Thoughts on Human Capital Contracts

Okay folks, back from a break and ready for at least one good substantive post this week.

A while back I promised my thoughts on the benefits and drawbacks of human capital contracts (HCCs). Richard Vedder, the first serious HCC advocate in higher education (I suspect it’d work even better far better for professional education, which is a later post), came up with two: (1) Unenforceability and (2) Adverse selection.

Unenforceability refers to the fundamental problem that human capital investments can’t be securitized, which is the ultimate source of all higher education’s problems. The solution, such as it is, that the government found was to give out loans, eventually make ‘em nondischargeable in bankruptcy (with no real basis beyond pure mistrust of graduates), and allow the creditors to hunt down the debtors when they defaulted.

As for adverse selection: an HCC system would not work so well if the only people to use it were those who planned to go into low-paying occupations to begin with, e.g. social work. Obviously, this isn’t a problem for the loan system: once you take on the debt, you must pay it regardless of your major’s value, which is another problem we’re seeing. The natural solution is to individualize/underwrite the contracts and risk-pool them.

I should note two things about Vedder: first, he prefers a progressive higher education voucher system in which every potential college student gets a $5,000 grant to attend college. It’d be adjustable depending on performance, and those of wealthier backgrounds would be ineligible for them. Secondly, and more significantly for my following thought exercise, Vedder is through with government-funded higher education. The only advocate of anything resembling publicly-funded HCCs I know of is former Labor Secretary Robert Reich. Sherman Dorn believes that a combination of public funding and HCCs would work because anyone who went to college more than a few years after high school would be considered a much higher risk than someone who immediately went to college with good grades. Public investment also creates an intangible “public good” in an educated populace. Unlike private goods (stuff we can buy for ourselves), public goods are vastly more difficult to quantify. [i]

So, as promised, here’s a rough thought experiment on the pros and cons of HCCs, both private (ala Vedder) and public (the Reich model). I try to match up the pros and cons between both tables.

Private HCCs

PROs CONs
Sponsors have an incentive to underwrite majors accurately to limit higher education adverse selection. You won’t be able to take out six figures in debt for a humanities degree. Whither the liberal arts? Seriously. The meta-point of all these higher education financing discussions is that education IS a free lunch. Some aspects of education don’t give a direct economic return—something Charles Murray, who advocates against mass higher education, is heavily criticized for. 

Also, it’s hard to invest in people when you don’t know what their major is, but this wouldn’t be a problem for professional education.

Sponsors are incentivized to find work for their graduates, even during economic downturns or if they’re returning to the workforce. This is a vast improvement over current college career services offices. Enforcement Issues: 

(1)  If the grad bails or refuses to work, the sponsor gets nothing. The sleeper problem here is sex-discriminatory sponsorship because women often leave the workforce to raise children.

  • For example, Slate reviewed a book in which the author encourages women with MBAs to remain in the workforce after having children, even though half of these women never return to the workforce.[ii] With student loans, they pay debt on an education they probably didn’t need; with HCCs, rational sponsors would avoid investing in women, or at least they’d demand higher returns than they would with men.
  • As far as law is concerned, consider an anecdote from the After the JD study, which reported on one 2000 UW Madison graduate’s outcome. By 2007, she’d retired to raise five kids, though she’d worked only a few years full time. If she’d gone to law school on a 10-year HCC, her sponsors would’ve received far less than their investment.

(2)  Sponsors may interfere in grads’ lives, encouraging them to work where it’s profitable rather than where the graduate wants to work, e.g. Dr. Joel Fleishman from Northern Exposure. Bet you’d forgotten about that show.

These problems could lead to litigation where in the student loan context there should be bankruptcy: sponsors may sue graduates, on contract grounds, to move or take jobs where it’s convenient for them.

Solutions:

  • Sponsors can buy human capital contract insurance. The insurance company would pool the risks.
  • Sponsors can place options in their human capital contracts that allow them to be converted to student loans. Then we’re back to the bankruptcy dischargeability problem.
Possibility that sponsors will invest in their own human capital. I like this option quite a bit, and it allows for a more decentralized education system. For example, a law firm might send a good paralegal to law school. 

