Debating a Harvard Professor’s Criticisms of the Finance Industry
The Finance Field is Full of Good People, Despite What Economists Say
A recent article in The New York Times Upshot section by the Harvard economist, Professor Sendhil Mullainathan, titled, “Why a Harvard Professor Has Mixed Feelings When Students Take Jobs in Finance” was a weak attempt at arguing the case that finance professionals add little to no value to society and that people working in the industry are mainly carrying out immoral or illegal acts.
In fact, finance does add value to society and the industry is filled with many good people. I hope the professor will work to make sure that rather than lamenting his students’ decisions to work in finance, that he helps them make better ethical choices, no matter what industry they are in. And, that he does it through sound, logical arguments, rather than typical appeals to emotion.
The op-ed from Prof. Mullainathan got me wondering what Harvard professors are teaching their students these days. His article covered a lot of ground, such as: that the profession of finance is “rent-seeking”, that arbitrage should be limited at a certain point, that inventors are denied the monetary benefits of their inventions, that careers in finance are not the best use of his student’s talents, and that a career in finance falls short of being particularly good for society as a whole.
A Career in Finance Does Add Value to Society
From the start, I admit, I am biased, as I spent my whole working life building a career in finance. I worked with a long list of people who applied themselves to serving the needs of the client. And, I dare say that the majority of people employed in finance do the same. A great example is the financial advisor to my mother and father, who for the past 15 years has honestly and honorably put my parents’ interests first. As a result, they are able to live comfortably in retirement.
Finance is all about the efficient allocation of cash. Think of finance in terms of the individual (usually the supplier of cash), the company (usually in need of cash), and the government (almost always in need of cash). The function of finance is the efficient movement of this cash from one area to another. When a financial system is functioning properly, money is moving toward profitable investments and away from unprofitable ones. This is a critical function in a society, and without it, a society could fall apart. You, dear reader, as a saver, want your financial professional to allocate your money toward profitable investments. Over the past 10 years, I’m sure you wanted to own Apple, Inc. rather than Nokia Corporation.
How Could a Harvard Economics Professor Not Pass ‘Economics 101’?
Three areas that the professor speaks about need further clarification. First, he refers to people in the financial industry as “rent-seekers”. Wikipedia describes this term as follows: “In economics, rent-seeking is expending resources on political activity to increase one’s share of existing wealth without creating wealth.” If this is also his description of rent-seeking then I would agree wholeheartedly that we want to reduce attempts by any industry or business to use their power and influence to gain monopolistic positions through manipulation of government in their favor. But, in his article it appears that his idea of rent-seeking is something quite different.
The second he talks about is “arbitrage”, and again we turn to Wikipedia: “In economics and finance, arbitrage is the practice of taking advantage of a price difference between two or more markets. In simple terms, it is the possibility of a risk-free profit after transaction costs. For instance, an arbitrage is present when there is the opportunity to instantaneously buy low and sell high.” He then refers to there being a point of diminishing returns to society for reducing the speed of trading, then goes on to make a weak attempt at linking a “gold rush” to this concept.
I would challenge this by stating that the market is pretty efficient at solving this issue of diminishing returns. If traders still see a profit opportunity from shaving off milliseconds of a trade, then let them do it. Eventually, they will hit a point at which the investment is no longer worth the effort. There are other possible negative side effects of this behavior that we could debate, but the professor does not acknowledge these in his article, so I will do the same.
In his gold-digging allegory, the professor states, “Still, arbitrage is valuable only to a point. It has a gold-rush element with prospectors racing to get to the gold first. While finding gold has value, finding gold before someone else does is mainly rent-seeking.” This is just plain wrong. The whole principle of capitalism and entrepreneurship centers on the challenge of being the first to a new idea. The rewards of this can be enormous. And, what about the poor guy who arrived at the gold mine after nearly all the gold was removed? Well, he should be allowed to dig for gold as long as he thinks that there is a return possible from digging. Aside from the man allocating his own labor, who should determine the point at which he should stop digging? The government? An economics professor? The fact is that one person may prefer digging for gold – even for a small return – over flipping burgers at a sandwich shop for very low pay. Let him dig in peace.
Finally we come to the professor’s discussion of inventors being denied the monetary benefits of their inventions. First, only a small number of inventors actually produce a successful breakthrough. The rest work very hard, but do so in obscurity. For those who do come up with an invention, they can have the option of turning that invention into a business. Even if they do not own the patent, they could propose to license it from the owner. But besides that, I fear the author may have missed the difference between invention and commercialization of the idea. The statistics are clear – most businesses fail within their first few years. The path to commercialization of any idea is a painful one, and those who succeed tend to get the rewards. Isn’t that just “Economics 101”?
There are Bad People in Every Industry – Let’s Help our Young to be Good
The point that I believe the professor is making is that there are bad people in finance, doing immoral or illegal things to make money. And of course there are, as there are in any industry. Now, allow me to address Prof. Sendhil directly, because as a professor from Harvard, you, sir, are in a perfect position to work toward improving this.
You could – and maybe already do – teach your students about ethics. You could advise them about their career choices, and if you think the field they are going into, such as finance, is particularly perilous, then you can give them more industry-specific advice.
You could advise them to study a program, such as the CFA program from the CFA Institute, which puts a very strong focus on ethics and correct behavior in operating as a financial professional. You could help them understand when they have done something wrong in their life, what they can do to admit that, make amends, and move on.
Most importantly, you could teach them that ultimately, for a society to be ethical, it means that each individual, no matter what industry she works in, must take pride in making the right ethical choices. As I learned when I became a CFA Charterholder, in the field of finance, that choice should always be to put the “interests of clients above your own”. If you need support in further educating the Harvard student body on this subject, just let me know – I am at your service.
Do you agree with me or Prof. Senhil? Any comments or question you might have, I would like to know. Is anything unclear? Or would you just like to add anything to the post? Please let me know in a comment below.Â
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Originally published on April 15, 2015 at:Â www.equities.com.