Fischer Black started from a model of efficient markets with diversified investors. However, there is nondiversifiable risk in the economy, there will be times when you get a bad draw. At those times, the value of physical and human capital will fall.

Tyler Cowen says that we are poorer than we thought we were. He says that this means that our estimate of future earnings has fallen. This sounds like a drop in the value of physical and human capital.

I think that it is impossible for people to diversify effectively with respect to human capital. So I will not be talking about a perfectly Black-like world. But I would like to elaborate on the Black-Cowen model, using lawyers as an example.I get a sense that the Recalculation is affecting lawyers. There seems to be an excess supply. Large firms laid off lawyers. New law school graduates are having more difficulty landing jobs than they did a few years ago.

My guess is that salaries for lawyers in the private sector will decline over the next five years. Government salaries will remain elevated, so that the quality of lawyers attracted to government will tend to rise.

On average, lawyers must be reducing their estimates of future earnings. Nonetheless, many young people may be applying to law school, perhaps even more than usual. However, that in turn may reflect a perception that the value of an unadorned BA has fallen even more than that of law degree.

In some sense, the market value of the asset of a law degree has declined. This may be due to the fact that lawyers did a lot of the work in processing the complex financial transactions of the mortgage credit boom, and the demand for that work has declined. Or it may reflect the fact that companies are developing fewer new capabilities and products (what I call the Minsky-Jones economy), and thus they only need whatever lawyers are required to maintain current operations.

Suppose that when Recalculation is complete, we will have restored full employment with fewer lawyers and more physical therapists. The return on investment in a physical therapy degree will be as high as that on a legal degree, for people of equal ability (if one may speak of equal ability in this context). This comes from a drop in the return on a law degree and an increase in the return on a physical therapy degree.

The point of the Black-Cowen model, as I interpret it, is that the people with existing law degrees take significant capital losses. People with existing physical therapy degrees enjoy capital gains, but they do not have to be nearly enough to offset the losses of the lawyers. Thus, on average, we are poorer than we thought we were.

I still want to think about Ricardian non-equivalence in this model. That is, if government runs a deficit and people do not assign themselves the liability to repay this debt in the future, then the government can make people feel richer than they are. In fact, the government does not have to run a deficit today in order to do that. By promising to take care of all of my health care after age 65, government can make me feel very rich today. But if we get to the point where government cannot keep that promise, then lots of people will suddenly discover that they are not as rich as they thought they were.