The benefit is that if the sponsor’s business fails, the graduate still has the degree à Graduate windfall.

The benefit to a limited HCC repayment period, e.g. 10 years, is that people could move on to public interest work or start their own businesses.

A sponsor’s windfall (sponsor gets more productivity than the education cost) disserves workers and their families, though not as badly as a malfunctioning student loan system. It could be more profitable for workers to remain in their current positions or move to different occupations if they don’t have the right information. This is more a market problem, though, so we’d expect it to be minimal. 

Might lead to more difficult HCC contract issues down the line, such as competition covenants.

Might lead to a reverse-amakudari problem: highly-trained business experts become government bureaucrats tasked to regulate their former employers.

Sponsors become an interest group that favors cheap, efficient education. Sponsors’ demands on education institutions may compromise quality. 

There’s also the possibility of a vertical monopoly disserving workers. A business could own the schools that it sends its workers to, which could create a conflict of interest leading to substandard worker education if the worker wants to work elsewhere. Asymmetry of information could cause a “miner’s scrip”-style sponsor windfall if the sponsor promised more post-graduate income than it delivered, or a sponsor creates its own certification/degree of little value outside the firm. I doubt this’d be a problem though. For instance, large law firms already hold their own in-house CLEs and train summer associates in “classes”. It wouldn’t be too hard for these practices to evolve into a new kind of decentralized law school. Do we want businesses to consolidate this much, like, into American keiretsu?

Sponsors still have to get their money from somewhere, and they may end up borrowing it from banks. I’m wary of more unsecured education-related debt.
Might lead to graduate windfalls for breakthrough innovators, e.g. an author who publishes a widely distributed novel. The intellectual property belongs to the author and not the sponsor. What happens if a graduate gets blacklisted, e.g. fired for-cause because of sexual harassment (legit or not)? Sponsors wouldn’t like this and would want to mitigate it somehow.

From this I have two conclusions:

(1)  Private human capital contracts would be more complex than student loan documents because it’s easier for one debtor to file for bankruptcy than it is for an investor to order someone to work.

(2)  Private HCCs could greatly benefit large efficient businesses over smaller firms. We may see a decentralization and privatization of higher/professional education.

Public HCCs—The Robert Reich Model

PROs CONs
More likely to support liberal arts at a nominal loss. Still no massive debt though. Won’t encourage as efficient underwriting for majors/professions.
Easier to enforce because the government can always find its graduates (hint, your Social Security gets garnished), and less need to force people to work. Friendlier to families. 

Less meddling by the investors in people’s lives

Risk is pooled by the government, and it’s probably cheaper to manage. Less of a need for complex agreements and creation of equity to debt conversion options.

Doesn’t have the job assistance incentive that private HCCs provide, especially during economic downturns. Might lead to greater deficit problems during periods of high unemployment. 

The government’s return might not be that great. Then again, that’s not the point of education. It’s considered a public good in this context.

Government may still invest in its own human capital. Might lead to amakudari?
No more student debt bubbles! 

Lesser likelihood of non-standardized credentials.

Perhaps there’d be another way to scam the government, similar to Pell Grant fraud: people take the money and then drop out. Could use escrows or other mechanisms to prevent it. Although, universities don’t like teaching someone and then not getting paid for it. 

Also, would this really prevent the Title IV Trap we’re in? We’re back to the Direct loans + Grad Plus loans + Income-Based Repayment = taxpayer rip-off. Universities could still charge whatever they want for tuition and the government would still pay. After all, the government doesn’t care much about the growing mass of higher education debt now; arguably, what does guaranteeing people’s education solve?

Left hand/right hand problem: the government (legislature) must adequately invest in the public education system (administrative agency) for this to work.
Very easy for people to move into public interest positions from the traditional college model. Government takes the loss. (Or does it?)
Money comes directly from taxpayers Money comes directly from taxpayers, and if we’ve learned anything about how education is financed in the US, we know public education is the first thing that’s cut in recessions.

