Esther Duflo feels that the growth of financial sector until now has led to unproductive distribution of intelligence (talent). She argues that with stricter oversight and monitoring of CEO salary and bonus and disappearance of their exorbitant earning may encourage talents to seek job opportunities in other industries, thus leading to a more realistic allocation of talent.
If paying the bankers (a lot) less or taxing them (a lot) would certainly be more desirable from a moral point of view (not to mention considerations of equity), would it be harmful in terms of economic efficiency, as many economists suggest? Is there a risk of discouraging the most talented to work hard and innovate in finance? Probably. But it would almost certainly be a good thing. A study on Harvard graduates showed that those who work in finance earn almost 3 times more than others. The temptation for young talent to work in this sector is enormous – 15% of 1990 Harvard graduates are working in finance, compared with only 5% of the class of 1975. More generally, the massive deregulation of the financial sector, which began in the 1980s, and the opportunity to make extraordinary profits have been accompanied by an increase in the number and qualifications of employees in this sector. Again, according to Philippon and Resheff, one has to go back to 1929 to see such a gap between the average education of an employee in the financial sector and one in the rest of the economy. The complex financial products, but also the evolution of standards in the social sectors over the past 30 years, have made the financial sector particularly attractive to any graduate, intelligent as he or she may be.
What the crisis has made bluntly apparent is that all this intelligence is not employed in a particularly productive way. Admittedly, a financial sector is necessary to act as the intermediary between entrepreneurs and investors. But the sector seems to have taken a quasi-autonomous existence without close connection with the financing requirements of the real economy. Thomas Philippon calculates that the financial sector, which accounts for 8% of GDP in 2006, is probably at least 2% above the size required by this intermediation. Worse, the sub-prime crisis is almost certainly in part linked to the fact the needs of the financial markets (the insatiable demand from banks for the (in)famous “mortgage-backed securities”) led to excessive borrowing and a housing bubble. Watching the events of the last few days unfold does make us one want to send some of the finance CEOs back home. More pragmatically, the disappearance of their exorbitant earnings may encourage younger generations to join other industries, where their creative energies would be socially more useful. The financial crisis could plunge us into a severe and prolonged recession. The only silver lining is that it could cause a more realistic allocation of talents. One must hope that the bail-out packages in Wall Street and in Europe do not convince the best and brightest that the financial sector is still their best option.