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Too much finance is bad for the economy (economist.com)
313 points by cs702 on Feb 20, 2015 | hide | past | web | favorite | 207 comments



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


> 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

So, buy barrier puts on those R&D intensive industries that is activated by a high growth of the companies in the financial sectors (bank...). As someone who used to do pricing, I find it pretty ironic that I can get investment tips from an article criticizing finance - I am not working in finance anymore and tend to agree with the article, though.


Sounds like the ABCT to me.

http://en.wikipedia.org/wiki/Austrian_business_cycle_theory

Sounds to me like printing money and pumping it into finance leads to an unsustainible economy.


Austrian school economics seems unheard for many. After skimming books by Mises, I believe Austrian school is on the right track. But the tool for it has not ready at that time. When I learned about complexity systems. I think it can supply the right tool. And just this week, I'm reading papers by W. Brian Arthur. (http://en.wikipedia.org/wiki/W._Brian_Arthur) Quite fascinating experience.

Another issue with economics is it has very tight connection with financial and political systems. Until some players could take advantage with those more advanced theories, a new wave of mind-sets would not emerge and widely accepted by the public. Money, power, information, control, it sounds like crazy words. When things become closer to those, you have to think harder to get closer to the reality, if you do care about it.


That's an interesting thought. Any papers you'd recommend in particular?


"All Systems will be Gamed: Exploitive Behavior in Economic and Social Systems"

http://tuvalu.santafe.edu/~wbarthur/Papers/All%20Systems%20G...

He has a new book with all his papers: Complexity and the Economy (http://www.amazon.com/Complexity-Economy-W-Brian-Arthur/dp/0...). I have not bought it yet. The preface is free to download here: http://tuvalu.santafe.edu/~wbarthur/Papers/Complexity%20&%20...


Since there is an obvious political slant to the message, it should be pointed out that it is the finance industry itself that is "printing money". So take that into account while thinking through the political implications, if skylan_q's premise is actually true.


And it should also be pointed out that only governments can grant the power to print state-approved money. If you don't have permission, you will go to jail. There are countless movie plots dedicated to this simple topic, it should already be pounded into most peoples' minds already.


That's what it sounds like to me too. Unfortunately, most people don't want to hear the truth so they downvote you. Big news for the ostriches; we never paid for the 2008/9 mortgage bust and those chickens are coming home to roost -- fattened up by the Feds ZIRP, TARP and continued credit creation. The mortgage bust was papered over by the Fed printing $4B+ and that is what they admit. It wouldn't surprise me if they printed double that to secretly loan to US and foreign banks and governments. Actions have consequences and soon we will see what von Mises meant by the crack up boom.


See also: Dutch Disease

http://en.wikipedia.org/wiki/Dutch_disease

(Also from The Economist initially)


see also: the present Australian economy.

Our future is not bright...


Seems an odd statement. Australian economy is awesome, transitioning from resource to service long before it needs to... Which part of the future isn't bright?


Exactly what about it is awe-inspiring? In what services does Australia have an intrinsic advantage, or an advantage that will remain for the medium to long term? Why is a service economy a good thing?

Australia went through the entire commodities boom without posting a current account surplus. Australia has been a net debtor every year since 1973. Australia has no money to invest in itself because its population is too busy borrowing money from overseas to speculate in real estate such that shitty brick veneer houses built in the 1960s are worth 1 million dollars.

Our economy is so dependent on borrowing from overseas for "growth", that if we stopped borrowing and started paying back, then our economy would shrink, due to all the interest going overseas. Unlike Japan, for instance, Australian private debt is ultimately owed overseas, in another currency.

If that borrowing had been directed towards productivity rather than real estate speculation things might be better.

As it stands, the really expensive real estate is nothing more than a massive overhead for the economy. I challenge someone to argue how it aids Australia's productivity and competitiveness.


If GDP is increasing, there is no reason to get account surplus, but instead to manage debt/growth ratio. Admittedly Australia hasn't done too well on this recently, but it's still in a good position (~30% of GDP). Unless you subscribe to the "Countries should be run like households" school of economics.

Service based economies are desirable because they are human resourced (i.e they are renewable), and given Australia was resource based, there was a significant risk it could just sit on that and fall apart when it runs out. I'm not sure what you are talking about with "Intrinsic advantage"... Are their states with service based intrinsic advantages?

The awe-inspiring part: The economy has done nothing but grow (in recent years, and has been one of the only ones to do so).

Is it perfect? not at all. But seriously, you've got to have pretty massive global blinders on to say its future is not bright.


That ~30% of GDP number is government debt.

I am not talking about government debt. I am talking about private debt.

Australia has a much much worse private debt problem than a government debt problem: total private debt ~150% GDP; mortgage debt ~80% GDP; gross foreign private debt ~85% GDP; gross federal public debt ~20% GDP [1].

The reason you take on debt matters. Almost all of that debt went towards unproductive bidding up of real estate. Much of the "growth" experienced in the last 20 years was just making the economy larger by importing more money via debt from overseas. I challenge anyone to argue that was a prudent course of action, unless you were a political party that wanted to get re-elected by making people feel richer.

Why intrinsic advantage? Australian wages/salaries are high, in part, because the average Australian has to pay so much to service their mortgage debt. Because service economies are human resourced, any where with humans can do those jobs. If Australia is inherently more expensive due to the overhead of high house prices, what services can we offer for which others are willing to pay a premium? Also, we must have a service economy bringing money in from overseas, rather than just supplying services internally, because we still have all that interest to pay on our debt.

The future for Australia might be bright in as much as it is slightly less dark than some other countries.

