A black hole for our best and brightest | The Washington Post

28 Sep


A black hole for our best and brightest
Wall Street is expanding, and the economy is worse off for it.

Story by Jim Tankersley
Photos by Bonnie Jo Mount
Published on December 16, 2014
NEW YORK — The thing Deborah Jackson remembers from her first interviews at Goldman Sachs is the slogan. It was stamped on the glass doors of the offices in the investment bank’s headquarters just off Wall Street, the lure of the place in two words, eight syllables: “Uncommon capability.”

Jackson joined Goldman in 1980, fresh from business school and steeped in the workings of government and finance. She found crackerjack colleagues and more business than she could handle. She worked in municipal finance, lending money to local governments, hospitals and nonprofits around the country. She flew first class to scout potential deals — “The issue was, can you really be productive if you’re in a tiny seat in the back?” — and when the time came to seal one, she’d welcome clients and their attorneys to Manhattan’s best restaurants.

Above: Deborah Jackson, center, founder and chief executive of Plum Alley, works with staff members in New York. Jackson spent two decades on Wall Street and now works to develop and support women’s businesses.
The clients would bring their spouses and go to shows. Everyone drank good wine. Her favorite place, in the heyday, was the 21 Club, which felt like an Old World library and went heavy on red meat. More than the perks, Jackson loved the work — the shared struggle of smart people trying to help the country, even as they banked big money. “It was all about solving problems,” she said.

Years later, she would come to see it differently, growing disenchanted with an industry she didn’t think was fixing much anymore.

Economic research suggests she was onto something. Wall Street is bigger and richer than ever, the research shows, and the economy and the middle class are worse off for it.

ABOUT THIS SERIES:  The American middle class is floundering, and it has been for decades. The Post examines the mystery of what’s gone wrong and shows what the country must focus on to get the economy working for everyone again.
Chapter 1: Why America’s middle class is lost
Chapter 2: The devaluation of the American middle class
Chapter 3: The college trap that keeps people poor
Chapter 5: What’s killing entrepreneurship?
Chapter 6: What went wrong, and how to fix it
There’s a prominent theory among some economists and policymakers that says the big problem with the American economy is that a lot of Americans don’t have the talent to compete in today’s global marketplace. While it’s true that the country would be better off if more workers had more training — particularly low-skilled, low-income workers — that theory misses a crucial, damaging development of the past several decades.

It misses how much the economy has suffered at the hands of some of its most skilled, most talented workers, who followed escalating pay onto Wall Street — and away from more economically and socially valuable uses of their talents.

The financial industry has doubled in size as a share of the economy in the past 50 years, but it hasn’t gotten any better at its core job: getting money from investors who have it to companies that will use it to generate growth, profit and jobs. There are many ways to quantify how that financial growth-without-improvement hurts the economy.

In 2012, economists at the International Monetary Fund analyzed data across years and countries and concluded that in some countries, including America, the financial sector had grown so large that it was slowing economic growth. Using a different methodology, the most prominent researcher on the size and economic value of Wall Street, a New York University economist named Thomas Philippon, estimates that the United States is sinking nearly $300 billion too much annually into finance.

In perhaps the starkest illustration, economists from Harvard University and the University of Chicago wrote in a recent paper that every dollar a worker earns in a research field spills over to make the economy $5 better off. Every dollar a similar worker earns in finance comes with a drain, making the economy 60 cents worse off.

It’s not that finance is inherently bad — on the contrary, a well-functioning financial system is critical to a market economy. The problem is, America’s financial system has grown much larger than it should have, based on how well the industry performs.

To understand how and why that is, think of money as water and the financial system as a series of pipes. Ideally, the pipes deliver the water from people who have stockpiled it (investors) to people who want to put it to productive use (entrepreneurs, executives, home buyers, etc.).

Over the past half-century, America’s financial industry built a whole bunch of new pipes. The sector grew six times as fast as the economy overall during the past three decades. Other advanced countries didn’t see anywhere close to that growth in their financial sectors.

Some of America’s growth was driven by Washington. Lawmakers kept encouraging financial innovation, which built a market for smarter investment bankers. They did that by changing the tax code to encourage businesses to hire financial whizzes who could spin ordinary income into certain, preferred types of investment income, and by loosening restrictions on the kinds of financial activities that the titans of Wall Street could engage in.

