The Human Capital Bubble

Charles Wheelan, Ph.D. The Naked Economis

I recently had dinner with some of my students who will be graduating in the coming weeks. To make conversation, I asked what they will all be doing next year. An uncomfortable silence settled over the table. No one ever did answer the question.

I suspect there are many such conversations going on around the country, as students pick up diplomas, take stock of their student debt, and wonder what the heck comes next.

This isn't just a bad job market - it's the popping of a "human capital bubble." Wall Street and its assorted reckless offshoots didn't just squander much of our capital; the financial industry also sucked up human talent for the better part of a decade that should have gone somewhere else. It's the human equivalent of those empty subdivisions in foreclosure that never should have been built.

That's what happens with bubbles. Resources -- including people -- are allocated poorly because the market sends faulty signals.

Too Many Investment Bankers

Several years ago I looked at the list of jobs for the graduating seniors in my old fraternity. These are really bright kids at an Ivy League school. At least half were going to consulting and investment banks. I remember thinking: "That's too many," which is an odd thought for someone who believes in labor markets.

But I had a similar thought around the same time when I saw new golf courses and developments springing up like weeds across southwestern Florida. The units were priced at $700,000 or $800,000, even though the land had no inherent scarcity value. The developments weren't on the ocean, or even near the ocean in some cases, meaning that there was nearly unlimited space to build more and more identical developments across Southwest Florida.

"Those prices don't make sense," I remember thinking. The land doesn't have much value, and the construction costs for stucco condominiums around a golf course are only a fraction of what's being charged.

Believe me, I didn't predict the crash; I'd be a much richer man if I had. If anything, I talked myself out of believing that there were problems afoot because I'm such a firm believer that the most beautiful thing about markets is their ability to allocate resources efficiently.

After all, the whole point of a market, whether it is real estate or labor, is that prices send meaningful signals. Graduates take jobs with high salaries because that is where their skills will be most productive. Developers build new units where prices are high because that is where there is the most demand relative to supply.

Signals Were Wrong

Here's our problem now, particularly for the new graduates: Those signals were wrong.

In fact, if you want a snapshot of the impact of what happens when a bubble sends inaccurate market signals, ask yourself this question: How many people do you know who became real estate agents over the past five years? In hindsight, does that make much sense?

In the case of the financial industry, salaries had become rock-star huge, both for new graduates and for Wall Street veterans. (In fact, I would venture that the "stars" in finance were making a lot more than most successful rock musicians.) When we were in the midst of it, people like me assumed that those salaries reflected real value for the economy -- that we'd found more efficient ways to allocate capital and reduce risk and that the people who'd come up with those innovations were being compensated for their innovation.

Now it turns out that Wall Street hadn't really built a better mouse trap. Much of what was going on was just reckless speculation with borrowed money -- more like tearing up the old mouse trap and selling it for scrap. At best, these complex financial products offered minimal improvements over what we already had; at worst, they squandered enormous sums of capital and devastated the financial system.

When smart young graduates were lured to Wall Street (and related jobs) by staggering starting salaries, they were making the same mistake as the Florida condominium developers. The problem was NOT greed; self-interest is and always will be at the heart of market behavior. The problem was that self-interest is a disaster when the market signals are wrong. It's like giving someone a bad map and then criticizing their driving when they show up in the wrong place.

Smart People, Bad Choices

With real estate, that means we now have empty subdivisions and millions of homes in foreclosure. In the labor market, the effects were more subtle but arguably more damaging: Smart people could have and should have been doing something else. The clever men and women who made a lot of money designing and trading credit default swaps could have been conducting research on alternative energy, teaching math, practicing medicine, or doing any number of other jobs that strengthen society, rather than making bad bets with borrowed money.

The human capital bubble will take time to unwind, just like all other aspects of the larger financial crisis. People followed the money into jobs for which there is now less demand. In my world, college students flocked into economics, not necessarily because they were scintillated by its ability to predict human behavior and make the world a better place but because it was perceived as the best route to Wall Street.

But in the long run there is good news, too, though it may not be much immediate solace to the college graduates who are now moving in with their parents.

First, a tough job market will lead to a healthier job search for young people. Nothing focuses the mind like struggling to find a job rather than having one handed to you. I watch students participate in "corporate recruiting," which is the process in which firms come to campus and make it enticingly easy to take a lucrative job. It's a stunning opportunity for smart young people who know what they want to do; it can be a sad trap for those swept along by what everyone else is doing.

Twenty years ago I opted not to participate in corporate recruiting. After graduation, my friends had jobs; I was broke, unemployed, and unhappy. It was an awful stretch, but it also forced me to think hard about what I really wanted to do and then go out and find it. (I wanted to be a writer.)

Second, the post-Wall Street collapse job market will be healthier in the long run for the economy, as smart people do other things. It's the human equivalent of NOT building unneeded condominium developments.

The economic tragedy is that some of our smartest graduates took the big salaries on Wall Street (and in law firms doing Wall Street work and so on). Those folks could have made significant contributions somewhere else. That problem is now fixing itself.