[1] https://independentaustralia.net/politics/politics-display/a...

edit: figures


Australia's competitive advantage is the rule of law. This is the main reason it and places like Canada are valued by foreigners buying real estate.

Australia is particularly valued as the only non-city-state country with close to perfect rule of law and predictable individual rights in Asia, i.e. a relatively short flight away from the homes of the current buyers. Fancy taking a punt on the direction foreigner investment rules are taking in the next ten years in Indonesia?

Arguably, Singapore's and Hong Kong's economic success stems from similar concerns.


I didn't RTFA, but I have a question.

> the finance sector lures away high-skilled workers

I only just recently learned that doing finance is something people want to get into. And I still don't understand why, so that's my question.

See, I've always thought of it as this thing that people only do because they thought they were supposed to. I'm in a maths degree right now, so I really know this feeling of not being qualified for anything real.

Other than being a teacher, which is the thing I want, being an office boy in an insurance company is like the only other option I've ever been given.

So I always thought finance people were only in it for that same reason. Not having a choice.

What's the appeal? I'm still learning.


Money. The amount of Money one can make in finance is the appeal. I graduated with my engineering degree ~8 years ago, if I knew in college what I know today about what any "real world" work environment/income levels are, I would have gone into the finance sector, hands down. Its's not too late for you. Sell out, cash in.


Can't say I agree with these statements. I would wager that the scale of money a rapidly growing finance sector is using is more important than an unsubstantiated claim of industry brain-drain.


Industry brain drain is a known phenomenon in other circumstances, such as the natural resources trap. It's plausible that it could occur here.


Totally agree. When the finance sector grows, demands for return interest on capital investment intensifies, acting as a gravity-well for capital away from development. Firms like Goldman make every investment require higher and higher returns at a greater and greater scale. Money chasing money. Casino economy. Instead of opening a new line of business, your profits must be funneled into paying back on that loan at higher and higher rate.


Take a look at the allergy to investment in broadband in the US.

The economics for Fiber Optics looks good in almost all situations in the US if you look at a ten year horizon. In the short term, however, Verizon can make more money by building an LTE infrastructure that costs more and does less and will be thrown away in five years and has 15x the OPEX of an optic fiber network.

Today interest rates are crazy low and you'd think a company like Frontier would do this and know that that they won't be overbuilt in the flyover states and will pay a great dividend year after year for decades, but they don't.

But just watch, once interest rates are crazy high you'll see companies scramble to get money.


Frontier's home city of Rochester had to redeploy fiber for all their trunk lines after a disastrous ice storm in the 90's. You'd still be lucky to get 4Mbit DSL from them. They are bottom feeders only out to milk a dying cow. Improving infrastructure is cost center that doesn't pad the execs wallets so it gets ignored.


I've often held the opinion (and someone argue/correct me if I'm wrong here), that a lot of this artificial demand for growth is a problem due to inflation. I.e. Government keeps devaluing the currency and lowering natural interest rates, causing individuals (and banks) to seek riskier returns. This effect is pervasive in the economy.

I can't even begin to comprehend what our economy/world would look like if interest rates and inflation weren't controlled/manipulated by state governments. Sustainable companies? Ones that don't chase every tiny increase in short-term profit/gain? I don't know.

Would we even have such a huge equity market? Most of everyone's money is in the equity market, and I have no idea why. Everyone is trying to leverage what little they have to "beat inflation" that they only thing they can do is either a risky business venture, or play the equity market.

</rant_while_under_the_influence_of_food_poisoning>


The bond market is larger than the stock market (by 2x or more). There's also quite a few people whose primary asset (most of their money) is their house.

I think you are also using a different definition of natural interest rates than is typical in economics jargon, in the jargon, the natural interest rate is approximately the rate at which the economy is growing (it isn't particularly likely that easy money is restraining economic growth, so low central bank rates shouldn't lower it; if anything, they would tend to push them higher).

Poorly structured regulations are probably a bigger problem for the economy than easy money. An example would be regulation that appears to approve of the activities of a company that is giving derivatives high ratings when they know it is bullshit. That regulation either needs to be effective or to not exist.

Another example would be the tax incentives surrounding mortgage interest, combined with pseudo-governmental programs to lower the interest rates on mortgages. It turns out that people don't buy a house based on some carefully estimated value of the house, they buy the house based on the payments they think they can afford to make. Given that psychology, the tax incentives lead people to pay a higher price for a house, and the lower interest rates lead them to pay a higher price for a house. What do you get? Skyrocketing housing prices that don't particularly benefit anybody.


Lower inflation favors those with lots of capital parked in low productivity growth, high output sectors like resource extraction (oil, logging and mining). It makes it harder for sectors with intense R&D and complicated LoB like aerospace and other tech.

A good sampling of some big national success stories exist over the last half century or more where inflation was over 4% where economies grew and diversified much faster than the US in the same period. Up to a point, inflation alone is not a very insightful indicator of economic health. Lots of other factors have to be compared, too.


The really scary thing is that our leaders talk like this is a good thing. It's as if to them there is no other way to make money but to put your money together with other people's money and hope that someone with real initiative comes along and generates profit with it.

In short it seems like they've created a system where the only way to truly be successful is to work in high finance, where you collect 2% of everyone's money as a fee no matter what.


The finance sector does more than lend/invest capital themselves. Large investment banks provide a wide range of services for companies (e.g. bond issues, IPOs, secondary offerings, working out M&A deals, brokerage services, ...). The biggest problem with the finance sector is that it is extremely opaque and almost no one outside the industry understands what financial institutions actually do. Yet, everyone seems to know that banks are bad.

Which is better: a bright graduate working on making a large web company's advertising algorithms slightly more efficient or the same person working for an investment bank on a bond deal that helps a biotech company raise more money for future R&D?


