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

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.


  • 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

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.


  1. Vedder has also had the balls to discuss the role of grade inflation. Students who take out loans often see themselves as entitled to receiving a high grade. Of course, the schools are only too happy to comply. The schools have no integrity.

    Both schemes have serious flaws. You diagrammed this well, for your readers. From a practical standpoint, Vedder is delusional if he thinks people will opt out of the Humanities.

  2. I have never been comfortable with HCCs – even though I recognize that they are close to student loans, it seems like they would introduce many undesirable incentives into the system. For example, investors would now have an incentive to get colleges to graduate students as quickly as possible – that seems initially good, but may translate into there being a lot of half-trained doctors or engineers on the market – not my preferred choice for surgery. Also, the aspect that your payment goes up if you work harder and earn more seems like it saps motivation – which is not good.

    Additionally, I think HCCs go in the wrong direction. We should be working toward being able to provide less expensive education for our people instead of implementing ever more complicated and expensive systems. Governments want to reap the benefits of an educated populace (increased tax revenues) without having to pay for the education – at least beyond high school – but that’s not really fair. However, that’s really what a private HCC system would be. We need to cut the cost of education instead of institutionalizing and accommodating increasing “expenses” far in excess of inflation and without any real commensurate gain.

    Frankly, the very thought of HCCs just gives me the heebie-jeebies. I can just see the repayment periods becoming longer and longer as “expenses increase” until we are frankly talking about lifelong indentured servitude. The additional comments above about penalties imposed if the student engages in certain acts after graduation also send up big red flags.

    I also don’t like the aspect that the HCCs would “punish” those who worked harder (and thus made more) by taking away more of their income. There is a persistent myth that students “study what they like in college” – as if the sole reason a student selected an area of study is that they like the area. If that were the case, you would have far more students majoring in sports-stuff like kinesiology and majors that don’t take much time and far, far fewer engineers, for example. (If sports and engineering paid the same, why do the work?) At root, our system works because people are motivated to work harder by a promise of reward. I am cautious with regard to things that run counter to that.

  3. Thank you for your input Managing Partner. I agree and disagree with a few of your points. Allow me to summarize as best I can:

    (1) Undesirable incentives
    a. Creates substandard education
    b. Punishes harder workers/Myth of studying what you like
    (2) Institutionalizing education expenses
    (3) Inability of investors to hold the line on repayment terms

    Substandard education: it depends on who the investors, educators, and consumers are. In the legal field, the educators are running the education system, not legal employers or consumers. In the suboptimal world you describe, the employers merge with the investors, and they create a self-serving education system that still neglects consumers’ needs. To escape this, we’d want consumers to determine what education is necessary and ensure that investors negotiate with educators to restrain costs to the point of minimum competency.

    Punishing harder workers: I’m only concerned with the worker’s after-tax/HCC repayment income being greater than the opportunity cost of not obtaining the education. Partly this is an ethical view I have; I am a “satisfizer” rather than a “maximizer,” and (now I’m getting *really* ideological) I think we’d all be both spiritually and materially better off if we encouraged satisfaction over maximization. Now that doesn’t mean I’m abandoning human nature and capitalism, but just because the amount that the HCC investor takes increases as the worker’s income increases doesn’t mean the worker is worse off or has been denied something he or she is entitled to.

    Myth of studying what you like: I’d like to hear more on this myth, so if you could direct me to sources, please do. One similar myth I encounter is how lawyers shouldn’t go to law school for the money and that they should jump at the chance at client service—as if underpaid professionals are better than those compensated at a living wage. As for college, given that there’re 17 million college-educated Americans working jobs that don’t need them, I don’t think the system works, unless one can document the positive externalities that a college education provides. In the meantime a college education promises positional goods, not necessarily absolute ones. I want to hear more on this debate.

    Institutionalizing education expenses: I find your point here persuasive. Education is a free lunch for students that provides a cheaper dinner for everyone. I can see limited use of private HCCs for professional educations having some utility. What reading Richard Vedder and Charles Murray has taught me is this: the intelligence and productivity of a population varies in predictable ways. Where there is predictable variance, there is risk, and where there is risk, there is potential ROI. The American education system, top to bottom, shies from accepting this reality. Thus the defense for HCCs is that unlike the Title IV system, which’ll loan out the same money irrespective of output, HCCs willingly picks winners and losers. Your point takes the logical next step: accept the variance, and have the state take the place of the patron. My only concern is that the government doesn’t seem to want to and would rather cut education spending when it perceives a deficit problem.

