20 ms·

Too much finance is bad for the economy

313 points by cs702 12y ago

bhouston 12y ago
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
- badloginagain 12y ago
  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.
  - Kalium 12y ago
    Industry brain drain is a known phenomenon in other circumstances, such as the natural resources trap. It's plausible that it could occur here.
  - cynicalkane 12y ago
    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".
  - nickbauman 12y ago
    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.
    - PaulHoule 12y ago
      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.
      - kevin_thibedeau 12y ago
        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.
    - Retric 12y ago
      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.
    - this_user 12y ago
      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?
- S4M 12y ago
  > 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.
- skylan_q 12y ago
  Sounds like the ABCT to me. http://en.wikipedia.org/wiki/Austrian_business_cycle_theory 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.
  - nhaehnle 12y ago
    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.
    - zo1 12y ago
      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.
  - dmfdmf 12y ago
    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.
  - LiweiZ 12y ago
    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 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.
- pkaye 12y ago
  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.
  - deleted 12y ago
    [deleted]
  - notahacker 12y ago
    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.
    - MaysonL 12y ago
      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.
      - branchless 12y ago
        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.
- gaius 12y ago
  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.
  - robrenaud 12y ago
    What's your number?
  - Bjartr 12y ago
    What is meant by "public schoolboys" exactly? I'm struggling to grok the intended message.
    - bhayden 12y ago
      I believe he is saying it's run by people of weak moral fiber and character.
      - lifeisstillgood 12y ago
        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.
    - crdb 12y ago
      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 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 http://en.wikipedia.org/wiki/Tristram_Jones-Parry
- dredmorbius 12y ago
  See also: Dutch Disease http://en.wikipedia.org/wiki/Dutch_disease http://en.wikipedia.org/wiki/Dutch_disease (Also from The Economist initially)
  - wycx 12y ago
    see also: the present Australian economy. Our future is not bright...
    - 1stop 12y ago
      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?
      - wycx 12y ago
        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.
        1stop 12y ago
        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.
- smorrow 12y ago
  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.
  - ImprovedSilence 12y ago
    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.
leereeves 12y ago
No paywall via Google: https://www.google.com/search?q=%22Warning:+too+much+finance+is+bad+for+the+economy%22 https://www.google.com/search?q=%22Warning:+too+much+finance...
- woodchuck64 12y ago
  Don't you mean https://www.bis.org/publ/work490.htm https://www.bis.org/publ/work490.htm
ixtli 12y ago
"Too much finance is bad for the economy. Please pay us to hear our reasoning."
- bequanna 12y ago
  finance != commerce
- navait 12y ago
  Given that the working paper is free, I have no idea why you would say that. http://bis.org/publ/work490.pdf http://bis.org/publ/work490.pdf
  - ixtli 12y ago
    Did you find that out by circumventing the pay wall? Perhaps I missed it but it wasn't clear from the stub.
- puranjay 12y ago
  "Or, don't pay us and get used to getting your news/op-eds in GIF form through Buzzfeed" What would you rather have?
  - ixtli 12y ago
    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.
  - maximuscoolimus 12y ago
    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.
gumby 12y ago
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 12y ago
  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 12y ago
    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.
  - msandford 12y ago
    Except farming! That's a means and an end.
  - wffurr 12y ago
    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.
- hawleyal 12y ago
  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.
  - astazangasta 12y ago
danbruc 12y ago
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.
- deleted 12y ago
  [deleted]
- CalRobert 12y ago
  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.
  - rtkwe 12y ago
    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.
- mikeash 12y ago
  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.
  - danbruc 12y ago
    Why do we need growth for that? Wouldn't redirecting wasted resources do just fine?
grandalf 12y ago
there is also the interesting coordination game by which systemic risk is ignored.
guardiangod 12y ago
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.
- magic_beans 12y ago
  Business is much more lucrative than science. Not surprising.
  - AnthonyMouse 12y ago
    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.
    - lifeisstillgood 12y ago
      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.
      - AnthonyMouse 12y ago
tbrownaw 12y ago
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.
- hawleyal 12y ago
  That is all that was said, correlation between too-large financial sector and negative overall growth.
  - erikhansenwong 12y ago
    You touched on the point I wanted to make. The reporter is making a jump between correlation and causation.
- crdoconnor 12y ago
  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.
- randyrand 12y ago
  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 12y ago
    Holding a position for a few days, hours, minutes, or seconds is not investing. It's gambling.
    - randyrand 12y ago
      The financial sector holds things on many different timescales, not just minutes or hours. Sometimes for decades if its profitable.
golemotron 12y ago
> 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?
- xdissent 12y ago
  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.
- rqebmm 12y ago
  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.
- eli_gottlieb 12y ago
  >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.
eyphka 12y ago
Would love to see the numbers on brain drain from the technical fields to finance. Any takers?
- jeffreyrogers 12y ago
  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.
josu 12y ago
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$is;shi=t;ly=2003;lb=f;il=t;fs=11;al=30;stl=t;st=t;nsl=t;se=t$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$inds=i211_t001980,,,,;i105_t001980,,, http://www.gapminder.org/world/#$majorMode=chart$is;shi=t;ly..., [2] http://www.amazon.com/The-Power-Productivity-Poverty-Stability/dp/0226476987 http://www.amazon.com/The-Power-Productivity-Poverty-Stabili...
eldavido 12y ago
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.
- nightski 12y ago
  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.
  - kmkemp 12y ago
    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.
  - copsarebastards 12y ago
    > 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.
    - deleted 12y ago
      [deleted]
    - nightski 12y ago
esja 12y ago
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
Animats 12y ago
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 12y ago
  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.
  - wnissen 12y ago
    > 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.
kokey 12y ago
> 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.
sebastianconcpt 12y ago
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.
stretchwithme 12y ago
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.
pippy 12y ago
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 12y ago
  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 12y ago
    Until there is a flaw in the offsetting positions and everything collapses in a heap.
Gimpei 12y ago
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 12y ago
  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.)
Havoc 12y ago
It works just fine. Well until there is a loss of confidence anyway.
lordnacho 12y ago
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 12y ago
  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.
joshjkim 12y ago
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-jumped-62-in-2014-1421039104 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-silicon-valley-140238593.html http://finance.yahoo.com/news/mbas-abandon-wall-street-for-s... http://money.cnn.com/2014/08/22/investing/wall-street-silicon-valley-talent/ http://money.cnn.com/2014/08/22/investing/wall-street-silico...
- joshjkim 12y ago
  (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)
jackgavigan 12y ago
There's probably a crossover point when the finance sector's focus shifts from efficiently allocating capital to extracting economic rent from financial activity
WalterBright 12y ago
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)
PythonicAlpha 12y ago
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.
known 12y ago
http://www.lietaer.com/2010/03/the-worgl-experiment/ http://www.lietaer.com/2010/03/the-worgl-experiment/

