Why I support a high pay commission


8:48 am - August 19th 2009

by Sunny Hundal    


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I’ve written a short article for the New Statesman about why the idea for a High Pay Commission, mooted by Compass this week, isn’t a bad idea. I’m expanding on some of the arguments here.

I’m going to start by noting that a ‘High Pay Commission’ isn’t necessarily about setting a maximum wage limit but about reviewing pay at the top and considering capping “excessive remuneration”.

Greed creates instability
There’s an article from the New Yorker magazine that is passed around to Bloomberg interns and employees as the article to read on the financial crisis. I can’t locate it for now. Found it, but the full version isn’t available online. But the basic gist is: you can blame the sub-prime crisis, confusing government regulation and increasingly complicated derivatives for the financial crisis, but actually it comes down to two things: excessive, unchecked greed and disregard for shareholder returns.

The financial crisis exposed the fallacy of the assumption that remuneration is closely linked to performance, especially at the top. The system not only hid deep losses in the financial sector but failed to penalise executives when their failures came to light.

To take one example, Merrill Lynch had record earnings in 2006 of $7.5 billion, with about $5-$6 billion handed out that year in bonuses. Mr Dow Kim, who managed the company’s mortgage business, was awarded $35 million in bonuses that year in addition to his nominal $350,000 salary. But the compensation system, as New York Times later pointed out, “turned out to be a mirage.”

The current pay structure for executives rewards them for making huge short-term profits at the expense of building stable, growing businesses. It encourages them to take massive risks, putting our pensions and the economy at huge risk, and getting out when the company crashes.

Since the financial system, by nature of its size and link to all other parts of the economy, is increasingly unstable because of pay structures, it needs over-hauling.

Productivity argument
But the call for a High Pay Commission isn’t just about preventing another financial crisis. It is about creating a healthier economy.

The main reason executive pay has shot up is not because there is less talent to go around. It is because executive boards are filled with people who have an interest in pushing up executive pay up generally everywhere. So they are happy to partake in bidding wars for top talent. They may eventually become a CEO and demand a higher salary, or they’ll negotiate more as non-executive directors on the basis of how much higher the CEO is getting paid.

Either way you get constant bidding wars for talent. As the pay-gap between workers and executives rises exponentially, it creates a disconnection between them. It creates resentment at the bottom end because workers feel they are not sharing equitably in the fruits of the company’s success. This reduces productivity.

Advanced economy argument
In more advanced, knowledged-based economies, where Britain should be, incentives to innovate are needed across all levels of the company. But if executive pay keeps shooting up because there are constant bidding wars for executives, then people at middle management will feel relatively less

Shareholder returns
A recent report from Harvard University found that executive pay was eating a larger share of company profits than ever before. So limiting top pay could also free up more money for re-investment (healthier for the economy) or to return back to shareholders (better capitalism).

Minimum Wage Scare-mongering argument
When the National Minimum Wage was floated there was scare-mongering then too that the economy would crash and burn with millions added to the dole queue immediately. They were proved wrong. No doubt we’ll see more of that in response to this initiative.

Other reforms
I don’t think this really is the answer to everything. Our economy needs a wider re-think on how to stop financial companies becoming too big to fail (Citigroup, RBS), ending systematic risk within the financial sector and simplifying legislation while regulating derivatives better.

But unlike some MPs who are more worried about protecting the rich and attracting right-wing acclaim, I do want the government to think about bold reforms at a time there is still considerable anger at the way the financial sector has been allowed to get off scot-free despite nearly wrecking the economy (and god forbid a Labour government should do anything left-wing that helps the economy. Why would they want to shore up the core vote?).

The point of the letter is to keep up the pressure, start a discussion about excessive remuneration and push for some form of reform that produces a healthier economy. That’s why I was happy to sign the letter.

More
Sunder Katwala: The impeccably New Labour case for scrutiny of top pay
Though Cowards Flinch: Tom Harris, Compass and the need to focus on low pay, not high
Chris Dillow: Against a High Pay Commission (on anti-statism grounds)

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About the author
Sunny Hundal is editor of LC. Also: on Twitter, at Pickled Politics and Guardian CIF.
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Story Filed Under: Blog ,Economy ,Our democracy ,Westminster

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Reader comments


Greed somes in many forms. People at the top of this government can be accused of excessive greed just as much as the bankers. For too long, the housing bubble was allowed to inflate because the government would rather keep everybody happy (and thus, keep their votes) rather than risk an unpopular albeit necessary for stability move towards a controlled burst. They, through the FSA, allowed banks like Northern Rock to offer 125% mortgages rather than accept that house prices had increased too far and that they would be come down eventually, either through a crash or a gentle descent.

They have ignored welfare reform. Over a million people on benefits in 1997 are still on benefits. Rather than risk losing office over attempted reforms they have allowed the system to eat up vast amounts of money and consign people to a life on government handouts.

They have ignored the devaluation of our A-levels, preferring to keep everyone happy with loads of high grades rather than risk the wrath of the voters by getting harder exams set.

If your only aim, once you get into a position of power, is to ensure that you do not lose that power then you will have let down those who let you in. Whoever wins the next election, they must take action that will risk losing the one after. If they fail to do that, they will fail the country.

