Are financial advisors paid too much?
There is a notion prevalent in the academic literature and at the popular level that financial advisors claim an undue share of the national wealth. Specifically, some question if something nefarious such as unfair, rent-seeking behavior might explain why total compensation of financial intermediaries is at all-time high of 9% of GDP.
A newly published academic paper takes a far more benign view of financial sector compensation, arguing that the financial sector’s share of GDP is related to the growing importance of wealth preservation in a maturing economy.
The 40-page working paper by Nicola Gennaioli of Università Bocconi, Andrei Shleifer of Harvard University and Robert Vishny of the University of Chicago—titled “Finance and the Preservation of Wealth”—also finds other causes of the financial sector’s rise and fall in economic history.
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Financial advisors will not be surprised that declines in productivity and, especially, trust reduce opportunities for advisors in the long run, though they may be surprised that in the short run productivity drops enhance their prospects.
“This is because the drop in productivity reduces GDP and growth opportunities a lot but leaves the wealth preservation service of the financial sector relatively unaffected,” the authors writes. “As a consequence, the financial sector shrinks less than GDP, increasing the share of national income going to finance.”
Gennaioli, Shleifer and Vishny point out that the finance sector’s share of national wealth ebbs and flows over the years, rising from 2% of GDP in the 1940s to about 8% at the time of the financial crisis.
Its level before the Great Depression was 6%, but that earlier economic crisis “in all likelihood combined a decline in productivity with a sharp decline in trust in the financial system,” which took fully 40 years to reverse, assuming prewar levels only in the 1980s.
That financial intermediaries’ share of national wealth rose to prewar levels decades after U.S. productivity and wealth surpassed prewar levels illustrates the key role trust plays in lubricating the financial economy.
A related and counterintuitive insight is that competition in the seemingly crowded financial sector increases intermediaries’ wealth. That broker down the street is not eating your lunch but rather adding to the overall level of trust.
“Part of the reason why the income of the financial sector grows over time is that the entry of new intermediaries increases the proximity of money managers to investors, increasing risk taking and the size of the financial sector,” the three researchers write.
New entrants “got ‘closer’ to their clients and therefore became more trusted,” they add.
Gennaioli, Shleifer and Vishny refer to financial intermediaries—bankers, brokers, wealth planners, or money managers—as “money doctors,” suggesting that an innate lack of confidence draws savers to professionals without whom they would be putting their money into mattresses and gold.