My two brief conclusions:

(1)  Public HCC documents will be less complicated and more diverse.

(2)  Public funding for education benefits the public more broadly, and public HCCs are probably easier to enforce.

Later I’ll go into what assumptions we can change about how higher education (and legal education) works to see if there is a better model.


[i] As an editorial aside, I think how we value public goods to complement private goods is rapidly becoming one of the most contested societal problems in contemporary American politics.

[ii] Note no one is reporting whether it’s a good idea to invest in an MBA generally, or whether there’s a business school tuition bubble—just that women with children don’t see much use for the degree.

No Bubble, Just ROCK!!! Vol. 2

Folks, I said I’d be busy for a few days, so here’s some music to keep your thoughts focused.  Actually, I thought I’d be putting these up more often!

Okay, meditate on these truths, primates:

This Byrds psychedelic instrumental is my new theme song [sorry for the redirect :( ].

Not to be outdone, the Soft Boys give us the best arthropod-based rock & roll song since the Who’s “Boris the Spider.” [You might wanna listen to this on YouTube; the audio is better.]

When you send me to CLEs, I will doodle!

Finally, your love(less) song of the day, courtesy of another band worthy of special mention for getting me through law school: Mr. Airplane Man.

Sweetlinks of the Rodeo—“Dean” Tamanaha Destroys His Law School to Save It

Three quick links:

(1) Brian Tamanaha, “My ‘Dean’s Vision’ Acceptance Speech,” in Balkanization

Anti-law school tuition bubble superhero Brian Tamanaha writes a speech that would likely cause faculty to flee in rage while his law school’s US News ranking irreparably plummets…until the tuition bubble pops.

I deliver unto you Dean Tamanaha’s prophecy, behold!

No one knows when the crunch will happen—and it won’t happen at the same time or in the same way for every law school—but happen it will. The schools trapped in this crunch will be those that have embarked on substantial expansions of their faculty. Faculty is the biggest expense on the budget—and tenure makes it difficult to trim this expense. To pay the bills, these schools will be forced to take more students from a declining pool of applicants (leading to a reduction in student credentials), and they will be forced to take greater numbers of transfers from schools of much lower standing. Those lower down schools, in turn, will suffer a serious revenue drain from the departure of a significant proportion of their upper level students.

One quibble: I think it might help a bit if the dean were to lower his law school’s enrollment.

Now let’s see if any law school will hire him as dean.

(2) Managing Partner, “Restoring Dignity to the Law – Those Entering Law School” Part 1 and Part 2, in The Legal Dollar

Managing Partner’s conclusions are similar to my own (namely crushing the tuition bubble, requiring experience before law school), but if you scroll down to my comments, you’ll find I’m a bit more revolutionary than he is.  Specifically, I think we need to specialize the profession along a certification system (one for practice areas as they exist, not a la bar exams designed for general practitioners of 100 years ago), and require several years’ experience up front in a variety of contexts, e.g. paralegals, police detectives, &c.

(Essentially, I was gearing up to a post like this, so I’m a little jealous MP beat me to it.  Early bird, sir.  Early bird.)

(2) Knut, “New York Times Columnist and Cardozo Law Visiting Professor Defends Tuition Increases,” in First Tier Toilet !

&

Stanley Fish, “There Is No College Cost Crisis,” in The New York Times Blog

I’m just gonna outsource this because I’m really busy this week, so you’ll get no detailed evaluation of either the original or the FTT rebuttal.  I took this nugget:

Just because you are trying to score points by bringing up John “Bailout” Boehner (and, by implication, the Tea Party/Republican resurgence) does not mean that the reader should sympathize with overpaid professors who teach at dubious institutions like Cardozo Law, one of the more prominent culprits of the “law school scam.” This issue, unfortunately for law professors like Mr. Fish, unites both right-wing and left-wing students, who share the same goal of not being exploited or swindled.

