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to the paper, the culprit is a strict regime of federal regulations on banking enacted in the 1930’s and gradually repealed starting in the 1980’s. The authors conclude that regulations on banking stifle innovation, which keeps down earnings and wages, drawing fewer talented workers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)