Back to Basic banking


The AFR is running a series on the Basel reforms and the fact that they are likely to lead to a more regulated and simpler world of banking. The piece on the front page today started with the story of a young law-arts graduate who chose investment banking over other, perhaps more productive, careers such as medicine which was apparently on offer to her. In future my hope is that such a graduate might choose to follow a different career, and a less lucrative investment banking world resulting from heavier banking regulation would help in pushing her in such a direction. A simpler, more regulated banking world will not reduce economic growth – Australia has had heavier banking regulations than the US for some years and there is no evidence that this has adversely affected our growth. I wrote a piece in the AFR 4 years ago on the sort of decisions that the young graduate above made, and the fact that such decisions are likely to reduce long run growth. The context was a Federal Budget that tilted funding away from commerce and economics towards other areas…[DDET Read more]

Among the many measures in the most recent Federal Budget related to education was a reallocation of funding towards some discipline areas and away from other areas. Specifically, funding for student places in maths and statistics, allied health, clinical psychology, dentistry, medicine and veterinary science was increased, while funding for commerce and economics was cut. Despite being an economist, I view changes such as these as tilting incentives in the right direction. It is difficult to know what the right number of lawyers or accountants is relative to the number of scientists or mathematicians, but it seems that in a world where innovation and creativity are increasingly valued, the latter disciplines ought to be encouraged, meaning that other discipline areas must contract.

In a very well known paper in the Quarterly Journal of Economics in 1991 Kevin Murphy, Andrei Shleifer and Robert Vishny study the factors that determine the allocation of talent within countries, and how this allocation of talent affects economic growth. They cite the example of 18th century France, where the great chemist Lavoisier changed career mid-life to become a tax collector because of the greater pay available to government employees. It is claimed that such incentives are among the reasons why the industrial revolution took off first in the UK rather than in France. In the same paper evidence is presented that countries with greater numbers of university students in law will subsequently grow more slowly than countries that have a larger fraction of students in engineering.

 Of course every countries needs lawyers and accountants, but in countries where legal red tape and bureaucracy create the need for these type of workers, and where the rewards to entering these careers are too great we are all made worse off. Relatedly, a world where the best and brightest often want to join Macquarie Bank rather than the CSIRO or one of Australia’s many outstanding medical and biological research organisations should lead us to suspect that the incentives to become a commerce graduate are already sufficient.

 Of course one could argue that funding to universities should be increased further so that funding to commerce did not have to be cut. On this the debate is not clear cut – economists know that there is no free lunch in these matters, and the reality is that such funding takes resources from elsewhere – be it health, defence, or other forms of education. However, the point remains that it is relative prices that determine demand and supply for various disciplines, and only by changing the relative prices, and the relative returns to different disciplines will we create greater incentives for tertiary entrants to enter the sciences and related disciplines. In this regard Australia lags well behind many of our Asian neighbours, where funding to innovation related disciplines greatly exceeds Australian levels.[/DDET]

7 Responses to "Back to Basic banking"
  1. I’m not sure that \CSIRO or one of Australia’s many outstanding medical and biological research organisations\ are the best examples. They’re mostly taxpayer funded, and it’s probably not in Australia’s best interests for its best and brightest to be chasing government jobs.
    Anyway, the incentives are changing. Thanks to the mining boom there’s a shift in demand toward engineering subjects, since BHP and Rio pay higher starting salaries than the banks.

  2. I’ve just read Ragush Rajan’s book on the roots of the GFC.  This Chicago economist (and former Chief Economist for the IMF) argues strongly that “making finance boring” would be throwing the baby out with the bathwater.  He wants “smarter, not more” regulation.

    I think he is dead wrong, precisely because of the sort of effects and the empiric evidence on growth that you cite.  A “sophisticated” finance sector seems to have only marginal benefits, and far more risk, than a rather simpler one – except of course to financiers.

  3. “Of course every countries needs lawyers and accountants, but in countries where legal red tape and bureaucracy create the need for these type of workers….we are all made worse off.”
    love this phrase. I can just see the endogenous growth model with a productivity-decreasing effect of more lawyers.

  4. By extension, it’s parliament – and the public’s demands on it – that generates the legislation leading to loss of productivity. Lawyers and accountants only occupy one side of the supply-demand equation in that respect.

  5. Am I missing something?  How does a law-arts graduate go into medicine?  If she wanted to go into medicine, why on earth did she do a law-arts degree?

  6. It’s probably the American tradition of a liberal arts degree prior to entering their “serious” degree of choice.

  7. DP, you shouldn’t ignore the considerable percentage of parliamentarians who are also lawyers +the huge numbers in the public service, who are all helping to cripple us with burdensome compliance requirements.
    Ask any academic about the ever-escalating reams of regulatory reporting requirements that are pushed down to them on a seemingly daily basis.

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