Tuesday, January 19, 2010

A Wall Street pay puzzle

Washington Post column "A Wall Street pay puzzle" (January 18th, 2010) displays a complete lack of economic understanding in reporting financial pay. The column brings up an article by Larry Katz, but

A study of Harvard graduates found that those who went into finance "earned three times the income of other graduates with the same grade point average, demographics and college major," reports Harvard economist Lawrence Katz, the study's co-author.

Is it possible that what Wall Street does is three times more valuable to society than other well-paid occupations? That's hard to believe

The study cited, by Claudia Goldin and Lawrence Katz in the American Economic Review: Papers and Proceedings, was simply a survey with no exogeneous variation. The regressions they ran, therefore, cannot have causal implications, but merely descriptive ones. In other words, there may be an underlying reason why individuals who have the same grade point average, demographics and college major still have different wages: they are a different brand people, with different underlying motivations, ambitions, intelligence, or other unmeasured qualities.

The column then errs further, arguing that individuals in this situation would be paid three times as much as equal peers who go into other occupations because what they do is more valuable. If individuals are going into other occupations, and foregoing wages that are three times higher, it begs the question of whether or not there are compensating differentials involved. That is to say, when one sees two people they think are the exactly the same taking jobs with three times different pay, either the individual are different, or the job that pays three times as much has some undesirable attribute that makes the "real" pay equalize--otherwise both would take jobs in the same industry.

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