One thing I’ve noticed is how clear the tuition bubble (law or higher ed) is to people who are either right-leaning or libertarians, whereas I’m neither.  Now, there’s good reason to suspect an ideological basis for these beliefs: rightists hate universities for corrupting our youth with evil liberal ideas like income inequality being a problem in society, and libertarians hate government period.  The only liberal who’s commented on higher education reform is Robert Reich, who argues that professionals should pay 10% of their income for 10 years back to the government.  By contrast, my economic hero, Dean Baker, appears clueless as to the legal profession’s ills.

I’d prefer a more robust coalition.

Folks, as I said, I’m gonna busy all the rest of this week, so I’ll cover up my absence with some rock and roll later.

Linkth Dimension—Law School Buildings

Three links.  I know I haven’t placed any substantive posts (or doodles) recently, but work has kept me busy.

(1) Josh Dawsey, “Law School Struggles,” in The Daily Gamecock (University of South Carolina student newspaper), part I, part II, & part III

&

Editorial, “In Our Opinion: Law School Needs New Building, Vision” in The Daily Gamecock

USC’s law school isn’t doing well, dropping into US News’s scorned third tier, and suffering a building with leaking ceiling tiles.

On the plus side, South Carolina has very few attorneys per capita (third standard deviation above average!), and average numbers of law students per capita, and lawyers/law students relative to economic indicators.  It’s probably much easier to start a practice there than elsewhere, if it is at all.

Meanwhile the law school has been asking for a new building since 1997, and it’s looking for funding.  I should also point out that SALT reports adjunct/assistant/full professors at USC make $99,190/$109,433/$155,666 per year, and in-state tuition is $19,034 per year, out-state $38,014 annually.  That should mean a minimum $13.7 million annual revenue, which isn’t enough to build the kind of multimillion dollar building law schools want (Marquette’s state-of-the-art law school building cost it $83 million, mostly paid by a $50 million gift from the Eckstein family).

The editorial reflects the exact attitudes universities have toward law schools and the value of their reputations:

Not only does [the unsafe law school building] discourage high quality applicants from attending USC Law in the future, but it exponentially decays the value of every juris doctorate degree the school has ever given to deserving future attorneys… A successful law school is critical to the image of any large university.

What is the half-life of a law degree?

This is the problem with rankings dog-piling and super-law-school arms races.  If law schools try to reduce their ecological footprints, or close (as some inevitably will), people will wonder what their “orphaned” juris doctors are really worth.

This doesn’t necessarily apply to USC, whose students deserve safe buildings.  Its law school also isn’t the costliest or worst-situated law school, but we need to remember that the genesis of legal education’s problems lies in a model that prioritizes reputation over the legal market’s demand.

(2) Elie Mystal, “Tuition Is Going Up at Notre Dame Law (But Not as High as Some Other Places),” in Above the Law

Speaking of new law school buildings, Dean Newton of Notre Dame responded to ATL about its tuition increases to pay for its long-term plan to increase faculty by 25%:

First, I would like to clarify that no part – none – of the proposed tuition increase is being used to fund the new law school building. The new Eck Hall of Law and the renovation of Biolchini Hall of Law are already completely paid for by our generous benefactors.

That’s good, just not for the benefactors, who join the growing number of (I suspect without any direct evidence) older lawyers who give money to law schools that’d probably be better spent on lower rather than higher education institutions.  Marquette[i] moved into its new building this year.  It also increased tuition by 12% over the previous year.  Buildings are another place where tuition bubble monies go.

(3) Dan Treadway, “The Tuition Is Too Damn High,” in The Huffington Post

Mr. Treadway recommends starting campus political parties against higher education tuition–an idea I like.  He writes:

As President Obama has said, “Higher education is the economic issue of our time.” As such, politicians across the country must make funding our education system a priority. Doing so is not so much an expense as it is a solid investment. An uneducated populace will simply not be able to compete in the global economy moving forward. While Obama has taken positive steps to assist indebted students by advocating for more Pell Grants, this measure will only put a band-aid on what is a gaping wound.

