August 03, 2015
John Brooks (Georgetown) and Jonathan Glater (UC Irvine) argue in today’s Los Angeles Times that the Federal Government should raise the borrowing limit on federal student loans so that college students can borrow more from the government and less from private lenders.*
“Banks and other lenders offer so-called private loans, which often have higher interest rates and less flexible repayment terms [than Federal Student loans]. . . Private student loans are usually much more costly for students; a government report from 2012 found interest rates in excess of 16%, and nothing has improved since then. By contrast, the rate on the most widely used federal student loan currently is 4.29%.
[B]ecause federal loan caps have not budged even as tuition has increased, private lending is rising . . . borrowing is going to happen in some form anyway. This is not about whether college is a good investment (although it is), it is about whether students should be forced to take out loans that put them at greater risk of repayment difficulty and possible default.”
Brooks and Glater have effectively framed the student loan debate. Federal Student loan policy is not a question of how much students should be allowed to borrow, but rather only a question of who they should borrow from, how much they should pay, and when they should pay. Any government imposed loan limit is the point at which the borrowers will shift to expensive private sources of credit.
In other words, private student lenders have a strong incentive to scale back public student loan programs. The less available and less generous public programs become, the larger the market opportunity for private lenders. (It is possible that higher or lower interest rates could affect the amount that students ultimately borrow—i.e., the quantity of credit demanded may respond to the price of credit—but Brooks and Glater are clearly correct that a federal student loan limit is not a hard cap on borrowing).
The idea that increases in federal student loan availability or other public higher education funding programs will increase tuition is sometimes called the “Bennett Hypothesis,” and those who wish to scale back public investment in higher education frequently tout it. However, there is little evidence in the peer-reviewed literature that increases in the availability of public student loans drive up tuition net of scholarships and grants at non-profit and public institutions of higher education (there is some evidence that this might be the case at for-profit trade schools). The evidence of harm to students is even slimmer when one considers the potential benefits of tuition increases, which can fund better instruction, better administrative support, more modern facilities, and more generous scholarships, and the possible role of public funding in increasing enrollment and completion rates. By contrast, higher interest payments will generally only benefit student lenders, unless higher rates convey useful information about risk to which students respond. For a review of the literature, see here and here.**
Those advocating scaling back federal student loans argue that it is theoretically possible that income based repayment with debt forgiveness could lead to an explosion of tuition growth because, for some students, the marginal cost of additional borrowing will be zero and these students will not be price sensitive. (See here)
However, federal student loan critics have not shown that the introduction of IBR with debt forgiveness, or changes to the terms of these programs, has actually affected the rate of tuition increase net scholarships and grants. (Indeed, tuition increases, less scholarship, have been relatively mild in recent years). And this is not surprising—most students do not know in advance whether they will need or qualify for debt forgiveness, and will not know for sure until 10 or 20 years after they graduate. Most of them will likely ultimately repay their loans in full. Ex ante and in expectation—when they are shopping for a college or professional school—student borrowers do not face zero marginal cost.
Similarly, think tank arguments about high costs to taxpayers from income-based repayment and debt forgiveness rely on dubious assumptions such as:
- Starting salaries for recent college and professional school graduates will grow at an extremely low rate (much lower than one could reasonably forecast after examining the historical data)
- Every single dollar of debt forgiveness is a cost of the debt forgiveness program, because if not for debt forgiveness programs, no borrower would ever fail to repay their loans and the government would collect every last dollar on time
- A loan in which the government recoups partial payments with a present value exceeding the amount of the original loan is not a profitable loan; it’s actually a loss
- The cost of lending $100,000 and receiving partial payments over the next 10 or 20 years is somehow much higher to the government than the cost of giving away $100,000 today and receiving no payments in return (this is related to assumptions 2 and 3 above, as well as inappropriate uses of discount rates and growth rates).
- Income based repayment plans have no impact on enrollment and provide no benefits to the government in the form of a more educated workforce that pays higher taxes and depends less on taxpayer funded social services
* Brooks and Glater also praise income based repayment plans as a progressive-income-tax-like system of higher education finance in which those who earn more pay more. These arguments will be familiar to those who have followed Brooks and Glater’s research. (here and here)
**The Wall Street Journal publicized a recent working paper that claims to have found a possible link between federal student loan availability and tuition growth at undergraduate institutions. While some of the nuance may not have been reflected in the WSJ's coverage, the authors of that working paper note that: (1) They do not have good data that can distinguish an increase in borrowing from a shift between public and private loans; (2) They are only looking at sticker tuition, not actual tuition paid less scholarship and grants; (3) There are many ways in which public funding can benefit students even if it does increase sticker tuition; and their findings do not demonstrate that public funding is a harmful policy; (4) Variables omitted from their analyses could be driving tuition increases and introduction of additional controls dramatically changes their results.
