This is one of those off-message rants that marks, I guess, one of the real differences between “blogs” and “old media,” and if you’re only here for the options stuff, you can skip this post.
From 1990 to 2006, the GDP share of the financial sector in the broad sense increased in the United States from 23% to 31%.
-Már Gudmundsson, Bank for International Settlements, 2008
This point has been made many times before – and better – by others, but while reading a Times article on a recent breakthrough in the analysis of junk DNA, it struck me again how poorly organized our society is. Instead of creating incentives for people to pursue work in genetics and environmental science and all the other fields that might solve urgent, significant problems, we take a huge percentage of the smartest and best college graduates and stick them in the financial sector, where they can – in the absolutely best case – make the portfolios of wealthy individuals and institutions slightly more efficient or more profitable. I’m tempted to agree with Paul Volcker that the only meaningful financial innovation in recent history has been the automated teller machine. I say that as someone who spends a lot of time and effort fiddling with options and futures, and I can do so without fear of contradiction because I’m not foolish enough to equate “meaningful” with “profitable.”
Leaving aside the worst-case outcomes of pushing so much talent into finance – and we’re arguably living through those outcomes now – even an optimal scenario looks like an outrageous failure of that supreme object of American faith, the free market. Even if we imagine a world in which the American credit super-cycle was able to continue indefinitely, and further posit that the collective output of Wall Street wasn’t just to dump everyone into one big ETF – and hey, tack on any other wild counterfactuals you want – I still don’t understand why the size of the U.S. financial sector isn’t prima facie evidence against the rationality and efficiency of a market economy. We’ve got a good society here, with plenty of smart and hard-working people, and we had to go and waste it on something as derivative as finance. (There’s an old, unfair joke that “those who can’t do, teach;” I wonder if, in a similar vein, we can say that those who can’t succeed in maths, physics, economics, or prostitution do finance.)
The disconnect is clear enough, I think: we humans care about things like quality of life, about having breathable air and potable water, and even about things like the arts and humanities. But markets struggle to recognize the value of any of those things: if you strip away all the quasi-religious reverence that the Western world has for markets and remember that they are, after all, just one method for processing information, then it seems much clearer that the needs of human societies are inadequately served by market systems. With enough hand-waving about regulatory capture and political corruption and so on, it might be possible to mitigate the particular example of the over-allocation of “human capital” (a nasty, embarrassing phrase) to the finance sector. But, ultimately, the inability of markets to deal with the major problems we face must be taken seriously: call this or that individual issue a “negative externality” if you want, brush it under the rug, and keep reading your Mises or Friedman or Hayek. But as the problems pile up, pretty soon it starts looking like all externalities.