Extra pipes attracted better plumbers — the more the finance industry grew, the more it tugged at highly educated workers. Philippon is a French economist at NYU’s Stern School of Business. He and a co-author, Ariell Reshef of the University of Virginia, have shown that from the end of World War II until the early 1980s, finance was just like any other desk job: The average Wall Street worker was paid about as much as the average worker in the private sector and was only slightly more educated.

But starting at about the time that Jackson joined Goldman, when Congress began tweaking investment-tax rates, Wall Street started drawing more educated workers. This made the average finance salary go up — from less than $50,000 a year in 1981 (which is about $100,000 in today’s dollars) to more than $350,000 a year in 2012.

Salaries rose even faster in the mid-1990s. The average finance worker began to earn more than a similar non-finance worker who had the same amount of schooling. Wall Street executives began to command salaries several times the rate that non-finance executives could.

In sheer dollar terms, it became irrational for almost any qualified American graduate to pass on a Wall Street job. By the mid-2000s, finance workers earned about 50 percent more than they would have in a similar job anywhere else in the economy. There are almost twice as many financial professionals in the top 1 percent of American income earners today as there were in 1979, according to researchers from Williams College, Indiana University and the Treasury Department. Almost 1 in 5 members of the top 0.1 percent work in finance.

You might think finance workers earned all that money because they were selling new and improved financial products that delivered more value — that helped get money more efficiently from investors who had it to entrepreneurs who could put it to profitable use. Research suggests that’s not the case.

A few years ago, Philippon set out to study 130 years of financial-sector performance. He expected to find that performance improved as the industry grew in recent decades.

Philippon tracked the fees that banks and other asset managers take when they move money between investors and borrowers. In theory, the managers should charge less as their technology improves, because they become more efficient and more competitive with one another. (Or, if they charge the same amount, they should generate better returns for investors.)

That’s how it works with, say, your laptop: As the technology improves, you can either buy a better computer for the same price as your last one or you can buy a clone of your last one for less.

In finance, Philippon found, the opposite is true. Financial firms pocket about 2 percent of the money that passes through their hands. That’s basically unchanged from the price of finance in 1920, and it’s actually an increase from the mid-1960s. “It seems that improvements in information technologies over the past 30 years have not necessarily led to a decrease” in the price of financial intermediation, he concluded in the paper.

What that means is that the growth of complex financial products has served primarily to boost income for the firms themselves, Philippon said. A new paper from researchers in the United Kingdom supports his findings. It analyzes decades of data on individual workers and finds no connection between financial professionals’ specific skill sets and why they make so much more money than similarly skilled workers in other industries.

Those finance pros could have been doctors or researchers or product engineers. They could have gone into the business of solving human problems, commercializing big ideas and creating jobs. Almost anything they could have done, by Philippon’s calculations, would have added more value — more growth and job creation — to the economy.

Today, fewer top graduates are heading to Wall Street than a decade ago, possibly because of the fallout from the financial crisis. But the industry still makes up just under 8 percent of the economy, two percentage points above what Philippon calls the optimal size of the sector, given its performance. It’s still adding workers.

Deborah Jackson works with staff member Joan Costello in New York.
Deborah Jackson spent 21 years in the financial industry after she left Columbia Business School. Gradually, over 10 or 15 years, she began to suspect that her industry had stopped caring about solving problems.

She left Goldman in the 1990s for a boutique firm; she later launched an investment-banking practice focused on health-care technology. Her next itch to move was different — more existential. Shortly before the 2008 crisis, she left finance for good.

“It just lost its interest for me,” she said. “It just became work instead of enjoying what I was doing.”

When Jackson left Wall Street, she called it retirement. She day-traded to keep her brain engaged. But she knew she wanted to get back into the business world, somewhere she could solve problems again, where she could make a difference.

Then, in the course of some volunteer work, she started meeting female entrepreneurs, and she was taken with their ideas and energy. She co-founded an accelerator program for women building new mobile technologies. She helped organize an all-female “hackathon,” where programmers get together to build something cool from scratch. She rented a home in the Hamptons and invited 18 women, all skilled coders, to start at 10 p.m. on a Friday. They worked around the clock until 4 p.m. Sunday, building an interactive game to show the horrors of sex trafficking.

