Investment Bankers, Dentists, and the Inequality Puzzle
By Arnold Kling
But the biggest winners of all have been top earners in the financial services industry. Thus, according to Institutional Investor’s Alpha magazine, James Simons, a hedge fund manager, earned $1.7 billion last year, and two other hedge fund managers made more than $1 billion. The combined income of the top 25 hedge fund managers was over $14 billion in 2006.
…Most dentists today earn little more than their counterparts from 1979, but the best paid dentists earn almost three times as much.
The pointer comes from Greg Mankiw, who wonders how dentistry can be a superstar market.
A couple of possibilities. First, dentistry is not much fun, so that if you happen to enjoy it or are willing to work hard in spite of not enjoying it, maybe you can earn more than the typical dentist.
But the other possibility is that there are spillovers from inequality in part of the economy to inequality in other parts of the economy. Once you have rich people, then service providers who cater specifically to the rich may be able to charge higher prices. My guess is that a popular dentist in Beverly Hills or Bethesda can charge a lot more than the best dentist in Peoria.
As long as there are actual or perceived differences in quality of service, my guess is that there are rents to be earned from establishing a good reputation with the super-affluent. This is probably as true for Greg Mankiw’s employer as it is for dentists and other professionals.
So, once you have some inequality to begin with, that inequality can spill over into service industries where providers can acquire reputations among the rich. That may account for some of the rents earned by the richest investment bankers, as well. Corporations and wealthy individuals will pay a premium for a reliable investment banker or hedge fund manager, which creates a differential between earnings at the top tier and earnings of those who have not yet established stellar reputations.
And of course, this ties in with the whole issue of college education and signalling. The story I’m telling for the superstar phenomenon is a signalling story. The fact that you are the dentist for some rich folks will be a signal to other rich folks that you are a reliable dentist. Relative to people on modest incomes, rich people may be particularly sensitive to signals and insensitive to price.
It could be that employers who require a college degree are particularly sensitive to signals and insensitive to cost. They are more worried about wasting management time and training effort on a lousy hire than they are about over-paying for skills.