Sunday, September 5, 2010

Supply and Demand - Responding to Comments

The recent posts about supply and demand and its impact on the ability of law students to get a job at a law firm seem to have garnered some interest.  You can read the posts here: Part 1, Part 2, Part 3, Part 4.  Below I will respond to some of the questions that people have raised.

In response to a recent post, Coder E said (slightly edited):
While my advice to a prospective law school applicant may be to wait it out a little bit to see if the market picks up, I do agree to some extent in that there is a risk that tuitions rise. And quite frankly, tuitions might rise above inflation rate.

You are pretty adamant about the whole supply and demand thing, and that's fine. the only problem is, it doesn't seem to work in a pure sense for higher education. People have been calling a bubble pop for a long long time.

As an example of why I think there's a chance the bubble just won't pop, you've mentioned in one of your posts (I think the second?) that when you were hiring in the years around 2003, your firm had to raise starting salary because there were fewer kids graduating from law schools. Or at least not enough. The theory was that a few years before 2003, less and less kids were going to law school because they would rather be internet millionaires. However, I would ask whether college or law school tuitions decreased or even stayed flat during those years where kids were forgoing law school and instead trying to be internet millionaires. I was in school around that time, and I seem to remember tuitions going up. Perhaps more slowly or around inflation rate, I'm not sure. But I certainly don't remember tuitions going down.

Higher education seemingly has no downward pricing ever. Demand goes up, prices go up. Demand goes down, prices go up. So by historical record, I think comment #2 is at least plausible.

Now, that doesn't make it a good idea to go right now instead of later. Just that the risk of higher tuitions in the future is plausible.

Great comment, Coder E.  However, I think that there are a lot of issues buried in your comment and I would like to try and parse them below.  First, with regard to actual number of graduating JDs per year, we do have some pretty good statistics from the ABA.  As you can see from the chart, in 1996-1997, there were 41,115 JDs awarded.  By 2000-2001, you are down to 37,910 - and not much increase in 2001-2002 (38,606) and 2002-2003 (38,875).  In fact, if we look at the chart and try to find the last year before 2000-2001 that graduated fewer JDs, we have to go all the way back to 1989-1990, when 36,386 JDs were graduated.

To put it more bluntly, in 2000-2001, the number of graduating JDs had reached an 11-year low. Further, even in 2001-2002 and 2002-2003, you were looking at such low numbers of JD graduates that you really had not seen since 1990-1991 - 10 years previously!

Also, try to consider these numbers in context.  If we assume that the total amount of needed lawyers rises at a rate similar to the US economy, and we assume that 1) the number of lawyers produced was substantially balanced by what was required in 1990, and 2) the US economy continued to increase from 1990-2000, you can see that the mis-match in terms of number of needed lawyers is even greater than the decline in pure numbers might suggest.

Further, we should realize that all law students are not created equal and all law students are not equally attractive for a law firm job.  Law students with undergraduate degrees in business, accounting, finance, science, and engineering are preferred for law firm jobs over law students with degrees in art history, for example.  However, from the law school side, they don't care who the customer is and will just keep trying to get people in as long as there is demand.  My point here is that even though you see a decline in pure numbers of JD, this decline seems to considerably UNDERESTIMATE the decline of firm-attractive JDs that were graduating from law school during that time.  To put it another way, during that time period the whole applicant pool was declining, but the particularly attractive law school graduates were declining at a rate even greater than that of the pool in general.

This put considerable supply and demand pressure on law firms - the total amount of work was increasing, but the total number of available JD graduates (particularly the attractive graduates) had declined pretty significantly. 

Now on to your second area of comment, Coder E - and it's another good one.  To summarize it, you suggest that although you can see the economic impact on law firm hiring, it does not appear that the law schools felt any economic impact.  You allude to this point, but I will agree with it and state it clearly - law schools and law firms have different markets and experience economic impacts differently.  In one very real sense, even if law firm hiring goes to zero, as long as law schools can still convince suckers students to go to law school, then the law schools will continue making money.  However, the law school market has historically been at least loosely coupled to the law firm market because those considering law school would consider whether they would be able to get a job after law school and then decline to go to law school if the odds of a job were not good.  However, in a bubble (like the present law school bubble) potential purchasers stop considering the value of the asset that they are purchasing and are instead more motivated by the appearance of escalating price.

Also, maybe we should get clear on what constitutes a tuition rise and some ways that the tuition can appear to rise, but may not actually be rising.  First, I am going to consider it a tuition rise if the price of tuition exceeds inflation.  That being said, a tuition "rise" that equals inflation is not actually an increase in the tuition.  You would really be paying the same price in real dollar terms.  That's my recollection of the early-to mid 1990s before law school tuition started taking off in about 1997-ish.