Finally, she hopped into the job-creation space. She founded Plum Alley, a company focused on spurring innovation and job creation among female entrepreneurs. It can help them find money to get started (through a six-step plan to tap potential donors in their social networks) and help them find customers (through an online shopping site). She hired three highly educated women, then four more. The company recently moved to an office on Park Avenue South.

Jackson had found the meaningful work she’d been looking for, using knowledge in finance to try to create value in the economy. She had taken a risk and started a business. She’s already thinking about expanding the company to help start-ups grow and thrive. “It kind of reminded me of the early days,” she said. Like back at Goldman, all those years ago. Solving problems.

Coming in Chapter 5: If the shoes don’t fit, find a better way to make them

Story by Jim Tankersley
Photos by Bonnie Jo Mount

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1/2/2015 4:27 PM EST
I have always “joked” that the demise of the space program, and the resultant migration of math wiz’s from Houston, Pasadena, Sunnyvale and Huntsville, to Wall Street and Greenwich, was a tipping point in the economic development of our country. Looks like I was right.
12/30/2014 7:49 PM EST [Edited]
This is just fallacious. How can you be a reporter on financial news when you don’t even understand that profit = price x volume?

The growing industry and profits hasn’t come about because of a price increase, it has come about because of an increase in the funds invested by consumers and companies alike.

You claim that the industry hasn’t “gotten better at its core job” of funnelling funds from investors to companies. 

If the amount of funds moving from investors to companies has increased (as a proportion of funds in the economy), this suggests that the finance sector has indeed gotten better at its job. Whether it’s that the returns can be larger, or that the types of investments vary far more than before, or that the average consumer has far better access to the industry, what this implies is that it has gotten better at taking funds from investors and providing it to companies simply because it’s funnelling more and more funds through as our economy develops.

12/27/2014 8:55 AM EST
Cited Chicago and Harvard study is absolute horse**** in at least one respect. Most academic careers are economic and social drains on the nation; leftist academics provide intellectual cover for destructive anti-capitalist policies.
Ruthmarie Garcia Hicks
1/6/2015 1:12 PM EST
OK, so I guess the government and academic hacks that launched satellites in response to Sputnik were a “drain” on our nation. Of course we wouldn’t have the world-wide-web, GPS, SmartPhones, tablets and WiFi without any of that…but what the hell? Or how about the academic hacks at ARPANET CSNET CERN that developed the internet…Yeah…that was a huge DRAIN on our resources. Of course we have the internet now, but that would have happened anyway? Right? WRONG!!!

How about the profits from those biotech companies? You think that happened out of vapor? That entire industry was built on the shoulders of the long slog that is basic biomedical research. 

Business feeds on that feast created in academia and we are rapidly chewing up what is left of the seed corn. Most of the real DISCOVERY occurs in academia through basic research. No basic research, no new discovery, nothing for industry to sink its teeth into for the next “internet”. Businesses can’t and WON’T do what the public sector can. The initial risk has to be taken in the public not-for-profit sector.
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12/27/2014 3:23 AM EST
A comment on the article: “Those finance pros could have been doctors or
researchers or product engineers”. No, they could not have, because the
type of intellect in science has little to do with making money. That should 
never be the goal. I know some of these people, and they’re slow.
12/27/2014 12:36 PM EST
Nonsense. Wall Street is drawing people who are talented at math, a talent that is essential to science and engineering as well. Instead of writing artificial intelligence programs that can make trades a millisecond faster than competitors, those talents could be applied to something that is useful, rather than enabling the parasites on Wall Street who caused the Great Recession as Bush dozed in the White House.
Jericho Slaughter
12/20/2014 6:03 PM EST
The fact checkers at the Washington Post must be asleep at their post. A central claim of this article is that economists at Harvard and Chicago write that “every dollar a worker earns in a research field spills over to make the economy $5 better off. Every dollar a similar worker earns in finance comes with a drain, making the economy 60 cents worse off.” However, if you look at the paper that supposedly contains this “research,” “Taxation and the Allocation of Talent,” you’ll find that claim nowhere in the paper. It seems to have been made up. This paper is on a completely different topic, which is optimal tax policy. 

This article cites other papers that make various claims. However, if you look at the evidence and arguments in these other papers carefully, you’ll see the arguments are very weak. 

12/21/2014 12:07 PM EST
The paper is not “on a completely different topic”; the issue about spill over effects is addressed in the extensive discussion of externalities in section 3. However, a range of (subjective) externalities is considered, and I don’t see any claim that “every dollar a worker earns in a research field spills over to make the economy $5 better off.” This lies well outside of the range considered. 

