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财经观察 2422:When scientists become hedge fund managers

(2012-06-25 17:41:34) 下一个

When scientists become hedge fund managers

There are many gems in the annual report of the Bank of International Settlements that came out on Sunday. One of the most intriguing is a trail which leads to an actual estimate of the cost to society of scientists becoming hedge fund managers.

The trail starts at a section about debt sustainability across a number of countries. It notes that elevated levels of debt got us into this crisis and the situation still hasn’t improved for many countries. In fact, for some countries, the debt burden of the private sector has gotten even worse. Check out the last row of these charts on debt service ratios (looking at the red lines):

This isn’t necessarily bad, but there are potential pitfalls. As the report points out (emphasis ours):

Rapid credit growth is not necessarily bad. Financial systems in many emerging economies are still relatively underdeveloped, and many households and firms are shut out of formal credit markets. Thus, rapid credit expansion could reflect financial development as much as financial excess. And even in advanced economies, rapid credit growth need not by itself herald the onset of financial vulnerabilities.

That said, financial deepening takes time: credit growth that overwhelms the capacity of financial institutions to screen and process loans may result in bad lending decisions and financial stress even when the share of credit in GDP is low. Similarly, a bloated financial sector can also suck in more than its share of talent, hampering the development of other sectors.8

That last sentence is a smack in the face, isn’t it? FT Alphaville was dying to know what Footnote 8 would contain.

Here it is:

8 See S Cecchetti and E Kharroubi, “Reassessing the impact of finance on growth”, BIS, January 2012, mimeo

So we looked it up. From the introduction:

… in our examination of industry-level data, we find that industries that are in competition for resources with finance are particularly damaged by financial booms. Specifically, we show that manufacturing sectors that are either R&D-intensive or dependent on external finance suffer disproportionate reductions in productivity growth when finance booms.

At first, these results may seem surprising. After all, a more developed financial system is supposed to reduce transaction costs, raising investment directly, as well as improve the distribution of capital and risk across the economy. 1 These two channels, through the level and composition of investment, are the mechanisms by which financial development improves growth. 2 But the financial industry competes for resources with the rest of the economy. It requires not only physical capital, in the form of buildings, computers and the like, but highly skilled workers as well. Finance literally bids rocket scientists away from the satellite industry. The result is that erstwhile scientists, people who in another age dreamt of curing cancer or flying to Mars, today dream of becoming hedge fund managers.

That many scientists, engineers, and mathematicians leave university and head straight for the financial sector is well-known. It is, however, intriguing to see a study that attempts to formalise this and provide empirical data around the impact it has.

It is, after all, a huge issue in terms of misallocation of brains:

There is an important sense in which this description of the consequences of a financial boom is no different from those of the dotcom boom of the 1990s; or the impact of any other boom tied to more tangible output. While they are booming, these industries draw in resources at a phenomenal rate. It is only when they crash, after the bust, that we realise the extent of the overinvestment that occurred. Too many companies were formed, with too much capital invested and too many people employed. Importantly, after the fact, we can see that many of these resources should have gone elsewhere. Following the dotcom bust, for example, innumerable computers were scrapped, office buildings vacated and highly trained people laid off.

As well as the brain-misallocation, there’s competition between the R&D heavy industries for funding and the finance industry itself, as it needs ever more capital to continue to grow.

The sample for the empirical analysis consists of Austria, Belgium, Canada, Denmark, Finland, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland and the United Kingdom. The conclusion from the model that the researchers employ:

That is to say, a sector with high R&D intensity located in a country whose financial system is growing rapidly grows between 1.9 and 2.9% a year slower than a sector with low R&D intensity located in a country whose financial system is growing slowly.

To give an idea of what R&D intensity is: aircraft and computing are high R&D intensity industries, whereas textiles, iron, and steel are low intensity.

Usual caveats around the result not proving causation and so on, but despite that limitation (and others of the dataset mostly due to data availability), it’s amazing to even try to put an estimate on how much it costs us that scientists become hedge fund managers.

The next time you are feeling glum about impact of the global financial crisis, perhaps think of this… maybe the scientists who flocked to banks and hedge funds will start doing research again. Maybe we have more breakthroughs to look forward to as a result of the retrenchment of resources.

Or are we trying too hard to look on the bright side of life? [Whistles]

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