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Monday, July 22, 2013

Diamond on The $1 Million Value of a Law Degree

One MillionFollowing up on my prior posts (links below):  Stephen F. Diamond (Santa Clara):  The One Paper Every Law Professor and Law School Dean Should Read This Summer:

While the personal motivations of these law faculty “critics” with respect to law school itself may be difficult to explain, the nature of their core argument is much easier to understand. They have been artful and persistent in contending that the real meaning of the recent downturn in legal employment is that the American law school is based on an “unsustainable” business model.

Because of the surrounding macroeconomic crisis – which, like a one hundred year storm swept up everyone in its path – separating cause and effect with respect to this model has, in fact, been very difficult. The anecdotal data appeared to be very much on the side of the critics. After all, with even the most prestigious law firms laying off partners and the most prestigious law schools reporting difficulties for their graduates in the job market it was very hard to consider the possibility that what was happening was, in fact, the result of the inherently cyclical and volatile nature of modern capitalism. ...

A new paper, peer reviewed prior to its presentation to the 2013 American Law and Economics Conference at Vanderbilt, provides concrete data upon which to judge the sustainability of the law school model. ... The good news is that, yes, the recent crisis is cyclical not structural; yes, law school represents a worthwhile investment for a substantial majority of students who earn JDs; and, therefore, as a general matter, law schools and their university administrations should be very cautious about taking drastic action in response to the recent pressure created by the downturn in law school applications.

The reason one can draw these general conclusions is that through careful empirical work the authors are able to track the lifetime earnings premium that holders of JDs win over those students who hold only BA degrees. Their estimate is that at the mean this premium is worth $990,000 for JD holders and at the median is worth $610,000. These figures do not include taxes or tuition although they do include the cost of living incurred while attending law school. After deducting for tuition, however, it is the authors’ conclusion that “for most law school graduates, the net present value of a law typically exceeds its cost by hundreds of thousands of dollars.” Deducting taxes lowers that outcome, although it remains positive for most law students and, the authors argue, “may dramatically increase” at the lower end of the distribution with the availability of debt forgiveness or IBR type programs.

Of course, an institution such as the American law school that can produce graduates who attain such a substantial financial advantage over their non-law school BA colleagues can easily maintain a sustainable business model.

It is important to stress two important aspects of the study that one should keep in mind when considering this paper against the arguments of the law school critics:

  1. this paper is based on a large data set from the U.S. Census Bureau over a long period of time (1996-2011) and thus is the first thorough effort (that I can find) to consider the sustainability of earning a JD without relying on anecdotal information; and
  2. the authors conclude and, in my view clearly demonstrate, that the recent difficulties for JD holders were generated by a cyclical downturn in the wider economy and not by some kind of unique event that hit the legal profession in a manner not experienced by every other profession; and perhaps of greater importance the study’s data clearly show this downturn is over now and the earnings premium of JD holders has now turned upward consistent with its behavior over many years and in spite of the ongoing, if short term, difficulties of recent JD holders (the data on earnings is carried through 2011 for all JDs who graduated from 1996 through 2008).

Now, however, with actual verifiable data in front of us, it is clearer that the challenges facing recent JD graduates and now law schools are consistent with the long term cycles of the wider economy. In fact, the decline in the earnings premium of JD holders in the wake of the dot com crash in 2000-01 was steeper and deeper than what was experienced by JD holders after 2008. Yet the earnings premium recovered and increased substantially for the next several years, then turned downward (but retained an advantage over the BA) and has now turned upward once again. Thus, the authors conclude that the “law degree earnings premium is stable over the long term, with short term cyclical fluctuations.”

The following chart illustrates this:

Chart 1

The authors are sceptical as well that anything has occurred in the last few years that suggests some kind of unique “neutron bomb” like event has hit the legal profession that did not also hit the rest of the economy. Thus, the relative significant advantage of a JD, across a wide range of income levels (i.e., for JD holders at both the 75th and 25th percentile of lifetime earnings – see chart below), persists.

  Chart 2

In short, for most JD holders law school has made sense for a very long time and it continues to make sense today.