>Which is better: a bright graduate working on making a large web company's advertising algorithms slightly more efficient or the same person working for an investment bank on a bond deal that helps a biotech company raise more money for future R&D?

That's the very definition of a false choice. We should be pouring more resources into developing new technology itself, not just trying to advertise or fund it more efficiently. Right now small technical innovators are being absolutely starved of capital, and it's going to have some pretty dire consequences for the US economy in the coming decades. When is the last time that you saw a successful hardware startup that did something nontrivial (a la Intel)? The only reason software businesses are doing so well is because they require very little capital.

All of the shifting money between hands on Wall Street is sucking the air out of our industries.


> When is the last time that you saw a successful hardware startup that did something nontrivial (a la Intel)?

Define 'nontrivial'. I'd call Tesla and SpaceX nontrivial. Or what kind of hardware are you talking about? Maybe take a look here: https://angel.co/hardware

> All of the shifting money between hands on Wall Street is sucking the air out of our industries.

That's the very definition of a false cause and it's also so woolly that is barely means anything. Which money is "shifting hands on Wall Street" and what is is that even supposed to mean? Of course money is being transferred, that's the very idea of a financial system. And how does this "suck the air out" of anything? Banks are not the ones who would rather fund your photo sharing app than the next Intel. If you want to go down that route, blame the Angels/VCs who are the driving force behind what is getting funded. Or blame the people who are more interested in reading about/working on the latest flavour-of-the-month Javascript framework instead of actually tackling the hard(ware) problems. Wall St. are not the ones behind the wheel when it comes to determining which new ideas get attention.


Elon Musk nearly bankrupted himself funding SpaceX and Tesla.


IBM, Apple, Google, Telsa, Microsoft, SpaceX, Intel, BAE Systems, Raytheon, Lockheed Martin, Governments (a la ITER) and others, are pouring money in to R&D.

The lack of capital for small hardware innovators (if this concept even is true) is rational because there's little profit to be made there. The age of small hardware innovators has come and gone. To bring non-trivial innovative hardware to market is a huge undertaking and requires a lot of capital.

There's nothing unfair about this.


The economy wasn't blown up because an M&A or bond issue went bad. I don't think anyone seriously believes that "banks are bad", I think they (myself included) tend to think that "the banks we have are bad". It's a subtle, but important difference and totally consistent with the article.


>Which is better: a bright graduate working on making a large web company's advertising algorithms slightly more efficient or the same person working for an investment bank on a bond deal that helps a biotech company raise more money for future R&D?

The bright graduate working at the biotech company, of course.

You know, not that biotech companies actually train or hire permanent professional employees these days (source: fiancee is a biologist).


Returns are relative. Using the US example there has been a continious downward trend in post inflation returns over the last 100 years, but investment keeps growing.


Brains are part of the real economy. Money is just money, and large amounts of it flows through institutions of various brain quality without being "eaten".


I thought that the finance sector taking on too much risk is what led to the 2007 financial crisis? They would invest in things with less or no collateral to pledge.


The problem with the finance sector was actually largely the opposite: financiers were so confident the collateral would hold its value that they were happy holding loans made to people with little or no skin-in-the-game or ability to make regular payments. They assumption was that even if significant numbers of loans in a portfolio failed, the repossessed houses could be sold on, perhaps even at a profit,

Unfortunately the value of that collateral didn't hold up when a glut of repossessed houses appeared on the market and many prospective housebuyers suddenly found they couldn't borrow quite so easily any more.


The banks and mortgage brokers making all those "liars loans" knew that the loans weren't going to be repaid, but they didn't give an effing eff. They knew that they would be able to sell the mortgages in RMBSs and pay their loan officers and executives handsome bonuses for all those massive phony profits. They would blacklist appraiser who wouldn't give them appraisals to fit the loan they wanted to make.


Spot on. Other responses are naive. They speak of "the banks". There are two entities here: 1. companies 2. individuals working for companies who get commission for selling loans whether they get paid or not

Plus there are many many other problems with banking other than sub-prime which boil down to the above.

That's why we need to start putting individuals in jail.


This is ludicrous and ill informed.

To put someone in jail, typically they need to commit a crime. If someone lies about their income, and borrows money based on that information, the borrower has committed fraud, not the lender.

I'll grant that it is immoral to steer someone into a loan which they probably won't be able to repay. However, unless the lender's agent materially misrepresented the loan, it is not illegal.

The originate-to-sell model does introduce perverse incentives on the part of the lender's agent -- prudence takes a back seat when you don't hold the note. But if a borrower lies, and the lender's agent willfully ignores the lie and then sells the loan, both the agent and the borrower have defrauded the buyer of the loan, and it is that investor who is the victim of the fraud.

No one was making borrowers take out loans. The reason why no one is going to jail, is because no one is wants to talk about 1) the culpability of the borrowers; and 2) the trillions of dollars of lost wealth did not flow into Wall Street bonuses, rather it went into loans to the public which were not repaid.


Is it not part of the banks responsibility to be checking that these loans can realistically be repaid? Would you lend a large amount of money to someone without a job and expect to see it all back?


It is their responsibility -- their responsibility to their shareholders. However, unlike an unsecured line like a credit card, the claim on the property that a mortgage entails, makes the more likely to be repaid even in the event of a default.

In the industry, the terms 'subprime' was often used interchangeably with 'home equity'. 'Home equity' was used not in the sense of the consumer borrowing 'Home Equity Lone of Credit', but rather that the basis of the loan was not the borrowers ability to pay, but rather the value of the home.

This made sense in an environment of rising home prices. No one defaults when they can just sell to get out of the loan. That was the realistic basis for the loan being repaid. (However in an environment of stagnant prices it fell apart.)