2. Mike Killingworth

Mark, you forgot to mention the many people who are willing to create jobs but not to pay the people who do them – the so-called “internship”. Another form of greed.

A more interesting question is, why all this short-termism now? I think we can probably take it for granted that human nature hasn’t changed in the last 20 or even 50 years.

One factor, I think, is the impact of “green issues”. If there is a chance – rather, if people in positions of economic power think there is a chance – of total economic and social meltdown in the next 20-50 years then a higher discount rate is rational – and thus the crowding out of profits by bonuses.

A more interesting question is, why all this short-termism now?

It’s not like it hasn’t happened before. In fact, it happens quite frequently. Then there’s a round of re-regulation, which lasts until everybody forgets why it was introduced and / or people figure out new ways around it, and then off we go again.

Mark M – don’t forget that the government also gained a great deal from the housing bubble in terms of tax revenues (stamp duty)… E.g. £2.47 bn in 1996/97 to £13.4 bn in 2006/07.

Gordon Brown (as Chancellor and PM) had a vested interest in not regulating the mortgage / property industry – and as you point out, when Northern Rock offered 125% mortgages, the FSA were apparently nowhere to be seen.

Strange, that!

They have ignored the devaluation of our A-levels, preferring to keep everyone happy with loads of high grades rather than risk the wrath of the voters by getting harder exams set.

I was hoping people would stick to the topic….

A more interesting question is, why all this short-termism now? I think we can probably take it for granted that human nature hasn’t changed in the last 20 or even 50 years.

Because there are more incentives now (in the form of more opportunity for risk and more pay for taking risk) than ever before.

“But the compensation system, as New York Times later pointed out, “turned out to be a mirage.””

Err, no. The compensation scheme was all too real. It was the profits that were a little more difficult to find later on.

“This reduces productivity.”

Odd that. Prductivity has been rising strongly for the past couple of decades. Until the recession hit, of course. It would seem a little odd that, if increasing inequality reduces productivity, at a time of increasing inequality we’ve been seeing good productivity numbers. Most odd in fact.

“In more advanced, knowledged-based economies, where Britain should be, incentives to innovate are needed across all levels of the company.”

Sure. And we all know that government regulations are a spur to innovation, don’t we?

Tim, you’re good at using quotes out of context to try and dismiss an entire article. It’s getting rather tedious, no? If you have a broader point to make – do it. Don’t beat around the bush with lame one lines.

Err, no. The compensation scheme was all too real

Meaning it didn’t do it’s job.

Odd that. Prductivity has been rising strongly for the past couple of decades.

I’m talking on a micro scale, you’re talking as an aggregate.

And we all know that government regulations are a spur to innovation, don’t we?

I know, let’s get rid of all regulation! that will vastly makes things better! (don’t answer that). The point about govt regulation in this case is to create a more level playing field, and ensure the economy isn’t going to fall over if a few traders bet too much on one market and take the company down with them

The current pay structure for executives rewards them for making huge short-term profits at the expense of building stable, growing businesses. It encourages them to take massive risks, putting our pensions and the economy at huge risk, and getting out when the company crashes.

Wise words. And it all stems from that. Now, when people respond that this is “statism gone wrong”, they probably didn’t call it “statism” when 9 months ago hundreds of public billions were used to shore up the banks. The state was alright back then, wasn’t it?

Hence, measures have to be taken if we want to avoid repeating the same situation. In an ideal world you wouldn’t cap anything, but we’re not in an ideal world. The crisis has been unprecedented, so they tell us, so we need unprecedented measures.

Sunny . People are mobile. Frankfurt, Paris,Dubai, Singapore, New York,Shanghai, Hong Kong etc , etc would all love to reduce the finacial power of London for their own benefit. The Financial world is more mobile than most as all one needs is an office there are no mines, farms, oil fields, chemical plants, shipyards or factories to move. The german car industry is not just the Mercedes, BMW, Audi, or Porche but the hundreds if not thousands of parts manufacturers which would not be feasible to move. Bar Cap probably employs a hew hundred or thousands of people in 1 or 2 office blocks which could be moved overeas.

How much tax has Bob Diamond and BarCap paid? I am sure Dubai or Doha would love Barclay’s to be based in these cities.

Jay. Also Bradford and Bingley’s buy to let mortgages, self certified mortgages( liars mortgages) and incresing the ceiling on mortgages from 3.5 to 6 times of salery. Lloyds were criticised having too conservative mortgage lending policy but this organisation was persuaded by Brown to save HBOS ( and therefore save the Brown and Labour, especially as HBOS was based in Scotland). When LLoyds assessed HBOS lending based on their criteria, the losses went from £1B to £11B.

Brown created a deaf and blind FSA which allowed an asset bubble to occur . Salaries and bonuses were paid on a bubble. In the 1970s and 1980s the Governor of the B of E would keep an eye on the banks borrowing and warn them if it was too risky.

“Bar Cap probably employs a hew hundred or thousands of people in 1 or 2 office blocks which could be moved overeas.”

Why haven’t they already left?

“I’m talking on a micro scale, you’re talking as an aggregate.”

Aggregates are, by definition, aggregations of micro…..

Sunny,

I support the high pay commission idea, but I don’t think you’ve done it or yourself justice in this short blog (your New Statesman article is much better).

