Imagine an economy set in a world where free trade in goods equalises product prices worldwide and free capital mobility sustains profits at global rates. The economy produces goods that require capital along with either skilled or unskilled labour. Unskilled labour is an undifferentiated mass without productivity differentials, where the headcount is all that matters. Skilled labour is heterogeneous and a college education is indispensable for it. The economy has a college system that caters to this demand. Colleges admit students on the basis of a test of their pre-college ability, accepting all those who score above a certain cut-off. They then train their students up to a final level of skill which is reflected in their eventual grades.
A firm that requires skill will hire a college graduate on the basis of his grade, which is the only signal it has of his ability and productivity. Firms have to match the global rate of profit if they are to retain their capital. Given their technology and the price of their product, this implies that they cannot afford more than a specific unit cost of work. Competition among firms for labour ensures also that they do not pay any less. So, in a globalised economy, the unit cost of work in each viable firm is set by global parameters. Now the unit cost of work is the ratio of the wage per head and the productivity of the worker. Thus, firms can absorb low-productivity workers, provided they pay them proportionately less. There is, however, a minimum below which wage per head in skilled industry cannot fall: this is determined by the wage in the unskilled sector plus the cost of college education.
Labour in the unskilled sector is homogeneous and earns a uniform wage, which represents the unit cost of unskilled work. This, too, is determined by global parameters: the imperative of paying the global rate of profit to attract capital dictates the wage of unskilled labour (given the technology and the product price). The global economy thus imposes the unskilled wage and sets a floor to the wage per head of skilled labour. Since it also determines the unit cost of skilled work, it fixes the minimum productivity of skilled workers. Skilled industry can only hire those graduates whose grades match this minimum productivity requirement. Since colleges are interested in the employability of their graduates, they will admit only those applicants whom they expect, on the basis of their admission test scores, to achieve such grades. Indeed, if the relationship between admission test scores and final grades, and that between final grades and employability, are common knowledge, the college need not have any admission policy at all. If it simply discloses the admission test scores, applicants who do not, on the basis of these scores, expect to achieve the grade-requirement for employability would simply select out of college education — they would prefer unskilled work to the pursuit of an expensive college education that would not culminate in a skilled job.
Taken from here