Thu, Sep 26, 2013 - Page 9 News List

The best, brightest
and least productive?

There are many ways in which financial deals might be completely unnecessary. They only exist in order to create jobs and to generate income, but provide no useful service to society. Careful consideration must be made about the regulations written for the finance industry

By Robert Shiller

Illustration: mountain people

Are too many of our most talented people choosing careers in finance and, more specifically, in trading, speculating and other supposedly “unproductive” activities?

In the US, 7.4 percent of compensation paid to employees last year went to people working in the finance and insurance industries. Regardless of whether that percentage is too high, the real issue is that the share is even higher among the most educated and accomplished people, whose activities may be economically and socially useless, if not harmful.

In a survey of elite US universities, Catherine Rampell found that in 2006, just before the financial crisis, 25 percent of graduating seniors from Harvard University, 24 percent from Yale, and a whopping 46 percent from Princeton were starting their careers in financial services. Those percentages have fallen somewhat since, but this might be only a temporary effect of the crisis.

According to a study by Thomas Philippon and Ariell Reshef, much of the increase in financial activity has taken place in the more speculative fields, at the expense of traditional finance.

From 1950 to 2006, credit intermediation — lending, including traditional banking — declined relative to “other finance” — including securities, commodities, venture capital, private equity, hedge funds, trusts and other investment activities like investment banking. Moreover, wages in “other finance” skyrocketed relative to those in credit intermediation.

We surely need some people in trading and speculation. However, how do we know if we have too many?

To some people, the question is a moral one. Trading against others is regarded as an inherently selfish pursuit, even if it might have indirect societal benefits.

As economists like to point out, traders and speculators provide a useful service. They sort through information about businesses and — at least some of the time — try to judge their real worth. They are helping to allocate society’s resources to the best uses; to the most promising businesses.

These activities impose costs on the rest of us. A 2011 paper by Patrick Bolton, Tano Santos and Jose Scheinkman argues that a significant amount of speculation and dealmaking is pure rent-seeking.

In other words, it is wasteful activity that achieves nothing more than enabling the collection of rent on items that might otherwise be free.

An example of rent-seeking is that of a feudal lord who installs a chain across a river that flows through his land. He then hires a collector to charge passing boats a fee — or rental of the stretch of the river for a few minutes — to lower the chain.

There is nothing productive about the chain or the collector. The lord has made no improvements to the river and is helping nobody in any way, directly or indirectly, except himself. All he is doing is finding a way to make money from something that used to be free. If enough lords along the river follow suit, its use may be severely curtailed.

Those in “other finance” often engage in similar behavior. They skim the best business deals, creating a “negative externality” on those who are not party to them.

If the bad assets that they reject — for example, the subprime mortgage securities that fueled the 2008 financial crisis — are created anyway and foisted on less knowledgeable investors, financiers contribute no more to society than a lord who installs a chain across a river.

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