So, like Mr. Slaughter, I wonder where the author of this piece came up with these figures. Is it some other study?
Jericho Slaughter
12/22/2014 12:48 AM EST

I realize that the paper linked to does discuss externalities. However, as you have noted, the authors of “Taxation and the Allocation of Talent” just postulate the parameters of the externalities from different subjective points of view in order to derive optimal tax policy given these assumed parameters. The authors of the paper were in no way trying to estimate what the parameters of the externalities actually are in reality. That’s what I meant when I said the paper was on an entirely different topic–optimal tax policy rather than externality estimation. Like you, I’d like to know where these numbers came from since they could not have come from the paper linked to from the article. On the face of it, these numbers sound quite dubious. 

Setting aside the question of where these numbers actually came from, the other claims in this piece are equally problematic. The author of this article seems to have cherry-picked research findings that fit his pre-conceived view without much of a critical appraisal of the strength of the evidence for them or consideration of any contrary evidence.

For example, he refers to an study by some IMF economists that supposedly establishes that the financial sector has grown so big that it actually reduces the rate of growth. But when you look at the argument behind that, it’s not very persuasive. The IMF economists have merely run simple regressions in which they find that their particular measure of financial depth is non-linearly correlated with slower growth. But that doesn’t mean that the high financial depth caused slower growth. There are serious statistical problems with these sorts of regressions, since financial depth is likely influenced by the growth rate. 

Plus, you really do need a cogent theoretical explanation backed up by evidence for why there is a threshold beyond which growth in the financial sector lowers growth. But you only get some speculation on this point in the IMF paper. 

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12/19/2014 7:34 PM EST
With the GOP moving into power the trend of financial engineering being most valued will increase.
12/19/2014 2:02 PM EST
This Series is absolutely phenomenal. I only wish that more Americans would spend time to think through the economy. It’s much deeper than surface-level talking points that I hear most people spouting back and forth.
12/19/2014 1:25 AM EST
It’s not just Wall Street. I worked for a number of years as a consultant to “Not for Profit” and “Non-Governmental Organizations”. Similar, but not exactly the same.

I was always amazed at the “entrepreneurial spirit” I found in these organizations. Sometimes as much as 50% or more of the staff was involved in developing and “distributing” “products” such as training courses, software, DVDs, etc..

These organizations also had highly talented people working on “cash flow” problems, increasing “accounts receivable” via grant writing, and reducing payroll via “volunteers” who were certain they were “benefiting mankind.”

Unfortunately most of the time they were “benefiting” a small number of people at the top of the organization who enjoyed being feted by the creme-de-la-creme of the local society while patting themselves on the back for “helping the unfortunate” at the same time they helped themselves and frequently spouses and family members to significant salaries, “organization cars”, and other “perks.”

I talked at some length to one executive director about his “entrepreneurial” tendency and his comment was “Why pay taxes when we don’t have to? As long as we get a few pictures published now and then of the Mayor and his wife everyone is happy.” 
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12/18/2014 2:27 PM EST
I truly wish pharmaceuticals and medical devices were far more profitable. Imagine the benefit to all of us if the best and brightest were attracted to an industry that lengthens our lives and improves our health.
Tom Ritchford
12/18/2014 9:04 PM EST
Actually, it turns out that running a medical office is one of the ten most profitable types of business in the United States, says Forbes.
Dan Litwiller
12/22/2014 7:57 AM EST
That’s probably only if you run patients through on a turnstile. Quality healthcare doesn’t work that way.
Ben Simmons
12/21/2014 2:15 AM EST
The U.S. puts $100 billion per year into pharma and medical device research. There’s plenty of incentive, and in fact many of our best and brightest DO work in those fields.

