Let the Human-Capital Exodus Begin

One effect of President Obama‘s $500,000 salary cap on the executives of bailed out firms (if it has any effect at all; Gary Becker thinks it won’t) could be an exodus of human capital from the top echelons of the finance industry.

A new paper suggests that talented people are likely to leave finance in droves anyway, once tighter regulations set in. Contrary to popular belief, bankers didn’t always command sky-high salaries. Tomas Phillipon and Ariel Resheff found that, over the last 100 years, finance workers have mostly been paid wages proportionate to professionals in other industries — except for two periods: in the 1920′s through the start of the Great Depression, and in the 1980′s through the start of this economic downturn. During the boom times, wages in banking skyrocketed and talent flowed into the industry. During the bust cycles, that wage premium vanished.

What kept down wages in between? According to the paper, the culprit is a strict regime of federal regulations on banking enacted in the 1930′s and gradually repealed starting in the 1980′s. The authors conclude that regulations on banking stifle innovation, which keeps down earnings and wages, drawing fewer talented workers into the field.

Tamping down the level of innovation in the financial sector, of course, might not be an entirely bad thing. (Credit default swaps, anyone?) Furthermore, as financiers’ wages became far higher than those of government regulators, it made it that much harder for the latter industry to attract top talent.

Accordingly, the authors note, “the flow of talented individuals into law and financial services might not be entirely desirable, because social returns might be higher in other occupations, even though private returns are not.”

If all of this talent does start to flow out of the banking sector and into the rest of society, what other good could come of it?

(Hat tip: Free Exchange)

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  1. Nancy Jane Moore says:

    Your recitation of the two periods in which financial workers made absurd piles of money is the best argument that can be made for regulating those sectors and keeping the salaries in line with those of other professionals.

    It’s crazy to have a society that provides its best financial rewards to people whose only contribution is to come up with new and different ways of gambling with other people’s money. They produce nothing. And while there needs to be a sector that provides the financing for those who are producing things, in the past ten years or so it appears the high-flying bankers weren’t even doing that.

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  2. Ken B says:

    “talented people are likely to leave finance in droves anyway, once tighter regulations set in”

    There’s also the small matter of the financial sector going through a profound contraction, since there are far fewer interest-only and negative-amortization mortgages to be written. Finance grew to an absurd size during the credit bubble.

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  3. Eric M. Jones says:

    Excuse me, Mr. Freak O. Nomics, what are you saying?

    “The authors conclude that regulations on banking [someone watching out for our interests] stifle [restrain] innovation [clever scams], which keeps down earnings and wages [wild looting of our assets], drawing fewer talented workers [fraud artists and con-men] into the field.”

    Did I go to bed and wake up stupid? Are we both speaking English? Just because you steal with a fountain pen and a contract instead of a gun or a knife doesn’t make you a nice guy.

    “The law, in its majestic equality, forbids the rich as well as the poor to sleep under bridges, to beg in the streets, and to steal bread.” Anatole France

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  4. PsiCop says:

    How talented could these folks at the top echelon of the finance industry have been, given that, collectively, they led us into this disaster in the first place? How much are we losing — really — if they all leave?

    Let them go to other countries and wreck their economies. Why should I care? Let a new crop of finance leaders — who maybe won’t have plunder on their minds since they will take charge while the compensation-cap is in place — take the reins for a while.

    Also, if we just dole out bonuses to these guys as if they never did anything wrong, do we not open the door to a massive moral hazard? Do we not reward incompetent management and thus incentivize future government bail-outs?

    Is there no benefit to holding the line and saying, “Look, you guys have made enough money leading this country into ruin … be happy with what you’ve plundered stolen grafted earned from the system already.”

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  5. Jim says:

    So, if the “talent” that brought this world-wide financial mess upon us exits the financial sector, the problem is….?

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  6. Cory says:

    When are we going to realize that it wasn’t the quantity of compensation that was the problem in finance? The application and incentives were the problem.

    The pay structure incented many in the world of finance to focus on the immediate term to drive their bonus. They weren’t being paid for what the firm looked like in 5 years or 25 years, so that was a secondary concern to making this year’s numbers.

    The bosses of the financial firms got exactly what they incented their employees to do, escalating at an unsustainable pace until it all came tumbling down.

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  7. Roger, FCD says:

    Good. The system was set up so that people who were good at /making themselves money/ floated to the top. This is not the same group as the group of people who are good at /making their shareholders money/. If you run your company into the ground, then ask taxpayers for a hand out, the taxpayers – as shareholders – get a say in how much your compensation is.

    You’ll see no tears from me.

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  8. Evan says:

    So, in both cases (1920s and just prior to the current downturn), “talent” is defined as “talent at causing nationwide catastrophes.” Yes, let’s please start that exodus immediately.

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