I'm sure you can find enough anecdata of predatory lenders to get your dudgeon up, but the reality is that they were a cause of the crisis only at the far margins. Th bulk of the crisis was caused by banks and borrowers making foolish decisions in good faith.

The crisis, like virtually all financial crises, was caused by leverage. Home buyers want it (they'd rather put 3% down than 20%); home lenders should be averse to it. The combination of the originate-to-sell model along with asset-backed security structures which were intended to de-lever the loans to make them palatable to investors had consequences which should have been foreseeable, but which were not.

People (and bankers) did not somehow become more greedy, more evil and more shortsighted in the lead up to the crisis.


> People (and bankers) did not somehow become more greedy, more evil and more shortsighted in the lead up to the crisis.

Actually, by most accounts, they did.

The problem was that when 90+% of your financial colleagues are betting that the market will go a certain way, it doesn't pay to fight that. That self-reinforces and things get worse and worse.

Look at the game theory:

1) I'm right about the economy going bust and the economy is about to collapse. Well, I can protect myself (a bit), but my company is going to collapse if the economy goes off a cliff and I'm out a job.

2) I'm wrong about the economy going bust and the economy is not about to collapse. Well, I'm still out a job.

3) I'm wrong about the economy going gangbusters and it goes haywire, I'm laid off along with everybody else.

4) I'm right about the economy going gangbusters and it goes gangbusters, "Yay! We're all rich. Where's the hookers and blow?"

I only have one good outcome--drink the Kool-Aid and pray I can get out before it all goes bust.


Prem Watsa of Fairfax Financial lost money for a few years betting against the markets, until the markets tanked in 2008 and he finally made a boatload on selling short. Unfortunately for him, he then turned around and invested his winnings in Blackberry. :)


I really find it hard to believe that people became more greedy, more evil, and more shortsighted.

1) there was a global capital glut chasing returns. 2) stability and growth in the US economy, made investing in US property (through mortgage backed securities.) 3) this additional capital was enough to prime the bubble and drive up home prices faster than the general price level. 4) a combination of economic and political factors in the US led to the growth of 'affordability product' -- subprime loans -- which kept the bubble inflating.

No extra evil, no extra greed.


> The banks and mortgage brokers making all those "liars loans" knew that the loans weren't going to be repaid, but they didn't give an effing eff. They knew that they would be able to sell the mortgages in RMBSs and pay their loan officers and executives handsome bonuses for all those massive phony profits. They would blacklist appraiser who wouldn't give them appraisals to fit the loan they wanted to make.

The problem that created the problem was still that people were investing in mortgages rather than companies doing R&D. You can't sell bad mortgages to investors who don't buy mortgages.


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.


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


Although the other comments covered the gist of it, you might be wondering why Britain's best private schools are called "public": http://en.wikipedia.org/wiki/Public_Schools_Act_1868

FWIW all the schools have relatively extensive scholarship programs whose breadth and funding is cyclical and dependent on the views of the Headmaster and Board.

Amusing anecdote: I attended Westminster (on a scholarship) under Tristram Jones-Parry who was known for both keeping the school at the top of the UK ranking for the duration of his tenure, and for expanding the scholarship programs. He was the quintessential "close to the troops" manager, he chatted with all pupils regularly, cornering them in the yard or the street to ask them their thoughts, and occasionally barging into a maths class and teaching it (incredibly well). When he retired and wanted to spend a bit of time teaching disadvantaged kids in state-run schools, his application was rejected by the government because he did not hold the appropriate teaching qualification. See: http://en.wikipedia.org/wiki/Tristram_Jones-Parry


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


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.


Are you suggesting that finance isn't?


I think that's mostly just a British thing.


What's your number?


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.


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.


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!


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.


I have generally seen people finishing PhD.s lately reluctantly start looking for jobs in alternate industries only because there is an extremely slim chance of getting a reasonably well-paid, secure job doing the type of scientific research they trained for. If they don't explore alternate options, they can easily be trapped in postdoc purgatory for a very long time.


That's an interesting story. It's too bad your sister had to make a decision like that while still in high school.

FWIW, the English term for a head of an academic department is spelled "dean", which is pronounced the same as "Deen", common as a person's name.


Business is much more lucrative than science. Not surprising.


It is kind of surprising actually. Scientists create more wealth than managers. If they aren't better compensated it indicates an economic inefficiency that someone could profit by eliminating.

There are obviously structural reasons why this hasn't happened or it would have already, but given the amount of money on the table, someone who figured out how to do it would stand to profit immensely.


That's a great thought.

I am assuming that the structural issue is that science in order to create the wealth must "open source" it's knowledge and this be unable to capture private profit, whereas corporations can maintain proprietary control and create less wealth but more profit.

If we do solve it however, perhaps through some patent system, we will incur another problem - Albert Einstein for instance (photons, relativity and atomic structure) would be owed about 20% of the entire world GDP ...

But yeah, I like the idea.


The patent system is actually highly problematic because it a) provides no reward for research leading to negative results (which is extremely important to scientific progress) and b) provides the money after the fact rather than while the research is being conducted, requiring scientists to solicit investors up front (and possibly not be able to find any) and then gives the fruits to investors who may or may not reinvest it into future R&D. Then on top of that the patent monopoly makes the new invention more expensive and discourages third parties from making improvements they can't deploy without permission, which reduces the overall value of the invention.

We might actually do better to just throw the patent system away and replace it with massive direct public funding of scientific research. The interesting question then is how to decide what to fund and in what amounts, which seems to be the heart of the problem.