It moves too fast on a number of key points, and hence Tim Worstall (and co.) have a number of points they can exploit.

Predictably, Tim’s on his hobby horse about productivity already. But he has a point about empirical trends. What you need to do is rather than assert that higher executive pay causes lower productivity lower down the ranks from disgruntled employees is make a case acknowledging that whilst productivity has increased (as Tim points out), it could be even better if people felt valued as part of their organisation…which is less likely when pay structures are skewed towards bidding wars at the top end. (Maybe John Lewis’ share-holder based approaches are a good example? I don’t know, maybe somebody else does?).

And Tim is also right (it galls me to say it) about points like what was a mirrage was the profits not the bonuses. There’s a number of areas where you move a little to fast. Attributing the entire economic crisis to greed is almost certainly one. What about enormous trade imbalances with China and the west for 15 years, whereby they supplied us with cheap manufactured goods which kept our goods inflation rates down, whilst we saw asset inflation (in the housing market) fuelled by debt which was in turn facilitated by the Chinese having high levels of saving, thus offsetting western debt by e.g. buying US gilts – all made easier by the Chinese suppressing their exchange rate? This is a massive factor – though I don’t dispute that greed (in various forms) is involved in the story about China as well as the story you put forward. But to leave this out of your account is a considerable omission.

Also, I’m bemused by your passive acceptance of the notion that chief execs are in a bidding war for *talent*. This opens up a can of worms, but is it really that all these top FTSE 100 companies (etc) need to pay grotesque salaries to get the *best* people, or is it a case of a culture of being able to levarage as high a salary as possible at the top end becoming the norm, but this having little actually to do with the talents of those who are rewarded vis-a-vis each other? That, in fact, once you get to the top ends you can just command an ever higher salary because that’s now how the system works and everyone accepts it, but the link to talent may have been broken because e.g. the “talented” at that end are all very similar in their abilities and really what’s driving the huge pay rises is an institutionalised culture and the bargaining power of some individuals within that culture, which may be only tangentally related to talent vis-a-vis each other.

So whilst I agree that a high pay commission is a good idea, and changing the culture of short-termist risk-friendly executive remuneration is important and desirable, I just feel you may have left the door wide open to your opponents on a number of points, whilst accepting things that need challenging on others.

I guess what I’m saying is, can you do us a much longer version?

Sunny, none of this adds up to an argument for anything

Greed Creates Instability? Does it? You don’t prove it, you just point out that some people at Merrill Lynch took home huge pay for what turned out to be poor performance. But Steve Jobs takes home huge pay for good performance. Does his “greed” create instability? Probably not.

Jerome Kerviel, the French rogue trader was not, by the standards of the banking industry, that well paid. His motivation was widely reported to be the prestige of being one of the smart guys.

It was not greedy for Mr Dow Kim to write all those mortgages if he genuinely thought that the US housing market would never crash and if he thought that the risk of default was properly costed. If he thought those things then it was his job to grab as much of that business for the bank as the bank could get. It may have been stupid to think those things but you can’t make the case that greed was the core problem unless you can show that greed made Mr Dow Kim do stupider things than he would have done otherwise. You have not actually shown the existence of such a “greed effect”

Moreover, your choice of Mr Dow Kim’s $35 million bonus illustrates another part of the problem with your case. People do bad thing for sums far smaller than that. If the greed effect is real, the pay caps you would need to impose in order to prevent it would be absurd. To illustrate this, think about a field where there is undoubtedly a greed effect – corruption.

People bribe police officers, MPs, etc etc to do things that the bribees know is wrong. Even if they don’t know why it is wrong, they do know that the fact they are being offered a bribe makes it wrong. And yet people sell their integrity remarkably cheaply. Corruption cases tend to be about a few thousands of pounds rather than hundreds of thousands.

So perhaps the size of the bonus is not the important issue. Perhaps the fact of the bonus is the fundamental issue.

In that case, the job of the High Pay Commission would be to look at the things people are being rewarded for rather than the amount they are being paid. That isn’t its remit but, even if it were, it would be stupid for reasons I hope are obvious.

Anyhow, the assertion that greed creates instability is an odd one. In fact, the very stability of the economy over the last ten years was one of the contributory factors to the crash. But you could equally argue that risk aversion had created the instability.

You have a stable economy. In this stable economy, it becomes possible to mitigate risks through securitisation. So it becomes the norm to do so. In this world, profits are nearly guaranteed, but only small ones (because of the cost of hedging). Some people want more profits (greed) This gives them two options. They can either take risk – by starting a new company and building a better mousetrap or they can use leverage. Because of securitisation, even leverage is, supposedly risk free but it still creates higher returns. On that basis, why would anyone bother building the better mousetrap. So, greed can create either new value or stupid leveraged investment strategies – it is risk aversion that leads investors to the latter option.

That is why financial services have sucked talent out of the rest of industry. That is why R&D investment declined during the fat years before the crisis. Everyone used cheap credit to pursue profit without risk. A High Pay Commission will not address the central problem created by the crisis – why the financial industry has become so central to the advanced economies. It will not address the question of why it is more attractive to invest than it is to do and it therefore won’t change the status quo.

Its is a crap idea all around.

