Thursday, August 5, 2021
Wall Street Journal law school analysis overlooks increased diversity and lower interest rates (Michael Simkovic)
In my last post, I discussed problems with WSJ coverage of law schools. In particular the WSJ has effectively faulted law schools for broad, national declines in employment that are most likely due to macroeconomic conditions such as the financial crisis of 2007-2009 and its aftermath, to COVID, and to other broad secular trends in labor markets, not to declines specific to law graduates or the legal profession. In challenging economic climates, although law graduates suffer along with others, they continue to do better than most, primarily because they are more highly educated.
There are additional attribution problems with the WSJ's recent coverage.
The WSJ claims that the real value of a law degree has declined over an extended period of time and cites slow growth in lawyer starting salaries. This is problematic for several reasons. As the analysis below explains, it is almost certainly the case that over the last 20 years, the lifetime present value of legal education has dramatically increased. This is particularly obvious when one controls for the changing demographics of law graduates, as one should to assess the value added by law schools. However, the increase in lifetime value of legal educaiton is largely because of lower interest rates. Smaller contributions have been made by improvements in legal education. Those improvements appear to have done more to broaden access for more diverse students than to increase value for students fitting demographics that were more prevalent a few decades ago (i.e., white male students from upper middle class backgrounds with high-quality K-12 and undergraduate educations).
- How should we calculate the "economic value of a law degree"?
- Earnings premiums should control for changing demographics
- Falling Interest rates have dramatically increased the lifetime value of a law degree
- Even small percentage increases in lifetime value can offset large percentage increases in tuition
- Student loan default rates are declining nationally, and are much lower for law graduates than overall
How should we calculate the "economic value of a law degree"?
First, the economic value of a law degree, ignoring non-pecuniary hedonic value, is defined by the discounted present value of earnings premiums.* Starting salaries don't matter all that much. They are one year in a 40+ year career. Starting salary matters especially little when interest rates are low, as they are now. Low interest rates mean that future earnings are discounted less and account for more of the total present value. Moreover, law earnings premiums tend to peak later in careers, typically at middle age.
What is an earnings premium? An earnings premium is the difference between what someone would earn with a law degree compared to what that same person would earn with an alternative form of education. By convention, this alternative form of education is assumed to be a bachelor's degree in the same major as the law school graduate, although this conventional assumption might not always be right.
Earnings premiums should control for changing demographics
The second problem is that it's not what law graduates earn that matters. It's how much they earn relative to their next best alternative. Education can only change someone's level of education. It cannot change their race or sex or other pre-existing characteristics such as the quality of K-12 education that they received or where they grew up. Thus, an analysis of the value of legal education should control for these covariates or look at subsamples.
Law graduates have become more diverse over time, and now include more women and racial minorities. For a variety of reasons that are beyond the scope of this post, many racial minority groups earn less on average than educationally similar non-hispanic whites. This is true for bachelor's degree holders and it remains true for law degree holders as well. But the boost to earnings that minorities receive from attending law school is still sufficiently high that minorities typically benefit from attending law school. (Women benefit as well. They appear to benefit less than men toward the top of the distribution but by as much or more than men at the median and below).
See Frank McIntyre & Michael Simkovic, Are Law Degrees As Valuable to Minorities?, Int’l Rev. L. & Econ (2017).
By forgetting to control for law students' changing demographics, the WSJ is effectively blaming law schools for serving a workforce that is becoming more diverse. Students of each race and sex are continuing to benefit from legal education. The mix who graduate from law school is just shifting toward those who have lower average earnings at all levels of education.
The WSJ incorrectly claims that lawyer earnings have not kept pace with inflation. Cross-tabulations from the Census Bureau's American Community Survey (here Download Growth in Nominal Lawyer Earnings) show that within each race-sex group, average earnings for lawyers** have grown faster than inflation. The data shows annual nominal earnings from the 2001 ACS through the 2019 ACS, which roughly corresponds to earnings from 2000 to 2018. 2000 earnings can be converted to 2018 earnings using an inflation calculator. Earnings are lower for women and blacks than for white men, but have been growing faster.*** (I focus on whites and blacks because the number of Asian and Native American lawyers remains relatively small). Census data has important advantages over BLS data. It includes self-employed lawyers--both law firm partners and solo practitioners--whereas BLS data only includes employees. Census also provides demographic information such as race, sex and age. And Census earnings data are less severely top-coded than earnings in BLS data. And unlike starting salaries, Census data reflects lifetime earnings.
After controlling for law graduate characteristics, the percentage law earnings premium has remained relatively constant over many decades (or at least statistically not distinguishable from constant). That's across cohorts, not just for recent graduates, although the same is true for recent graduates.
