Of Bubbles and Bankers: The Impact of Financial Booms on Labor Markets

Abstract

This paper studies the effect of financial booms and extreme asset valuations on the relative demand for skills and the wage structure. The substantial rise in wage inequality in the U.S. since the late 1970s has been accompanied by a major expansion of financial services, a series of asset bubbles, and rising relative wages and relative education in the financial industry. I motivate and develop a theoretical framework where financial institutions benefit from financial booms and asset bubbles. Yet the complexity and novelty of financial products and fundamentals surrounding bubbles favor the supremacy of skilled individuals in exploiting these opportunities. Hence financial booms increase opportunities for skilled labor, contributing to the rise in overall wage inequality in the economy. Simple extensions of the basic framework allow us to study the implications of financial regulation and globalization of financial services, as well as further topics. Finally, the paper documents and compares relative wage and employment patterns in the U.S., U.K., Germany, and France, providing suggestive evidence for the theoretical framework.