15. Peter Jukes

Let’s get to the bottom of this

I don’t have the figures to hand, but the differential between executives and employees pay has vastly increased from something like 20 to 1 to 200 to 1 in the last thirty years, both in the UK and US. The one common factor has been deregulation, both in finance and corporate controls. Most of these inflated salaries come from bonuses or share options.

Surely high pay is the symptom of something else – a malfunction in the rewards and risk taking in major corporations. I don’t have the expertise to track it all down, but those I know involved in the productive business sector constantly complain of the distorting effects of leveraged buy outs, stock price speculation, etc.

If this is the cause, then it’s even more damaging than the odd bonus or share option. It’s the Enron problem writ large – and indeed the collapse of securitised debt was one expression of it. Are these not just symptoms of a larger structural malfunction, especially in the modal monopolies operating in finance and equity.

also, Sunny, i want to say something else: something hard line and left wing about equality.

Like this: “the reason we need a high pay commission is because the UK’s system of remuneration has grown out of control and been part of a general trend towards increased inequality, which it has recently been revealed included the poorest getting worse off in absolute as well as relative terms. This is wrong in itself, but as the Spirit Level showed, is bad for everyone in society. A high pay commission is needed to make Britain a more equal – and thereby better – place”

Though I appreciate that may not be tactically wise…

I don’t like the idea of a High Pay Commission, for roughly the reasons that Chris Dillow and Though Cowards Flinch set out.

But it occurs to me that this could be a good opportunity for a kind of deliberative exercise engaging people to consider:

– what should be the maximum ratio between top earners and the average wage

The thing is, setting up a quango to scrutinise high pay is not going to be effective, and is very, very easy for its opponents to caricature. But the rich and powerful would find it much harder to get a majority of people to agree that they need more than, say, 50 or 100 times the average wage.

“what should be the maximum ratio between top earners and the average wage?”

Umm, why is that any of anyone’s business?

US median household income is around $45 k a year I think (right order of magnitude anyway). Tiger Woods makes $100 million a year for being the world’s best golfer.

2,000 or more times average wage. Who are you to tell golf tournament promoters what they can pay Tiger? Or sponsors? Or advertisers?

19. Mike Killingworth

[14] Good call, George. People value £1 they feel is “something for nothing” at far more than £1.

[15] Too right. A ten-fold increase in differentials cannot be explained by economics, only by sociology.

I added this Tom Harris blog entry:

“‘THERE’S a terrific scene in the TV adaptation of Chris Mullin’s A Very British Coup in which the newly-elected left wing prime minister, Harry Perkins, is catching the train to London and is asked by a journalist: “Do you intend to abolish first class, Mr Perkins?” To which Perkins replies: “No, I intend to abolish second class. I think everybody’s first class, don’t you?”’

Yes, and why should anyone eat bread when they can have cake instead..?”

He didn’t allow it. Not surprising when he is all about saying fine things that make him look like a really ‘sensible’ bloke, that he will never have to back up with action. But at least he’s three up on Nadine Dorries, so that’s all right.

21. the a&e charge nurse

[18] Who are you to tell golf tournament promoters what they can pay Tiger? Or sponsors? Or advertisers?

That’s a red herring – the point is high rollers exert undue political influence by virtue of the power that is associated with great wealth.

As the old adage goes Americans (since we are talking about Tiger Woods) do not want to conquer the world – they are happy to own it.

It is the power issue, not the cash per se, that is the important issue in my mind.

Also note that Tiger Woods is pretty directly accountable to the public who pay him – one wrong move and pop! There go the sponsorships.

Faceless execs, less so.

How much tax has Bob Diamond and BarCap paid? I am sure Dubai or Doha would love Barclay’s to be based in these cities.

I don’t buy the ‘these companies are looking to get the hell out of our country’ argument much. One can also argue that a stable economy is better for all firms than one based on a lot of volatility thanks to financial markets jumping up and down.

Paul S – you make some very good points:
What you need to do is rather than assert that higher executive pay causes lower productivity lower down the ranks from disgruntled employees

Agreed. but I didn’t say the empirical evidence pointed that way, only that productivity (relatively in this case than absolutely) could fall. Besides, that productivity growth could be thanks to capital investment rather than people actually working harder.

Attributing the entire economic crisis to greed is almost certainly one. What about enormous trade imbalances with China and the west for 15 years, whereby they supplied us with cheap manufactured goods which kept our goods inflation rates down

I’m not convinced the trade-imbalance meant that the economy was inherently going to crash. The trade imbalance is part of a broader problem – that we don’t produce goods any more while the Chinese control their currency prices. But that goes back to the need for coordinated investment in some industries as seed, say for example ‘green jobs’.

But I didn’t want to write an economic thesis here, just point out some basic reasons for supporting this campaign.

The social implications of this are quite straight forward:

“When it comes to height, every inch counts–in fact, in the workplace, each inch above average may be worth $789 more per year, according to a study in the Journal of Applied Psychology (Vol. 89, No. 3).

“The findings suggest that someone who is 6 feet tall earns, on average, nearly $166,000 more during a 30-year career than someone who is 5 feet 5 inches–even when controlling for gender, age and weight.”
http://www.apa.org/monitor/julaug04/standing.html

For greater social equality, we obviously need a cull of tall people.

