Arnold Kling  

Anti-Finance Bias

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Greg Mankiw writes


A student who regularly reads and comments on this blog asks me for career advice, from a social point of view:

How does someone like Warren Buffett contribute to the economy? It seems investing in old line industrial businesses is more of a rent-seeking activity. I take it that people on Wall Street are in some sense parasitical ... yes? Do you still think it makes sense for me to go to work on Wall Street and be, say, an investment manager at a hedge fund? Can one improve an economy's productivity gains by working on Wall street?
Mankiw gently tries to correct the student. I would have sent the student to read The Mind and the Market, by Jerry Muller. I would hope that after doing so, the student could recognize that his view of financiers as parasites is in a long tradition (think Jesus on money-changers in the temple, for example).

One of the duties of economists is to try to explain that people who are involved in production are no more deserving of the living they earn than others. As Douglass North points out, our economy becomes more productive as a result of the activity of all of the people (he now estimates it as a majority in the U.S.) who are doing work that facilitates trading of goods, as opposed to production.

Anyone who has taken an economics course and cannot recognize that those involved in the market to allocate capital are creating value is a poster child for our failure as teachers.


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CATEGORIES: Political Economy



COMMENTS (25 to date)
ryan writes:

this is hardly my area, or the important point in the post, but my impression was that the incident (or incidents? -- IIRC, there are two in the Bible) between Jesus and the moneylenders was not so much about opposition to finance or profit as it was about him not wanting a religious institution to be a for-profit enterprise (or the location of for-profit enterprises)

Mr270 writes:

Ryan is quite right, the issue was the inappropriate use of a house of worship for business purposes.

Jesus actually endorsed sound financial practices; see the parable of the talents in Matthew chapter 25 and the parable of the shrews manager in Luke 16. What are we to make of these words:

9)I tell you, use worldly wealth to gain friends for yourselves, so that when it is gone, you will be welcomed into eternal dwellings.

10)"Whoever can be trusted with very little can also be trusted with much, and whoever is dishonest with very little will also be dishonest with much.

11)So if you have not been trustworthy in handling worldly wealth, who will trust you with true riches?

12)And if you have not been trustworthy with someone else's property, who will give you property of your own?

Jesus in Luke 16:9-12

caveat bettor writes:

Arnold, your takeaway on Jesus and the temple moneychangers demonstrates teaching failure just as effectively as your chosen poster child.

Jesus was acting out on rent seekers. Whether or not an economics blog might have been more effective than his hastily fashioned whip is, like a lot of other stuff, an exercise in faith.

Phil writes:

I still don't understand the argument here.

Suppose I spend a day analyzing stocks, and eventually determine that stock X is overpriced by 10 cents. I buy 1,000 shares and duly make $100 profit.

If I had spent the day mowing lawns for $100, the world would be better off by having more mown lawns. But how is the world better off by me having analyzed the stock? My $100 came at the expense of the seller of the stock (or at the expense of the owner who sold that day, but wouldn't have been able to without my bid).

I understand that I have benefited the world by making the market slightly more efficient, and perhaps moving the stock price in line with its intrinsic value. But is that worth $100? It seems to my gut that it's worth less. But maybe not -- maybe it's more. Or maybe it's exactly $100.

Is there an argument that when I make $100 in the market, I have created a benefit of exactly $100? If not, how much *does* Warren Buffett contribute to the world?

SheetWise writes:

"But how is the world better off by me having analyzed the stock?"

You have added information that was previously unavailable. Almost anyone can mow a lawn -- how many people can add correct information that was previously overlooked?

BTW - If you information is not correct, you will be mowing lawns.

Sstefistateve Fisher-Stawinski writes:

In the stock analysis example, one of the things you are are doing for society, in addition to adding information, is assuming some risk. The example has you earning $100 by buying some stock which goes up in value. You didn't know for sure that it would do that when you bought the stock. You cold have been wrong and lost money on the deal.

If you mow a lawn for a hundred dollars, then you'll be tired and sweaty, but you don't go into the deal unless you know beforehand that you are getting the $100.

Ramon writes:

Jesus expelled the money changers from the temple while saying:

"...But you have made it a den of thieves"

implying that money changers were thieves in general not because they were in the temple. At least that's what was written down in the bible.

If those money changers were fooling people by forming some cartel or rent-seeking scheme, it would have given Jesus reason to call them thieves. But that wasn't written down on the bible so that it doesn't matter. The bible teaches moneychangers=thiefs.

TDL writes:

In regards to the stock analysis/trading example; it has to be recognized that what you are also doing in this instance is providing liquidity to the financial marketplace. This has a benefit because deeper and more liquid markets allows for a higher level of confidence to those who wish to float paper in order to raise capital. Furthermore, the person who sold is not necessarily out of a $100 either; if this individual no longer wished to own the stock (for whatever reason,) they would have sold it anyway (regardless if you were there to make the trade, since you were there you were able to offer them a price and quantity that they were seeking, otherwise they may have had to sell the stock for less.)

