The Social Value of Financial Expertise

Stanford University, Stanford CA

Investigators

Abstract

This project seeks to develop a new measure of the value of time, effort, money, and other resources devoted to the financial sector. Firms in this sector of the economy develop expertise that allows them to participate in markets with limited (asymmetric) information. For example, a mortgage company must assess the credit-worthiness of potential borrowers. Property insurers evaluate the chance of damage from natural disasters. Venture capitalists decide whether or not to invest in a start-up business. Developing expertise is expensive; it takes time and effort. Expertise is valuable to the individual firm, since more expertise means better decisions and eventually higher returns. Expertise is also valuable to the wider society as a whole. Society is better off when credit-worthy people can get mortgages (but very risky loans are not made), when insurers require that builders and owners mitigate natural disaster risks, and when the best new firms can get capital to expand. In the language of economics, this kind of expertise is socially valuable because it reduces the effects of asymmetric information and allows us to realize gains from trade that are a net benefit. The principal investigator plans to develop a method for measuring how the social value of additional expertise compares to the private value. The results could help us understand how financial markets contribute to US prosperity, and whether the US economy would be better off if more talented individuals went into medicine, technology, or research rather than into financial sector jobs. The PI plans to derive an expression for the ratio of marginal social value to marginal private value of expertise. If firms are optimizing, the marginal private value is equal to the marginal cost of expertise, so it is possible to understand how social value compares to costs. By focusing on the ratio of marginal social value to marginal private value, he is able to avoid making any assumptions about the technology that leads to expertise acquisition. He will use a sufficient statistic approach to measure the ratio, decomposing the ration into parts that correspond to measurable quantities for different branches of the financial sector. The results will provide empirical evidence on whether or not talent and effort that is now employed in the US financial sector might be more valuable in other pursuits.