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Friends Don’t Let Friends Get Into Finance

By Vivek Wadhwa on Techcrunch. (Source)

After having been a tech executive for many years, I needed to take a break, and I wanted to give back to society. Duke University engineering dean Kristina Johnson gave me a great spiel about how the school’s Masters of Engineering Management program churns out great engineers, and how engineers solve the world’s problems. She said that I could make a big impact by teaching engineering students about the real world and encouraging them to become entrepreneurs. I felt so excited that I joined the university without even asking for a proper salary. That was in 2005.

I was shocked—and upset—when the majority of my students became investment bankers or management consultants after they graduated. Hardly any became engineers. Why would they, when they had huge student loans, and Goldman Sachs was offering them twice as much as engineering companies did?

So when the investment banks tanked in 2008, I cheered because engineering had become sexy again for engineering grads (read my BusinessWeek column).

But thanks to the hundred-billion-dollar taxpayer bailouts, investment banks recovered and went back to their old, greedy ways. And they began offering even more money to engineering grads (and themselves).

Kauffman Foundation’s Paul Kedrosky and Dane Stangler have just published a report that analyses the damage this has done to our economy.

http://tctechcrunch.files.wordpress.com/2011/03/finance-sector-as-percentage-of-gdp.pngThey note that the finance sector today produces a greater percentage of GDP than at any time in history. In the mid-nineteenth century, its contribution was between 1 percent and 2.5 percent of GDP. It peaked at around six percent of GDP at the beginning of the Great Depression, and then fell sharply. Since 1945 it has been steadily increasing, to 8.4 percent over the last two years.

Historians will tell you that empires collapse when they become too dependent on finance, but I’m not so pessimistic. I do, though, share the concern that Kedrosky and Stangler expressed in their paper:

Fewer people are being added to industry employment, but they are coming from new and narrower places. The financial services industry used to consider it a point of pride to hire hungry and eager young high school and college graduates, planning to train them on the job in sales, trading, research, and investment banking. While that practice continues, even if in smaller numbers, the difference now is that most of the industry’s profits come from the creation, sales, and trading of complex products, like the collateralized debt obligations (CDOs) that played a central role in the recent financial crisis. These new products require significant financial engineering, often entailing the recruitment of master’s- and doctoral-level new graduates of science, engineering, math, and physics programs. Their talents have made them well-suited to the design of these complex instruments, in return for which they often make starting salaries five times or more what their salaries would have been had they stayed in their own fields and pursued employment with more tangible societal benefits.

An analysis of MIT’s graduate-employment data shows that the financial sector increased its hiring from 18 percent of its graduates in 2003 to 25 percent in 2006. So not only are the investment banks siphoning off hundreds of billions of dollars from our economy with financial gimmicks like CDOs; they are using our best engineering graduates to help them do it. This is the talent that our country has invested so much resource in producing.


When most sectors of the economy grow, new companies are created. The authors found, however, that the finance sector is not driving firm formation; it is cannibalizing entrepreneurship in the U.S. economy by offering wage and skill premiums to individuals who might otherwise have started companies. It is also causing far greater volatility among publicly traded firms and a reduction in the quality of businesses started.

The report concludes that a shrinking finance sector will likely lead to a higher entrepreneurship rate and the creation of companies with greater social value, and still provide the financial intermediation services that are most important to young companies. So that’s what we need in order to save this empire: to tame this beast.

Paul Kedrosky says that the virus that infects scientists and engineers and causes them to go to Wall Street rather than create something of societal value is “economic Ebola”. He wants to be an “economic virus hunter”. Let’s all help him. Let’s save the world by keeping our engineers out of finance. We need them to, instead, develop new types of medical devices, renewable energy sources,and ways for sustaining the environment and purifying water, and to start companies that help America keep its innovative edge.

Editor’s note: Vivek Wadhwa is an entrepreneur turned academic. He is a Visiting Scholar at UC-Berkeley, Senior Research Associate at Harvard Law School, Director of Research at the Center for Entrepreneurship and Research Commercialization at Duke University, and Distinguished Visiting Scholar at The Halle Institute for Global Learning at Emory University.
 

DominiConnor

Quant Headhunter
The question is also why do engineering firms pay so much less than finance ?

