
Too much finance is bad for the economy - cs702
http://www.economist.com/blogs/buttonwood/2015/02/finance-sector-and-growth
======
bhouston
Summary:

> In short, the finance sector lures away high-skilled workers from other
> industries. The finance sector then lends the money to businesses, but tends
> to favour those firms that have collateral they can pledge against the loan.
> This usually means builders and property developers. Businessmen are lured
> into this sector rather than into riskier projects that require high R&D
> spending and have less collateral to pledge.

> A property boom then develops. But property is not a sector marked by high
> productivity growth; it can lead to the misallocation of capital in the form
> of empty Miami condos or Spanish apartments.

> R&D-intensive industries - aircraft, computing and the like - will be
> disproportionately harmed when the financial sector grows quickly. By
> contrast, industries such as textiles or iron and steel, which have low R&D
> intensity, should not be adversely affected

~~~
gaius
_In short, the finance sector lures away high-skilled workers from other
industries_

LOL. When other industries aren't run by chinless public schoolboys where
engineers are second class citizens, call me.

~~~
Bjartr
What is meant by "public schoolboys" exactly? I'm struggling to grok the
intended message.

~~~
bhayden
I believe he is saying it's run by people of weak moral fiber and character.

~~~
lifeisstillgood
In England Public School is where the "upper class" send their children for a
private education. Chinless wonders is a derogatory term for less than
intelligent children from those schools (in-breeding amounget limited
aristocratic gene pool lead UK to have royalty with unusually small jaw lines
for a while) And jobs in finance were considered till mid century to be
available only to those people who knew each other, went to the same schools
and used same networks.

In short - an industry run by in-bred, unintelligent, privately educated with
a small and elite job network.

------
guardiangod
Reminds me of a story.

One of my local universities (top 3 in the country) had a chemistry lab
competition and invited high schools from local cities to participate. My
younger sister was selected to be part of her school's team.

So she went and won the competition. The deen of science was so impressed by
her performance that after the reward ceremony he invited her to enrol in the
science program. She replied no and that she was already accepted into the
university's school of business (like most of her overachieving classmates).

According to my sister, the deen was both taken aback and looked sad at the
same time. So here's an anecdote to you.

~~~
kqr2
In a somewhat related issue, many of these financial firms will recruit top
science & engineering talent at competitive universities. In some sense, it
would have been better if these people had just studied finance to begin with
since that would have opened a spot for someone who really wanted to practice
science and engineering as a profession.

~~~
tanderson92
While what you say is true, I would draw a different conclusion. It seems more
likely that the students would prefer working in a field closer to what they
studied, but the lack of positions means they had to look elsewhere. Finance
knows they can find people with highly transferable skills in sci/engineering
at competitive schools, so the brain drain is really the fault of the job
market in the sciences and engineering.

Of course you can still look at it as finance not investing in long-term R&D
such as in science and engineering directly causing this brain-exodus (as
opposed to brain drain), so it's still finance's fault!

~~~
dagw
That's like a friend of mine with a math degree. He didn't want to work in
finance, but despite his best efforts he could not find anyone offering him a
job where he would get to use his degree. So he ended up in finance after all
and gets paid lots of money and works on interesting math problems.

------
eldavido
I'm an engineer. I could go into a high-risk career trying to cure cancer, or
I could flip houses.

By my (admittedly rough and speculative) math, I'd make more money doing the
second.

This has nothing to do with finance and everything to do with how capitalism
privileges owners. Just because I _can_ do something (e.g. cure cancer)
doesn't mean I _should_ do it out of some regard for the "public good",
requiring great sacrifice, work, stress, and low pay, on my part. I might
think differently if I got paid 1 cent for everyone who used my cancer drug,
but that's just not how things work today.

~~~
rayiner
I hate it when people complain about bright kids going into finance instead of
STEM. My brother went to an Ivy and majored in physics. He asked me sometime
junior year what he should do with his life. He'd already worked in research
labs on nanotech, and was seriously considering getting a PhD. I told him to
apply for finance and consulting jobs instead. He's glad he went into finance.
He gets a ton of responsibility and respect at work, instead of getting dumped
on by the hierarchy of a research lab or academic department. And he makes
more two years out than PhDs at the peak of their career.

