In the interminable debate on Wall Street compensation Ryan Avent makes an important point:
Officials in Washington scrutinising the pay packages of TARP recipients are primarily focused on the incentive effects of those pay structures–whether financial pay packages are inducing financial employees to take excessive risks. But the bigger incentive problem may be–almost certainly is–the drain of talent from other fields, into finance. If there were more evidence that this drain was producing significant net benefits for the economy, than there would be less cause to worry. To an increasing number of people, it looks as though the financial sector is recruiting the nation’s best brains and putting them to work endangering the global economy.
Let’s table whether financial engineers are really endangering the global economy.
Since 1800 the world economy has produced a radical increase in wealth which is qualitatively different from what came before. The chart to the left has the y-axis as the log of per capita income. Something happened in 1800. In the popular imagination we call it the Industrial Revolution, though economic historians argue whether we should bracket out the phenomenon in this manner. No matter, a change did occur. In fact, many changes occurred. Modern finance emerged during this period, as did our contemporary legal and political structures. The corporation matured with the groundbreaking example of the VOC. Ideologues campaigned in favor of free trade, surplus population emigrated to the New World, and the vast spaces and resources of North America served to free up Europe’s labor and capital for its workshops instead of extracting more for the sake of primary production.
All of these changes are important on the margins. But the biggest change, the biggest driver of productivity growth and therefore wealth, has been innovation, in particular technological innovation. The greatness of technological innovation is that its effects spillover and accrue to all of society, as all boats rise with the tsunami of productivity growth. There are a few technologists who become fabulously wealthy, but it can be argued (rightly I believe) that these technologists do not in fact capture the vast majority of the wealth which they generate indirectly to themselves. In other words, the productivity growth fueled by computers which leads to a wealthier population is only marginally reflected in the value of technology firms themselves or incomes of their employees. Imagine if Johannes Gutenberg captured all the economic growth and controlled the totality of the societal ferment which the printing press generated.
In contrast intelligent people who go into finance, or medicine or law, make a contribution to society, but they capture a much greater portion of the value which they add economically in compensation. The total value may be less, but if they capture a much larger fraction then rationally on an individual scale society’s loss is their benefit. Who does society admire, the surgeon who saves lives, or the technologists who toil away to produce tools and instruments which allows thousands of surgeons to save lives? Who has greater cachet on the marriage market, a doctor who is pulling in $200,000 a year, or an engineer at Intel pulling in the same money? How does a family whose breadwinner is a post-doc bringing in $50,000 a year working on cutting edge basic research feel in relation to a colleague who went to Wall Street after grad school and is pulling in $500,000 a year?
The command economies of the Eastern Bloc failed to create the incentives which resulted in technological innovation, their forte was copying. But the reality is across the history very few economies have been able to lay the cultural seedbed for innovation. At his talk at the Singularity Summit Peter Thiel argued that in fact the amount of innovation occurring in our culture has decreased. Why? There are many reasons. But I do wonder if price and social signals to our best and the brightest are part of the reason why innovation is not occurring at the same clip. As a friend who is an engineer at Intel communicated to me nerd with an M.D. is a “catch,” a nerd with a doctorate from MIT is a nerd. We live in a world where all the glory goes to those who fish, not those who produce better hooks & lines for the fishermen.
H/T Matthew Yglesias.