And there is also another point, which is that maybe scientists aren't particularly underpaid, maybe it's that managers are overpaid, e.g. because investors in public companies are so diffuse and distant from the companies they're invested in that they can't prevent executives from paying themselves more than they deserve. If you solve that then fewer people will want to go to business school instead of becoming scientists and companies will have the money they're no longer paying managers to potentially invest in R&D.


>The patent system is actually highly problematic because it a) provides no reward for research leading to negative results (which is extremely important to scientific progress)...

And how is that different from absolutely any known system for managing science? You don't get publications for failed results either. FWIW I dedicated a whole quarter of my Master's thesis to a failed approach, just because I also thought it was important for progress, even though it provided little value from a thesis defense perspective

>and b) provides the money after the fact rather than while the research is being conducted, requiring scientists to solicit investors up front (and possibly not be able to find any)

Again, sounds like how the current proposal-for-grant system we have now.

> and then gives the fruits to investors who may or may not reinvest it into future R&D.

There really is no way to differentiate this from the alternatives. The government decides to invest based on a budget that is subject to way more conflicting forces than a profit-driven private entity.

> Then on top of that the patent monopoly makes the new invention more expensive ...

That is a commonly postulated hypothesis, but if one looks at empirical evidence, one finds a great deal of positive impetus to innovation provided by patents... in some industries. As always, the data is messy, the situations are complex, and the hypotheses are simplistic, but a large number of studies show that the patent system has significant benefits as well as costs. However it is impossible to tell from the data which one outweighs the other, mainly because it is like comparing apples and oranges. In general, though, risky, capital intensive fields are benefited more than harmed by patents.

>* massive direct public funding of scientific research.*

I don't know what you mean by "public", but to me it sounds like "government", in which case, see point above regarding budgets.


I read a "negative result" as different from a "failed result".

A negative result, which has scientific value but no patent value, would be something like, "We have conclusively shown that blood-letting by leeches is not an effective treatment for fever."

A failed result, on the other hand, would read more like "We were unable to conclusively determine one way or the other, but here's the method we used"

You could certainly publish the former (back in a time where that wasn't already accepted fact in the scientific/medical community), but it's unclear how you'd apply that to the patent (or even market) realm. You can't patent "stopping doing something".


I think this problem could be solved with relative simplicity: partially nationalize all patents based on publicly-funded research. The state becomes entitled to a percentage of royalties from the commercial fruits of all such research, and in return, it offers uniform percentage-based licensing terms to all comers.

In one sweep, we capture some of the value of publicly-funded science for publicly-funded science, and we get rid of patent trolls, and we strongly reduce the intellectual-property risk of building a product based on others' research.


Somebody already has. They're called Renaissance Technologies.


It is kind of surprising actually. Scientists create more wealth than managers.

Creation of wealth only plays a role in salaries in the sense that you can't pay someone more than the value created overall.

Supply and demand is really what drives salary.


Supply and demand sets the price of everything. You're just restating the fact that scientists don't make a lot of money. The interesting question is why there isn't more demand for scientific research when the returns are so high. Clearly it isn't that the market and society have no desire for additional scientific progress.


The returns for genuine basic scientific breakthrough can be very high.

They also are very rare, and tend to create financial payoff only after a decade or more.


Hyperbolic discounting makes decades-scale scientific projects "unwise" from a private firm's point of view: many private firms don't exist in the same form across 40-year time-spans.


>Scientists create more wealth than managers

[Citation needed.] While I completely agree that progress in science creates much more value than efficient management, a very small fraction of research efforts actually yields any useful results (as you mention downthread). Abstract value is different from wealth.

Even assuming that value translates proportionally into wealth (a huge assumption, considering that commercialization itself of scientific advances is risky and often far into the future), how can you even try to consistently determine the wealth an average scientist creates?

This is why science is like the startup game that VCs play. Invest a pittance into people who see promising and hope one of them turns out to be the next Google. Of course, despite the immense wealth a Google creates, all the non-Googles get nothing.


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.


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.


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!).


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.


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


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.


> 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”?


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).


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.


> 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.

Anything with revenues in excess of expenses has the potential for exponential growth if you use the profits to expand the business. A successful landscaping business can have exponential growth, that doesn't mean each of the guys mowing lawns will be making exponentially more money.

But it has been set up that way in finance. It isn't a law of nature that mutual fund managers make a percentage of the fund as their compensation. The profitability of arbitrage is strongly influenced by the regulatory environment and the amount, timeliness and accuracy of information available to traders without privileged access.

Here's an example. I propose that we make insider trading entirely legal. According to all of the arguments used to justify HFT and the like this is the right choice because it will increase liquidity and more quickly and accurately reflect the true value of securities in their market price. Somebody please tell me why this argument is wrong in a way that doesn't apply equally to HFT.


I don't read "has been set up this way" in the parent as necessarily implying agency, but rather as an idiomatic way of referring to the status quo.


It's hard to say. We're talking about humans and the systems we live within. Humans, by definition, have agency. When does an effect resulting from the actions of humans cease to be the product of agency?


Sure, where and how you draw those lines can be interesting, and possibly meaningful. I merely meant to raise awareness that you might have been addressing something the parent had not meant to say.


Exactly. The more leverage you have, the more money you (can) make. That's why we had a string of billionaires coming from internet companies (in a relatively short period of time) - internet enables a small team of humans to provide a service and sell to anybody in the world. Finance has a smaller, but less risky and longer-lasting leverage - invested money.


There's a slight problem there: real wealth rarely grows exponentially, and capital owners can only be paid via real wealth. So everyone else actually has a bargaining position.


Well put.

As much as people bemoan the state of things, the fact is that that's the deal one makes to get ahead. If we treated the sources of intellectual capital better than those who manage them, things might be different.


