Finance and the allocation of human capital

How finance sucks human capital from more productive activities. FT Alphaville:

... a bloated financial sector can also suck in more than its share of talent, hampering the development of other sectors.8

That last sentence is a smack in the face, isn’t it? FT Alphaville was dying to know what Footnote 8 would contain.

Here it is:

8 See S Cecchetti and E Kharroubi, “Reassessing the impact of finance on growth”, BIS, January 2012, mimeo

So we looked it up. From the introduction:

… in our examination of industry-level data, we find that industries that are in competition for resources with finance are particularly damaged by financial booms. Specifically, we show that manufacturing sectors that are either R&D-intensive or dependent on external finance suffer disproportionate reductions in productivity growth when finance booms.

At first, these results may seem surprising. After all, a more developed financial system is supposed to reduce transaction costs, raising investment directly, as well as improve the distribution of capital and risk across the economy. 1 These two channels, through the level and composition of investment, are the mechanisms by which financial development improves growth. 2 But the financial industry competes for resources with the rest of the economy. It requires not only physical capital, in the form of buildings, computers and the like, but highly skilled workers as well. Finance literally bids rocket scientists away from the satellite industry. The result is that erstwhile scientists, people who in another age dreamt of curing cancer or flying to Mars, today dream of becoming hedge fund managers.

See also my earlier post A reallocation of human capital (pre-financial crisis).