July 31, 2015
One of the key claims of critics of legal education in general, and of ABA-approved law schools in particular, is that accreditation requirements drive up the costs of legal education without improving quality. If only we could deregulate law schools and unleash the creative power of free market competition and the awesome technological potential of online learning, legal education would become cheaper without any loss of quality. Or so the story goes.
Fortunately, deregulated law schools exist alongside regulated law schools, so we can get a sense of what deregulation might look like. And while unaccredited California law schools are less expensive than their accredited counterparts, their completion rates and bar passage rates are much lower than those for even the lowest ranked ABA approved law schools, as revealed by a recent Los Angeles Times investigation.
This is likely due at least in part to the incoming academic credentials and life circumstances of the students who enroll in unaccredited schools, and not simply due to differences in quality of education. But there is no law preventing unaccredited law schools from competing with accredited law schools for the best students who want to stay in California, a large and prosperous state where many lawyers will spend their entire careers. If accreditation is really an inefficient waste of time and resources, the unaccredited schools should have substantial advantages in the competition for students, and those students should have advantages in the competition for jobs.
At first glance, deregulation hardly looks like the panacea its advocates have made it out to be. ABA accreditation also looks pretty plausibly like standard consumer protection--a paternalistic attempt to eliminate low quality, low cost, and high-risk options--rather than a self-serving scheme to inflate prices.
There are usually tradeoffs between cost and quality. It's not surprising that as goes the world, so goes legal education.
The Wall Street Journal’s recent story about law-school funded jobs is a good example of the slant that has pervaded its law school coverage for the last several years. The general outline of the WSJ story is as follows: job outcomes for law school graduates have become so terrible that law schools are creating fake jobs for their graduates, not to help students succeed, but to game the U.S. News rankings. The implication of the story is that law school is not only a bad idea for economic reasons, but that law schools are fundamentally corrupt and dishonest.
The problem is that the WSJ has taken information out of context and presented it in a way that is misleading. Like a Rorschach test, the story reveals more about the Wall Street Journal than it reveals about the subject of the story.
Here are some problems with the WSJ's coverage:
1. The data visualizations are misleading
There is a standard and widely accepted way to present percentage data. The minimum possible value is 0 percent. The maximum possible value is 100 percent. Therefore, a figure showing percentages should almost always be scaled from zero to 100 percent. The Wall Street Journal violates this rule of data visualization in ways that are revealing.
The WSJ scaled the figure at the left, showing law school employment, from 60 percent to 95 percent. This makes law school employment look lower than it really is, and exaggerates the decline in employment.
The middle chart, showing law-school funded employment is scaled from 0 to 6 percent. This makes law-school funded jobs look like a huge proportion of employment rather than a tiny one (4 to 5 percent). Contrary to the thrust of the WSJ’s story, there does not seem to be much of a relationship between overall employment outcomes and the proportion of school-funded jobs.
(The third chart, showing the proportion of school-funded jobs that are full time, long-term legal jobs increasing over time, is not commented on in the text of the story).
2. There is no discussion of what percentage of graduates of other programs are working positions funded by their institutions and little discussion of whether such jobs might be helpful
School-funded jobs are not unique to law schools. Whereas press coverage of law schools hiring their own graduates has been overwhelmingly negative, coverage of colleges hiring their own graduates has generally been positive or the issue simply hasn’t been covered. People might have doubts about educational institutions that never hire their own graduates for open positions, just as we might doubt a manufacturer or retailer that did not use any of its own products.
Are law schools more likely than other educational programs to hire their own graduates? Are law-school funded jobs better or worse than these other school-funded jobs? Are law-school funded jobs more or less likely to lead to good outcomes over the long term?
None of these important contextual issues are raised by the WSJ.
Even Above the Law provided a more balanced discussion of the possible upsides and downsides of school-funded jobs.
A similar issue arose with press coverage of competitive merit scholarships. Law schools were condemned harshly for policies that are also widely used by colleges and state governments, whereas colleges generally received more balanced coverage. This was the case even though law students were actually more likely to keep their competitive scholarships than were many undergraduates.
