The brain drain from financial liberalization

The financial sector is not riding high in popularity polls lately. First, compensation is deemed excessive. Second, the general public often does not perceive the benefits of a financial industry. The most common error there is the idea that finance plays a zero-sum game: anything it gains is necessarily taken away from others. Finance allows a better reallocation of resources and funds to the most productive businesses, and this raises overall productivity. But as it is well rewarded for this, it seems to be attracting perhaps an excessive number of top talents who could, at the margin, be more productive in other sectors. This brings us to a third issue: the financial sector is hiring away the best people from other sectors.

Christiane Kneer studies this inter-sectoral brain drain by looking at the consequences of financial deregulation on sectoral productivity. The assumption here is that financial deregulation attracts top talent to the financial industry because it allows the design and management of new and complex financial instruments. She finds that industries that rely the most on human capital are hurt: after an episode of financial liberalization, they have lower labor productivity, lower value added growth and lower total factor productivity. This is what happens when, for example, a software engineer moves to finance to exploit arbitrage in trade by gaining micro-second advantages over competitors. The social benefit of this arbitrage is close to zero, and some industry lost a great software engineer.