studying economics vs. finance

o-china-pollution-factory-facebookI recently started a masters in finance degree at Washington University. While finance and economics share a lot in common, I’m starting to realize how different the types of people are in each field.

Economics is a research discipline. Things are changing slightly, but for the most part, economists primarily work for universities and research institutions, not Wall Street. Because of this, they tend to be more left-leaning and less worried about excessive government regulation and more worried about human “irrationality” and breakdowns of markets.

A classic example of this is when economists talk of externalities. When a market produces too little or too much of something, economics teaches that subsidies or taxes should be introduced bring markets closer to the socially optimal level of production. For example, too many people smoking cigarettes might led to higher insurance premiums for everyone, so a cigarette tax should be implemented to bring down the amount of cigarette smokers.

Finance types, on the other hand, don’t have much patience for government regulation and (in general) believe that markets (i.e. prices) are free of error. Because people who studied finance in college tend to go on to work for Wall Street, it’s pretty logical that they would have this opinion: Who wants to admit they’re bad at something? Isn’t it easier to blame someone else (i.e. government regulation)?

Today in one of my finance classes, as an example of how crowds tend to converge to be correct, the professor passed around a jar full of jelly beans. He claimed that the class average of all our guesses would be very close to the actual number, which shows that a large group of people are better at figuring out what’s best rather than one person. This exercise might work for a jar of jelly beans, but it has shortfalls in the real world.

For example, there might be a new financial instrument that very few people understand how to accurately price. If everyone is allowed to take their best shot at pricing this instrument, the “market” might get it terribly wrong. If there is incentive for financial companies to collude and price things higher than their true value, the price will not be the “true” price.

I’m not totally sure where I fall on the economic-finance spectrum. But, It’s always important to keep a nuanced view of the world, and I think economics does more to explain those nuances.