Regards,
TDL

Stan writes:

A thinking exercise that I think is underused is the water and diamonds paradox. We can think of capital as the diamonds in the example, because it is scarce. This is a unique way of teaching the value of capital.

Phil writes:

Thanks to those who responded to my question above, which was: when I spend a day analyzing a stock, determining it underpriced, and making $100 because of that, have I benefited society $100 worth?

1. Agreed that I am assuming some risk. But I could have done that by buying any stock.

2. Yes, I have contributed capital. But, again, that would be true for any stock. Specifically, I am referring to the $100 above the normal return on my capital. What have I done to benefit the world over and above just having bought an index fund?

3. I hadn't bought, either someone wouldn't have sold, or someone else would have bought at a lower price. If they bought at a lower price, it might have been pennies less than I paid (if the stock is heavily traded). In any case, that doesn't go to the question of the extra $100. And, again, if I had bought a random stock, I would have benefited a seller to exactly the same extent that I benefited the seller of my stock.

So, at the margins, isn't stock analysis less productive for the world than lawn mowing?

Alex writes:

In terms of creating value on the stock transaction, you need to keep in mind that you are benefiting the seller as well. He may also recognize the additional $100 in value, but needs to allocate capital elsewhere. You are providing a service to him.

It may be that someone else would have purchased the stock--and possibly for more or less than you paid--but the same can be said about mowing lawns.

Finally, reconciling the $100 profit and that value to society as a whole for the stock transaction seems to be an issue. Why is $100 to mow lawns not a question. By having grass a 1/2 shorter, what benefit is truly gained by society?

caveat bettor writes:

Phil: You may have made a profit of $100--but let's say stock X is issued by a company that has 400 million shares oustanding (the median of the S&P 500). Your 10 cent price improvement represents $40 million to society. Now, society can take the $40 million and allocate it to the higher marginal value that Company X provides to the marketplace.

Ramon: I don't see thieves as a separate class of people than rent seekers. The latter can be enabled by the government, that's the main difference to me.

Michael Sullivan writes:

If those money changers were fooling people by forming some cartel or rent-seeking scheme, it would have given Jesus reason to call them thieves. But that wasn't written down on the bible so that it doesn't matter. The bible teaches moneychangers=thiefs.

Actually it is well described in any good study bible, and the original audience of the gospels would have known this about their temple history -- these money changers typically engaged in fraudulent and deceptive practices, and also engaged in rent-seeking by capturing the favor of temple priests who granted them monopoly privileges in selling sacrificial animals/items. They (and the priests who dealt with them were specifically using the social capital of the temple to extract rents for themselves.

Jesus considered this a great sacrilege, and I don't believe one need hate finance to agree. It's not dissimilar to the pre-reformation practice of selling indulgences which Martin Luther so abhorred. These guys were the Jim Bakkers and Bhagwan Shree Rajneeshes of their day, selling salvation for a profit.

Bob writes:

Phil,

At the margin, yes, stock analysis is worth very little. But that's true in (I think) all cases - how much value does having lawns cut twice a week instead of once a week really add? How much value does that last bite of cheesecake add?

A better question might be which would be worse - if we all stopped doing investment analysis or we all stopped mowing our lawns?

peter jackson writes:

IMHO the role of risk assumption is too often underestimated, in part because our system of securities trading works so well. We simply cannot know the future, thus risk is ever-present and must be constantly dealt with in order to produce anything in an efficient, sustainable way. By trading stocks, that risk is diverted from firms and their employees to those in the marketplace most willing and able to assume that risk. Capitalism is a profit and loss system; someone's gotta take the hit. Without the stock market, every Edsel and New Coke that comes along is a firm killer and job destroyer.

yours/
peter.

Matt writes:

Look at the market for CDOs. Rich investors are losing billions of dollars on instruments that ended up facilitating loans to poor people so they could buy homes. Financial markets were able to transfer the risk of default from the bank to deep-pocketed investors. There were excesses, but the fact is that millions of people are in homes today, with no financial difficulty, that could not have gotten a loan 10 years ago.

I think most people who have difficulty understanding the stock market do not think of it as a collection of living companies, but rather a bunch of paper. I buy a share of IBM for $100 from you, you get my $100, no gain to society. They think it's a big poker game, with I-banks and brokrs acting as the house.

(-_-) writes:

Stock analysts provide information to allocate money where they would be the most productive.

Sorry If I am merely repeating what others have said, There were many posts, and I did not feel like reading them all.

quadrupole writes:

Phil,

When you buy a stock, you are doing two things:

1) You are providing the service of liquidity to the market. That liquidity frees up assets to be invested in other 'real' capital improvements.
2) You are providing the service of removing the risk from the seller of the stock, who now has locked in his gain or loss and is no longer at risk (in that stock anyway).