But I basically agree with your underlying point, that it wouldn’t hurt for even more people of exceptional talent to be directed toward those research fields.
12/18/2014 12:01 PM EST
Looking again at Philippon’s study makes me wonder how much he considered the development of the credit card market. Credit cards are now ubiquitous and their ubiquity has enabled our modern era of e-commerce. When you save money (or get other value) by buying the thing you want online your credit card bill goes up, even if you don’t carry a balance. The interchange fees can be high, yet vendors look at those fees as a no-brainer due to decreased tender time, credit risk, and increased sales. What other major innovations are assumed not to exist and thus be a drain on the economy?
12/18/2014 9:21 AM EST
What is a reasonable percentage for finance profits? Finance operates as a middleman in an economy. How much profit should be given to the truck driver delivering your goods? What percentage of the profit from the sale of goods should go to the person that loads your car or checks out your purchases? How about the owner of an oil pipeline? What percentage of the cost of your gas should go to the pipeline owner? All they did was move oil from point A to point B. How about Visa and Master charges, they collect money on every purchase made by a credit card using their networks. That means they get a percentage of most consumer transactions in the USA. This cost is passed on to you, the consumer, even if you don’t use credit cards. That is the type of analysis that must be used to determine the value of financial services. Do we over estimate the value? This article suggests we are getting over-charged.
12/18/2014 11:17 AM EST
Right! And that analysis is hard to do. The authors of the study compares today’s services to those of yesteryear as if the service had not evolved and noticed the price went up. Their conclusion is that it must be negative on the economy, but the has not shown that the services haven’t improved and moved into more costly but more valuable areas. It’s possible that the services haven’t improved, but the conclusion based on that assumption is unfounded.

In the authors’ words, “while we and others have personal view about externalities, we have no systematic strategy for measuring these empirically.”
12/18/2014 7:40 AM EST
“The point is, ladies and gentleman, that greed, for lack of a better word, is…” bad.
12/18/2014 6:19 AM EST [Edited]
Real businesses start with real people who are able to save money to begin small enterprises on their own. They don’t borrow money from Wall Street. They don’t even borrow money from local banks. They generally have started with their own money, saved over a period of work for others. That’s the way it used to work, just fine. 

However, over the last 40 years, excessive regressive payroll and self-employment taxation have destroyed the ability of the middle class to save, thus destroying their ability to engage in new enterprises that could have become the backbone of our economy. 

Today, Social Security and Medicare cost virtually every worker 15.3% of every dime earned. Employees essentially bear this full percentage because the burden of the portion of the tax imposed on their employers is shifted to them in the form of lower compensation.(Look up the economic concept of “tax incidence” for further information about this.) And self-employed persons see this full tax rate on every dollar beyond their legitimate business expenses. 

Excessive regressive payroll and self-employment taxes really are the root of most evil we face today in the United States. And most distressingly, they are destroying the ideal of America as a place of equality of opportunity.
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12/18/2014 6:32 AM EST
Spot on. In a world where capital is kingm our government does everything it can to prevent the average person from accumulating it
12/18/2014 11:22 AM EST
Businesses that borrow aren’t “real.” Kind of like how “real men” don’t eat quiche. Nevertheless, lots of men eat quiche and lots of businesses borrow money.

Economies with a thriving finance sector outperform those without it. How did our own economy perform when the financial sector was in trouble? 

The Polonius school of economics will lead the country into a permanent depression.
12/18/2014 6:01 AM EST
Isn’t the finance industry pat of the service economy? If so, they are supposed to provide a service to the part of the economy that is actually producing wealth. Instead, the finance industry now acts like the rest of the economy exists to support the finance industry.
The manufacturing industry started falling apart when the finance guys started running the show instead of acting as advisors.
Finance thinks they are creating value by printing a bunch of paper called derivatives or whatever. In the end it is just paper.
One step in changing this whole mess would be to treat all income as equal for tax purposes. Capital gains income should be taxed the same as labor income.
Last thought: I would like to see similar studies of the increasing size and cost/productivity of the K-street lobbying industry and of congress.
12/18/2014 1:57 AM EST [Edited]
This is all fine and good, and brings up important food for thought, but the problem isn’t really what the article says, it’s the reaction of people like Warren. The answer to this problem isn’t taxing them at a higher rate and giving that money to other people…that doesn’t create anything. The answer isn’t overregulating them into non-existence either. Nor is the answer letting them continue doing what they’re doing.

So far, nobody has the answer, but a LOT of people want that money, and that’s why things are not ever going to change


Part 1 America’s middle class is lost in space
Part 2 The devalued American worker
Part 3 The college trap that keeps people poor
Part 4 A black hole for our best and brightest
Part 5 The great start-up slowdown
Part 6 Fixing the broken talent flow
The American middle class is floundering, and it has been for decades. The Post examines the mystery of what’s gone wrong, and shows what the country must focus on to get the economy working for everyone again.


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