313 points by cs702 12y ago

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

badloginagain 12y ago
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.
- Kalium 12y ago
  Industry brain drain is a known phenomenon in other circumstances, such as the natural resources trap. It's plausible that it could occur here.
- cynicalkane 12y ago
  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".
- nickbauman 12y ago
  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.
  - PaulHoule 12y ago
    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.
    - kevin_thibedeau 12y ago
      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.
  - Retric 12y ago
    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.
  - this_user 12y ago
    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?
S4M 12y ago
> 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.
skylan_q 12y ago
Sounds like the ABCT to me. http://en.wikipedia.org/wiki/Austrian_business_cycle_theory 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.
- nhaehnle 12y ago
  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.
  - zo1 12y ago
    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.
- dmfdmf 12y ago
  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.
- LiweiZ 12y ago
  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 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.
pkaye 12y ago
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.
- deleted 12y ago
  [deleted]
- notahacker 12y ago
  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.
  - MaysonL 12y ago
    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.
    - branchless 12y ago
      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.
gaius 12y ago
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.
- robrenaud 12y ago
  What's your number?
- Bjartr 12y ago
  What is meant by "public schoolboys" exactly? I'm struggling to grok the intended message.
  - bhayden 12y ago
    I believe he is saying it's run by people of weak moral fiber and character.
    - lifeisstillgood 12y ago
      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.
  - crdb 12y ago
    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 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 http://en.wikipedia.org/wiki/Tristram_Jones-Parry
dredmorbius 12y ago
See also: Dutch Disease http://en.wikipedia.org/wiki/Dutch_disease http://en.wikipedia.org/wiki/Dutch_disease (Also from The Economist initially)
- wycx 12y ago
  see also: the present Australian economy. Our future is not bright...
  - 1stop 12y ago
    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?
    - wycx 12y ago
      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.
      - 1stop 12y ago
        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.
smorrow 12y ago
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.
- ImprovedSilence 12y ago
  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.

