You have a mature industry with about 175 or so producers collectively having massively excessive production capacity relative to demand. The industry nevertheless continues to produce at full capacity. What happens next?
The price the industry members receive for their product should fall. In response, industry members should cut their prices until demand and supply equilibrate. But then what happens to the excess productive capacity?
Obviously, some of the weaker players should close up shop through bankruptcy or liquidation. But many managers are reluctant to pull that trigger. So in many industries we observe a wave of mergers intended to consolidate the industry into a smaller number of players, each of whom then downsizes while staying in business. Example:
In the airline industry, over-capacity and high fuel costs have wiped out recent profits. Incumbent airlines have locked themselves into their existing, failing business model, and have not succeeded at imitating the success of low-cost carriers such as Southwest or Ryanair (witness the recent grounding of United’s Ted).
With few exceptions, they have also proven unable to enter the profitable business of operating regional feeder airlines. Prisoner to sunk costs in airplanes and hubs, union contracts, travel agents, and other inflexible elements of their business model, their only option has been to remove capacity and raise fares through consolidating their industry.
With that background in mind, consider this post from Brian Tamanaha:
The New York Times released a chart yesterday showing that law schools are churning out far more lawyers than the number of available legal positions. That is old news, of course. What's worse is that the oversupply promises to continue. In 2010, Georgetown enrolled 591 first year JD students, Harvard enrolled 531, Fordham enrolled 477, and NYU enrolled 476. Large classes are not limited to top schools: New York Law School took in 641, John Marshall (Chicago) enrolled 539, and Suffolk enrolled 531. (Let's not talk about the 808 first year students taken by Florida Coastal and 1,583 by Cooley.) Law schools now pump out about 45,000 graduates annually at a time when the Bureau of Labor Statistics projects about 28,000 new lawyer positions per year.
In an ordinary industry, such a fall in demand would trigger the wave of consolidation described above. But legal education is no ordinary industry. First, law schools get paid by their inputs rather than being paid for their outputs. A fall in demand for our outputs thus does not put direct price pressure on law schools. Instead, we only feel supply-demand pressure if the number of inputs falls. In other words, law schools suffer financially not because their graduates can't find jobs but because they have too few applicants to fill their spaces.
Over capacity could deter applicants, as Tamanaha explains:
With tuition high and job prospects low, it seems likely that the number of law school applicants will continue to fall--although it's hard to say how far or for how long. One concrete indication of a continued drop is the google trend line for LSAT searches (check it out here), which shows a steady downward trajectory since the peak in 2004. (Tellingly, the applicant uptick in 2009 and 2010 barely disrupts the overall trend.)
If the drop in applicants continues, while enrollment stays up, schools will reach deeper in the pool to fill their classes, bringing in students with lower qualifications. A significant decline like this has happened before, in the early eighties and the nineties. The consequences for each school will depend upon its standing in the overall law school hierarchy and in the local legal market. But every school will feel it (although much less at the top). Schools would be prudent to anticipate a cumulative drop in applications of perhaps a third from their high. (Even if the reduction does not go that far, the number will be misleading because prospective students now apply to more schools than in the past.)
The 2010 acceptance numbers suggest that many law schools are already in a worrisome spot. That year, twenty schools accepted between 45% and 49% of the students who applied; twenty-two schools accepted between 50% and 59% of applicants; and seven schools has an acceptance rate of 60% or higher (Cooley was the highest at 83.3%). Added together, nearly a quarter of law schools in the country accepted close to half or more of their applicants—and this was before the latest decline in the number of applicants.
If that happens, law schools will start to feel a pinch from the problem of industry over capacity. Unfortunately, the M&A solution is barred because law schools are protected by takeover defenses far stronger than those possessed by any corporation:
- Law schools are in a regulated industry with lots of barriers to competition
- University presidents think it is prestigious to have a law school, so as to be a complete research university (see, e.g., UC-Irvine's illogical decision to start a law school)
- Influential local figures support "their" law school (ditto)
- Legislatures protect law schools from closing (see, e.g., UC Hastings)
- Most basically, you can't buy stock in a law school
The point should be obvious. Unless law schools voluntarily start consolidating and downsizing, which seems about as likely as yours truly winning the Miss America pageant, we face a long-term prospect of ever increasing competition for fewer and fewer applicants. Long before the day comes that there are fewer applicants than available seats, we will be in very big trouble. Budgets will have to be slashed to pay financial aid to attract students. Admission standards will have to go down. Relations between deans, faculty, and students will be increasingly fraught.
What we have here is a classic collective action problem. Unfortunately, what we don't have is a market in which to develop solutions to that problem.