[Please note: this is a sick joke to make the important point that there are many causes of unequal incomes.]

Wicked old China with its fixed exchange rates. If only they did whatever the IMF and the World Bank told them to – like Russia did in the early nineties – we wouldn’t be in this mess…

Look greedy bankers did not cause the crash. The financial sector getting obscenely rich without adding new value is a symptom, not a cause of the main problem. You might not like them much and they may have overstated their own wisdom and importance but all they did was spot the problem and milk it for every penny it was worth. Therefore, regulating pay, whether for bankers or anyone else, will not solve the problem. The problem is that we are sitting on top of vast trade imbalances which can be summarised thus.

The ability to make things cheaply is in one place while the ability to charge high prices is somewhere else. Rich consumers cannot themselves access the cheap labour and the cheap labour cannot go to the places where the cost of labour makes them rich consumers. However, large companies can exploit this asymmetry (effectively an arbitrage) through globalisation. And, the founding principle of mercantilism is, if you can buy cheap and sell dear you get rich.

However, this has, indeed caused a vast trade imbalance. The problem is not that the Chinese are saving too much. The problem is that the Chinese aren’t getting paid enough. If they were, the market asymmetry would be reduced.

The job of macro-economics right now is to create a framework in which the Chinese can get as rich as us without leading to too much financial turmoil or resource scarcity. When a unit of comparably skilled labour costs roughly the same in China as it does in Germany these arbitrages will go away and we can get back to the situation where industrialists rather than financiers are the engines of the economy.

And, I need hardly say that I would not wish this to mean that British workers should be reduced to the same income as Chinese workers – so, if there is any levelling to be done, let us level up.

So, if you want a massive pay commission, a low pay commission is the one to have but it should be looking at the wages of workers in the developing world.

One way of looking at it would be to use access to rich markets to ratchet up global labour standards. If you want to import to the US/EU, you need to be able to demonstrate that your staff are paid a (locally determined) living wage, that you do not use child labour and that safety standards are adequate. Arguably, it is a tariff but the tariff is paid to the people who produce the goods instead of the rich country erecting the trade barriers.

This would do much to restore the balance of power between labour and capital. It would give the Chinese more money with which to buy goods and services from us, which would, in turn begin to resolve the balance of payments. It would also give the Chinese state more tax revenue with which to build the infrastructure to further accelerate rises in living standards and wealth.

I find it hard to have a strong opinion on all this “High Pay Commission” waffle until someone actually explains what the aim is. According to the article, it “isn’t necessarily about setting a maximum wage limit but about reviewing pay at the top and considering capping “excessive remuneration”.” Previous articles on the subject have been similarly vague. If not a wage cap, what does “reviewing pay” actually mean? Who defines “excessive”?

“So, if you want a massive pay commission, a low pay commission is the one to have but it should be looking at the wages of workers in the developing world.”

Why would we need a commission to tell us what we already know?

Chinese manufacturing wages have been rising at 14% a year (yes, after inflation) for over a decade, they’re nearly 4 times higher than they were a decade ago.

We know what raises the wages of workers in the developing world: rising productivity of labour. Just as that is what raises the wages of those not in the developing world.

Even Marx got that one.

Or as Paul Krugman puts it (Ricardo’s Difficult Idea, strongly recommended reading, available free online):

“Finally, and most importantly, it is not obvious to non-economists that wages are endogenous. Someone like Goldsmith looks at Vietnam and asks, “what would happen if people who work for such low wages manage to achieve Western productivity?” The economist’s answer is, “if they achieve Western productivity, they will be paid Western wages” — as has in fact happened in Japan. But to the non-economist this conclusion is neither natural nor plausible.”

23. Sunny H. Market volatility will not be influenced by where financial organisations are located. There are already people working in the City commuting from Monte Carlo. If these institutionsle move offshore we lose the tax revenue- coporate and personal . If tax revenue decrease so will the money for the NHS/Welfare Society. If the UK had developed a larger manufacturing capability ( 20-25% of the economy such as in Germany) over the last 65 yrs we would not so dependent upon the City and construction sectors for tax income. What I have said is that the financial sector has a high level of mobility and their are plenty of countries who would be happy to encourage a move- an expat life , if well paid can very pleasant.

@28 – Why haven’t they already left?

Tim,

First of all, I was not suggesting such a commission, merely that there is work to done to ensure that the world can assimilate all these newly wealthy people as smoothly as possible and that such a commission would be far more useful than a High Pay Commission (not difficult since such a body would have no value at all)

I am not sure about your second point. Are you suggesting that Krugman’s economist is correct and the layman is wrong or is Krugman drawing attention to the weakness of the economic model.

After all, if the unit of productivity cost the same all over the world then it would make no difference where companies located their labour. Dyson’s decision to move his works to the Far East for example would not have been motivated by a desire to get the same productivity for lower cost (the stated goal of the exercise) but rather to build a less effiicient factory where more labour was hired at lower hourly rates in order to achieve the same ends. This is certainly neither natural nor plausible.

“Krugman’s economist is correct and the layman is wrong”

Yes, we tend to think that about Nobel Laureates on their subject of expertise.

Ah, that’d be why you never affect to know better than Krugman, then?

