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"the social value of such careers"

What about the "social value" of leaving private individuals alone to pursue private careers in which they enter into private contracts with other private individuals?

Oh right, I forgot -- we're discussing Robert Frank. Without a presumption of central planning by "enlightened" economists like him, his theories become utterly irrelevant (i.e., generate zero "social value" themselves).

Never mind.



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Lawrence Indyk, University of Kansas School of Law

A large majority of the population may be sufficiently risk-averse that they would come to view rare risk-neutral (and ideal) behavior as seeming to be significantly risky and dangerous based on the social norm of over-caution. So what Frank labels as "overconfidence" could actually be non-normative but optimal behavior which nevertheless provokes an impression of overoptimistic recklessness.


"It is not like a race for buried treasure or to exhaust a coal mine or an oil field, because there is no fixed quantity of financial opportunities."

It is not a resource extraction activity where the resource being extracted it limited, but isn't it essentially a resource (capital) placement / investment activity where the resource is limited?

So how is it any better too many people trying to figure out where to place the resource so it is used most efficiently compared to having too many people trying to find the most efficient way to extract a resource?

In other words, expressed inarticulately, I think the marginal utility of additional talented individuals going into financial services may be less than the cost to society of their forgoing other activities because if more people are looking for places to invest, they may make better investments, but not that much better than if slightly fewer were looking, past a certain number.


Here's a link to the Frank column:



I see that's essentially what Frank is saying, though I think it's unfortunate that it's based on anectodal information. Reading that, though, it seems as though what this is really about is whether tax reform under the circumstances is appropriate. It is.

It makes no sense to have a 15% tax rate on one profession. It's an accident resulting from an attempt to encourage long-term investment. People shouldn't have to explain why hedge fund managers should pay more taxes; people not wanting the mistake in the tax code to be fixed should explain why hedge fund managers, some of the most highly compensated individuals in the world, deserve to pay less than half what other high earners do in taxes (15 v. 35%), especially where their income is earned from providing a service and not investing their own money (what the lower long-term capital gains tax is aimed at).

Advocates of the status quo should be able to put forth a convincing argument that hedge funds are so beneficial to society that they deserve government subsidies relative to other businesses.

Not to mention that Blackstone's partners, for example, are paying even lower rates of taxes, and are, in fact, getting supplemental pay from the government, due to how they structured their IPO (paying 15% on their income but depreciating their goodwill assets at 35%). Their effective tax rate, far from 35%, is around -10%. I'd like some letters to the editor to explain why that is fair and why the law should remain as is.

I think Frank's point is that the market isn't being allowed to work efficiently because the government has intervened and imposed a lower tax rate on a single profession, leading too many people to go into that profession.




"One empirical dimension is the actual social value added of star financial managers."

Then you might also consider how the pseudo-celebrity status and massive compensation given to managers serves as a marketing tool. The hedge funds are asking for large sums, total control, and an unprecedented % take off the top. One way to pitch this setup to the people putting up the money to play with is to hang mythology onto a "star" manager. "He's the next Gordon Gecko!"

On another note, there are unstated reasons here that many people are uncomfortable with hedge funds:

The scope of the funds under "investment" or "management" by these star managers is such that individual policies and plays can move the market.

The command structure of these funds is such that ONE star manager can set policies and plays.

So the situation is functionally identical to the 1980s junk-bond kings and takeover barrons. One, or maybe several fund managers could, for example: buy a controlling share to tip the scales on a contested merger vote, then dump the shares a week later after the short-term pop produced by the successful merger. It has happened.

So what's the problem with that. 1) Profoundly undemocratic, 2) disruptive of every other investor's reasonable expectations, 3) harmful to the companies so played. Even if they are Wharton educated math geniuses, these managers can't possibly know more than the union, employee shareholders, insiders, and even long term investors about what is healthy for the company. This is profit motive stripped of even the small accountability our law has seen fit to place on CEOs and traditional insiders.

Posner mentions a fund helping bootstrap an undervalued new company to market success, but it is just as likely (and profitable faster) for a fund to buy up, loot, and cash out of an undervalued established company. Or to sink funds into a deservingly failing startup in order to provoke an industry leader to buy it at a premium.

You can't properly incent long-term economic growth with a model that rewards short term profit-taking. "Star" status + legions of young turks waiting in the wings = immense near-term profit pressure.

Dan C

How many skilled people do you need before a market becomes efficient? The problem that I have with most behavioral economist is that they seem to argue that unless the average person is skilled enough to exploit an opportunity, the market is not working properly.

In this case, Mr. Frank argues that only a few talented people are needed to run hedge funds and that too many people enter the field.

I would ask Mr. Frank not to look at gold prospecting but at acting as a field that too many people enter. A few top actors can make enormous sums, but most actors are unemployed actors. If you are an engineer who can make a good income as an engineer, you will only become an actor if you think you are an outstanding actor with a competitive advantage (perhaps personal contacts) or you enjoy the perks and psychic income of being an actor.

For Mr. Frank, I suppose, the world is full of talented actors and the marginal difference between them is small. If one actor is not available another actor can fill the role without a significant difference in quality. (I suppose the same could be said for economics professors.)

And perhaps Mr. Frank is correct that that if one hedge fund manager had never been born, some other hedge fund manager would have taken his place. After all, if Marlon Brando had never been born, some actor would have played Stanley in A Streetcar Named Desire. Of course modern cinema would be different.

Still, lets assume that acting is a drain on societal resources – too many people pursue entertainment careers. If we taxed the successful actors heavily, we would remove some financial incentives for entry to the profession. Of course those who continue to pursue acting careers may just be different from the previous population – they may pursue a calling based on non-monetary incentives. (I suppose we could try to tax entertainment stars for the charity services of groupies.) Trying to find the correct tax to get a desired societal outcome is tricky and as Judge Posner argues it becomes a complex empirical question.

So how do you design an incentive system that attracts a very gifted actor but discourages the merely competent ones? How do you, as a taxman, know that a given actor, with training, will break loose from the pack and become special?

Still, I can agree with Mr. Frank that the tax code may be overly generous to people who pursue some complex financial deals. If many deals are being done only because the tax code encourages them; if these deals just use the tax code to transfer wealth to a select group without significant net societal benefit, then I agree with Mr. Frank that we should discourage these deals. (Entry into the field just becomes a trivial secondary issue.)

For example, I understand that we as a society spend large sums to attract people to become professional athletes. Mr. Frank can argue whether the pursuit of an athletic career by youths is a net drain on society.

The fact that athletes from around the world come to play sports in America, mostly based on financial incentives, greatly improves the product. (You could argue that baseball was just as exciting during the Babe Ruth era, but the average baseball player is more talented today.)

But I would agree with Mr. Frank that if the tax code favors the diversion of resources into professional sports, corrective steps should be taken. I enjoy sports but it does bother me that modern professional sports depend heavily on tax benefits (the teams and their clients) to generate revenue. But the fact that athletes, or would be athletes, follow the money is really a secondary issue.

In the end I think Mr. Frank has it wrong. He argues that the tax code should be used to help discourage people from entering a given field. No. If the tax code is distorting economic activity, encouraging economic activity that would not occur absent the tax incentive, and the net societal benefit is negative, do away with the incentive. People entering the field is a trivial secondary issue.


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