What happens when you have a society composed of nothing but managers and financiers shuffling paper around?


This should worry us all! Someone halfway intelligent has to do something other than finance, or standards of living will stagnate and fall even for the financiers.


There are plenty of people who lose money flipping houses. It might sound easy, but in practice it isn't.

More likely, if you go into a career trying to cure cancer; there is a big pharmaceutical company or research institution behind it. They may be taking a big risk; but the career risk for you personally is not that big. You'll draw a salary even if you don't cure cancer.


In a way this is partly a good thing. If everyone focused on going to space or curing cancer and were unsuccessful for quite some time we'd be in trouble. While there is a place for these endeavors and they are very important we have to be careful not to allocate too much focus to them.


H igh risk endeavors in science are worth the risk because when they pay off they may shift the way we have been doing things in the past, which leads to unforeseen opportunities in the future. This is not an insightful thought, but I believe it is usually overlooked.

The British Engineer Charles Babbage (Father of the Computer in many respects) wasn't afforded the opportunity to complete the first working mechanical calculator because of cost restrictions by the British Gov't, an invention which could have altered the British course in History. High risk projects in Science and Engineering may rarely pay off, but when they do the ROI is incalculable in many ways. Flipping houses, not so much.

Curing cancer is a place holder for any number of fields that are still under-explored. Finance really shouldn't be a driver of growth, especially when the growth is concentrated in public financing of debt, it just doesn't seem sustainable.


> In a way this is partly a good thing. If everyone focused on going to space or curing cancer and were unsuccessful for quite some time we'd be in trouble.

Implicit in this claim is the idea that somehow we need someone to own things. Why is that exactly? In fact, employee-owned cooperatives demonstrate that when the doers own what they're doing, it can have some benefits for all involved.


You are correct, it was worded poorly. There is no overseeing entity controlling allocation of resources.

All I was trying to say is that just because there are people who choose not to work on the high risk/high reward items does not mean they are not valuable. Balance is important.


> Implicit in this claim is the idea that somehow we need someone to own things. Why is that exactly?

Tragedy of the commons. When scarce resources are communally owned, they tend to get exploited even worse than when they're privately owned.


I am not able rightly to apprehend the kind of confusion of ideas that could provoke such a comment.

Employee-owned cooperatives aren't communally owned, they're employee-owned (as the name indicates).

The resources, in this case, are the employees themselves. So you're claiming that employees will exploit themselves more than an employer would?


I disagree. Decisions are made based on risk/reward. Just because the reward is raised doesn't necessarily mean that its ratio is higher than another endeavor's. Economic incentives lining up with the public good is the ultimate goal that produces the best outcomes for everyone.


What opportunity is there for a traditional engineer to cure cancer (or the like)? As far as I can tell, we can only work indirectly to enable the chemists and biologists who work directly with cancer. Which is good, but you do that by making lab equipment, not by working in a lab.


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


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.


Not sure I agree with putting doctors and cooks on that list. Providing services basic to life is not the same as supporting recreation, wealth, or luxury.

To put a finer point on it, doctors and cooks, along with farmers, builders, teachers, daycare workers, et al. existed ever since everyone started specializing. They directly support life needs.


There have been gardeners for at least as long as there has been civilization. Entertainers have probably always been around. Your idea of "life needs" doesn't seem to coincide with history's.


If we diverted billions of dollars to doctors or cooks we would gain the benefit of increased, more healthy lifespans.

If we did the same for bankers we would get, well what we got in 2008.

The difference between service jobs which are purely symbolic, in that they only work within human created environments, only interface with other people and ultimately the only arbitrator of how good a job they do are people and those which have to deal with the real world at least tangentially is huge. Artists and banker are in the former category, doctors, gardeners, cooks are in the latter.


Completely disagree. Entertainment is the first to go when there is a crisis or somehow we return to basic needs.

Edit: Also, not that it matters, but I have studied anthro for many years.


Bankers are middlemen and gatekeepers.

Unlike pool cleaners, doctors, cooks and gardeners.


Not always. Finance is a pretty big industry and its hard to make a sweeping generalization like this.

For example, let's look at your checking account. A banker's not a middleman here - they're providing a service that allows you to keep you money safe for free while they invest it and assume the risk. Seems like a good service to me.


The bank doesn't invest your money. You lend it to them and receive very little interest in return. They separately create brand new money to provide loans to other people, mainly for purchase of existing assets. At no point is your money given to anyone else.

Update: Having been down-voted below zero... I would encourage everyone to visit the Fed, BoE, ECB, BIS etc. websites and discover how money is created. We would not be in our current economic state if this was better understood.

http://www.bankofengland.co.uk/publications/Documents/quarte...


> The bank doesn't invest your money.

Yes they do. That's why runs on banks are a problem. Only the central bank (at least in the US) creates money. And you can't invest your money in the central bank.


That's no longer correct: all banks create money.

When a US bank approves you for a loan, it simply credits your account with new money. This money does not come from other accounts, i.e. this "investment" in you is made entirely with new money, created by the bank. When you repay the loan, the money disappears from the system.

There are limits to how much money can be created in this way, but those aren't relevant here.

http://www.positivemoney.org/how-money-works/how-banks-creat...


You are correct. Fractional reserve banking is a myth . Banks do not lend out deposits. Deposits come from loans. Reserve requirements do exist but they do no limit bank lending. Lending is only limited by demand for loans and capital requirements.

Here is a pretty good site which explains how the banking system actually operates in detail.

http://wfhummel.cnchost.com/

Its a disgrace you are being downvoted.


