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.







3 responses to “Mankiw: Do Equity Analysts Create Prosperity?”

  1. Jason Preston Avatar

    I was totally going to leave a one word comment, but apparently those aren’t allowed???

  2. Asymptosis Avatar

    Jason Preston :

    I was totally going to leave a one word comment, but apparently those aren’t allowed???

    Je ne sais pas. Ze anti-spam software she has ze rules zat ze blog owner know not of…

  3. spencer Avatar

    The study also assumes that that stock market analysts and/or portfolio managers actually play a significant role in the allocation of capital in the US economy.

    Despite all the propaganda I suspect the stock market only plays a secondary role in capital allocation in the US economy. What really drives the allocation of capital is the economic returns across industries and the stock market largely reflects this — relative growth.

    The stock market plays a role in raising capital for new industries, but this is largely to allow the original investors to cash out or convert their concentrated holdings in a single firm across many firms.
    Of course the ability to do this plays a significant role in investors willingness to provide capital to start ups in the first place.

    On a net basis the amount corporations pay out in dividends is a multiple of the amount of new capital corporation raise in the stock market. Even during in the 1990s bubble, when the market was essentially providing start ups free capital, dividend payments were three to four times the volume of new IPOs.