Is the High Pay of Finance Workers Bad for the Economy?

Is the High Pay of Finance Workers Bad for the Economy?

by | Apr 28, 2018

In Brief  For years, financial service firms have been criticized for overpaying their workers.  But empirical research suggests that this conclusion is not necessarily warranted.

Why this matters  Many policy analysts have expressed concern that the high wages paid to finance workers put a damper on macro-economic growth, as they may make it harder for other economic sectors to attract top talent.

The takeaway  In many countries around the world, finance workers often receive wages that are commensurate with their contribution to the economy as a whole.

In Depth  Ever since the economic meltdown of 2008, the financial sector has been subjected to some fierce criticism. One common refrain is that this rapidly growing slice of the American economy, which employed 6.2 million people in 2016, is inefficient. Another is that financial service firms overpay their workers, creating, as policy analysts Brink Lindsey and Steven Teles put it in their 2017 book, The Captured Economy, “growth-sapping diversion of some of the nation’s best minds into unproductive or counterproductive pursuits.” For Lindsey and Teles, the country would be much better served if more of that young brain power simply headed off to Silicon Valley instead of Wall Street. “But that’s not always the case,” says Francesco D’Acunto, an assistant professor of finance at the Smith School. “As it turns out, the financial sector often does a reasonable job of allocating capital efficiently so that other sectors such as tech can innovate.”

To back up his argument, D’Acunto cites the recent working paper, “Finance, Talent, Allocation and Growth,” that he co-wrote along with Laurent Fresard, an associate professor of finance at the Smith School. The authors studied a rich dataset produced by the WORLD-KLEMS 2008 Initiative, which looks at 13 broad sectors in 24 countries from 1970-2005.

To capture the possible discrepancy between the private and social value of the financial sector, D’Acunto and Fresard came up with a new metric, AGFW, which refers to the adjusted growth of finance wages. A positive AGFW in a country in a given year means that the relative compensation of finance workers has grown more than their contribution to the economy as a whole—a result which indicates that they are being overpaid. In contrast, a negative AGFW in a country in a given year indicates that the relative compensation of finance workers has grown less than their contribution to the economy as a whole—a result which indicates that they are being underpaid.   

For most of this 35-year period, the AGFW in the United States was around 0, meaning that American finance workers typically received a fair wage, one that was consistent with how productive this sector was to the economy as a whole.  But this was not true for all countries. In the United Kingdom, for example, the AGFW fluctuated wildly over the years, hitting a high of 4 in about 1980 and a low of about -6 in 1995. These figures suggest that British finance workers were vastly overpaid in the 1980s, but vastly underpaid in the mid-1990s. In any event, D’Acunto and Fresard find that over this 35-year period in all 24 countries, the relative pay of finance workers—whether they were overpaid or underpaid—had little effect on overall macroeconomic growth. “Throughout our recent history,” says D’Acunto, “finance workers typically managed to make capital available to companies in other sectors efficiently—say, tech or pharma—which could then spur economic growth. Inefficiency in the financial sector has not been a problem.”

While these data are historical, D’Acunto does stress that the past is prologue. “We can’t predict the future, but we can say that paying finance workers a high salary isn’t necessarily a bad thing, as many of the same forces affecting the economy today are similar to those that were at work in previous decades.”

Digging Deeper:

https://www.theatlantic.com/business/archive/2017/12/captured-economy/547967/

http://fortune.com/2014/10/06/wall-street-pay/

https://www.selectusa.gov/financial-services-industry-united-states

https://www.theguardian.com/careers/finance-industry-wages-earnings

https://www.sheffield.ac.uk/polopoly_fs/1.342913!/file/serps_2014002.pdf

https://www.msn.com/en-us/money/markets/bankers-average-bonus-jumps-to-highest-since-2006/ar-BBKIBpX

Joshua Kendall has written on business and healthcare for numerous publications including BusinessWeek, Fortune.comThe New York Times, The Boston Globe and The Washington Post. For more about his work visit JoshuaCKendall.com.