Our society rewards those who own or help manage capital, and reserves the
best healthcare, education, and housing for those with the most money. At the
same time, our industries are structured so that scientists and engineers give
up control of the technologies that create the capital in the first place.
Entrepreneurship as practiced in Silicon Valley offers a little bit of
reprieve from this, but just a little, and who knows how long it will last. In
light of all this, I view telling kids to go into science or engineering
similarly to telling kids to go pursue theater or art. If it's your burning
passion, go ahead, but I don't consider it the most rational choice.

~~~
Chinjut
The complaints are not necessarily directed at individual people who
rationally choose careers in finance over other vocations, given the system
they live in. The complaints are to a large extent over the fact that our
society has been set up this way, with the goal of perhaps trying to change
that so that people would feel less incentive/need to abandon science,
mathematics, etc., for finance (in multiple senses!).

~~~
chongli
It hasn't really been _set up_ this way. It didn't even evolve to be this way.
It's ultimately a law of nature: ownership of capital yields exponential
growth. The more you start with, the faster you grow. Most other sorts of
vocations yield linear growth.

~~~
mietek
A law of nature? Are you joking?

It absolutely _has_ been set up this way, after having been set up in the
_opposite_ way for quite a while.

 _> Historically, some cultures (e.g., Christianity in much of Medieval
Europe, and Islam in many parts of the world today) have regarded charging any
interest for loans as sinful._

 _> The pivotal change in the English-speaking world seems to have come with
lawful rights to charge interest on lent money,particularly the 1545 Act, "An
Act Against Usurie" (37 H. viii 9) of King Henry VIII of England._

[http://en.wikipedia.org/wiki/Usury](http://en.wikipedia.org/wiki/Usury)

~~~
chongli
Usury and debtor's prisons, like slavery, died out not because they were
morally reprehensible but because they gave way to more efficient means of
achieving growth. Don't kid yourself.

~~~
mietek
_> Usury and debtor's prisons, like slavery, died out not because they were
morally reprehensible but because they gave way to more efficient means of
achieving growth. Don't kid yourself._

The word “usury” means either the practice of making unethical loans, or
simply charging any interest for loans. It should be clear that neither form
of usury has died out — even if you consider regular loans ethical, surely
you’ve heard of “payday loans”?

~~~
chongli
Neither has slavery but both ills are greatly diminished from their peak. It
is now more profitable to do other things (lend at reasonable rates, pay
wages) due to a variety of factors (mostly technology).

~~~
mietek
You objected to the assertion that society has been set up to reward ownership
of capital. You somehow fail to acknowledge that when lending at interest is
disallowed, owning capital does not automatically lead to accumulating more
capital — a process which you called “a law of nature”, and which is clearly
anything but.

The question is not whether reasonable interest rates are more profitable than
others, but rather — whether society would be better off if lending at
interest was disallowed altogether. I submit that it would.

------
esja
A huge part of the problem is where modern finance goes, i.e. what it
finances, and why.

The traditional definition of a bank as a middleman between savers and
businesses is very, very wrong.

Almost all bank financing is directed at existing assets, mainly real estate,
and that financing is unconstrained by deposits.

Therefore it is mainly speculative and parasitic, rather than investment-
oriented and productive. It is also self-reinforcing in that finance drives up
prices which become collateral for more finance... and so on.

Hence... inequality, stagnation, and the rest.

Adair Turner gives a good overview here:
[https://www.youtube.com/watch?v=UVQdeb0EdWA](https://www.youtube.com/watch?v=UVQdeb0EdWA)

------
gumby
Basically bankers are like lawyers, gardeners, cooks, doctors, pool cleaners
etc: service jobs to help other people get things done. When you elevate the
sector to have implicit value you get a terrible distortion.

