Saturday, July 25, 2015

"Should the "Best and Brightest" Go Into Finance?"

From Priceonomics:

"Finance literally bids rocket scientists away from the satellite industry."
-- Bank for International Settlements study, 2000
In the opening pages of American Psycho, a novel set in the finance boom in 1980s New York, a fictional investment banker raves, “I mean am I alone in thinking we're not making enough money?” 

From context, it’s clear that the character is indignant that his -- seemingly enormous -- paycheck isn’t higher. But, in a sense, financiers don’t “make” money. They just move it around. The sector makes most of its revenue through providing a service, not to their individual customers but to the economy. As Nell Irwin explained in The New York Times: “[Finance] exists to channel capital effectively from savers to investment. [...] Most of modern finance doesn’t exist as an end in itself, but to make the rest of the economy more efficient.”

Once upon a time, the finance sector was vilified in Western culture, for exactly this reason. (Also because, since Catholic doctrine banned money lending for interest, in Europe for centuries it was the nearly exclusive profession of Jews). Slowly, capitalism emerged, people realized the benefits of an efficient economy, and finance was lionized.

“While there have been dissenting views, today it is accepted that finance is not simply a by-product of the development process, but an engine propelling growth,” economists Stephen G. Cecchetti and Enisse Kharroubi wrote in a 2012 study. “This, in turn, was one of the key elements supporting arguments for financial deregulation. If finance is good for growth, shouldn’t we be working to eliminate barriers to further financial development?”
Investment banker, American icon (still from American Psycho, 2000)
But these researchers were skeptical, so they dove into the data. They suspected the relationship between financial development and overall economic growth was more nuanced: 
“Is [finance good for growth] regardless of the size and growth rate of the financial system? Or, like a person who eats too much, does a bloated financial system become a drag on the rest of the economy?”
They found very strong evidence that the finance sector can, in fact, get too big. Certain measures of size and rate of growth clearly negatively correlate with per-worker GDP.

The authors have recently published a follow-up study, outlining a plausible explanation for why this is. A big part of it has to do with competition for skilled labor: When a Finance Sector booms, it attracts a lot of smart, educated, and talented people. Some of these people, without the boom, would have otherwise started businesses of their own, or made technological discoveries. In one way or another, many of them would have contributed to the growth of the GDP.

Instead, as Kauffman Foundation economist Paul Kedrosky told NPR, during financial booms they get "yanked off into the financial sector never to be seen again.” ...MORE