3. There is no discussion of how overall law school employment compares to employment for recent college graduates or graduates of other programs.
When it comes to apples-to-apples comparisons of law school graduates to similar bachelor’s degree holders with similar levels of work experience at the same point in time, law school graduates are more likely to be employed, more likely to be employed full time, and no less likely to be employed in a job that is related to what they studied. They are also likely to be earning substantially more money than their less educated counterparts. For the overwhelming majority of law school graduates, the lifetime boost to earnings more than makes up for the cost of law school.
The problem is not law school employment outcomes. The problem is that the labor market in general is challenging for everyone, especially the young and inexperienced. Law graduates generally do better than similar college graduates, who in turn generally do better than similar high school graduates.
Law schools are not the employment story. The employment story is the debate about aggregate demand and fiscal stimulus, and how best to provide more workers with the benefits conferred by higher education.
4. There is no discussion of how law school employment reporting compares to employment reporting for other educational institutions or standard definitions of “employment” used by the government
Under standard definitions of employment used by the U.S. government and just about everyone else, employment counts as employment whether it is school-funded or not, whether it is long term or full time or not, whether it is highly paid or not.
The use of non-standard definitions by law schools makes law school difficult to compare to alternatives. This does not reflect higher or lower ethical standards—it simply reflects data collection and reporting practices that are not well thought out. It can bias the presentation of the data in a way that makes law school look worse relative to alternatives when in fact law school employment outcomes under standardized measurements are usually better than many likely alternatives.
The standard definition of employment is not the only interesting measure of outcomes, so law schools may also want to consider other measures. But any measure they use needs to be standardized and comparable across educational programs rather than used exclusively by law schools.
July 22, 2015
...has been updated again. They write:
We just updated our charts about law journal submissions, expedites, and rankings from different sources for the Fall 2015 submission season covering the 204 main journals of each law school.
A couple of the highlight from this round of revisions are:
First, the chart now includes as much information as possible about what law reviews are not accepting submissions right now and what dates they say they'll resume accepting submissions. Most of this is not specific dates, because the journals tend to post only imprecise statements about how the journal is not currently accepting submissions but will start doing so at some point in spring.
Second, there continues to be a gradual increase in the number of journals using and preferring Scholastica instead of ExpressO or accepting emails submissions: 22 journals prefer or strongly prefer Scholastica, 14 more list it as one of the alternative acceptable avenues of submission, and 10 now list Scholastica as the exclusive method of submission.
The first chart contains information about each journal’s preferences about methods for submitting articles (e.g., e-mail, ExpressO, Scholastica, or regular mail), as well as special formatting requirements and how to request an expedited review. The second chart contains rankings information from U.S. News and World Report as well as data from Washington & Lee’s law review website.
The Washington & Lee data, I should note, is mostly silly (among other things, it does not control for publication volume by the journals). Law review prominence and visibility tracks law school reputation, full stop. For some specialty journals, the W&L data is somewhat useful, but that's about it.
July 14, 2015
Two Colorado law professors (actual scholars, not the notorious clown!) have undertaken an interesting longitudinal study of law school success, looking at data, though, from just two schools: Colorado and Case Western. It is informative about schools with similar profiles, but I wonder whether the results hold if one looks at much stronger or much weaker schools?
(Thanks to Dean Rowan for the pointer.)
June 18, 2015
June 16, 2015
So how should our understanding of student loans apply to law students? Mortgages are routinely repaid over 30-years, even though owner-occupied housing is close to pure consumption (most of the value of housing is consumed as imputed rental income, with appreciation averaging only around 1 percent above inflation). Legal education typically provides a much higher rate of return than real estate, and is probably closer to investment than consumption.
Rather than focus on initial salaries at graduation alongside student loan balances, it would be more appropriate to emphasize student loan debt service payments, assuming students pay their loans over several decades and with payments that match the expected trajectory of earnings. This would be an apples-to-apples comparison—initial cash flows compared to initial cash flows.*
It also makes sense to report student loan payments in real terms by subtracting expected inflation (typically around 3 percent) from the nominal interest rate before calculating loan payments.** (As inflation increases wages and the prices of goods and services, a nominally flat debt payment becomes less valuable in terms of what the money can buy and how much work is necessary to earn enough to make the payment). Adjusting for inflation won’t take into account the increase in real earnings (above and beyond inflation) that typically comes with additional work experience and secular increases in economy-wide productivity, but at least takes into account increases in earnings that match inflation.