~~~
bhouston
I agree with a caveat. In the grand scheme of things everything is a service
to help others get things done (there is no final all important job) and there
needs to be a balance.

~~~
bonaldi
Isn't there a sense in which the jobs that serve the bottom of Maslow's
hierarchy _are_ the final all-important ones.

If we don't have food production, heat production and shelter production, the
lack of financiers or telephone sanitizers is going to pale.

------
Animats
The US finance industry uses self-generated work which generates commissions.

One of the drivers behind this is the tax preference for debt over dividends.
There's been a trillion dollars worth of stock buybacks since 2008, an action
taken mostly to reduce taxes. That generates work for Wall Street, and wealth
for those "near the money", working on various deals.

Then there are "hedge funds". Hedge funds, as a class, underperform the
market, partly because of their excessive fees. The traditional hedge fund fee
is "2 and 20", or 2% of the amount invested each year plus 20% of gains. This,
too, is self-generated activity of Wall Street.

Then there are Exchange Traded Funds. Regular mutual funds are priced once a
day, after the market closes. ETFs are constantly traded, generating
commissions. ETFs have some tax advantages over regular mutual funds, and are
thus another exploit of a flaw in tax policy. They can also be shorted and
optioned, which are zero-sum operations which do nothing for the economy.

Then there's high-frequency trading, which is a form of front-running. This
skims a tiny percentage off of other transactions.

None of this contributes to capital formation, and most of it was illegal a
few decades ago.

~~~
jeffreyrogers
I think you're taking an overly pessimistic view on a number of things. Both
volatility and bid-ask spreads are down considerably since the growth of high-
frequency trading.

Buybacks in general are bad for everyone involved because they're often done
when valuations are high, however, they can be beneficial to shareholders when
valuations are low.

Shorting helps facilitate price discovery and options are used to protect
against large downside risks.

> Hedge funds, as a class, underperform the market, partly because of their
> excessive fees.

You're thinking of mutual funds. Hedge funds as a class do outperform the
market, even after fees.

~~~
pinky1417
Hedge funds do indeed underperform the market:
[http://www.zerohedge.com/news/2013-12-13/hedge-funds-
underpe...](http://www.zerohedge.com/news/2013-12-13/hedge-funds-underperform-
sp-5th-year-row)

Same with mutual funds. With both mutual funds and hedge funds, investors are
paying a ton of money for nonexistent skill.

~~~
jeffreyrogers
You chose a five year period of underperformance when the markets are doing
extraordinarily well. On the whole HF returns are higher than the market by
about 6%. And in particular during the financial crisis hedge funds did better
than the market as a whole.

------
leereeves
No paywall via Google:
[https://www.google.com/search?q=%22Warning:+too+much+finance...](https://www.google.com/search?q=%22Warning:+too+much+finance+is+bad+for+the+economy%22)

~~~
woodchuck64
Don't you mean
[https://www.bis.org/publ/work490.htm](https://www.bis.org/publ/work490.htm)

------
Gimpei
The economist article makes it seem like there's a lot of rigorous empirical
evidence behind this result, but it is a fundamentally theoretical result.

Basically, the authors come up with a toy model that, given a long list of
assumptions, produces the reported result.

They then test these results by running a simple cross-country regression with
no time dimension and a sample size of around 300.

I don't place much stock in these kinds of studies. Empirically speaking,
there are just too many confounds in cross-country studies for them to be
convincing. Theoretically speaking, the assumptions are highly unrealistic for
all the reasons that have been said before. With a little bit of ingenuity,
these models can be made to say just about anything.

~~~
throwawaykf05
I have only looked at a specific field, but I have noticed similar issues with
all the model-based studies I've seen. I don't even bother considering papers
that don't involve empirical data and analysis, because at least then they
have some solid tie to reality. (Assuming their data, assumptions and
hypotheses are reasonable, of course.)

------
tbrownaw
No, a large financial sector is an _indicator_ of inefficiencies elsewhere.
Else, there wouldn't be a reason to pay middlemen to solve said
inefficiencies.

~~~
randyrand
The financial sector does a lot more than play middle man (in fact arbitrage
is so quickly found these days its a hard to make much money doing this
anymore)

Primarily, they invest. Putting money into places that need capital and will
likely grow.

