- Professor Kwong Kai-Sun, Sunny
Our educational machinery is pretty efficient in churning out financial economists (FEs). Every year, scores of university graduates exit from financio-economic programs to take up well-paid jobs in the industry. By the time they are thirty or so, many are occupying powerful positions in banks, fund houses, and consultancies, earning big salaries and leading enviable lifestyles. People openly admire them but some privately view them with disdain. There are negative views which portray FEs as being selfish and greedy, getting rich by either speculation in the markets (using their own money or other people’s money) or sucking the last penny out of poor debtors. FEs are regarded as necessary evils of the capitalist system and their existence does little in furthering social well-being. If this is the full story, then our educational machinery is actually not paying society any service.
If I may jump to conclusion, what I want to argue is that our educational machinery is actually bringing about social improvement, for our graduates do play a role in furthering social well-being, even though they may not be aware of it. In fact, they can play an even larger social role if they exercise their creativity a bit more. They can be as socially responsible as any other occupation.
Let’s look at financing in the primary market.
The modern society has a new breed of organizations – the social enterprises. These organizations do not sell a product or a service. They sell a mission, something that the public (or a proportion of the public) subscribes to. We have organizations campaigning for global warming, animal rights, conservation, health and education in poor countries, etc.
These organizations have social value as they fill some of the gaps left by market failure in one way or the other. However, their business cannot be sustained by customers and the market in the usual way. To carry out their work, they need financing. The creative FEs have a role to play here – by using creative financing mechanisms, they can raise funds from a large number of donors. Their work does not end after money is raised, for they have to account for the usage of funds and raise awareness in a wider community so that their work can be sustained and expanded. They are practically “owners” of those organizations. If you look around, many investment fund managers have converted to become social investors and social enterprise “owners”. On the one hand, they feel a vocation arising from social responsibility. On the other hand, they find the skills they have acquired as a FE transfer pretty well to their new positions.
When an economy has reached maturity, its GDP growth hits a ceiling, because wages and other production costs are high and competition from other economies is intense. We all know that its further growth depends on human capital, which translates into creativity and innovation. That is the technological side of the growth strategy. There is also a financial side of the strategy. All innovations require financing to turn ideas into products. Financing comes in the form of venture capital, angel investment, debt issuance etc. In the real world, technologists and entrepreneurs work hand in hand with investors and FEs. The growth of a mature economy depends very much on the existence of a vibrant population of FEs.
The same argument applies with extra force on underdeveloped economies. These economies are characterized by poor infrastructure, poor living conditions, and low income. The inhabitants are caught in a poverty spiral that they cannot easily escape from. Even though they might possess natural resources and abundant labor, because of a lack of capital, progress does not happen by itself. Foreign aid (like food and medicine), even if available, does not offer sustained improvement. What is needed is financing. Capital, either from investors or lenders, can provide the initial push to allow them to escape from poverty – through procuring fertilizers, simple machineries, transport vehicles, rudimentary infrastructure etc. The income they earn can be used to pay off their debts, and win the confidence of investors to invest further. The elevation of living standard arising from this process is long-term and sustainable. Here the expertise of the FEs in creatively structuring financial contracts that take care of the interests of all parties is crucial. Without their presence as intermediaries, investors will not reach out to the needy in poor regions.
A similar scenario happens much closer to home. Around us are numerous urban poor, people who are marginalized, perpetually dependent on social assistance, and with no hope of escaping dire living conditions. In the past, improvement depended on the wisdom of the government or the altruism of large corporations or philanthropists. An emerging trend is, given that the improvement of living conditions of the urban poor is a social goal, everyone can chip in a little (which is different from a tax because it is voluntary). Enormous social returns may result. The cost of building a many-to-many financing platform was exorbitantly large in the past, but with the advancement of IT, the cost is manageable. However, here again FEs are needed to serve as intermediaries to pull off financial arrangements that are sustainable and acceptable to all parties.
It is financial activities in the secondary market that have attracted the bulk of negative publicity. In the eyes of the skeptics, traders make substantial profits through buying and selling of stocks and other financial instruments, while not putting in any real work into the economy. Worse still, in playing derivatives, one trader’s gain is another trader’s loss, so it is hard to argue that what they are doing is productive. Their social responsibility score appears to be zero.
The truth is efficiency of the market system depends crucially on a mechanism that allocates capital efficiently among alternative investment instruments. If a company is well run (due to managerial efficiency, superior technology, or more appealing products), society would like to see it expand in scale. On the contrary, if a company is poorly run, it should contract. When this happens, resources are re-directed to the best uses. However, unless we live in a frictionless Modigliani-Miller world (where information is symmetric, an economic jargon) this process does not happen by itself. The price of the shares in the good company must rise and the price of the shares of the poor company must fall, so that investors in the former earn higher return than those in the latter.
What must be in place is a well-functioning stock market where the price of shares reflects the profitability of companies. In turn, this requires a large population of FEs who study individual companies and assess the fair value of each of them. They also have to act on their research, so that the market price of a company reflects its true value. This mechanism is of tremendous value to an economy. Without it, capital may be grossly misallocated, and the economy suffers in terms of stagnant growth. One needs to just observe the economic performance of centrally-planned economies (such as North Korea) to convince herself that this is not just a theoretical conjecture. When FEs do research in the hope of maximizing private return, they are actually contributing to making the stock market more efficient.
When our students go out to work, they should be aware of the actual and potential contributions they can make to society at large. With some creativity, they could generate substantial social benefits. They can alleviate poverty, improve living conditions, eradicate urban slums, lower fatality rates, stimulate economic growth, and prepare workers for a fulfilling retirement.
September 11, 2015
Prof. Kwong is the Co-Director of the Global Economics and Finance Program at The Chinese University of Hong Kong.
- Professor Kwong Kai-Sun, Sunny