I get to talk to leaders of both banks and engineering firms, and overwhelmingly the bankers say they value engineering talent more than engineering firms. Someone with an engineering/science PhD is now far more likely to be a future CEO of Goldman Sachs or Morgan Stanley than of Boeing, Microsoft or Intel.

Often the engineers won't even be in the same city as management, and note that management does not intersect with engineering.

It's tempting, but stupid to say that non-finance firms can't compete because they don't have the cash which is both a lie and fatuous.

Engineering firms will pay gladly for accountancy and sales talent, but not engineering.

A friend of mine is leading a major aspect of engineering Ford's next generation of engines, he is very smart., Given the calibre of people I deal with where merely having a PhD in something hard from a top university is nice but far from unique and where I've drunk with 90% of the people who's models you use daily, or the book you are studying, when I say someone is very smart, that's a small exclusive club.
He earns a pitiful amount, some of you will start on more than he gets paid, and if you aren't earning more than him within three years of starting your career you might well judge yourself as having failed.
That's Ford as in motor company, not some piss poor little start up in Ireland.

They could pay more, but they won't because they know that no other car firm will pay more, so it's not just Ford, it's the whole industry.

As my mother used to say fuck'em, if they want our talent they can pay for it.
 
Wadhwa isn't saying anything new; nothing most of us don't already know. It's not the predatory nature of financial forms or the greed of engineering graduates that's the culprit; it's just the way the wind is blowing, as the economy becomes more "financialised" and industry becomes eviscerated. It's a "meta-trend." In some sense, finance now drives the economies of the UK and US. Innovation -- such as it -- is taking place in finance in "mature" economies like the UK and US. Some -- including myself -- may question the worth of such innovation, but there it is. I've cited this before but I recall the letter to FT last year from an Imperial College engineering grad who just couldn't find an engineering internship. Why should he not then drift towards finance like others in his cohort? Even if he does find an engineering job, he won't get paid enough (in and around London) to afford a house and raise a family. And his job will be no more secure than one in banking and finance.
 

Joy Pathak

Swaptionz
The question is also why do engineering firms pay so much less than finance ?
.

It depends on where you work. Most companies that hire engineers don't have profit sharing schemes. There is a significant over-time concept at Ford and GM. Although the base salary is low, many engineers make 100K+ with OT. That is a great pay for young engineers.

If you work for Schlumberger you get a share of the profits on the projects you work on. There are engineers that I knew of when I worked in the oil industry who made 300K because of the profit sharing system at SLB. There are not too many companies that make the money to give their engineers high salaries which is why they just CANNOT pay them high salaries. Google and other tech firms make huge profits and spend it on giving their engineers incredible amenities and incentives.

Also, engineers are not directly making the sales. They are making products and then its upto the sales and marketing team to do the rest. The structure or model of the companies is very different from financial firms.
 

Yike Lu

Finder of biased coins.
The question is also why do engineering firms pay so much less than finance ?
Engineering firms will pay gladly for accountancy and sales talent, but not engineering.
That's interesting. I'm not going to surmise about why they value accountants more but for sales...

Perhaps because value (in the economic sense) is mostly perception. Perhaps because making a car 10% better in quantifiable metrics doesn't make it sell 10% more. Perhaps because there's a better ROI to make an ad claiming the vehicle is "Built Ford Tough" than to actually build it better.
 
I believe that software engineers are getting paid much better, and the market for them is also become more competitive, for example

http://www.nytimes.com/2011/03/26/technology/26recruit.html

But how about the conclusion of the article?

"When most sectors of the economy grow, new companies are created. The authors found, however, that the finance sector is not driving firm formation; it is cannibalizing entrepreneurship in the U.S. economy by offering wage and skill premiums to individuals who might otherwise have started companies. It is also causing far greater volatility among publicly traded firms and a reduction in the quality of businesses started.

The report concludes that a shrinking finance sector will likely lead to a higher entrepreneurship rate and the creation of companies with greater social value, and still provide the financial intermediation services that are most important to young companies. So that’s what we need in order to save this empire: to tame this beast.

Paul Kedrosky says that the virus that infects scientists and engineers and causes them to go to Wall Street rather than create something of societal value is “economic Ebola”. He wants to be an “economic virus hunter”. Let’s all help him. Let’s save the world by keeping our engineers out of finance. We need them to, instead, develop new types of medical devices, renewable energy sources,and ways for sustaining the environment and purifying water, and to start companies that help America keep its innovative edge."
 

