On Worker Equity

A recent AER paper used data on what 20,000 college freshman in 2012 thought they would earn upon graduation, on what they actually earned in 2017, on stats of the sort that finance firms could easily get on these students in 2012, and private estimates by these students, as freshmen, of what they’d earn in 2017. 

This allows a calculation of what would happen if finance firms offered the students tuition money up front, to be paid back upon graduation, and paying more if they earn more then, assuming both sides made good used of their data. The result: due to adverse selection, no students make this deal. 

Does this show that proposals for people to sell shares of future incomes to cut taxes, hedge risks, or incentivize parents and career agents can’t work? Well it does suggest that students would find it hard to hedge in their freshman year against graduation income levels, if finance firms had access only to currently easy to find stats on those students. 

But this analysis doesn’t say that such hedging won’t work if payments are tied to much later income levels, or if the choice is made much earlier than freshman year. Furthermore, the very contracts that the above analysis considered, chosen freshman year and tied to graduation income levels, could work if speculative markets were used to aggregate more information about these students’ prospects.

Imagine that during the last two years of high school, and the first year of college, subsidized-but-thin speculative markets in each students’ college-graduation income levels were easily available for anonymous trades by all those students’ associates, such as family, teachers, other students, etc. Those markets would surely aggregate a lot of info about each student, yet offer only very weak incentives for sabotage. And they’d be a lot of fun. 

Finance firms could then use the prices in these markets to estimate individual student income levels, greatly reducing adverse selection. Yes, each student (and their family) would be tempted to manipulate such markets, to make them look more promising, but that manipulation would on average make these prices more accurate, and subsidize these markets, so they’d require fewer other subsidies.

As the other possible uses of such assets, such as cutting taxes or incentivizing parents and career agents, face even less adverse selection problems, this fix should ensure the feasibility of all these applications.