Nonetheless, while the economic recovery helping the earnings premium turn upward again is taking hold, it is doing so slowly and so the job market for many graduates remains a challenge. While eventually the market will absorb these talented and hard working and highly trained JD holders and in light of past experience they will do well, their shorter term plight is impacting the attractiveness of law school to new applicants. In addition, as the economy recovers there are more opportunities for BA holders and so larger numbers are staying away from what may appear to be a higher risk effort to enter law school. That actually may hurt recent JDs who have not found work as lawyers because they are competing for similar jobs with those BA-only candidates. Over time, the added value of the JD will take hold if one accepts the results of the authors but it will take time. The following chart illustrates the earnings curves for both groups over a lifetime:

Chart 3

This means, of course, that for many law schools there are significant pressures with respect to enrollment. Schools that were too aggressive during the period prior to when the recent crisis took hold will be under pressure to meet their costs. That may mean some difficult conversations with University Provosts, Presidents and even Trustees. Thus, it is a good idea for law school faculty and deans to absorb fully the conclusions reached in the Simkovic/McIntyre paper.

If a law school or university panics and makes significant cuts based on the propaganda and anecdotal data pushed on them by those who have another agenda, they could be making very serious mistakes. The human capital that a university builds up and the goodwill it accumulates can disappear very quickly. As Warren Buffett once remarked, ”It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.” ... It is, thus, very fortunate that the American law school now has a data-based objective picture of the overall economic value of the JD project.

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Professor Diamond states: "the personal motivations of these law faculty 'critics' with respect to law school itself may be difficult to explain."

As one of those "critics," I would suggest that my personal motivations are actually very easy to explain. First, I believe I have an ethical obligation to express my honestly held belief that many schools are significantly overcharging students for a JD degree. Second, I have a very selfish interest in the long term health of legal education, which I believe likely requires some short term pain for long term gain.

In short, Professor Diamond and I may disagree on the propriety of current law school tuition pricing, but my motives are just as easy to explain as his.

Posted by: Jack Graves | Jul 22, 2013 8:21:27 AM

It would be amazing if Prof. Diamond allowed signed comments on his blog.

Posted by: Dept. of Truth | Jul 22, 2013 10:08:15 AM

A potentially amusing thought experiment: Suppose a 22-year-old college senior who is about to graduate with a liberal arts degree were to ask you for advice regarding this offer:

Should he take one million dollars in cash, or an offer of admission to Santa Clara's law school? According to Simkovic and McIntyre (and Diamond), assuming the person is risk-neutral, and that having a law degree has at least some positive non-pecuniary value, the obvious choice here is the offer of admission.

Posted by: Paul Campos | Jul 22, 2013 11:15:28 AM

Unlike Mr. Graves, I do not read either Profs. Simkovic and McIntyre or Prof. Diamond as addressing the question of tuition levels at all. The Simkovic/McIntyre paper simply attempts to quantify the life-time financial benefits of a JD. Obviously, in deciding whether to attend law school, any applicant should undertake a more complete cost/benefit analysis, including both financial costs and non-financial costs and benefits.

In looking at financial costs and benefits, an applicant should also take into account the tuition his or her prospective school charges, any scholarship offers he or she has received, the likelihood of income-based repayment and/or foregiveness options, and the likelihood the law school he or she is thinking of attending will open the financial doors that he or she hopes to pass through. These will vary significantly from applicant to applicant; Profs. Simkovic and McIntyre rightly focus on the portion of the question their data set can answer.

But applicants should also take into account the many non-financial costs and benefits of law school. Lawyers are empowered to change the world in ways that few other professionals are. Desegregation, gun rights, gay rights, consumer rights -- whether you like them or not, none of them would have happened without lawyers. The same BLS data suggest you could make more money as a podiatrist. Is that what you want?

I have chosen to spend my working life empowering students and thinking about issues I believe need to be thought about. I teach roughly 20 units per year -- twice the standard load. I write on issues I care about, generally for free. I will be consulting tomorrow for the Senate Committee on Homeland Security -- completely uncompensated. I could make far more money as a big-firm partner; I have chosen not to.

Folks thinking about whether to attend law school should consider their own goals and values. They should not run with the herd. Law school isn't for everyone. The Simkovic/McIntyre paper offers just one useful new piece of data that may factor into some applicants' decisionmaking. Like every good paper, it empowers. What you decide to do with it is up to you.

