Krugman Spins on Boring Banking

In a recent New York Times column titled Making Banking Boring, Paul Krugman points to evidence regarding financial regulation and Wall Street compensation that appears in a paper by Professors Thomas Philippon and Ariell Reshef. In particular, Philippon and Reshef find that the level of Wall Street compensation has been inversely correlated with the degree of financial regulation in the US from 1909-2006, with high compensation corresponding to the two periods of light regulation (pre 1930 and post 1980) and with lower compensation corresponding to the intervening period of greater regulation. 

Krugman spins this finding to support his own political narrative, ignoring the authors' conclusions, which in some cases run counter to Krugman's views. 

In brief, Krugman's argument is:

1. More stringent financial regulation is required, since greater regulation would prevent future crises.
2. But more stringent regulation would result in lower compensation for Wall Street.
3. Therefore, Wall Street will try to use its friends in high places to block needed regulatory reform.

Krugman presents the findings of Philippon and Reshef to support point (2) in this political narrative. But he weaves the findings of these academics so tightly into his story that it's difficult to tell where the facts ends and Krugman's opinions begin.

Let's consider what Professors Philippon and Reshef actually conclude.

"Our investigation of the causes of this pattern reveals a very tight link between deregulation and human capital in the financial sector. Highly skilled labor left the financial sector in the wake of the Depression era regulations, and started flowing back precisely when these regulations were removed. This link holds both for finance as a whole, as well as for subsectors within finance. Along with our relative complexity indices, this suggests that regulation inhibits the ability to exploit the creativity and innovation of educated and skilled workers. Deregulation unleashes creativity and innovation and increases demand for skilled workers."

"Our research has two important implications for financial regulation. First, tighter regulation is likely to lead to an outflow of human capital out of the financial industry..."

"Our results have another important implication for regulation. Following the crisis of 1930-1933 and 2007-2008, regulators have been blamed for lax oversight. In retrospect, it is clear that regulators did not have the human capital to keep up with the financial industry, and to understand it well enough to be able to exert effective regulation. Given the wage premia that we document, it was impossible for regulators to attract and retain highly-skilled financial workers, because they could not compete with private sector wages. Our approach therefore provides an explanation for regulatory failures."

Of course, Krugman is free to incorporate the factual findings of Philippon and Reshef in support of his political narrative. But he does his readers a disservice by failing to note that the authors reach very different conclusions from these findings than he does.