An easier solution is to diminish lending to universities for bloated staff and facilities.  Student advocates should also know that at least 17 million Americans with higher education credentials work in jobs that don’t require them.  That excludes the large number of unemployed or underemployed college degree holders.  Global economic competition comes by…economic competition, not by simply throwing more money at universities, especially since most economic growth is going to wealthy Americans already.


[i] Is Eck Hall better than Eckstein Hall?  Or vice versa?

To Everything, There Is a Link—Third Tier Surreality? Carnegie Mellon’s Pre-Law Society Webpage Tells Us Its Law School of the Week

(1) Debra Cassens Weiss, “Why a Better Economy Is Bad News for Some BigLaw Partners,” and, “Largest Law Firms Still Shrinking, Shedding 1,400 Lawyers This Year,” in the ABA Journal

There’s only the thinnest slice of plausibility in which these two articles don’t facially conflict.  It would require clear evidence of economic recovery in the legal sector.  Simply believing (as I suspect the ABA does) the NBER’s recent conclusion that the recession ended in June 2009 is insufficient.  Unless the legal economy starts adding lawyer jobs fast, Debra Cassens Weiss (and her editors) will have to write more consistently.

(2) Carnegie Mellon Pre-Law Society, “Law School of the Week: Boston College Law School

I noticed CMU’s “Law School of the Week” last week when it celebrated Albany Law School but chose to ignore it.  This week, though, it cracked me up.  On Boston College Law School, the Society teaches us:

The employment prospects are even more promising: almost 98% of students in the 2008 class secured jobs within nine months of graduation. This class enjoyed a median salary of $160,000 in their first year, with 65% accepting jobs in the private sector and about 15% taking on judicial clerkships.

Normally, I just sigh and shrug my shoulders when anyone relays a law school’s self-reported graduate employment statistics, but CMU Pre-Law really has to do better.  One, BC’s 2009 statistics are readily available on its website.  Two, CMU Pre-Law really bumbles into newspeak territory when it dedicates precious Internet electrons to a law school whose own 3Ls futilely ask for a tuition refund when faced with their non-job prospects.  Now, I have neither the time nor the patience to correct everyone on all God’s little law schools—I leave that to Third Tier Reality—but if you’re going to report on law schools, do your research and at least try to appear to know what’s going on in the law school news.

Quick Link– “Creative Hustler” Says Stuff about Law School Tobacco Warnings, Champions Creative Hustling

Ari L. Kaplan, “Would Law School Warning Labels Make Any Difference?” in National Law journal

When someone opens an article with, “People smoke.  People speed.  They don’t exercise or get enough sleep.  They go to law school,” my eyes roll.  Mr. Kaplan, allow me to direct you to your comparison’s flaws:

  1. Tobacco is extremely chemically addictive and destructive; we try to prevent people from using it because they can’t once they do.
  2. Speeding isn’t strictly enforced because its danger depends on context: school zone versus interstate highway, sleet versus dry, summer weather.
  3. People don’t exercise because they often lack the free time to do so.
  4. People don’t sleep because our country hates people who prefer afternoon naps.  *Ahem*

In few of these cases are people misinformed, and the topics don’t compare to law school because, as Mr. Kaplan himself observes, 0Ls are either uninformed or overconfident.  Indeed, Angel would not devote blog posts to admonishing legal education profiteers if the knowledge was widespread.  Offline, she dissuades people from law school the Die Hard way—one at a time—at an average of three per week by her count.

But I’ll stop teasing Mr. Kaplan’s lead-in and take what he says a little more seriously.  First, he cites University of Miami Law School’s Dean Patricia White who compares student debt to the housing bubble.  This I like, and I’ve read elsewhere of Miami’s attempts to keep people out of its classrooms.

Kaplan then returns us to the recurring (and debated) idea of putting tobacco warnings on law school applications.  His ideas include (1) better salary data, (2) data on graduate outcomes 5 and 10 years along, (3) a money-back guarantee in exchange for higher 1L tuition, and (4) a paralegal certificate after only one year of law school.