I didn't downvote, but the parent is conflating money with credit. Banks and other lenders create credit. Only the Fed creates money. When credit starts to contract and economic growth isn't strong enough to sustain increased creation of money you get a deleveraging, as we recently experienced.

So yes, in one sense banks do create "money", but what you're calling money is actually credit.


Banks create deposits. Deposits are denominated in the unit of account, the dollar.


Furnish us with your definitions of money and credit


That's not "creating" money - you have "money" in your account, but that's just a number. In reality, that money is on the bank's balance sheet, and it can lend it to others (or a part of it, depending on the regulations). It can also lend money that was actually created by the central bank and loaned to the commercial bank. But regardless of the number on your account, if the bank runs out of money (is insolvent), your money is gone (absent government guarantees/bailouts).


You are confused. There is no such thing as a loanable funds market. The guy at the bank making the loan does not call the other guy at the bank to look in the safe and see if the funds exist to loan out. Doesn't work that way. Banks have to have appropriate capital ratios in order to stay in business and be considered solvent. Those ratios are entirely determined by regulation. By and large, the only thing stopping a bank from 'creating money' or making a loan is the willing and able consumers.


>For example, let's look at your checking account. A banker's not a middleman here

Yes, he is. He takes your money and lends it out to others, whom he charges for the privilege. That's how fractional reserve banking works.

Of course, these days since interest rates are zero, that's not really a profitable line of business. It's mostly used to upsell the more profitable products like mortgages or credit cards.


Yes, but the service that he provides is a secure place to store your money. You pay for it by giving the bank money that it can use as "collateral" (in the fractional reserve banking sense) for the loans it gives out, instead of paying with fees.


The banker actually creates brand new money to give to whoever is approved for a loan - he/she doesn't use your money for that purpose.


Not sure why you're getting downvoted. A fractional-reserves system does create more money than what is deposited.[1]

[1]http://en.wikipedia.org/wiki/Fractional-reserve_banking#Exam...


uh, well, you just perfectly described a middleman, and since not everyone qualifies to have a bank account, a gatekeeper.


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.


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.


Since the start of the industrial era, energy extraction has been the linchpin to civilization. Without net energy available to society to do work, we could never sustain such a huge population.


Except farming! That's a means and an end.


Another way of stating this is that those jobs are all part of the "Tertiary Sector"[0], but I disagree that those jobs have no inherent value. Providing a service is valuable.

[0] https://en.wikipedia.org/wiki/Tertiary_sector_of_the_economy


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.


This reads like you read one click-bait article about each subject mentioned and declared yourself an expert on all of the above. It really is woefully un-informed.


So how is he un-informed?


Since he paints such broad strokes in different areas, it would be extremely time-consuming to address every one of his points.

But, for one, simply saying HFT = front running shows an extremely shallow understanding of what HFT is. To say that HFT is "skimming" money off of every transaction is to ignore the what market making is, and has been throughout the existence of capital markets. Yes, there is a price to every transaction (much of which is the spread between bid and offer), and part of that spread goes to the market maker simply because of the way markets work. Because HFT outfits are so efficient at market making, this cost of transacting is lower than it has ever been.


Characterizing HFT as market makers takes advantage of the lay public's relative shallow understanding of market making. The general public's perception of market makers' function is closer to the old style DPM that is more akin to the "thick and thin" liquidity providers than the "fair weather friend" style liquidity providers that HFT's act as; HFT's turn off their liquidity spigot far faster than DPMs.

It is more descriptive to call HFTs price discovery specialists, or some other heretofore undefined term, than conflating with a historical term. They do serve a valuable function in price discovery and spread squeezing, through sanctioned, but unregulated, use of different and higher speed access to both market information and market access (typically through direct connection to an exchange as opposed to a SIP-like feed). That separate tier of access is what gives rise to the front-running characterizations. It is functionally similar to the many, many other separate tiers of access enjoyed by large capital holders over small capital holders, but it is in a highly publicized arena of the financial services world, so it becomes a very emotionally-charged topic, on all sides of the discussions.

I'm not getting into whether those separate tiers of access are "right" or "wrong" here, or even whether or not they should/shouldn't be regulated. There is likely little argument that financial services and politics (the two are far more intertwined than most realize) should perform as handmaidens to civilization, rather than the pilot house; I say the point of these kinds of discussions in this thread is it has become arguable for many that those fields have seized not only the ship's wheel but the navigator's table as well. I wouldn't personally go quite that far, but there are salient points being made.


Minor remark: one major selling point of (some) hedge funds is low correlation with other investments, not huge returns.


Right. The name comes from precisely that.


That's dated. "Hedge funds" once did that, but now they're just unregulated funds for "sophisticated investors", which includes pension funds.


Not all (or most) hedge funds do that, but my understanding is that there are still hedge funds that do.


I buy schwab and vanguard ETF equivalents of their mutual funds, and I get charged no commission when buying and selling them directly from them.

So where do they generate commissions as a company, compared to a person buying & selling their ETFs with a 3rd party exchange?


ETFs, like mutual funds, have an 'expense ratio'. Basically they skim a certain amount of the fund's assets off the top to cover expenses & profit.


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.


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

False. Lousy studies of hedge funds show they outperform, but the second you take into account survivor bias, the opposite is true. There have been huge numbers of terrible hedge funds created and liquidated that swamp the few successful ones that everybody hears about.


Hedge funds do indeed underperform the market: http://www.zerohedge.com/news/2013-12-13/hedge-funds-underpe...

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


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.


> 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.

The company paying you a dividend is mathematically equivalent to everyone tendering the company that percentage of their shares for cash and then having a stock split so that everyone ends up with the same number of shares they had originally. The only practical difference is the tax treatment.


The tax treatment is significant, though, and a lot of investors prefer buybacks to dividends because of it.