    Inability to hold the line: I agree completely. Longer repayment terms are essentially indistinguishable from higher or adjustable interest rates in loans.

  4. Wow, has it really been seven months since this has been discussed? I have been reading so many other articles recently that aren’t half as engaging (though still interesting obviously) with far more discussion. As a disclaimer, I have to admit that some of the jargon is still a little over my head, so pardon if I’m not truly understanding correctly.

    If we were to take the “hard workers are punished” stance, it really wouldn’t be any different than taxing the rich a higher percentage than the poor. It’s hard to hold on to wealth if you’re lazy and even harder to build it from scratch. But ultimately people still would prefer to be rich than to be poor. They might begrudge that they pay more taxes (or in this case back to their sponsor), but they wouldn’t give up the money that they do end up getting to keep because it’s still better than wondering if you’ll get to eat your next meal.

    This is not to say that people don’t try to fudge tax brackets or that there isn’t a ceiling to the amount of stress or BS any individual is willing take from their work environment. Buy the motor home and die of a heart attack earlier, or give up the yacht and increase the chances of living past retirement?

    I have to say that it was depressing to realize that a lender/sponsor might discriminate against me because I’m a female who might just get an expensive degree, have babies, and not work. (If she got married, wouldn’t that become a joint debt that the spouse would have to work to pay off? Or would the debt be non-transferable? If she didn’t get married, wouldn’t she have to work to support the family? I’m probably naively oversimplifying this…) That isn’t my personal plan, but just to know that I’m grouped into that category by virtue of my sex/gender means yet another obstacle for us gals in the workforce.

    I think the more the company is willing to pay toward my education up front to ease the strain on me during my time in college when I’m supposed to be studying and not worrying so much about the extras (so I could make the decision to give up hours at work so I can study for finals), the more I’d be willing to pay them back later. And maybe it’s just me, but I’d also be happy to know that if I am able to repay the lender/sponsor more than they paid into it that that money would go toward funding somebody else’s education so they could provide a function to society that I’m not really interested in taking on myself.

    If the sponsor/lender wanted to chain me to them for ten years over only a thousand dollars up front , I’d say no thanks. Maybe if they paid 50% of my college tuition for 4 years, and I had to pay out 50% of my salary for 4 years post-graduation, I’d have to get a kick butt job or be faced with not being able to feed myself off my own income. If they paid 100% of my college tuition for 4 years, and I had to pay out 100% of my salary for 4 years post-graduation, I would not only be indentured to the sponsor/lender but possibly someone else for putting a roof over my head, etc. (Like parents! Imagine that…) Unless, of course, I was able to work while I studied and save all that money up for those 4 years when I’d take home no money, which is highly unlikely that I’d make enough while studying to be able to do that.

    If the sponsor/lender played an active role in helping get good job placement post-graduation, I wouldn’t mind, since one of the major advantages of going to college is the networking. But I suppose the conflict of interest issues that might come up and the potential of being locked into a high paying job with a terrible work environment would suck.

    I wouldn’t mind apprenticeship programs becoming the norm again, although I’m sure you’re all more well-read on the advantages and disadvantages of such a system. It’s tough to find a good mentor yourself in the workplace that isn’t secretly you’re competition.

    As for studying what you like … I don’t have any sources, but I tend to notice around me that as the economy tanks, more people are willing to settle for something they might not like to do in favor of the income. This is not to say that everyone has the aptitude for the highest income jobs and simply opt not to pursue those careers when times are good.

    1. Thanks for the praise JC. Those of us in the Legal Ed/Higher Ed reform world of the Internet try to stay ahead of the curve. Of course, that means we don’t get a whole lot of acknowledgement for our work when we’re too far ahead.

  5. The HCC concept is very interesting. Where can I get a copy(ies) of typical HCC contracts?

  6. I think people’s mental models of HCCs are a bit skewed in coming to them as a replacement for loans. Seeing them as an alternative to a graduate tax changes the perspective a bit.

    I wonder if the unpopularity of HCCs comes in part from them originating from a faction of libertarianism that was deeply hostile to the income tax and not prepared to explain the repayments as a form of supplemental income tax.

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