Alternatively Tim, Krugman could, as I suggested, have been suggesting that the economic model to which he and other economists adhere, seemed to imply a result which did not seems to bear comparison with reality.

Before perhaps conceding that all models have limitations.

In which case, if one unit of labour productivity costs exactly the same around the world, please explain why it is that many European and American companies have gone to the expense of dismantling existing plants, shipping them around the planet and reconstructing them in low wage economies? In Krugman’s analysis, this is a total waste of time (and money)

Marx’s initial presentation of the LTFRP at the start of part 3 of Capital, volume III does assume a constant rate of surplus-value. He recognized, however, that there is a tendency for the rate of surplus-value to rise as a result of rising productivity (see esp. Marx 1991a, chap. 14). Although workers create no more value when their productivity increases, they do create more surplus-value. The increase in productivity lowers the value of the goods and services that workers consume, and thus, if the workers’ physical standard of living remains unchanged, the value of their wages (i.e., their wages in money or labor-time terms) falls. Consequently, their necessary labor-time (the portion of the workday during which they create a sum of value equivalent to their wages) is reduced and their surplus labor-time, the time during which they create surplus-value, is extended. Increases in the workers’ physical standard of living can offset this tendency, but unless their standard of living fully keeps pace with productivity––increases at the same (or a greater) rate––the value of wages will fall and thus the rate of surplus-value will rise.

The general rate of profit can be expressed as the product of two factors, the rate of surplus-value (s/v) and the percentage of the total capital advanced (C) that is laid out as variable capital (v) in order to hire workers, (v/C)

Link

Marx shows that the value and surplus value are one way of reducing productivity. Tim knows the rest and, like utilising certain sections of Smith’s theory and not all of it, it skews the end result.

On to the OP:

I don’t think it is just a matter of greed at the top – that is, as others have said a symptom – but using Tiger as an example is disingenuous, because, again, as has been said – if Tiger gets crap sponsors won’t pay and people will no longer be willing to watch him – not the case with CEO and underlings.

We can look at how high people are paid – but you could always tax them to death, call the special tax rate what you will but they know once they hit that mark they are going to get stung.

The bubble that happened is, quite simply, down to too lax a credit marketing machine. Property is way, way too high even now, that can be said for land. How you bring that back I am not the person to say but unless it is you will have another, more catastrophic burst in the near future.

People have said about China and her manufacturing base – and I will say, once again, if you don’t have a manufacturing base that cannot bring in real value to an economy you are bound to fail, and that is what is needed in the UK.

Blather as much as you want about a service economy, but it will fail without the manufacturing balancing act.

“Ah, that’d be why you never affect to know better than Krugman, then?”

This little phrase is doing quite a lot of work here “on their subject of expertise.”

Krugman’s subject of expertise is international trade. On that subject I tend to quote him, not affect to know better.

But that doesn’t make him a health care economist for example….

“if one unit of labour productivity costs exactly the same”

OK. A British (or USian…”western”) worker offers one unit of labour productivity per hour, just imagine. A Chinese labourer has lower productivity. Say, imagine, they offer 1 tenth of one unit per hour.

The Chinese will thus get one tenth of the wages.

Now I do strongly recommend that you read the Krugman essay I mentioned above, for he then explains the next extremely important part.

Average wages in an economy are determined by average productivity in that economy. So we’re not saying that a Chinese worker, working with modern equipment, to make a modern product, has one tenth of the productivity of a USian worker. We’re saying that on average across the Chinese economy productivity is one tenth (because they’ve got an awful lot of shit factories, using shit equipment, to make shit products)….and it’s that average that determines Chinese pay rates.

However, if you Mr. Mulitinational Executive go and build a modern factory in China, making a modern product, then you can get, say, 9 tenths of the productivity of a USian worker but only have to pay one tenth for it….or as you probably do, pay two tenths so that you get the best Chinese workers (yes, multinationals do tend to pay wll above local wages).

What will bring the average level of Chinese wages up to the average level of USian wages is when the level of average productivity in China is the same as the average level of productivity in the USA.

As I say, Krugman lays all this out in his essay and yes, this is exactly the sort of work that he got his Nobel for (or, rather, building upon this couple of centuries old idea from David Ricardo, of comparative advantage).

I’ve linked the New Yorker article above, though unfortunately it’s not fully available to people without a subscription.

This is the article Bloomberg was handing around as the best article to read on the crisis.

“Increases in the workers’ physical standard of living can offset this tendency,”

And as Marx pointed out, as long as there are competing capitalists competing for access to that surplus value then the wages of the workers will be bid up to reflect their increased productivity.

It’s only when there is a monopsonist hirer of labour that increased productivity does not flow through to increased wages….

“But that doesn’t make him a health care economist for example”

You have a nobel in that, then?

#34: “but using Tiger as an example is disingenuous, because, again, as has been said – if Tiger gets crap sponsors won’t pay and people will no longer be willing to watch him – not the case with CEO and underlings.”

So what of the hotshot investment managers that take a percentage of the profits that they earn for their clients? Clients are, generally, happy to pay large fees to people who provide a rather larger investment return than they think they could manage themselves. If they get crap, clients will move their money elsewhere.

