A further complication is introduced by the inappropriateness of fixed money loans to finance investment in training

Such an investment necessarily involves much risk. The average expected return may be high, but there is wide variation about the average. Death or physical incapacity is one obvious source of variation but is probably much less important than differences in ability, energy, and good fortune. In order to make such loans attractive to lenders, the nominal interest rate charged on all loans would http://www.rksloans.com/installment-loans-ny have to be sufficiently high to compensate for the capital losses on the defaulted loans. The high nominal interest rate would both conflict with usury laws and make the loans unattractive to borrowers, especially to borrowers who have or expect to have other assets on which they cannot currently borrow but which they might have to realize or dispose of to pay the interest and principal of the loan. 10 The device adopted to meet the corresponding problem for other risky investments is equity investment plus limited liability on the part of shareholders. The counterpart for education would be to “buy” a share in an individual’s earning prospects: to advance him the funds needed to finance his training on condition that he agree to pay the lender a specified fraction of his future earnings.

In this way, a lender would get back more than his initial investment from relatively successful individuals, which would compensate for the failure to recoup his original investment from the unsuccessful

There seems no legal obstacle to private contracts of this kind, even though they are economically equivalent to the purchase of a share in an individual’s earning capacity and thus to partial slavery. One reason why such contracts have not become common, despite their potential profitability to both lenders and borrowers, is presumably the high costs of administering them, given the freedom of individuals to move from one place to another, the need for getting accurate income statements, and the long period over which the contracts would run. These costs would presumably be particularly high for investment on a small scale with a resultant wide geographical spread of the individuals financed in this way. Such costs may well be the primary reason why this type of investment has never developed under private auspices. But I have never been able to persuade myself that a major role has not also been played by the cumulative effect of such factors as the novelty of the idea, the reluctance to think of investment in human beings as strictly comparable to investment in physical assets, the resultant likelihood of irrational public condemnation of such contracts, even if voluntarily entered into, and legal and conventional limitation on the kind of investments that may be made by the financial intermediaries that would be best suited to engage in such investments, namely, life insurance companies. The potential gains, particularly to early entrants, are so great that it would be worth incurring extremely heavy administrative costs. 11

But whatever the reason, there is clearly here an imperfection of the market that has led to underinvestment in human capital and that justifies government intervention on grounds both of “natural monopoly,” insofar as the obstacle to the development of such investment has been administrative costs, and of improving the operation of the market, insofar as it has been simply market frictions and rigidities.

The result is that if fixed money loans were made, and were secured only by expected future earnings, a considerable fraction would never be repaid

What form should government intervention take? One obvious form, and the only form that it has so far taken, is outright government subsidy of vocational or professional education financed out of general revenues. Yet this form seems clearly inappropriate. Investment should be carried to the point at which the extra return repays the investment and yields the market rate of interest on it. If the investment is in a human being, the extra return takes the form of a higher payment for the individual’s services than he could otherwise command. In a private market economy, the individual would get this return as his personal income, yet if the investment were subsidized, he would have borne none of the costs. In consequence, if subsidies were given to all who wished to get the training, and could meet minimum quality standards, there would tend to be overinvestment in human beings, for individuals would have an incentive to get the training so long as it yielded any extra return over private costs, even if the return were insufficient to repay the capital invested, let alone yield any interest on it. To avoid such overinvestment, government would have to restrict the subsidies. Even apart from the difficulty of calculating the “correct” amount of investment, this would involve rationing in some essentially arbitrary way the limited amount of investment among more claimants than could be financed, and would mean that those fortunate enough to get their training subsidized would receive all the returns from the investment whereas the costs would be borne by the taxpayers in general. This seems an entirely arbitrary, if not perverse, redistribution of income.