~~~
kevin_thibedeau
Holding a position for a few days, hours, minutes, or seconds is not
investing. It's gambling.

~~~
randyrand
The financial sector holds things on many different timescales, not just
minutes or hours. Sometimes for decades if its profitable.

------
lordnacho
True story coming up.

I did my undergrad/master's at Oxford. The course title was "Engineering,
Economics, and Management". Supposedly it was roughly 2/3rds of the
Engineering course, and 2/3 of the "Economics and Management" course, but when
you put it all together it seemed like 3/4 Engineering.

In the last year, there was a 6-month placement, which you were to use as
experience to write a thesis. You could choose from anything that fit under
any of the three rubrics (Eng, Econ, Mgt), and someone would find you an
appropriate advisor, ie a prof from the Engineering School, the Econ
department, or the Business school.

The kind of companies we got to show up were mainly banks. There was the
occasional engineering company as well as a few household industrials.

I didn't get any of the coveted bank jobs. I did manage to show up very late
(thank you Great Western railways) to an engineering interview, and got
offered the job anyway. The money on offer was £11K/year, which didn't seem
enticing at all, even for an internship. I ended up taking a marketing job at
a major chip manufacturer, which was happy to pay 15K. So I rented a place in
this little industrial town and got to work on powerpoint for half a year. (I
should say I had a great social life, and I know friends who are still there
13 years later.)

So of course one day, I go to visit a coursemate who did manage to get a bank
job, at a place that would later be called the giant vampire squid (not sure I
agree with the epithet). So, what does he get? £26K a year. Free apartment
within walking distance of work, on the South Bank. Gym and pool included.
That one bedroom apartment, at that time, was probably 250/week. So basically
he's making £38/year.

It's little wonder people want to work in finance when the numbers are that
skewed.

How many of my ~30 EEM coursemates went into engineering? I can think of one.
Just about everyone else went into finance.

I remember meeting a guy early on who'd started in Engineering. I asked him
why he'd quit. He said "One day, I accidentally saw what my manager was
making".

Is it a brain drain? Quite possibly. A lot of the brains in finance are
fighting a zero sum game with each other. How can I price this derivative a
little more smartly than the next guy? How do I grab the arb before another
guy does it? How do I get a guy to trade with me and not someone else? How do
I get my firm's name on this tombstone?

~~~
sweetmarine
Interesting you mention the squid, things aren't what they used to be. Don't
get me wrong, it's a good place if you are rich and well-connected already,
and if you join the front office, you will probably fit right in. But if you
are a programmer, well, they are building the biggest single office in India
of any American company with space for 9,000 people. Your job will probably be
next.

------
golemotron
> In short, the finance sector lures away high-skilled workers from other
> industries. The finance sector then lends the money to businesses, but tends
> to favour those firms that have collateral they can pledge against the loan.
> This usually means builders and property developers. Businessmen are lured
> into this sector rather than into riskier projects that require high R&D
> spending and have less collateral to pledge.