leereeves 12y ago

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

woodchuck64 12y ago
Don't you mean https://www.bis.org/publ/work490.htm https://www.bis.org/publ/work490.htm

ixtli 12y ago

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

bequanna 12y ago
finance != commerce
navait 12y ago
Given that the working paper is free, I have no idea why you would say that. http://bis.org/publ/work490.pdf http://bis.org/publ/work490.pdf
- ixtli 12y ago
  Did you find that out by circumventing the pay wall? Perhaps I missed it but it wasn't clear from the stub.
puranjay 12y ago
"Or, don't pay us and get used to getting your news/op-eds in GIF form through Buzzfeed" What would you rather have?
- ixtli 12y ago
  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.
- maximuscoolimus 12y ago
  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.

gumby 12y ago

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 12y ago
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 12y ago
  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.
- msandford 12y ago
  Except farming! That's a means and an end.
- wffurr 12y ago
  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.
hawleyal 12y ago
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.
- astazangasta 12y ago

danbruc 12y ago

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.

deleted 12y ago
[deleted]
CalRobert 12y ago
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.
- rtkwe 12y ago
  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.
mikeash 12y ago
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.
- danbruc 12y ago
  Why do we need growth for that? Wouldn't redirecting wasted resources do just fine?

grandalf 12y ago

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

guardiangod 12y ago

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.

magic_beans 12y ago
Business is much more lucrative than science. Not surprising.
- AnthonyMouse 12y ago
  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.
  - lifeisstillgood 12y ago
    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.
    - AnthonyMouse 12y ago

tbrownaw 12y ago

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.

hawleyal 12y ago
That is all that was said, correlation between too-large financial sector and negative overall growth.
- erikhansenwong 12y ago
  You touched on the point I wanted to make. The reporter is making a jump between correlation and causation.
crdoconnor 12y ago
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.
randyrand 12y ago
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 12y ago
  Holding a position for a few days, hours, minutes, or seconds is not investing. It's gambling.
  - randyrand 12y ago
    The financial sector holds things on many different timescales, not just minutes or hours. Sometimes for decades if its profitable.

golemotron 12y ago

> 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?

xdissent 12y ago
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.
rqebmm 12y ago
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.
eli_gottlieb 12y ago
>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.

eyphka 12y ago

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

jeffreyrogers 12y ago
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.

josu 12y ago

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=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,,, http://www.gapminder.org/world/#$majorMode=chart$is;shi=t;ly..., [2] http://www.amazon.com/The-Power-Productivity-Poverty-Stability/dp/0226476987 http://www.amazon.com/The-Power-Productivity-Poverty-Stabili...

eldavido 12y ago

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.

nightski 12y ago
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.
- kmkemp 12y ago
  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.
- copsarebastards 12y ago
  > 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.
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  - nightski 12y ago

esja 12y ago

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

Animats 12y ago

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 12y ago
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.
- wnissen 12y ago
  > 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.

kokey 12y ago

> 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.

sebastianconcpt 12y ago

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.

stretchwithme 12y ago

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.

pippy 12y ago

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 12y ago
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 12y ago
  Until there is a flaw in the offsetting positions and everything collapses in a heap.

Gimpei 12y ago

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 12y ago
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.)

Havoc 12y ago

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

lordnacho 12y ago

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 12y ago
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.

joshjkim 12y ago

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-jumped-62-in-2014-1421039104 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-silicon-valley-140238593.html http://finance.yahoo.com/news/mbas-abandon-wall-street-for-s... http://money.cnn.com/2014/08/22/investing/wall-street-silicon-valley-talent/ http://money.cnn.com/2014/08/22/investing/wall-street-silico...

joshjkim 12y ago
(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)

jackgavigan 12y ago

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

WalterBright 12y ago

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)

PythonicAlpha 12y ago

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.

known 12y ago

http://www.lietaer.com/2010/03/the-worgl-experiment/ http://www.lietaer.com/2010/03/the-worgl-experiment/