Financial Sector Wages

There is a lot of irritation currently about salaries and bonuses in the financial sector, especially in light of recent bail-outs. Critics of the exuberance in the financial sector should not worry. According to a new working paper by Thomas Philippon and Ariell Reshef, we can expect a sharp decrease in financial sector salaries in the coming years. This prediction is based on an analysis of the wage and skill development in the U.S. financial sector from 1909 to 2006. Until 1933, the financial sector was a high-skill, high wage industry. After the Great Depression, the financial sector not only lost its high human capital, but also the wage premium compared to the rest of the private sector. It was not until the 1980s that the financial sector became yet again a high-skill and high-wage industry, driven by financial liberalization and innovation.

Salaries

Both in the period from the mid-1920s to the mid-1930s and from the mid-1990s onwards, salaries in the financial sector were not consistent with education levels and employment risk, suggesting short-term rents for financial sector employees and an unsustainable labor market equilibrium. So, expect financial sector salaries to drop, although not immediately as the experience from the Great Depression shows, where it took several years for relative financial sector wages to drop. But given excess wages of 40%, expect big drops! These high excess wages might also explain regulatory failures in the run-up to the crisis; regulators could simply not attract sufficient talent given the high excess compensation in the private sector. So, the next question will be: what about the impact on MBA and Finance programs.


Posted by Thorsten Beck on January 28, 2009 in Lessons from the past | Permalink | TrackBack (0)