But commentary here and elsewhere is very much concerned with the short-term incentives given to hotshot fund managers and the like. Their pay and incentive structure doesn’t really look terribly different from Tiger’s in terms of timescale. The only significant difference is that Tiger’s golf performance (or Ronaldo’s football performance…) is completely irrelevant to anything else, whereas ignoring risk in the financial markets turns out to have bad effects on the whole economy.

#25: “Look greedy bankers did not cause the crash.”

Try instead: Kenneth Rogoff on: Why we need to regulate banks sooner, not later, in Wednesday’s Financial Times:
http://www.ft.com/cms/s/0/c2d523c0-8c21-11de-b14f-00144feabdc0.html?nclick_check=1

Rogoff makes a very persuasive case for tougher regulation of financial institutions notwithstanding orchestrated howls of anguish about the loss of innovation and competitiveness that would ensue

Rogoff also – persuasively – rejects the lament, popular among some, that if only Lehman Bros had been bailed out last September the subsequent recession induced by the financial crisis would have been much less severe.

It’s been said before, a financial system based on the principle of privatising the gains while socialising the losses is on a sure road to ruin. The present catastrophe was predicted:

Try this from Warren Buffett in 2003:

“The rapidly growing trade in derivatives poses a ‘mega-catastrophic risk’ for the economy and most shares are still ‘too expensive’, legendary investor Warren Buffett has warned.”
http://news.bbc.co.uk/1/hi/business/2817995.stm

And this from 2002 in Britain about the house-price bubble:

“CHARLES GOODHART, a former member of the Bank of England’s monetary policy committee [and economics prof at the LSE], warned yesterday that the Bank is failing to take sufficient account of the house price boom in setting interest rates.

“His warning comes amid growing fears among economists that house prices, fuelled by the lowest interest rates for 38 years, are getting out of control. Yesterday, new figures showed that homeowners are borrowing record amounts against the rising value of their homes. . . ”
http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2002/04/06/cngood06.xml

But they were ignored – because a lot of folks with political influence were raking in pots of money.

29. Phil Green, owner of BHS is resident in Monacco and apparently other people commute from their as well. If companies move to other countries we lose tax revenue. If people consider it is good idea for immigrants to move here to earn money then people can emigrate as well to earn money. Globalisation results in the movement of people, money and ideas. Will Hutton and McRae have written about ideaopolis’s being the engine of economic growth – people with intellectual capital living and working together such as the City of London, Silicon Valley, pharmaceutical and high tech companies of New England and the pharmaceutical companies north of london.
http://www.independent.co.uk/opinion/commentators/hamish-mcrae/hamish-mcrae-pay-attention-this-is-a-stupid-idea-1773998.html

A paper on: Globalisation and the reform of the European social models, prepared by André Sapir for the think-tank Bruegel, was presented at the ECOFIN Informal Meeting in Manchester in September 2005. It argued that there is not one European social model, but rather four – the Nordic, Anglo-Saxon, Mediterranean and the Continental:

• The Nordic model (welfare state, high level of social protection, high level of taxation, extensive intervention in the labour market, mostly in the form of job-seeking incentives)
• The Anglo-Saxon system (more limited collective provision of social protection merely to cushion the impact of events that would lead to poverty)
• The continental model (provision of social assistance through public insurance-based systems; limited role of the market in the provision of social assistance)
• The Mediterranean social welfare system (high legal employment protection; lower levels of unemployment benefits; spending concentrated on pensions)

http://www.euractiv.com/Article?tcmuri=tcm:29-146338-16&type=News

Andre Sapir’s paper on: Globalisation and the Reform of European Social Models, is here:
http://www.frdelpino.es/documentos/CONFERENCIASYENCUENTROS/OBSERVATORIOS/Espacio%20P%C3%BAblico/Sapir.pdf

The Sapir study concludes that only the Nordic and the Anglo-Saxon models are sustainable.

“Danes are the happiest people in Europe, a survey suggests.”
http://news.bbc.co.uk/1/hi/magazine/6563639.stm

Oddly, the Danes have one of the heaviest tax burdens in Europe – try the OECD Factbook 2009 on Tax revenues:
http://oberon.sourceoecd.org/vl=2033875/cl=20/nw=1/rpsv/factbook2009/10/04/01/10-04-01-g1.htm

43. Luis Enrique

Here’s something I wrote the other day, which expands on Sunny’s point about wanting to increase shareholder returns:

In a fascinating turn of events, a coalition of leading left-wingers has today called for higher profits across the economy, with a particular emphasis on improving the returns that capitalists enjoy in the banking sector, and encouraging banks to pursue risky business strategies.

Are we seeing the results of a secret conspiracy between cunning capitalists and deep-cover double-agents, posing as left-wingers? There are two alternative explanations that I can think of: firstly, the left-wing has revealed a hitherto unknown faith in the workings of competition to erase excess profits, or secondly a group of well-meaning individuals haven’t thought things through very well.

What will happen if these campaigners get their wish, and some sort of effective mechanism to restrain pay is brought into force? Think about this simple equation: profit = revenue – costs. Where do bonuses show up in there? Clearly, if revenues are held constant, costs go down, profits go up. Put yourself for a moment in the position of a bank that’s found a lucrative but risky investment strategy of the sort we wish to discourage. Today you make £1m in revenue annually from this ruse, £750,000 of which you pay out to your revolting employees. Does this risky investment strategy become more or less attractive to you tomorrow, should pay be capped at less revolting levels?