$100,000 in debt repaid in equal installments monthly over 30 years at a 3 percent real interest rate (6 percent nominal) comes to $5,059 per year ($422 per month) in real terms. In nominal terms (without adjusting for the power of inflation to make debts easier to repay), the payments are $7,200 per year ($600 per month).
With a graduated extended repayment plan over 25 years, the real initial monthly payments come to $3,420 per year ($285 per month). In nominal terms (without adjusting for the power of inflation to make debts easier to repay), the initial payment is around $6,000 per year or $500 per month.
Law graduates typically earn around $60,000 to $75,000 per year to start and have debt service payments of around $3,400 to $7,200 per year. Recent law graduates have much more cash at their disposal than most bachelor’s degree holders of a similar age even after paying down their loans.
Law students’ incomes can support their debt service payments, as demonstrated by the exceedingly low student loan default rates for recent law graduates. It is time for the ABA to rethink how law schools disclose debt balances and student loan repayment obligations so that students are not mislead into underinvesting in education.
Journalists and education experts should also be careful to discuss student loans using apples-to-apples comparison—cash flows to cash flows, and lifetime present values to lifetime present values.
* If student loan balances or initial cost of education are presented, these should be compared to the expected present value of the boost to earnings from the degree over the course of a lifetime. Thus, for example, whenever reporting that law school costs around $100,000 on average, it should also be reported that the average value before taxes and tuition is around $1,000,000 and that the median value is around $750,000.
** Part of what graduated loan repayments accomplishes is to make real payments closer to level. If nominal payments remain flat, as in standard fixed repayment loans, in real terms, payments decline over time and repayment of the loan is front-loaded.
Tom Friedman's latest New York Times column uses the labor market for executive assistants and executive secretaries to illustrate dubious claims about credentialing and over-education. Friedman argues that since most current executive assistants and executive secretaries don't have bachelor's degrees, employers should not try to upgrade the workforce by hiring new executive assistants and secretaries with bachelor's degrees. After all, executive assistants without bachelor's degrees can do the job, so who needs a bachelor's degree?
The problems with this reasoning should be obvious.
First, education is only one of many factors that are valued in the labor market. Some individuals who are smart, hardworking, personable, physically attractive, or fortunate, but have limited education, will inevitably be as successful or more successful than other individuals who are highly educated but less gifted in other respects. This does not in any way challenge the extremely strong evidence that a bachelor's degree can improve labor market outcomes. It simply means that we are dealing with a heterogeneous population.
If two homogenous groups who were initially equally strong on non-education factors were given different amounts of education, the more educated group would typically be more successful in the labor market. Labor economists who have studied identical twins routinely find that twins with more education are more successful than their less educated counterparts. When labor economists control for unobserved heterogeneity within education levels using fixed effects models rather than OLS regression, "over-education" effects on earnings diminish or disappear. In other words, highly educated folks who are about as successful as those with less education--and end up in the same occupations as the less educated--tend to be weak on factors other than level of education. But even within occupations that combine the worst of the more-educated with the best of the less-educated, those who are more educated still tend to earn more. Since profit-maximizing employers are not in the habit of handing out money for nothing, this suggests that the more educated are better at their jobs.
In sum, education many not always be enough to make you more successful than your neighbor or coworker, but it can make you more successful than a less educated version of yourself.
Second, the fact that something was "good enough" at some point in the past does not mean it is good enough today. Rising standards typically involve both increases in quality and commensurate increases in cost. In inflation adjusted terms, the average new car today costs about 10 times as much as a Ford Model-T in the late 1920s. But the average new car is faster, safer, more reliable, and easier to operate. Similarly, as education increases, so does the productivity of labor and the cost of labor--wages or earnings. Highly educated workers today are far more productive than their counterparts decades ago, and as a result, they earn more.
It is interesting that Friedman chose executive assistants and executive secretaries--a field where most workers have less than a bachelor's degree--as an example of supposed "over-education." According to the Bureau of Labor Statistics Occupational Employment Statistics, employment of executive assistants and executive secretaries is collapsing. Employment fell by more than half between 2007 and 2014, from over 1,500,000 workers to barely more than 700,000. In other words, the level of education that most executive assistants and secretaries had in 2007 was not enough to make it in the labor market of 2014.