Falling Interest rates have dramatically increased the lifetime value of a law degree
Even though percentage earnings premiums appear to be relatively constant, the lifetime present value of law school has increased dramatically because interest rates have declined.
When interest rate decline, all-else equal, the value of the stock market and real estate also go up, and for he same reason. Algebraically, the value of discounted cash flows goes up when discount rates fall. The chart below shows lifetime present values of a law degree (before taxes or tuition) under a variety of discount rate assumptions. The figure displays real 2013 dollars. To adjust for inflation to 2021 dollars, the dollar values should be increased by 17 percent.
Reducing relevant interest rates (i.e., student loan interest rates, which are correlated with treasury rates) from 6% to 3% more than doubles the present value of a law degree. On average, this is an increase in present value of more than $1,200,000 in 2021 inflation adjusted dollars. Even at the 25th percentile--that is, toward the bottom--going from a discount rate of 3% to 6% raises the lifetime value of a law degree by more than $500,000 dollars (in 2021 inflation-adjusted dollars).
Even small percentage increases in lifetime value can offset large percentage increases in tuition
The WSJ is correct that tuition has increased, but so have scholarships (tuition discounting). The tuition increases at most law schools have been much too low to put a dent in the rising value of a legal education. A 33% increase from a base annual net-tuition of $30,000 would increase the price of a 3-year law degree by less than $30,000 (0.33 * ~30,000 * 3). A modest 6% increase in the lifetime present value of a legal education at the median would more than make up for this, even after taxes. This is because the base value of a legal education is so much greater than the base cost of tuition.
Given declining interest rates over the last 20 years, the present value of legal education has likely seen double digit (and possibly even triple digit) percentage increases.
Student loan default rates are declining nationally, and are much lower for law graduates than overall
Not surprisingly student loan default rates show a long term trend toward declining since the end of the financial crisis.
Note also that law graduate default rates are significantly lower than the national average--on the order of 1 to 4 percent for law graduates versus more than 10 percent for other borrowers.
Even after accounting for income based repayment and future expected debt forgiveness, loans to graduate and professional students remain the most profitable in the Federal Government's portfolio, according to a recent analysis by the GAO.
* Economic value could be made more complete by also including any non-pecuniary hedonic value, i.e., whether it is more or less enjoyable to do the kind of works that law graduates do, and to enjoy the kind of social cache they enjoy, compared to the next best alternative without a law degree. However, such non-pecuniary hedonic value is difficult to measure.
** "Lawyers, and judges, magistrates, and other judicial workers."
*** Hispanics, who are primarily white according to their own self-reports to the Census, were not broken out separately in the cross tabulation linked above. A version of the same analysis is presented here for non-hispanics and exclusively for hispanics. Some readers may object to the use of the word "Hispanics", preferring more recent terminology. The Census uses the word Hispanics in its questionnaire and has done so for decades to maintain internal consistency across years. To avoid confusion, I use the same terms as the Census.
UPDATE: A reader at Stanford asks why I fault the WSJ for not taking COVID into account.
The WSJ's article discusses recent starting salaries for law graduates, current earnings relative to inflation, current tuition levels, and discusses the current situation of specific individuals, all during a time of COVID. Only a handful of the data points in their story (for example, relating to repayment rates or DTIs) are from a time before COVID. Moreover, the broader point stands that the WSJ is fundamentally wrong for discussing law graduate outcomes and repayment rates out of context without comparing them to a benchmark of similar individuals with a lower level of education in the same economy, and without noting law graduates' higher incomes and lower student loan default rates. This lack of a benchmark is an error, both pre-COVID and post COVID.
A casual examination of the data posted to the WSJ's website about first year incomes vs. debt balances--a largely meaningless measure given differences in earnings trajectories and the fact that loans can be repaid over 30 years--suggests that law graduates are not doing badly. Indeed, on this short-sighted measure, law graduates appear to be doing better than medical school graduates. But of course, medical school graduates on average have much higher lifetime earnings than law graduates, even discounted back to present value at reasonable discount rates. Consider that a college dropout with one semester under his belt working a minimum wage job will have a much lower student loan-to- starting income ratio than a resident who just finished medical school at Harvard. As Susan Dynarsky and the U.S. Treasury have noted, the groups with the largest initial debt levels have the lowest student loan default rates, because they have made the largest investments in their own human capital.
This again raises the question of why the WSJ chose single out law graduates when the data simply doesn't support their editorial decisions. The slant they've chosen looks like it was predetermined by the editors without even looking at relevant data. Considering that the newspaper business revolves around gathering and reselling consumer attention to advertisers, the story may have been selected based on something other than its correspondence with reality, such as its click-bait value. For an excellent discussion of the large disconnect between useful, accurate information and press coverage, I recommend Narrative Economics by Robert Shiller.