Yike Lu

Finder of biased coins.
The conclusion? What conclusion?

If you get paid more to do something in one field than another, it implicitly means that society's spending power as a whole demands more people in the field where you get paid more.

We are not talking about a 10k/year difference, we are talking an order of magnitude difference. The difference is clearly enough to outweigh the personal utility of "contributing to society" and clearly gives us a representation of society's utility function itself. Until society as a whole recognizes the value of engineers by paying them more, what obligation have we?

The guy shouldn't be trying to keep scientists and engineers out of finance, he should be trying to get them paid more to do science and engineering.
 
I guess my highlighting of that sentence is misleading. I was not thinking about how to attract scientists and engineers to do science and engineering instead of finance.

I was thinking more about the followings:

"the finance sector is not driving firm formation; it is cannibalizing entrepreneurship in the U.S. economy"

"The report concludes that a shrinking finance sector will likely lead to a higher entrepreneurship rate and the creation of companies with greater social value."
 

Yike Lu

Finder of biased coins.
That's a legitimate point. I don't know. Perhaps in mature economies, optimization of risk transfer (which is essentially financial innovation) pays off more than additional risk-taking itself (entrepreneurial innovation).

I agree with the overall sentiment, but you have to wonder why things are the way they are. It could be fundamental to human nature that as an economy matures, people naturally become more risk averse and those that are successful tend to become asset holders rather than innovators.
 
That's a legitimate point. I don't know. Perhaps in mature economies, optimization of risk transfer (which is essentially financial innovation) pays off more than additional risk-taking itself (entrepreneurial innovation).

I agree with the overall sentiment, but you have to wonder why things are the way they are. It could be fundamental to human nature that as an economy matures, people naturally become more risk averse and those that are successful tend to become asset holders rather than innovators.

That mature powers shift from being innovation-driven to being wealth-driven was a point made by Paul Kennedy in his magnum opus, The Rise and Fall of the Great Powers, which was published in the late '80s. It created a sensation both in the UK and US -- the US at the time was having some angst about Japan's apparently unstoppable rise to economic supremacy -- but now perhaps has been forgotten, though in my humble judgement it is still worth reading.
 

Yike Lu

Finder of biased coins.
Does he go over why this occurs? That would be far more interesting than just the fact that it does happen.
 
Does he go over why this occurs? That would be far more interesting than just the fact that it does happen.

It's been over twenty years since I read it, and it's a bit over 700 pages. I don't remember the argument he advanced. However, the book can be picked up used for a few cents at Amazon (plus $3.99 for shipping). My rough guess of his argument is that mature powers have a hub-and-spokes relationship with other parts of the world -- an overtly imperial or quasi-imperial set-up, where finance, insurance, and other technical services are conducted in the imperial centre, while actual manufacturing (and by implication, engineering innovation) is done elsewhere. Britain is a prime example, probably reaching its industrial peak around 1870, and sliding downhill ever since -- yet London remains a finance, banking, and insurance hub.
 

Yike Lu

Finder of biased coins.
In America to get paid you don't have to be skilled, you have to be a good salesman. Good scientists are typically piss-poor salesmen. Good salesmen are typically piss-poor scientists. Similarly, the problems that are worth solving are typically not profitable to solve. Neither is preparing for the future.
Sales IS a skill. It's the skill of creating value by altering perception.

It's not necessarily a flaw of the US, it's due in large part to how human nature is. Like I mentioned above, value is all perception. There's no reason to invest in something that you cannot perceive to have value. And regardless of how smart you are, you are still fundamentally vulnerable to psychological biases (perhaps moreso in some cases).
 

Eugene Krel

sunmulA
Yike is right about sales being an important skill. Unless you can convince people that your idea has value (whether it's selling a car or proving P=NP) you will not be successful. That is not to say that some ideas are easier to sell than others.
 
Sales is an "important skill" that adds no value to society or your product.
Define "sales skills".
Is the ability to convince people upstairs that the existence of your "quant team/prop trading desk" is critical to the long term growth and strategic plan of the bank considered important?
Is the ability to convince your boss that you play an important role in the group and your contribution deserves higher bonus and promotion important?

It's not all about talking your clients into buying your products or making a trade with you, but it's essential for where you will end up within a few years.
 

