Too much finance is bad for the economy

http://www.economist.com/blogs/buttonwood/2015/02/finance-sector-and-growth

by cs702 • 11 years ago

313 207 11 years ago

economist.com

leereeves• 11 years ago

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

woodchuck64• 11 years ago

Don't you mean https://www.bis.org/publ/work490.htm

bhouston2• 11 years 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• 11 years 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• 11 years 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• 11 years 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".

nickbauman2• 11 years 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.

S4M• 11 years 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• 11 years ago

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.

nhaehnle2• 11 years 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.

dmfdmf• 11 years 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.

LiweiZ2• 11 years 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) 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.

pkaye2• 11 years 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.

notahacker• 11 years 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.

gaius• 11 years 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• 11 years ago

What's your number?

Bjartr• 11 years ago

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

zik• 11 years ago

I think that's mostly just a British thing.

underpantsgnome• 11 years ago

Are you suggesting that finance isn't?

dredmorbius• 11 years ago

See also: Dutch Disease

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

(Also from The Economist initially)

wycx4• 11 years ago

see also: the present Australian economy.

Our future is not bright...

smorrow• 11 years 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• 11 years 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.

ixtli3• 11 years ago

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

bequanna• 11 years ago

finance != commerce

navait• 11 years ago

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

ixtli3• 11 years ago

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

puranjay• 11 years 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?

ixtli3• 11 years 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• 11 years 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• 11 years 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.

bhouston2• 11 years 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.

marbletiles• 11 years 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• 11 years ago

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

wffurr• 11 years 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.

hawleyal3• 11 years 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• 11 years ago

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.

crdoconnor3• 11 years ago

Bankers are middlemen and gatekeepers.

Unlike pool cleaners, doctors, cooks and gardeners.

temuze• 11 years ago

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.

ForHackernews2• 11 years ago

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

danbruc4• 11 years 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.

CalRobert• 11 years 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• 11 years 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.

mikeash3• 11 years 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.

danbruc4• 11 years ago

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

javajosh• 11 years ago

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.

nawitus• 11 years ago

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

danbruc4• 11 years ago

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.

sebastianconcpt2• 11 years ago

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

grandalf• 11 years ago

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

guardiangod• 11 years 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• 11 years ago

Business is much more lucrative than science. Not surprising.

AnthonyMouse6• 11 years 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.

ForHackernews2• 11 years ago

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.

kqr2• 11 years ago

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

tanderson92• 11 years ago

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!

akgerber• 11 years ago

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.

tbrownaw• 11 years 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.

hawleyal3• 11 years ago

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

erikhansenwong• 11 years ago

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

crdoconnor3• 11 years 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.

randyrand2• 11 years 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_thibedeau3• 11 years ago

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

collyw4• 11 years ago

like a housing bubble?

Devthrowaway80• 11 years ago

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.

golemotron• 11 years 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• 11 years 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• 11 years 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_gottlieb6• 11 years 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• 11 years ago

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

jeffreyrogers5• 11 years 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• 11 years 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...,

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

eldavido• 11 years 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.

nightski2• 11 years 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• 11 years 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.

copsarebastards2• 11 years 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.

hellgas00• 11 years ago

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.

cpwright• 11 years ago

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.

rayiner• 11 years ago

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

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

Chinjut• 11 years ago

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!).

kevin_thibedeau3• 11 years ago

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

angersock• 11 years ago

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.

eli_gottlieb6• 11 years ago

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.

sliverstorm• 11 years ago

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.

esja4• 11 years 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

Animats2• 11 years 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.

jeffreyrogers5• 11 years 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• 11 years 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.

pinky1417• 11 years ago

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.

AnthonyMouse6• 11 years ago

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.

dm3• 11 years ago

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

dllthomas4• 11 years ago

Right. The name comes from precisely that.

pgwhalen2• 11 years 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.

jschwartzi2• 11 years ago

So how is he un-informed?

mahyarm• 11 years ago

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?

danjayh• 11 years ago

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.

kokey• 11 years 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.

sebastianconcpt2• 11 years 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• 11 years 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• 11 years 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• 11 years 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.

pkaye2• 11 years ago

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

Gimpei• 11 years 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.

throwawaykf053• 11 years 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• 11 years ago

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

lordnacho• 11 years 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• 11 years 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.

joshjkim2• 11 years 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-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...

joshjkim2• 11 years 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• 11 years 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• 11 years 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• 11 years 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• 11 years ago

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

Too much finance is bad for the economy

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