechnic graduates start entering the labour market. This finding is inconsistent with the pure human capital model and can be interpreted as evidence that supports the signalling model. Keywords: Signalling; human capital; polytechnic education JEL classification: I 21; J 31 I. Background One of the oldest controversies in economics of education literature is the debate between human capital and signalling or screening theories of edu- cation. The former claims that education affects wages because it increases workers’ productivity. The latter explains the wage differences between those with different levels of education by the correlation of education and unobserved ability. In this case, education is only a signal that identifies the high-ability workers. The controversy is difficult to resolve because in most cases both theories have identical predictions. In particular, both theories predict that earnings rise with education. However, the policy conclusions are very different. According to the human capital theory, the increase in the education level has important effects on productivity and economic growth. According to the pure signalling theory, education has no effects on pro- ductivity and, even though investments in education may be profitable for the individuals pursuing education, they are, in general, not beneficial for society as a whole. C  The editors of the Scandinavian Journal of Economics 2008. Published by Blackwell Publishing, 9600 Garsington Road, Oxford, OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.