DominiConnor

Quant Headhunter
I do sales and engineering, in fact I've spent most of the last couple of weeks writing and analysing some code, and agree that sales is a skilled job, and it's wrong to see sales and marketing as part of a zero-sum game. Many good things have failed to be bought, and thus died because they weren't sold properly.

It's interesting to apply what we see to China, India etc...

Most of us are around average in what we do, so let us set our egos aside and look at the rational choices for an average 'engineering type person'.

In Germany, an engineer is paid well, has good job security and social status.
Thus even though Germans are amongst the most expensive manufacturing workers on Earth who work short hours, it does very well in this sector.
Japan, slightly less so, but again it's people are expensive and it makes lots of stuff.
Note that both Japan and Germany have surprisingly small and unsophisticated financial sectors.

In the US and UK engineers are not particularly well paid, and there are many other things they can do with their skills, so they do so.
Applications to do hard engineering at universities are worryingly low in quality, and the absolute numbers ain't great.
UK manufacturing is all but dead, and US manufacturing is in monotonic decline.

If you are numerate and Chinese/Indian you will see people making serious money out of making things, so engineering will be much more attractive to you.
Let's assume that the average Chinese/Indian is as smart as the average European/American, but that there is some sort of distribution of ability, I don't care what shape you assign to that, and you don't even have to assume that it's the same for all countries.
It follows from above that a larger % of smarter people will choose to go into manufacturing in China than in the USA, and unless you make the most bizarre assumptions about the shape of the talent distribution, the Chinese in manufacturing will be smarter than those in the USA or UK.

Engineering is a team sport.
You might be an amazing engineer, but if you live in Nigeria you won't ever do much, so you either leave or have a job banging bits of metal with a hammer.I have some ability with software, but am shit at wiring, I hate wiring, a lot. Wires hate me too. Rarely can you make a new thing without reliance upon people who have specialities you don't, so the quality of your colleagues is critical to your success.
So even the smarter US/UK engineers will be held back by the spiral of decline.

This can't be fixed.
It can be slowed, but won't be.
 
I was talking in more general than quant space, but we can move it there if you want.

My ability to convince my boss that I deserve a higher bonus in no way adds value to the company or to my work. My ability to convince a client that an asset has greater value for them than it actually does adds no actual value to the asset, or to the client for that matter.

I do understand that it is essential. I do want to get a competitive salary after all ;)
"Value is in the eye of the beholder." In other words, value is subjective. When you sell your boss, you're trying to increase his evaluation of you. When you sell an asset to your client, you're trying to increase his evaluation of your asset. There is no "objective" value.
 
Sure there is. Everything has an objective and subjective value. The objective value is a measure of "good" that something does to someone, so to say. The subjective value is how much "good" someone think that that thing will do them.

A case can be made that one of our responsibilities as quants is to find the objective value from the subjective value.

There's no distinction between subjective and objective -- it's a false duality. Recognising it as false is one of the first steps on the path to wisdom and becoming savvy with money. Perception creates value. There is no objective "value" that exists distinct from perception. Gravity and electromagnetic fields might exist independently of humans but not value.
 
Sure there is. Everything has an objective and subjective value. The objective value is a measure of "good" that something does to someone, so to say. The subjective value is how much "good" someone think that that thing will do them.

A case can be made that one of our responsibilities as quants is to find the objective value from the subjective value.
I tend to disagree. What is the objective value of gold, soil, or water? Is it possible to know? Is there still objective value if Earth had no living creatures? In any case, this is all very philosophical and getting away from the main point of the thread.
 

Yike Lu

Finder of biased coins.
Even suggesting that there is a objective value shows your ignorance of basic economics. Economists invented the notion of a utility function specifically to quantify subjective preferences, and the whole underpinning of micro-economics is based on the notion of utility functions.

Just taking your oil example, the value of the things you can produce from it is directly determined by the value OTHERS assign to them. In fact, they are largely determined by the value society assigns to them. If people didn't like driving cars, then that value would plummet. As we all know, driving is risky. If for some reason human risk aversion became very extreme (and note risk aversion is completely subjective), then you would see a drop in the value of things you can produce from oil as people decide they don't want to take the risk of dying from driving.

There is no objective measure of value. What's the value of a dollar? We're off the gold-standard at this point, so it's determined completely by the faith people have in the US government's ability to pay its debts.

Even if we were ON the gold-standard, why is gold valuable? As far as I can tell, it's just shiny and pretty and back in the old days, hard to forge.
 
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