Among secretaries, those with higher levels of education still earn more than their less educated counterparts after controlling for race. Employer hiring priorities cited by Friedman suggest that those who are more educated are more likely to keep their jobs or find new ones.
This is consistent with general trends in the labor market. Low and middle skill workers with limited educations are the hardest hit by automation, outsourcing and layoffs, while their more educated counterparts are navigating the recession and changes in the labor market more successfully. (During the 2007-2014 period, employment of a group of highly educated workers, lawyers--supposedly the victims of job-destroying structural change--continued to grow faster than overall employment).
For another angle on Friedman's column, readers may be interested in Frank Pasquale's critique. Pasquale discusses apparent bias in the New York Times' Higher Education coverage and argues that as newspapers struggle to adapt to a world replete with free online content and greater competition for advertising dollars, business priorities may be overriding traditional news values. Given the nearly 20 percent decline in employment for reporters and correspondents between 2007 and 2014, journalism does appear to be under serious financial pressure.
May 10, 2015
Competitive Scholarships, Mandatory Courses, and the Costs and Benefits of Disclosure (Michael Simkovic)
There is a wide range of views about the benefits, costs, and appropriate use of conditional merit scholarships—scholarships that under their terms, will only be retained after the first year of law school if students maintain a minimum GPA or minimum class rank (if there is a mandatory grading curve, a minimum GPA effectively is a class rank requirement). These questions implicate both broad value judgments and also very specific empirical questions to which we many not have clear answers.
1) Is competition for grades a help or a hindrance to learning?
2) Is competition, with greater rewards for winners than for losers, inherently moral or immoral?
- Does the answer depend on whether the outcome of the competition is driven by luck, skill, or effort?
- Does the answer depend on how large the differences in rewards are between winners and losers?
3) Does disclosure alter student decision-making?
- If so, how?
- Is this a good thing or a bad thing?
- If it is a good thing do the benefits of disclosure outweigh the costs of providing disclosure?
- Are some ways of providing disclosure clearer and more meaningful than others? Could too much disclosure be overwhelming?
Disclosures are sometimes very effective at improving market efficiency. Sometimes disclosures appear to have no effect. Sometimes they have the opposite of the intended or expected effect. For example, disclosure of compensation of high level corporate executives of publicly traded companies may have contributed to an increase in executive pay (see also here.)
In the case of conditional merit scholarships, the direct administrative costs of providing disclosure appear minimal. The effects of such disclosure, if any, remain unknown. I support access to greater information about conditional scholarship retention rates, not only for law schools but also for all educational institutions.
Scholarship retention rates at many undergraduate institutions under government-backed programs appear to be lower than scholarship retention rates at most law schools. Around half of Georgia Hope Scholarship recipients lost their scholarship after the first year. Around 25 to 30 percent of Georgia Hope Scholarship recipients retained their scholarships for all four years of college. Nevertheless, conditional merit scholarships can have positive effects on undergraduate enrollment and academic performance. A fascinating randomized experiment by Angrist, Lang and Oreopolous found that financial incentives improved grades for women but not for men. A recent experiment also found evidence that merit scholarships tied to grades can increase student effort and academic performance at community colleges.
Unfortunately, there is some evidence that the use of merit scholarships tied to GPA by undergraduate institutions—where grade distributions and course workload vary widely by major—can reduce the likelihood that students complete their studies in science technology engineering and math (STEM) fields. Students who major in STEM fields have a higher chance of losing their scholarships
In other words, if students can shop for “easy As” rather than study harder to improve their performance, they can reduce their own future earning prospects. The approach law schools take—merit scholarships tied to mandatory grading curves and a required curriculum—may be better for students in the long run. Indeed, law students might benefit financially if additional courses, such as instruction in financial literacy, were mandatory.*
Greater disclosure of grading distributions may exacerbate grade shopping and grade inflation, which can undermine student effort and learning. Some models suggest that grade inflation is contagious across institutions (see also here). (It should be possible to disclose scholarship retention rates without disclosing grade distributions).
In some contexts, such as securities regulation or pharmaceuticals, disclosure requirements tend to be high. In other areas, such as employment contracts, disclosure tends to be more limited. We may not always get the balance right. These questions have lead to a rich research literature in law, economics, and psychology (see Bainbridge, Lang, Mathios, Coffee, Kaplow, Easterbrook and Fischel, Romano, and Schwartz). In all cases, whether and how disclosures alter behavior is an empirical question. How the benefits compare to the costs are empirical questions mixed with subjective value judgments.
