Mike Massey is a member of the Coffee Party, and an environmental soil chemist currently focusing on research for his Ph.D. dissertation. He is a graduate of Stanford University and Colorado State University, and co-founded a small agriculture-related startup company in Colorado in 2008. He maintains active interests in environmental issues, energy and resource issues, education, politics, economics, and Japanese literature. More by Mike Massey.
I came across an interesting image a month or so ago. It was a photo of a leaflet allegedly “dropped” on Occupy protesters in Chicago. I’m not sure what to make of its authenticity, but when I read it I thought, “What a great idea!” The whole premise of the leaflet is a twisted cautionary tale. It can be summarized in a few brief points:
- We are Wall Street, we’re smart(er than you), and we work hard(er than you).
- If you make our business less lucrative, we’ll come and take your job instead, and we’ll do it better than you. (You’ll be out of work.)
- If you make our business less lucrative, you won’t get to benefit from our largesse anymore. (Even if we don’t take your job, you’ll still be out of work, because we’re the rainmakers in this economy.)
As I’m sure many readers will recognize, there are a number of issues with this line of reasoning, but my overall response was, “Bring it on! Let’s make this happen.”
The fact is that the growth of Wall Street profits (and bonuses) does little to help the economy. Most Americans know this intuitively, but let me try to explain why this is so by examining the concepts of “value creation” and “rent-seeking.”
Value creation is how economies grow, in real terms. One can take a tree, for example, and cut it into lumber. Then one could take the pile of lumber and build a house. Value was added to the economy several times: once when the tree was felled, once when it was turned into lumber, and once when the lumber was made into a house. Or consider the latte: a person takes a 50 cents worth of milk and coffee, steams it for a minute or two until it’s just right, and sells the result for four dollars. There can be value in a sequence of letters on a page, a series of bits in a computer, a particular arrangement of pigments on a canvas or notes on a page, new scientific knowledge, or a new critical perspective. Education is our investment in future value creators — the “value-creative class.” Value creation is the root of real economic growth.
Rent-seeking, on the other hand, is a way to expand an individual’s share of the economy, without actually producing anything new – without producing much new value. Rent-seeking is not necessarily a bad thing; I don’t begrudge an innkeeper or a landlord the fee for a bed to sleep in and a roof over my head. Nor, indeed, do I begrudge a broker her commission, or the mutual fund company their expense ratio. All of these activities can enable value creation, and everybody’s got to make a living. Rent-seeking just doesn’t really grow the economy that much, in comparison to value creation.
The financial industry can enable value creation. The economic benefits of having a financial system should outweigh the costs. The size and growth of the current financial industry is another matter. Assuming an individual business deal would have gotten done with a reasonably-sized financial industry, a bloated financial industry simply increases cost of doing business – without adding additional value. The same is true in health care industry: if the same outcome can be achieved with fewer resources, intermediaries, and procedures, the excess does not add value to the economy. It merely adds to the cost of doing business, and expands certain people’s share of the economy without directly growing it.
We need the health care and financial industries. But US economy is suffering from misallocated resources. As The New York Times‘ David Leonhardt points out, “...It’s hard to see how the jobs of the future will spring from unnecessary back surgery and garden variety arbitrage.” Some of our biggest industries are too big, and too costly. And it’s hurting us.
“We are Wall Street. It’s our job to make money.”
...Well, not exactly. As John C. Bogle, the founder and former CEO of The Vanguard Mutual Fund Group, is fond of pointing out, it’s Wall Street’s job to take money, not make it.
Indeed, the first chapter of Bogle’s 2009 book, Enough: True Measures of Money, Business, and Life is entitled “Too Much Cost, Not Enough Value” and is a stinging critique of the financial industry. In it, he contends that the financial industry actually subtracts value from our society – in the industry’s current form, that contention is probably true. Just ask anyone living next to foreclosed, vacant property.
The financial industry is certainly costly. Bogle notes in his book that in 2006 the financial industry (not counting finance-related businesses of non-financial companies) was responsible for $215 billion of the $711 billion in earnings of S&P 500 companies. That’s just over 30 percent. And most of those earnings came, not from value creation, but from fees and arbitrage (the practice of taking advantage of a price difference between two or more markets). Rather than producing value, much of the financial industry revolves around taking a large a cut as possible out of value creation. Bogle estimates the cost of the financial industry at over $600 billion per year. That’s about 3 percent of the entire US economy.
If a deal or a transaction would have gotten done anyway, adding layer upon layer of costly middle-men simply transfers money to the middle-men, without adding value. Arbitrage is the same – I once had a brilliant hedge fund manager tell me that arbitrage is basically “a cash machine” for those lucky and smart enough to figure out a way to be faster than the next guy. He was correct – basically, arbitrageurs take money from a buyer or seller (depending on the direction of the price difference) and put it in their own pocket. Imagine someone grabbing your change at the supermarket and running off with it, simply because you were a little slow in picking it up. That’s arbitrage in a nutshell. People get paid to do this sort of thing, but it’s not generally productive activity; it doesn’t create anything. It doesn’t really increase the size of the economic “pie;” it just changes the size of the slices. That’s why Wall Street doesn’t help the economy very much – money that goes to pay Wall Street isn’t made, it’s taken from elsewhere in the economy.
As I look at it, when “We are Wall Street” declares, “When our money dries up, so does yours,” we should sleep soundly and without worry. When their money dries up, that’s just fine – someone else, somewhere in the economy, will still have that money to spend since it’s no longer being vacuumed up quite so vigorously by the financial industry.
We Need Fewer “Financial Engineers,” More Real Engineers
“We are Wall Street” got at least one thing right: a lot of the United States’ brightest people gravitate toward the financial industry, lured by the promise of the huge payoff. And it’s true, they work hard. That’s why I got excited when I read, “What’s going to happen when we can’t find jobs on [Wall] Street anymore? Guess what: We’re going to take yours.” Why was I excited? I’ll let “We are Wall Street” explain it for me: “We get up at 5 am & work till 10 pm or later. We’re used to not getting up to pee when we have a position. We don’t take an hour or more for a lunch break.”
Imagine if we could unleash that kind of drive on productive, value-creating activity? Imagine if the “financial engineers” on Wall Street were designing products, launching the next great industries, making the next great scientific breakthroughs, or teaching our children?
America’s problem is resource misallocation. We have too many “financial engineers,” and not enough engineers.
We have too many financiers engaging in unproductive activity, when they could be using their considerable talents to create value that would not only benefit themselves but also the US economy, and thus, everyone else as well.
My response to Wall Street profiteers saying they will come take our jobs: “Come and join the world of the value creators! It’s about time!” It’s the value creators that are the basis of a strong and prosperous economy. Despite Wall Street’s over-inflated perception of themselves, the rainmakers in our economy don’t work on Wall Street. They work on Main Street. And we’d love to have those who currently work on Wall Street come and create value and prosperity with us.