The article doesn't explain the linkage. Why would poaching of high-skilled
workers lead to investment in companies with collateral? Or, are they just
saying that whenever finance becomes prominent it attempts to drive out risk
ruthlessly?

~~~
rqebmm
I don't think they are saying that luring skilled workers _leads_ to lending
to easily collateralizable businesses. Just positing that those two separate
statements are true.

------
jackgavigan
There's probably a crossover point when the finance sector's focus shifts from
efficiently allocating capital to extracting economic rent from financial
activity

------
stretchwithme
Its subsidizing the risks that are bad for the economy.

If you're taking a lot of risk and it blows up in your face, you SHOULD lose
your shirt.

The people who are NOT involved in your decision should NOT be made to pay.

People can only learn from mistakes if behavior and outcomes are tightly
coupled, not if all the outcomes happen to other people and you start getting
all your bonuses next year like nothing ever happened.

------
josu
Talking about thresholds like:

>The 2012 paper suggests that when private sector debt passes 100% of GDP,
that point is reached. Another way of looking at the same topic is the
proportion of workers employed by the finance sector. Once that proportion
passes 3.9%, the effect on productivity growth turns negative.

Does not make any sense. Each economy is different, and the available data is
probably not enough to give such accurate numbers.

>Ireland and Spain are cases in point. During the five years beginning 2005,
Irish and Spanish financial sector employment grew at an average annual rate
of 4.1% and 1.4% respectively; output per worker fell by 2.7% and 1.4% a year
over the same period.

Using Spain as an example for "output per worker" is not a very good idea,
they somehow broke productivity growth in 1994 and it's been stucked since
then [1].

Productivity is affected by many factors, so conducting a ceteris paribus
analysis is very complicated if not impossible. There is a really interesting
book written by a journalist about productivity: The power of productivity [2]

[1]
[http://www.gapminder.org/world/#$majorMode=chart$is;shi=t;ly...](http://www.gapminder.org/world/#$majorMode=chart$is;shi=t;ly=2003;lb=f;il=t;fs=11;al=30;stl=t;st=t;nsl=t;se=t$wst;tts=C$ts;sp=5.59290322580644;ti=2006$zpv;v=0$inc_x;mmid=XCOORDS;iid=phAwcNAVuyj1jiMAkmq1iMg;by=ind$inc_y;mmid=YCOORDS;iid=rcTO3doih5lvJCjgLSvlajA;by=ind$inc_s;uniValue=8.21;iid=phAwcNAVuyj0XOoBL_n5tAQ;by=ind$inc_c;uniValue=255;gid=CATID0;by=grp$map_x;scale=log;dataMin=194;dataMax=96846$map_y;scale=lin;dataMin=536;dataMax=64150$map_s;sma=49;smi=2.65$cd;bd=0$inds=i211_t001980,,,,;i105_t001980,,,),

[2] [http://www.amazon.com/The-Power-Productivity-Poverty-
Stabili...](http://www.amazon.com/The-Power-Productivity-Poverty-
Stability/dp/0226476987)

------
PythonicAlpha
The result can be seen in Great Britain:

Former British prime minister Thatcher ("Iron Lady") decided, that the future
is in the service sector. Also the most lucrative service sector was the
finance sector. So it was fostered to a big extend and the finance sector of
London is one of if not the biggest industries of GB.

In fact, it is all that is left of the former Empire. All other industries of
GB are not competitive any more. Car industry is not and many of the well
known car brands are already sold to other car corporations. Mini belongs to
BMW, so does the renowned "Rolls-Royce" brand, Rover was sold and sold again,
now belonging to Tata.

The concentration to the finance sector did the other industries of the
British isle not well. All what is left, is finance and so Britain is
struggling and fighting every time, when the EU wants to regulate the finance
sector.

They are captives of their own system.

------
pippy
The lack of regulation is more of a concern than the human resource allocation
or event the debt to GDP ratio.

The derivatives market is valued over $700 trillion dollars (forbes, 2013
est.), while the GDP of the world is S$74.31 trillion (2013). There's also
options and swaps markets. While their benefit is dubious, deregulation has
allowed these markets to ballon to ridiculous levels.

These markets keep investment capital away from more beneficial investments,
such as tech firms, infrastructure and research and development. These are
things we desperately need investment in. At the same time the property market
doesn't need more investment, and is devastating if speculation is allowed to
occur.

~~~
tdees40
The derivatives market IS NOT valued at over $700T. That represents the gross
notional of all derivatives, but most of those trades have equivalent
offsetting positions. Gross notionals are virtually meaningless.

~~~
pkaye
Until there is a flaw in the offsetting positions and everything collapses in
a heap.

------
kokey
> ONE of the biggest political issues in recent years has been that Wall
> Street has done better than Main Street. That is not just a populist slogan.

The economist behind a paywall is like an irony overload for me lately. This
time using a populist title and introduction paragraph is all I see.

------
eyphka
Would love to see the numbers on brain drain from the technical fields to
finance. Any takers?

~~~
jeffreyrogers
I'd be interested in this as well. My impression is that it isn't as severe as
many believe and the phenomena is equally prevalent in tech as well (i.e.
people doing startups who would otherwise do something more productive).

From what I've observed the people going into finance are a separate class of
people from those who want to be doing research.

A further issue is that the quality of life for PhDs is low. Something like 1%
of PhDs end up with tenure track positions and many are stuck doing years of
postdoc work. It's easy to blame finance, but there are problems with other
parts of our society that are driving peoples actions as well.

------
known
[http://www.lietaer.com/2010/03/the-worgl-
experiment/](http://www.lietaer.com/2010/03/the-worgl-experiment/)

------
joshjkim
Here's an alternative theory: Lower productivity in an economy causes a larger
finance industry, not the other way around.