Given the current limited state of knowledge, and good faith and understandable disagreements about subjective value differences, strident views on one side or another, and moral condemnations of those entertaining different viewpoints, are not appropriate.
Law professors have an obligation to teach students to think like lawyers, weigh evidence, and consider different arguments and different perspectives. We should not shut down discussion with swaggering declarations of the moral superiority of our own views or ad-hominem attacks against those with whom we disagree.
A recent post (in the comments) by Brian Tamanaha (or someone posting under his name and with a similar rhetorical style**) highlights the unfortunate tendency by some toward moral posturing. Tamanaha writes:
“[Those who condemn conditional scholarships are] speaking up for the integrity of legal academia. It is embarrassing that law professors would now rise up to defend employment reporting standards … criticized by outsiders (see New York Times "Bait and Switch" piece), practices which have since been repudiated and reformed by new ABA standards. I do not understand why Simkovic is re-raising these resolved issues, but it does not help us regain our collective credibility.
After reading these posts, I have begun to wonder whether a sense of professional responsibility is what separates the two sides in this discussion. It is not a coincidence that John Steele, [Bernard Burk], and others who strongly condemn these practices have taught legal ethics.”
In other words, if you question Brian Tamanaha’s reasoning and conclusions—as I have—then you have no integrity and dubious ethics, are irresponsible and unprofessional, and are an embarrassment to the legal academy.
Bernard Burk, though declaring his disdain for ad-hominem attacks, accuses those with whom he disagrees of being “partisan.” He compares competition for grades and scholarships to physically beating students. Burk compares law schools to gangsters and evil witches. He claims that the positive effects of conditional scholarships on student motivation and learning “smells of post-hoc rationalization.” (Most of the labor economics studies demonstrating positive effects of financial incentives on student performance were available before The New York Times and the law school critics targeted law school conditional scholarships; the critics overlooked the peer-reviewed literature).
Deborah Merritt, though generally providing an intelligent discussion of conditional scholarship issues, compares conditional scholarships in which adults who lose the competition for grades receive a free year of law school to the fictional “Hunger Games” in which children who lose a physical struggle are murdered. (Paul Caron repeats this unfortunate comparison when summarizing the debate; so does Bernard Burk).
Paul Campos compares those who disagree with him about data disclosure standards to “Holocaust deniers.”
Law school critics have not persisted through the force of argument or evidence, but rather through their ability to make an honest discussion of the issues so unpleasant that very few who disagree with them wish to engage. We should thank Professor Telman for his courage and for elevating the conversation from polemics to evidence-based inquiry. As more professors and journalists raise substantive questions about law school critics’ narrative, it will become increasingly difficult for the critics to foreclose factual and ethical inquiry through ad-hominem attacks and hyperbole.
* A recent survey by John Coates, Jessie Fried, and Kathryn Spier at Harvard suggests that large law firm employers believe instruction in certain technically challenging business electives, especially accounting, corporate finance, and corporations, is particularly valuable on the job. Data does not exist to evaluate whether enrollment in such courses actually boosts earnings or employment, or is even correlated with greater earnings or employment. However, one working hypothesis is that such courses might be the law school equivalent of undergraduate STEM or economics majors. A study of high school financial literacy mandates suggests positive long-term effects on enrollees’ financial well-being.
** The first and only time I met Brian Tamanaha in person was at the 2013 Law & Society meeting in Boston where he spoke on a panel. Professor Tamanaha shut down questions from the audience about whether his presentation of law school data was misleading by insisting that in our hearts surely we all knew he was right and that any question about whether he was wrong on the facts, and any attempt to rely on data rather than emotionally charged anecdotes, was a sign of flawed moral character.
May 10, 2015 in Guest Blogger: Michael Simkovic, Law in Cyberspace, Legal Profession, Ludicrous Hyperbole Watch, Of Academic Interest, Professional Advice, Science, Student Advice, Web/Tech, Weblogs | Permalink
May 07, 2015
One question in the labor economics literature is why education increases earnings. The dominant view is Human Capital Theory—education increases earnings by increasing productivity of educated workers. A minority view, signaling theory, holds that education increases earnings by revealing information about potential employees to employers and facilitating the employer-employee matching process, similar to marketing expenditures matching products with customers. In other words, education indicates to employers which employees were the best all along.
