Mankiw: Do Equity Analysts Create Prosperity?

In my peregrinations I just came across an old 2006 post by Greg Mankiw. He describes the situation of:

…a Harvard PhD in economics who left an academic job for a better-paying one in private equity. Based on the article, he seemed a bit wistful about leaving an academic job behind. At a higher tax rate on his new higher income, might he have stayed with the perks of the ivory tower? Perhaps. But, based on market prices, his talents are more productively applied in private equity, where he is filling the important role of allocating the economy’s capital stock. If he gave up that job because of a higher tax rate, the loss to the overall economy would be measured by the deadweight loss.

But Mankiw is making an assumption here: that the market pricing for equity analysts (versus professors) reflects and effects an optimum allocation of (human) assets — that if that professor becomes an equity analyst, it will increase overall prosperity.

Based on recent events (and reams of research and theory), it seems clear that this assumption is false.

1. The financial sector is far larger than is necessary to effectively lubricate and nourish the real economy — the part that produces valuable goods and services (such as … university educations).

2. It is many times larger than is necessary to set prices efficiently. Fama and French showed long ago that it requires very few players for a market to be efficient. (The same is probably true of types of securities; stocks, bonds, options, futures and shorts probably do all or perhaps far more than is needed to achieve efficient pricing.)

The size of that sector both reveals, and in a self-perpetuating cycle causes, a massive misallocation of resources by the invisible hand.

And that’s before we even consider the systemic risks of a top-heavy financial system.

Moving another smart person into that sector arguably decreases prosperity.