When you make that $100 gain, you are being paid for providing the liqudity and assuming the risk. The liquidity provides concrete benfit to society by allowing capital to flow into new ventures. The risk assumption provides concrete benefit to society by lowering the overall risk of investing. If no one was there to buy the stock from the seller then the risk of their investment would be the risk in owning that stock over all time, which is much higher than the risk of owning it over a finite time. By lowering the risk of investing in that manner, you are concretely benefiting society by increasing investment.

The whole financial market is about three things:

1) Allocating capital
2) Providing liquidity
3) Managing risk

These three are *crucial* to the economy.

Phil writes:

quadrupole: Thanks. I agree with everything you write here. But I still don't understand why buying the stock today benefits others (by my assuming risk and providing captial) by $100 MORE than if I had just bought an index fund.

To put it another way: suppose I spent eight hours analyzing stocks and made $100 that way. The world as a whole is no richer than if I had slept through the day and bought an index fund. But if I had spent eight hours working at McDonald's making $100, I would have provided $100 worth of services to McDonald's customers.

One answer is that the world is richer by $100 because I moved the price of the stock closer to intrinsic value. (Had I not done eight hours research, and just bought a random stock, I would have been (almost) as likely to move the price *away* from intrinsic value than towards it.) Millions of people doing what I did lowers the risk of investing, as even random investors can be more confident that they are more likely to buy at the "right" price, and eventually sell at the "right" price.

Is that worth the full $100?

Sorry if I'm repeating myself and boring everyone.

caveat bettor writes:

Phil, like I said before, your $100 profit implies a $40 million signal (assuming 400 million shares outstanding).

Fundamentalist writes:

Good comments on Jesus and the money changers. The primary mistake people make in reading the Bible is to assume it was written today. You have to understand the history and culture of the time in which it was written to really understand it. An excellent source is "Life and Times of Jesus Messiah" by Alfred Edersheim. It's old but still the best, and Edersheim was Jewish, so he has really good insights. According to Edersheim, Jesus's main objection to the money changers was that they were employed by the High Priest who had used his power to get a monopoly on money changing and charge exhorbitant rates, so the High Priest was robbing the people.

This is an important issue because so many religious people think the Bible is against commerce and finance in particular and capitalism in general. The opposite is true. In fact, the Dutch Protestants who created the first capitalist nation in modern times found their inspiration in the Bible. The anti-commerce/finance bias in the Church came Aristotle when the church adopted his teachings, not from the Bible.

As for the secular argument for Wall Street, it provides very valuable information for investors.

Fundamentalist writes:
Phil: Is that worth the full $100?

The stock market is zero sum. If I made $100 in the market, someone else lost it, such as the guy who sold it to me in the first place before the price went up. The only value to society is the liquidity that regular traiding provides.

What Wall Street and people like Buffet contribute to society is information and expert management skills. That's why they're valuable.

Phil writes:

caveat bettor: sure, that's a $400 million signal if I moved the price completely to its intrinsic value. But I probably haven't done that: I've moved the price a fraction of a cent, if at all (assuming the stock is heavily traded).

And by "$400 million signal" you mean "signal that the value of the company is worth $400 million more than market price". So it's not a real comparison to my $100.

By the way, assume that I put in a bid, and a seller accepted the bid an hour later. Wouldn't the value of my contribution have been putting in the bid, rather than buying the stock? The information that the stock is underpriced comes from my *willingness* to pay the price I paid, not from the actual purchase. (The other contributions -- risk taking, capital provision, etc. -- comes from the purchase, of course.)

Dan Hill writes:

Phil's stock trading question needs to be answered by looking at the outcome as a whole of free capital markets which is to allocate capital efficiently i.e. they produce the effect of ensuring that for a given stock of capital available, society receives the maximum possible return.

This can only happen because Phil and others like him are constantly looking for mispriced stocks i.e misallocated capital.

To look at the value of Phil's stock analysis activity in isolation from the market outcomes of which it is an essential element is a little like a wheel nut asking "I've been here on this wheel all day going round and round and have I really transported the passengers in this car anywhere?"

Michael Sullivan writes:

Phil, if you're still reading -- by $4 million dollar signal, what he means is that for you to make a $100 profit by capturing an arbitrage worth only 1/4 of a cent per share, then you must have moved 40,000 shares, probably worth somewhere in the neighborhood of $4 million. To make the kind of profit a normal arbitrageur makes on a 1/4 cent margin, you have to move ridiculous amounts of money, amounts that the market will pay a *lot* of attention to. Basically, the less information you're adding, the more certain you have to be and the bigger the signal you have to send in order to make a big profit. Only when the rest of the market has no clue and you do, can you make lots of money without moving orders of magnitude more. That kind of opportunity should be extremely rare in a functioning financial market. The participation of arbitrageurs is what keeps it rare.

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