The legal internets are atwitter with talk of a new paper
which suggests that a law degree is worth a million dollars. It’s an
interesting exercise in econometric advocacy, and I’m going to spend
some time analyzing the authors’ claims.
I’m going to proceed in two parts. First, I’m going to assume for
the purposes of argument that the paper’s interpretation of its data is
correct in regard to the value of law degrees acquired in the past, and
that, as they argue, there is no good reason to assume this value will
not be maintained in regard to law degrees acquired in the future. Then
I’ll critique those assumptions.
Simkovic and McIntyre estimate “the mean pre-tax lifetime value of a law degree as approximately $1,000,000.” ... The authors estimate that the median post-tax value of a law degree
is (or has been, which they treat as the same thing) $420,000. Since
they assume a working life of 42 years, they are in fact estimating that
for the median graduate a law degree generates a $10,000 annual income
premium (in 2012 dollars) over what an otherwise similar college
graduates who choose not to go to law school could expect to earn over
the course of their lifetimes. That still sounds like a pretty good outcome, even if it’s not nearly
as spectacular-sounding as the headline-grabbing million-dollar claim.
Yet the wary reader will have noticed a striking omission from the argument so far: how much is it going to cost a law graduate to generate this premium?
... Recall that the authors estimate the median post-tax value of a law
degree as $420,000. How much will the typical law student end up
paying, in principal and interest, in order to make this investment? The answer is $444,150. ...
Does this mean that, even assuming the authors’ claims about the
income premium generated by a law degree are actually correct, a law
degree will have negative net present value for the typical matriculant
in the class of 2013? Not quite. This is because the authors discount
the hypothetical future earnings of current law students to present
value. So – again, granting the accuracy of all of their data and
methods – the present value of a law degree for people now enrolling in
law school would be the difference between $420,000 and the negative net
present value of a legal obligation to amortize $200,000 of debt at
7.5% interest over the next 25 years.
What this latter figure is depends on various assumptions about
future rates of inflation and the like, but, given recent historical
trends (inflation has been considerably less than half of the interest
rate law students must pay on their debt), it’s reasonable to assume
that the negative net present value of this obligation is somewhere
around halfway between the present payoff cost of the debt and the total
future income stream necessary to amortize it under its terms. (The
authors use a real discount rate of 3%, which is congruent with this
In other words, if we give the authors’ analysis every possible benefit
of the doubt, we would conclude that, after including the cost of the
investment in the analysis, the typical pecuniary premium generated by a
law degree acquired by matriculants in the class of 2013 will be
$2,619 per year in constant 2012 dollars, or $218.25 per month
about $109,000 (On reflection I think the deleted numbers are wrong,
because they end up discounting the increased earnings inappropriately.
The $109K number represents net present value after subtracting the net
present negative value of the investment cost, discounted at the same
rate as the higher earnings).
In the world of corporate finance there is a very simple decision rule: managers should accept all positive net present value (NPV) projects.
This is a very simple and powerful concept. It lies at the heart of how
we train managers at every business school in the world. ...
[Paul Campos] has simply done exactly what the paper implies all analysts of the
value of a JD should do – apply relevant costs such as potential debt
and taxes and subtract those from the expected and discounted future
cash flows. Sure enough, even with his inputs (like the implication that
students must borrow $200,000 to go to law school) the result Professor
Campos comes up with is a NPV of $109,000, i.e., positive. ...
Now return to what I said at the outset: managers – in this case the
managers are prospective law students “managing” their own human capital
– should accept a project with positive NPV. In other words, even under
Campos’ analysis the conclusion that a student should reach is that law
school makes sense. The actual net dollar amount above present value is
irrelevant as long as it is positive. ...
So, far from undermining the Million Dollar JD Value paper, Professor
Campos simply confirms its fundamental insight: law school is a positive
net present value project for the vast majority of law students even
when tested by the institution’s leading opponent.