Why finance majors make more than engineers

Back in the 1970s and early 1980s, kids coming out of college didn’t lust after jobs in finance. The reason was simple: Finance jobs didn’t pay as well as those in other professions. That may be hard to imagine now, with some first-year financial analysts pulling down six-figure salaries and potentially six-figure bonuses, while newly minted engineers can only expect to earn around $70,000.

If you are wondering why things changed, you aren’t alone. Two economists at the National Bureau of Economic Research mused about the same thing. Controlling for education and other related qualities, they found that wages in finance in 2006 were about 40% higher than those in the rest of the private sector. For CEOs, the difference is even greater. Between 1995 and 2005, executive compensation in finance outstripped that of the private sector by 150% on average. The NBER economists decided to figure out why.

The two didn’t pursue this idea out of idle curiosity. Finance accounts for 15 to 25% of the overall increase in wage inequality since 1980, they say. To put it another way, lopsided compensation in the financial industry has greatly contributed to the disappearance of the middle class and the polarization of the U. S. into a country containing mainly people with low and high incomes.

The two economists, Thomas Philippon and Ariell Reshef, discovered something odd: There was another time in U. S. history when wages in the financial sector outpaced those elsewhere. That period extended from 1909 to 1933 which, in a spooky echo of today, spanned the roaring twenties, the 1929 stock market collapse, and the initiation of the Great Depression. It also casts doubt on the concept that information technology has been the force driving higher salaries — after all, there were no computers in the 1920s.

What the economists did find, however, was that the relative rise of salaries in finance corresponded with progressive deregulation of the industry beginning in the 1980s, probably because deregulation can intensify innovation and competition for talent. Similarly, salaries in finance started to fall during the 1930s, 40s, and 50s, not because of the punk economy or any nostalgic ideas about the rise of manufacturing industries. The more probable explanation, say Philippon and Reshef, is that that period was one of relatively heavy regulation of financial firms and, coincidentally, much higher tax rates on higher incomes.

Well, thank goodness for that. Otherwise, many entrepreneurially minded self-starters of the time such as Bill Hewlett, David Packard, or Bill Lear might have wound up inventing cockamamie debt instruments instead of founding manufacturing industries.

The economists beg off from opining about whether society is better or worse off when “financiers are overpaid from a social point of view.” But I contend that the real lesson learned from their results lies elsewhere: If society wants more engineers and scientists, it should forget about beseeching kids to pursue technical subjects and hoping they ignore the fact that such studies lead to lower-paying careers. Instead, just regulate the financial industry so it produces fewer “innovations” such as the credit default swaps that nearly sank economies worldwide two years ago.

— Leland Teschler, Editor

© 2011 Penton Media, Inc.