The discussion devolves to a debate between transparency advocates (White) versus applicant micromanagers (Indiana-Bloomington Professor Bill Henderson).

The rest of the piece oversells the notion that every law student can be a brilliant entrepreneur in a depressed, deflating economy.  I’m all in favor of clever, creative people (for example I blog as a creative outlet, and it’s even helped me find work), and I don’t want to discourage people or sound like a Negative-Nellie, but reform won’t be complete without accepting that the legal education system malinvests in our human capital.  It’s one thing to encourage overbuilding of houses people can’t afford, but it’s worse to encourage people into sophisticated fields where their productive potential could be much better directed.

My opinion on transparency vs. micromanagement?  This returns us to Kaplan’s lead-in.  In all his examples, people were addicts, rational actors, or overworked.  They all knew the dangers, which is why law school is a separate being.  It’s also why I don’t think both approaches will be sufficient.  I don’t trust the ABA or law schools to disclose all the relevant information, nor do I trust them to discourage 0Ls from giving them money.  For instance, Miami hasn’t closed or reported a major faculty contraction.

Aside from Kaplan’s ludicrous money-back guarantee, and the paralegal certificate which brings with it its own transparency issues, nothing here addresses the fundamental cause of all the legal profession’s problems:

Legal education rests on the flawed premise that anyone can choose law practice as their first career.

Until we revise this premise and require law school applicants to actually have some kind of legal experience upfront, or even mandate a minimum age requirement to, like, 35-year-olds, transparency and applicant micromanagement will always be the inefficient route to quality legal service.  An experience requirement is also more compatible with human capital contracts and employer-paid legal education, which often occurs with part-time students who start when they’re older anyway.  These two options also fail to counter the excessive law school profiteering we’re seeing.

I further believe the “first career” premise has also fed into the juris doctor’s degree-creep.  First it was a professional degree with a specific purpose; now Dean White casually describes law school as “the great generalists graduate school.”  We’re back to the versatile juris doctor—the degree with neither boundaries nor accountability. The thing about graduate degrees is they promise knowledge without expertise.  The law school tuition bubble exists because law schools promise expertise when they have no hope of providing it efficiently.  Transparency to inform the public of the juris doctor’s labor market value is good for the short term, but difficult structural reform must occur as well.  “Creative Hustling” might work for a handful, but it is not reform.

Mr. Tambourine Links—NY Daily News Sides with Students, Kaplan Scams the Troops

Ah the Byrds…

Editorial, “College Costs Just Keep Going Up, Hobbling Graduates with Unfair Burdens of Debt,” in New York Daily News

Quote of the day:

[The financial aid compensating for rising tuition] comes largely from the federal government. Meaning, out of your pocket. And ours. And out of the pockets of families scraping to raise that extra 8% for tuition.

A government-sanctioned racket is what it is. States cut back on assistance to schools, so the schools raise tuition. Then the feds jump in, dish out billions in taxpayer dollars in student aid, and tuition goes up again. And again.

Meanwhile, those fortunate folks who inhabit the groves of academe feel absolutely no need to hold the line on expenses. They ought to be ashamed, most of all for sending so many graduates out into the world with diplomas and loan statements showing a near-lifetime’s worth of debt.

Daniel Golden, “Kaplan Quest for Profits at Taxpayer Expense Ensnares Veteran,” in Bloomberg

Golden reports that Kaplan is targeting veterans for its for-profit education programs, often touting that it’s owned by the Washington Post (the same media company that gives space to David Broder to advocate for warfare to stimulate the economy).  Its recruiters also decline to inform applicants that its online law school enables one to sit only for the California bar.

Looking on Kaplan’s site, a four year (!) law degree requires tuition of $9,984 per year ($39,936 total??).  This is absurd.  Conventional law school business models are bad enough but given that there’s no building, no library, and no need for scholar-faculty beyond recorded lectures, it’s simply unbelievable that Kaplan’s legal education could be so expensive.  One more reason to hope for the Gainful Employment rule change and to pray for the Washington Post’s demise.

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