Finance Sector Wage Growth and the Role of Human Capital
| DOI | http://doi.org/10.1111/obes.12155 |
| Published date | 01 August 2017 |
| Author | Joanne Lindley,Steven Mcintosh |
| Date | 01 August 2017 |
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©2017 TheAuthors. OxfordBulletin of Economics and Statistics published by Oxford University and John Wiley & Sons Ltd.
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OXFORD BULLETIN OF ECONOMICSAND STATISTICS, 79, 4 (2017) 0305–9049
doi: 10.1111/obes.12155
Finance Sector Wage Growth and the Role of Human
Capital
Joanne Lindley† and Steven Mcintosh‡
†Department of Management, Faculty of Social Science and Public Policy, King’s College
London, Franklin-Wilkins Building, 150 Stamford Street, London, SE1 9NH, UK
(e-mail: joanne.lindley@kcl.ac.uk)
‡Department of Economics, University of Sheffield, 9 Mappin Street, Sheffield, S1 4DT, UK
(e-mail: s.mcintosh@sheffield.ac.uk)
Abstract
Wereveal the pervasiveness of the finance sector pay premium, across all OECD countries,
as well as all sub-sectors and occupations within the UK financial sector.Moreover, the UK
premium has continued to rise despite the financial crisis. We show that earnings increase
faster with value added in certain sub-sectors of finance, compared to the general economy,
providing evidenceof profit-sharing in these sub-sectors. Other possible explanations, such
as workers with higher qualifications or better cognitive skills, or technological change and
differing job characteristics, can explain some of the finance sector pay premium, but are
not sufficient on their own.
I. Introduction
Explaining wage growth in the UK financial sector has remained a relatively under-
researched area in economics, despite the issue receiving a lot of attention in the European
media and the implementation of policies designed to affect it, such as the Capital Require-
ments Directive capping banker’s bonuses at a maximum of one year of salary from 2014.
Reed and Himmelweit (2012) loosely link the recent stagnation of UK wage growth to the
increased importance of financial services in the aggregate profit share. Also Bell and Van
Reenen (2010, 2013) document how high UK financial sector salaries are an important
feature of growing wage inequality at the top end of the wage distribution. However, there
are few studies that seek to explain why the financial sector wage premium has risen so
quickly and why it is now so high.
Consequently, the main aim of this paper is to explain the large, and increasing, wage
premium in the financial sector. We do this by drawing upon existing theories and potential
explanations from the available literature on more general labour market inequality. For
any theory to be accepted as a possible explanation, it must be able to explain both the high
finance sector premium, and its further increase over time.
JEL Classification numbers: J20, J31, I24.
Finance sector wage premiums 571
The first potential explanation that we consider is that of rent-sharing, whereby rents
created in the finance sector are shared with employees.In order to explain both the high and
the rising finance sector wage premium, such an explanation would need to offer a reason
why such rent-sharing is particularly and increasingly prevalent in the finance sector. Such
issues have been discussed in previous literature. For example, Bivens and Mishel (2013),
with reference to the US but also relevantto the UK, suggest that the removal or reduction of
regulations on the finance sector, the implicit insurance provided by government bail-outs
of struggling financial institutions, and the increasing complexity of financial instruments
that allow financial workersto hide risk from their investors, have all helped in the creation
and increasing extraction of rents in the finance sector.As well as this opportunity to engage
in rent-sharing, Bivens and Mishel (2013) also discuss a rising incentive to do so, due to
falling marginal tax rates on high incomes raising the benefits from pursuing a larger share
of rents. As evidence for such a claim, the authors cite Piketty, Saez and Stantcheva (2012)
who show that higher pre-tax income in the top 1% of the distribution is associated with
lower marginal tax rates at the top, both over time in the US and across countries.
There are, however, other potential explanations of the high and rising finance sector
pay premium that we must also consider. It has been well documented that some countries,
most notably the US and UK, experienced substantial growth in general labour market
inequality over the last two or three decades.1The forces that have increased inequality
generally may therefore be the same that have increased the finance-non-finance wage
differential specifically. One such general explanation that has received a lot of attention in
the literature is technological change. The basic idea is that the falling price of information
technology has led to the substitution of routine labour by technology capital. As routine
tasks tend to be performed in jobs situated in the middle of the job quality distribution,
economies with access to information technology have witnessed decreasing employment
shares in the middle of the earnings distribution. Consequently, employment has polarized
into high paid and low paid jobs and inequality has risen.2This process has become
known as task-biased technological change (TBTC).3Here routine tasks are thought to be
substitutes with new technology, whilst high-skill, analyticalnon-routine tasks are thought
to be complements. An analysis of skill intensity and task use in the finance sector would
therefore determine the relevance of this theory to explaining the high and rising finance
sector pay premium.
While the literature on inequality and TBTC spans a number of dimensions and now
also a number of countries, there have been relatively few studies that focus specifically
on the financial sector. One notable exception is the study by Philippon and Reshef (2012)
who consider long-run variation in relative finance wages over the previous century. They
find a U-shaped pattern, with finance sector wages being higher relative to average private
sector wages in the periods 1909–33 and again from 1980 onwards, while losing their
relatively high status in the interim period.They go on to consider relative education levels
and relative task complexity levels, and find a similar U-shaped pattern for both time
1See Acemoglu andAutor (2010) for a review of this literature.
2See Katz and Murphy (1992), Autor, Katz and Kearney (2008) for the US and also Machin (2011) and Lindley
and Machin (2011) for Britain.
3This concept was first introduced by Autor, Levy and Murnane (2003) in their more refined treatment of skill
biased technical change (SBTC). For a survey of the literature on SBTC see Katz andAutor (1999).
©2017 The Authors. Oxford Bulletin of Economics and Statistics published by Oxford University and JohnWiley & Sons Ltd.
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