Second, one of the factors that may have caused tuition to rise in the past is pretty much gone - I am talking about states withdrawing support for their state-sponsored law schools.  For example, in my state, the state law school was supported over 50% in the early 90s, but state support now represents less than 1%.  That is a one-time factor that shifted tuition to law students, but did not really represent much of an increase in total "take" by the law school.  It seems like this is pretty much played out and will not factor into future increases.  I think that it is a terrible decision my the legislatures of the state, but it will not have an impact going forward - and the prior percentage increases in law school tuition due to this factor should not be used to model increases in tuition in the future.  It's done.

Third, during this time period, law schools really started playing games with their tuition.  In the early 1990s, the tuition that was advertised was the tuition that most people really paid.  There were a few need-based exceptions, but for about 95% of the students, everyone was paying the same.  Then there was a shift - and I place a lot of the reason for it on the impact of the US News report.  The shift made law school tuition into a factor that could be manipulated in order to attract better-credentialed law students in order to increase the law firm's prestige.  Of course, in order to attract the law students, the law schools began to offer them tuition discounts.  However, the law schools still needed to take in the same amount of money in order to cover their expenses, so they needed to raise tuition on the rest of the people.  Consequently, for example, a law school might raise their nominal tuition by 10%, but really not have increased in tuition receivables because they use the additional tuition dollars to fund scholarships (discounts) for more attractive students in order to increase the law school's "prestige" and ranking on the US News report.  This process is pretty endemic in law schools now.  If seems like at least a third (and in some cases the majority) of the students at most law schools are receiving some sort of tuition discount to encourage their attendance.  In effect, the lower-credentialed students are subsidizing the legal education of the higher-credentialed students.

Now, although the law school is nominally raising its tuition to offer scholarships, does it really present a tuition raise to an individual applicant?  Depends on the applicant.  For most, yes, but for a significant percentage, maybe not.  There are some numbers that would be really useful to know here - what percentage are receiving discounts from the school, what is the total tuition receivable vs. state assistance over the last several years, etc. - but law schools are either very closed-lipped with regard to this info, or the info that I have seen is suspect.

However, this represents a hidden factor in the supply-and-demand equation.  The first thing that is going to happen if the number of law students decreases is that law schools are going to be giving more discounts of this type - that is, the average cost of attending the law school is going to decline because the law schools want to attract more students and keep their "prestige" numbers high.  However, the law schools will really try not to touch their "official" tuition rates.  This will be a "shadow" law school tuition decline.

However, if there is a really significant decrease in the number of law students - say a 20% decrease, then there will have to be a significant, systemic re-adjustment in the law school operating model. That big a decline can not be hidden.  However, for the first couple of years, the law schools will react just like law students are now - they will attempt to deny reality ("I am sure that it will get better next year or at least by the time I graduate.")

Of course, the pressures are going to vary with school.  Harvard is going to experience a lot less pressure to chance than a 4-th tier law school because Harvard's student pool will not be as adversely impacted.  I think that one of the first pressures is going to be greater tuition differentiation (possibly disguised with internal law school discounts).  That is, there is no reason that most 4th tier law schools should cost the same or near to what Harvard (for example) costs.

One of the other aspects here is the availability of student loans.  I personally benefited from student loans, but I think that the program (which began with good intentions) has been co-opted and is now being used as an excuse by law schools to be less free from price sensitivity.  That is, it distorts the market to allow potential law students to use loans to go to law school.  I will flat-out state that if there were no student loans, there would be fewer law students and the cost of attending law school would be a lot lower.  In a very real sense, giving students more than enough rope to hang themselves with is just distorting the market in an undesirable way.

Returning to your comments, I think that law schools experience downward pressure on their prices based on the market.  However, I think that they are pretty good at attempting to hide or shift this downward pressure.  Additionally, we have to recognize that Harvard's market is not going to be the same as a 4th-tier's market, and Harvard's market is going to be a lot more insulated from supply-and-demand.  For example, if there is a 20% decrease in potential law students, I think that you are going to see a number of law schools on the lower end offer very significant discounts, but Harvard and the like will probably not offer much.

I think that one thing that we can both agree on is that the current over-demand to be a law school student is just hurting students - that is, the greater demand is just allowing law schools to raise their tuitions even more.  I have to agree with the point that you raise that a decrease in demand may not cause the official tuition to decrease - at least at top schools - but the impact would be non-uniform with ranking.  However, I think that you would see a substantial decrease in the actual amount paid by students - both on average and especially in lower ranked schools.

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