The financial industry is the “marketplace” where people (supposedly) figure
out the best places to deploy capital when the decision is not otherwise
clear, or access to such investments is difficult, or the capital holder does
not have expertise or want to learn to expertise to deploy the total amount
successfully. If that’s true (and I’m not sure it is but that’s the sales
pitch anyways), the finance sector grows as productivity in other industries
decreases, because then (a) the decision to put capital into other industries
becomes less and less clear and (b) the financial services therefore become
more valuable.

(If you want to change this, you need to modify the incentives to either (a)
make the finance sector less appealing, (b) make other industries more
appealing or (c) both - but that's another issue altogether)

(The biggest problem with the theory above is of course that prices and
returns are often a function of things other than actual productivity and
instead rely on future potential productivity, which is another word for
speculation, and so there’s a huge opportunity to manipulate the markets which
happens all that time, resulting in people making $$ without actually being
more productive)

For the HN audience, the good/interesting thing is that we are currently in a
market where tech is one of the industries with (relatively) high productivity
(for extreme example, see WhatsApp, Instagram, etc., where very few
individuals created very much value), and therefore you see interesting
trends: more institutional money is pouring into the market which leads to
more money competing for fewer start-ups which leads to higher valuations.

See: [http://www.wsj.com/articles/venture-capital-fundraising-
jump...](http://www.wsj.com/articles/venture-capital-fundraising-
jumped-62-in-2014-1421039104)

On a human capital level, talent is also moving (relative to historical
trends) from finance to tech, and on an anecdotal level, the number of former
bankers turned MBAs turned Product Managers has been pretty astounding to me -
fair amount of press addressing the issue as well:

[http://finance.yahoo.com/news/mbas-abandon-wall-street-
for-s...](http://finance.yahoo.com/news/mbas-abandon-wall-street-for-silicon-
valley-140238593.html) [http://money.cnn.com/2014/08/22/investing/wall-street-
silico...](http://money.cnn.com/2014/08/22/investing/wall-street-silicon-
valley-talent/)

~~~
joshjkim
(Another theory as to why financial services become larger as economies
develop: as markets advance and become more and more sophisticated and fluid,
capital gets rapidly deployed in industries where productivity is high such
that the prices in such industries get driven up quickly and the ROI lowers,
rendering the productivity less financially rewarding, UNLESS you are the
first one there, which is another selling point of the finance industry (aka.
finance will find the deal and get their first) - really another topic though)

------
WalterBright
The problem economists face is the delusion that the economy would be better
off if they were put in charge of it. -- my father (an economist)

------
sebastianconcpt
Industry brain drain. 3.9% vampirism is survivable. More than that and we
start to play risk-mania games with the point of no return.

------
danbruc
Meh. What do we need economic growth for anyway? Producing and throwing away
another hundred million tons of food every year? New phones every six months
or once a quarter? A third car? More shoes? We have enough of everything and
much more, there is absolutely no need to grow western economies any further.

~~~
nawitus
Why is the current standard of living the ideal? Why not 10 years ago, or 10
years into the future? How about 20? 30?

~~~
danbruc
I don't think that the current standard of living is ideal and I really hope
it will improve a lot. But I don't see that improving the standard of living
requires economic growth, I think change will do.

~~~
nhaehnle
This is a common misconception about economic growth. Economic growth often
means more physical stuff, but there is by no means a fixed link between the
two. Higher quality products built out of the same amount of physical stuff
have a higher price, for example, so if we somehow transitioned the economy in
that direction, there would be economic growth - and a corresponding increase
in the standard of living - without pushing environmental concerns, for
example.

------
Havoc
It works just fine. Well until there is a loss of confidence anyway.

------
grandalf
there is also the interesting coordination game by which systemic risk is
ignored.

------
ixtli
"Too much finance is bad for the economy. Please pay us to hear our
reasoning."

~~~
puranjay
"Or, don't pay us and get used to getting your news/op-eds in GIF form through
Buzzfeed"

What would you rather have?

~~~
maximuscoolimus
It's never quite that extreme. I've yet to see a respected publisher devolve
into GIF-delivered content out of financial constraints.

That said, there are plenty of free publications with quality writing. Paying
for an article hardly correlates with its excellence.

~~~
dagw
_I 've yet to see a respected publisher devolve into GIF-delivered content out
of financial constraints._

Check in with The New Republic in a year or so.