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.


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.)


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.


I think that assumes that the market is rational. Could it not be an indicator of increasing corruption instead?

A banker gets paid to allocate capital, manage risk, and so on, and gets to share in some profits as an incentive to make the correct decisions. Take the reward and allocate it towards bribing politicians to remove restrictions on banking, accumulate more money, spend more money on "lobbying" or "campaign contributions" (that is, more bribery). Lather, rinse and repeat for 3 decades or so, and suddenly you're not being paid a rational amount for improving market efficiency, you're just bleeding off money from the economy. Become "too big to fail", reap the rewards of risky investments that pay off, dump the cost of failed investments on the public purse, reinvest the money to skew regulations in your favour even more, profit.


That is all that was said, correlation between too-large financial sector and negative overall growth.


You touched on the point I wanted to make. The reporter is making a jump between correlation and causation.


In theory, although our large financial sector creates some of those inefficiencies and lobbies for others. It's rather like the mafia in that respect.

Fraud at the heart of high finance, unsustainable lending, de-regulation of gambling activities and ZIRP all contribute to said inefficiencies.


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.


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


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


like a housing bubble?


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?


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.


> 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?


>Or, are they just saying that whenever finance becomes prominent it attempts to drive out risk ruthlessly?

That's how I interpreted it. Finance would rather invest with high collateral or even rent-seek than accept the actual risks inherent in productive investment.


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.


I believe it's implied the finance sector knows they're draining the high-skilled worker pool, meaning R&D-heavy businesses won't be able to find the employees they need to succeed. So businesses with collateral are a better bet.


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


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.


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...,

[2] http://www.amazon.com/The-Power-Productivity-Poverty-Stabili...


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.


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.


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.


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


> 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.


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


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.



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...

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://money.cnn.com/2014/08/22/investing/wall-street-silico...


(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)


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)


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.


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.


I generally agree with the sentiment you express, but I think you're not really addressing the issue at hand. People moving in to finance does not seem likely to reduce our environmental impact.

Even so, you are right that western economies don't really have a shortage of goods, per se. The idea that low birth rates are a bad thing or that houses should go up in price, etc. are lunacy. Why do we want it to be hard to afford a secure home? Why do we need even more than 7 billion people? Maybe someday I'd like to not have to rent, but I won't be able to because houses will be $3 million by the time I can afford to buy what's out there now.


To choose one, low birth rates leads an aging population which is an issue because it generally means a contracting labor force and more burden on the younger group of the population to support things like Social Security as the ratio of 'young' productive workers to supported older non-workers increases. It also means a shrinking labor pool which drives wages up causing prices to generally rise as well.


It's true we as a species don't need economic growth, but we could really use some scientific and technological growth to achieve the twin aims of a) maintaining our beautiful biosphere, and b) extending it beyond earth.

Unfortunately, the individual, market demand for these large-scale "products" is minuscule - which means that (modulo SpaceX) you only get political will behind them, which means academic research funded by government grants, which means a not-very-well-paid and overtly politicized existence for anyone wanting to "get out and push".

That said, I think there's a curious and under-served middle-ground in First-World countries, particularly in the US, which is to develop distributed, self-reliant, green (and inherently 'local') ways of living through technology. It helps with the biosphere goal, and plays to the "rugged individualism" meme that is still present, at least in a vestigial form. Maybe when people are running their own solar panels, hydroponic garden/air purifier, reusing waste water, there will be less interest in finance.


We don't have nearly enough health. The ability to spend more on medical research is enough reason all by itself to keep the economy growing.


Why do we need growth for that? Wouldn't redirecting wasted resources do just fine?


That will get you some. Growth will get you more, faster.


Not really. If everyone worked one day a week less, and used that day to exercise, we would have lower productivity and better health.


If everyone worked one day a week less, and used that day to exercise, and put the other four days into continuing to grow the economy, we'd be better off still.


when its only the 0.1% that see any benefit in that growth, why bother? The point obviously was to compare like for like.


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


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.


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.


As long as there is violence, we will not be able to say we actually achieved Civilisation.

So, no. We are quite far from the ideal standard of living.

We are more in a semi-spherical ball of water and continental psychiatric hospitals


Sorry, but that is nonsense. Nobody cares if you can say you "achieved civilization," because that's not a term anybody has every used to qualify human achievement.

You're painting a portrait that nobody cares to look at.

That, and what you've said is just patently false by any definition in circulation.


I actually have to agree. Everybody is easily able to imagine what the world should be like - no war, no crime, no starving, no destroying the planet. And what are we actually doing? We are so incredible far off. And there are zero real obstacles, only human stupidity and evilness. Everybody on its own is only a bit stupid, evil, egoistic or what not, but all off us combined are anything but good. We are making little baby steps, ridiculous tiny baby steps.


Oh, I agree that there is work to be done. I don't see the value in framing that in terms of "calling ourselves a civilization."

"A civilization (or civilisation in British English) is any complex state society characterized by urban development, social stratification, symbolic communication forms (typically, writing systems), and a perceived separation from and domination over the natural environment." -- Wikipedia


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


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


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


Given that the working paper is free, I have no idea why you would say that. http://bis.org/publ/work490.pdf


Did you find that out by circumventing the pay wall? Perhaps I missed it but it wasn't clear from the stub.


finance != commerce


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

What would you rather have?


This supposes that you must EITHER accept cluttered, lowest common denominator content OR a monetization scheme from 1930 shoehorned into the internet. My point is that _Finance_ (as opposed to the simple desire to pay rent) has resulted in paywalls on websites. So in essence I'm agreeing with the article all while circumventing their attempts at getting me to pay.


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.


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.




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