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Three expensive milliseconds

Apr 16 2014, 02:37 IST
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SummaryWe’re giving huge sums to the financial industry while receiving little or nothing in return

Four years ago Chris Christie, the governor of New Jersey, abruptly cancelled America’s biggest and arguably most important infrastructure project, a desperately needed new rail tunnel under the Hudson River. Count me among those who blame his presidential ambitions, and believe that he was trying to curry favour with the government- and public-transit-hating Republican base.

Even as one tunnel was being cancelled, however, another was nearing completion, as Spread Networks finished boring its way through the Allegheny Mountains of Pennsylvania. Spread’s tunnel was not, however, intended to carry passengers, or even freight; it was for a fibre-optic cable that would shave three milliseconds—three-thousandths of a second—off communication time between the futures markets of Chicago and the stock markets of New York. And the fact that this tunnel was built while the rail tunnel wasn’t tells you a lot about what’s wrong with America today.

Who cares about three milliseconds? The answer is, high-frequency traders, who make money by buying or selling stock a tiny fraction of a second faster than other players. Not surprisingly, Michael Lewis starts his best-selling new book Flash Boys, a polemic against high-frequency trading, with the story of the Spread Networks tunnel. But the real moral of the tunnel tale is independent of Mr Lewis’s polemic.

Think about it. You may or may not buy Mr Lewis’s depiction of the high-frequency types as villains and those trying to thwart them as heroes. (If you ask me, there are no good guys in this story.) But either way, spending hundreds of millions of dollars to save three milliseconds looks like a huge waste. And that’s part of a much broader picture, in which society is devoting an ever-growing share of its resources to financial wheeling and dealing, while getting little or nothing in return.

How much waste are we talking about? A paper by Thomas Philippon of New York University puts it at several hundred billion dollars a year.

Mr Philippon starts with the familiar observation that finance has grown much faster than the economy as a whole. Specifically, the share of GDP accruing to bankers, traders, and so on has nearly doubled since 1980, when we started dismantling the system of financial regulation created as a response to the Great Depression. What are we getting in return for all that money? Not much, as far as anyone can tell. Mr Philippon shows that the financial industry has grown much faster than

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