Sunday, September 25, 2011

Is High-Frequency Trading (HFT) Harming Progress?



In part, yes. My thoughts below.

There are many definitions of progress, but I am going to skip over the more politically convenient ones. I view progress as truly novel ways to do old things (i.e. cell phones, internet, alternative energy), getting rid of widespread diseases (i.e. polio), order of magnitude cost reductions (i.e. chips for calculations), and the like. One can include things we can't imagine yet (past examples include plastics, telephony, flight). Twist-off beer caps, heated car seats or seaweed yoga pants do not count as progress.

For thousands of years, individuals have been able to make various important discoveries and inventions by and large on their own, or with relatively modest capital investments. These days are gone, for the most part: no one truly expects to mix up a cure for AIDS in a basement or to sequence the human genome on the kitchen table over yesterday's NY Post. The next large steps in progress will- in all likelihood- require that the person is a part of a large organization such as a university or a corporation. The next large steps would also likely require deep specialization in a certain field: after all, most- if not all- of the low-hanging fruit is gone, and the new generation has to step on the shoulders of the giants of yesterday.

Progress is in some aspects also a product of luck: you need lots of people doing lots of things, and some will be successful. These people nowadays are usually hard science PhD-level individuals- and, while I am mindful of individual choice and preferences, it seems that society (and progress) would be advancing faster if the high level of specialization was put to work in the proper conditions.

The problem is that less and less of this is happening. Big Pharma has been shrinking for years. The old tech giants seem more interested in behaving like patent trolls rather than funding R&D (for example, what used to be a highly innovative company, Hewlett-Packard, has cut its R&D from 6% of sales to almost 2% of sales in about a decade). R&D is viewed as a cost and is high on the list for outsourcing, creating even less incentives for people to take risks by working on what might be career and scientific dead-ends for a disloyal employer. Who is picking up the talent?

One industry is high-frequency trading. The low-to-negative societal value of co-location, quote/cancellation tricks in nano-seconds, order sniffers and the like is established beyond doubt, in my view. But these companies are dangling $300k++ packages to physics and engineering PhD's straight out of school to come up with even more innovative ways to milk fractions of pennies from your orders. This effectively removes talent from what might be the "unimaginable" developments and puts them to addictively lucrative work that one might argue contributes to regress, not progress, by undermining the faith in and the integrity of the capital markets (the flash crash last May being a recent popular example). So, it does seem to me that HFT is impeding human progress.

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