On some level, the distinction is irrelevant—from the perspective of potential students it does not really matter how education increases earnings, only that it does. Whether education makes workers more efficient individually or makes the economy in aggregate more efficient by moving workers to where they can do the most good does not change the fact that employers, employees, and the economy as a whole are better off with additional education as long as the marginal benefits of additional education exceed marginal costs.
Critics of higher education sometimes claim that there is over-investment in signaling and credentialing, a kind of arms race producing negative externalities in which the social returns to education are lower than the private returns. This view, though popular with political movements seeking to reduce public support for education, does not hold much sway in the modern peer-reviewed labor economics literature.
A recent literature review by Professors Fabian Lange at Yale and Robert Topel at the University of Chicago explains the problems with the view that employers would expend valuable resources paying a premium for employees who had over-invested in education as a signal of ability: “Employer learning about productivity occurs fairly quickly after labor market entry, implying that the signaling effects of schooling are small.”
In other words, employers can quickly and efficiently sort employees on their own by observing their productivity on the job, retaining and promoting strong performers, and terminating weaker employees. Employers do not need educational institutions to perform this task for them, nor are employers willing to pay premium wages for information they can more cheaply obtain themselves.
Suppose, for example, that the only value of a Harvard Law degree were as signal of ability to employers. Harvard admits students based almost exclusively on standardized test scores and undergraduate grades, which are also observable to employers. Almost everyone who is admitted to Harvard graduates.
A clever employer realizes it can save money by employing bachelor’s degree holders with admissions letters from Harvard, but who have not yet attended. Harvard gets wise and refuses to confirm admissions. Employers now look directly at LSATs and GPAs, and perhaps hire former admissions officers to consider softer factors. The employer and employee can effectively split the cost savings of not getting the Harvard degree and also the value of the time that would be spent in schooling instead of working.* If additional information is required, personality testing, assessments of physical and mental health, assessments of writing samples, background checks and the like can all be performed for a fraction of the cost and in a fraction of the time as a Harvard degree.
In spite of potentially massive efficiency gains and financial reward for employers and employees, this is not what actually happens in the real world (with the exception of a stacked "experiment" by Peter Thiel). Why not? Because employers believe that the schooling itself is valuable and makes employees more productive.
Lange and Topel also explain how “sheepskin effects” (disproportionately higher earnings premiums for college completers than for college dropouts with a few years of college) have been misinterpreted as support for the signaling hypothesis, when they actually reflect selection effects and dynamic decision making about educational investments:
"Diploma effects are often presented as evidence for screening theories of schooling. We disagree. Instead we view diploma effects as evidence that individuals face uncertainty about their individual returns to schooling and that this uncertainty is revealed as individuals acquire schooling. Those least capable to profit from schooling drop out before the completion of degree years. Those graduating exhibit larger returns than those who dropped out at lower levels of schooling. This reasoning was informally developed by Chiswick (1973). Since then, a number of authors (Altonji (1993), Heckman, Lochner and Todd (2003), Keane and Wolpin (1997) and Eckstein and Wolpin (1999)) examined different aspects of sequential schooling choice under uncertainty. We build a simple model in this spirit with the intention to show how individual’s schooling decisions can generate (large) diploma effects if individuals learn about their returns while in school."
There are additional problems with signaling theory, which I explained in Risk Based Student Loans:
“Signaling Theory implies that labor market outcomes should not depend on what students study, but only on how well they perform academically relative to other students with similar standardized test scores, or perhaps whether they demonstrate a strong work ethic by choosing a challenging major. Differences in earnings by field of study appear to reflect the value of field-specific skill development rather than differences in ability levels. Even within engineering, there are large starting wage differences by specialty.
Human Capital Theory also helps explain higher average per-capita productivity and wages in states and nations with higher levels of educational attainment. If education only sorted workers according to ability, it would presumably only increase the variance of wages (i.e., income inequality), while leaving the mean unaltered.
Further, Human Capital Theory helps explain the willingness of many employers to pay for professional degree programs for successful employees. Employers’ willingness to educate workers whom employers already know to be of high quality suggests that employers believe that professional education has skill-development value rather than mere sorting value.”
In The Knowledge Tax I expand on this, explaining the evidence linking investment in education to more rapid economic growth rather than merely redistributing income from the less educated to the more educated.
* Note that in many states, including New York and California which collectively comprise 28 percent of the law market, a law degree is not legally required to sit for the bar exam. Instead, “law office study”, or an apprenticeship under the supervision of an attorney, possibly following one year of law school, will suffice.