Friday, December 26, 2014

A black hole for our best and brightest | The Washington Post

Teaching within a top-ranked business school associated with nine Nobel laureates in economics, I am honored to meet some of the brightest young minds in the world. These students excel at math, as one might expect, and many also pursue second degrees or minors in additional STEM (science, technology, engineering, and math) fields. At our institution, economics is paired with statistics by default, as we emphasize quantitative economics over the philosophical approaches to the field.

Although I admire these students, I'm also saddened that so many chase financial industry careers over working in other STEM fields or in the public sector. These great minds set forth to turn money into more money, when they might use their skills to apply the lessons of economics and statistics to greater social good.

As Washington Post reporter Jim Tankersley writes, it isn't that finance is a "good" or "bad" pursuit for an individual — but in the last two decades finance has become a magnet, drawing away great minds from other potential fields of study and work. Worse, the financial industry is now a net drain on economic growth. I believe this explains the explosion of complex financial instruments, leading to yet more specialization and yet more demand for gifted graduates. You need to be a mathematician just to comprehend some of the financial instruments institutions use to generate money out of empty activity.
A black hole for our best and brightest
Wall Street is expanding, and the economy is worse off for it. by Jim Tankersley

In 2012, economists at the International Monetary Fund analyzed data across years and countries and concluded that in some countries, including America, the financial sector had grown so large that it was slowing economic growth. Using a different methodology, the most prominent researcher on the size and economic value of Wall Street, a New York University economist named Thomas Philippon, estimates that the United States is sinking nearly $300 billion too much annually into finance.

In perhaps the starkest illustration, economists from Harvard University and the University of Chicago wrote in a recent paper that every dollar a worker earns in a research field spills over to make the economy $5 better off. Every dollar a similar worker earns in finance comes with a drain, making the economy 60 cents worse off.

It's not that finance is inherently bad — on the contrary, a well-functioning financial system is critical to a market economy. The problem is, America's financial system has grown much larger than it should have, based on how well the industry performs.
Research in the above passages means STEM discovery and deployment, not financial research into the latest credit default swaps or options-based covering. Meaningful, productive research that creates things other than paper wealth is what historically drives an economy forward. We're stuck in neutral, as an overall economy, while wealth creates wealth. If you are fortunate enough to have some wealth, you'll end up with more wealth in the current economy. But, are you creating things that help society more broadly?

Understand, I appreciate that capital investments lead to innovation in a normal economic model. Still, that's not what our markets seem to be doing right now. Banks are not lending to start-ups at the same rate as in the past. If anything, large stale companies are expanding their valuations through stock buy-backs, low-interest bonds, increased dividends, real estate investment trust (REIT) lease-back schemes, and other gimmicks. Our brilliant math students enter a business world in which their role is to maximize stock value and trading fees, which is not the same as creating things and services with inherent value.

I'm not anti-Wall Street. I'm anti-stagnation, which is where the developed economies seem to be headed. Instead of improving retail experiences, stores spin-off real estate into holding companies and lease back the property. Instead of innovating, tech companies buy back shares in hopes of increasing earnings-per-share (EPS) or price:earnings (PE) data. Companies merge and invert their legal entity locations, resulting in reduced taxes or other benefits. It's all financial engineering, not real innovation.

Why are the people plotting these complex maneuvers not discovering new medicines? Why are they not working on alternative energy projects? Why are they not exploring distant galaxies? Because finance pays. What would lead bright young graduates into finance? Wealth, of course. It's all about the money — the money people earn in the financial industry.
Philippon is a French economist at NYU's Stern School of Business. He and a co-author, Ariell Reshef of the University of Virginia, have shown that from the end of World War II until the early 1980s, finance was just like any other desk job: The average Wall Street worker was paid about as much as the average worker in the private sector and was only slightly more educated.

But starting at about the time that Jackson joined Goldman, when Congress began tweaking investment-tax rates, Wall Street started drawing more educated workers. This made the average finance salary go up — from less than $50,000 a year in 1981 (which is about $100,000 in today's dollars) to more than $350,000 a year in 2012.

Salaries rose even faster in the mid-1990s. The average finance worker began to earn more than a similar non-finance worker who had the same amount of schooling. Wall Street executives began to command salaries several times the rate that non-finance executives could.

In sheer dollar terms, it became irrational for almost any qualified American graduate to pass on a Wall Street job. By the mid-2000s, finance workers earned about 50 percent more than they would have in a similar job anywhere else in the economy. There are almost twice as many financial professionals in the top 1 percent of American income earners today as there were in 1979, according to researchers from Williams College, Indiana University and the Treasury Department. Almost 1 in 5 members of the top 0.1 percent work in finance.
You could argue, "Four in five members of the top 0.1 do not work in finance!" Yes, and many of those others do have STEM degrees and work in STEM fields. Still, the number of gifted students entering finance continues to outpace what the economy needs. There is a bubble in finance, and it will burst.

Though I wish my words alone would encourage students to pursue more "altruistic" paths — or at least more productive paths, as I define productive — it isn't going to happen. Money is a powerful motivator when graduates of our best universities can't wait to be debt-free and racing for the penthouse suites.

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