Posted by: Theodore Seto | Jul 22, 2013 11:49:07 AM

Professor Campos already made a significant error in his attempt at analyzing the Simkovic/McIntyre paper approach to valuation yet he now doubles down and makes another. The paper does not suggest that the JD is like getting a million dollars in cash now, it only says there is an earnings premium RELATIVE to BA holders. Both a BA-only holder and a potential law school applicant face the same future of having to work for a living and the question is whether a JD leads to additional value. The paper demonstrates why that is, in fact, the case. Thus, Professor Campos' thought-less experiment is irrelevant to the discussion.

Posted by: Anon | Jul 22, 2013 4:58:00 PM

One flaw in the Simkovic/McIntyre paper is its alleged correction for ability. To do this it assumed that the bottom 25% of JD holders should be compared with the bottom 25% of BA/BSc ONLY holders. Even Steve Diamond hardly suggests that those who matriculate into Santa Clara law represent the bottom 25% of the BA/BSc pool. Even at Seton Hall that was not true and is not true today. Of course if you align say the bottom 25% of JD holders with say the next tier up of BA-only college graduates, the numbers start to look pretty bad. And that is before excluding tuition from the net-present-value calculation (a very odd decision, most NPV calculations include acquisition cost.)

That is of course the odd selection bias - why did Simkovic/McIntyre decide to compare cohort for cohort BA-only with JD holders? Why not say IQ (there are IQ/LSAT correlations) or GPA compared with average GPA for those admitted to law school (published for at least two decades school by school.) BA-only holders and bottom 25% do not represent those typically even admitted to law school.

Posted by: Anon | Jul 22, 2013 5:34:27 PM

Not quite anon. The hypothetical prospective law student in S&M's analysis who turns down the law school admission is still, per S&M's assumptions, going to work for 42 years for X total dollars. Going to law school means working for 42 years for X total dollars *plus* one million dollars. Unless you ascribe significant negative utility to working as a lawyer (or at least someone with a law degree) relative to working without a law degree, then the only difference between the college graduate and the law school graduate in their model is that the latter gets one million dollars in present value from going to law school (supposedly).

Posted by: Paul Campos | Jul 22, 2013 7:05:53 PM

Ted Seto: I'm not sure what reality you're living in, but it bears no resemblance to the actual world of most actual practitioners.

First of all, the vast majority of law school grads aren't doing anything sexy like gay rights, gun rights, desegregation, etc. For those law school grads who are lucky enough to have actual lawyer jobs, we're just pretty much pushing paper.

Second: that's so great (and quite frankly fascinating) that you "could make far more money as a big-firm partner." Go for it, dude! (But you might want to read the most recent edition of "The New Republic" first.)

Posted by: LaVonna | Jul 22, 2013 10:26:43 PM

But is this "hypothetical prospective law student" really someone who (a) would have matriculated at say Seton Hall, (b) applied to law school, (c) been in a position to turn down law school? Is the choice of control group legitimate and fair, or cherry-picked and spun to support their argument?

Simkovic/McIntyre's thesis claims that they are comparing like for like outcomes - the income that a putative group of law students would have had, if they did not go to law school with the income of those who did go to law school. Even assuming the validity of their regression analysis the entire exercise is nonsense if the BA-Only groups they chose as a control group were in reality much less qualified than the typical law student.

That would appear to be the case - Simkovic/McIntyre seem to have chosen to compare the least economically successful BA-Only holders with the least successful JD holders and so on. There are a tremendous number of studies though that link GPA, IQ and other criteria with income and indeed lifetime income. Why then not compare JD holders with their actual peers. Law schools, obsessed with prestige have published (often fibbing it is true) data about the GPA and LSAT scores of their incoming class for at least two decades. It would be pretty straightforward to determine how the range of law student GPAs compare with BA holders incomes and align the control group accordingly;

This is something that this study avoided doing - why? To a fair observer it would seem to be because dong so would have demolished their argument, and eliminated the nome gain in most cases.

Posted by: Anon | Jul 23, 2013 12:52:11 AM

...doing so would have demolished their argument and eliminated the nominal gain in most cases

Posted by: Anon | Jul 23, 2013 1:39:56 AM