Are There Too Many Smart People in the Financial Industry?

Thu, Jan 27, 2011 - 8:12am

I’ve always heard the claim that too many smart people are working at hedge funds and investment banks. Yes, this is definitely true to an extent, but it’s hardly the only sector guilty of luring intelligence from its most useful purposes.

Commentators want to dismiss the financial services as an area of the economy that produces nothing. Hence, these highly intelligent people are wasting their time. But this idea seems to contradict other criticisms of the industry. For example, many financial derivatives were supposedly too difficult to understand. Would this be an argument for more highly intelligent individuals or less? Also, it points out that real value can be created through smart people in the industry.

But nonetheless, there are too many doctorates of physics, mathematics, engineering, etc. in the finance world. And I’ll explain why in a moment. But first, let’s talk about other sectors where intelligence is misallocated.

In my opinion, a bigger waste of intelligence comes from the government sector. I know so many individuals who work for the government and are incredibly smart. Unfortunately, their presence doesn’t make the government work any better because the incentive structure is so messed up.

Government employment is a pretty good lifestyle for an intellectual: good salary, low stress, and lots of vacation time. It’s the perfect job environment for someone interested in reading books and pursuing other leisurely intellectual activities. In comparison to grueling work weeks on Wall Street, this doesn’t sound entirely unattractive.

Government agencies are packed to the brim with high-level degrees – just think about the FDA, USDA, and Energy Department alone. These places are loaded with scientists of all sorts that aren’t producing much of anything.

But it doesn’t stop there. The education system holds back many talented individuals through grants or subsidized employment. After college, my brother and several other very bright students worked for a professor with an enormous grant to study bugs in the Mississippi delta. The professor didn’t have a specific goal in mind with these bugs. They weren’t going to lead to a new medicine. If his position hadn’t been subsidized, the professor and his students would have been forced into the private market. Instead of studying bugs, they’d likely be producing pharmaceuticals or biotech.

Of course, some of these grants produce interesting advances. But it’s hard to evaluate whether they are worth all the failed ones and whether these same people could have possibly produced more with the incentives of the private sector in place.

And then there are the scientists and engineers wasting their talents in the employment of weapons manufacturers. Is this really where society needs them? Or what about medical doctors? The country desperately needs more, and the market has bid their wages upward. But government policies have resulted in limited space in U.S. medical colleges. The system turns away highly intelligent people in droves.

The central problem isn’t any one industry. The problem is that the government has distorted price signals in the economy. Higher wages and benefits necessarily attract more workers. One group of misallocations is the government jobs, contracts, and grants. These incentives attract many people away from important R&D jobs in the private sector.

The finance industry’s wages are also manipulated through policy. The Federal Reserve creates booms in the economy. These booms naturally increase the demand for financial services. The demand raises the wages that attract more smart workers until the next boost. It’s an economy-wide labor misallocation –not something in finance alone.

These misallocations of highly intelligent labor aren’t the fault of a particular industry, such as finance. The real culprit is the government through its distortions of incentives and price signals.

Republished from Casey Research Daily Dispatch, January 26th, 2011.

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