Should we expect revenues to stay constant? Well, maybe not. Perhaps competition between banks will see them cut the prices they charge for their services, revenues will fall and the economy will enjoy cheaper financial services? What wonderful outcome that would be! I’m used to thinking of myself as having more faith in competition and market mechanisms than the average left-winger, and finance is a sector that I regard as particularly dysfunctional, but perhaps I have misjudged things and the campaign is predicated upon the expectation that competition will hold back profits[1].

What other possibilities are there? One popular idea is to limit high-pay to some multiple of low pay. This has the potential to achieve redistribtion within companies, rather than a reduction in labour costs across the board. But it has limits. Unless we are to see security guards in investment banks being paid £100,000, such a policy would probably just end up cutting the pay of high earners. Hence generating higher profits. The capitalists will be delighted.

Here’s what I think the left should do: rather than attempt to limit salaries and bonuses directly, it needs to think about revenues. Why do banks make so much money in the first place? If we can address that, then worrying about how revenues are divided up between employees and capitalists won’t seem so important.

[1] If so, I find it hard to understand many of the other economic viewpoints I am associate with the campaign supporters. But that’s another story.

Bob B . The nordic countries probably have a lower percentge of unskilled poorly educated people who spend their working lives moving in and out of employment and a smaller percentage of long term sick.
For the unskilled and poorly educated we need to raise their skill levels to that of the semi skilled or carftsmen
For the long term sick we need to invest in phsyiotherapy, nutritionists , psychologists etc , etc to omprove their health so they are able to reurn to some sort of work.
Also there will be need to alter some workplaces to help people fit in.

What we need to do is invest in people to improve their levels of skill, self respect, confidence and well being and not threaten to cut off their benefits . Also raise the tax threshold to £10K.
Britain has far too many people who earn little or no money because of their poor health, and low education and poor skills. If we can increase someone’s income from £12k to £24K by enabling people to obtain the education, skills, health and confidence, then this will do more for people with low incomes than trying to cap pay at the top end.

#44: “For the unskilled and poorly educated we need to raise their skill levels to that of the semi skilled or carftsmen”

Sure. The continuing problem is:

“Up to 12 million working UK adults have the literacy skills expected of a primary school child, the [HoC] Public Accounts Committee says. . . The report says there are up 12 million people holding down jobs with literacy skills and up to 16 million with numeracy skills at the level expected of children leaving primary school.”
http://news.bbc.co.uk/1/hi/education/4642396.stm

“A £2bn scheme to improve basic skills among adults has been called a ‘depressing failure’ by education inspectors.”
http://news.bbc.co.uk/1/hi/education/4506410.stm

“An estimated 5.2 million adults have worse literacy than that expected of 11 year olds, while 14.9 million have numeracy skills below this level.”
http://news.bbc.co.uk/1/hi/education/4095153.stm

In Tuesday’s Guardian:

“One in six adults aged 18 to 24 in England are so-called “neets” (not in education, employment or training), the Department for Children, Schools and Families statistics from April to June show.”
http://www.guardian.co.uk/education/2009/aug/18/neets-young-people-jobs-recession

I am sure these bankks could get some indians who are just as good to work for half as much as the British and American bankers demand.

But the so called free market never seems to work like that. But then the so called free market does not exist. Never has done and never will.

“But the so called free market never seems to work like that.”

Oh, I dunno Sally. Try walking into a dealing room at some point. Quite probably the most ethnically diverse (and diverse in national origin as well) workplaces in the UK.

Bob B . Totally agree. The stats you reveal are a major reason why we have so many poorly paid people. Britain has always been good at winning nobel prizes and innovation( The Industrial Revolution ) but alas it has always been good at allowing a large uneducated unskilled class to continue which makes it almost impossible to replicates German high value manufactuing capability which accounts for 25% of their economy (15% for the UK). If we want a more balanced economy by increasing manufacturing in the former industrial areas we need to drastically improve technical education and skills.

#48

Charlie2: On the evidence, cultural influences on communities can be enduring and powerful. Sadly, in more than a few neighbourhoods, by way of values and social preferences not much has changed since George Orwell wrote this for the book that was to become: The Road to Wigan Pier (1937) – in chapter 7:

“The time was when I used to lament over quite imaginary pictures of lads of fourteen dragged protesting from their lessons and set to work at dismal jobs. It seemed to me dreadful that the doom of a ‘job’ should descend upon anyone at fourteen. Of course I know now that there is not one working-class boy in a thousand who does not pine for the day when he will leave school. He wants to be doing real work, not wasting his time on ridiculous rubbish like history and geography. To the working class, the notion of staying at school till you are nearly grown-up seems merely contemptible and unmanly.”
http://orwell.ru/library/novels/The_Road_to_Wigan_Pier/english/e_rtwp

49. Bob B. Good point,seen that myself. That is why high apprenticeships starting at 14yrs old with rigorous academic training should be looked at again.
For many people, the academic syllabus does not apear relevant to their lives.
Also polys should be re -established to enable people to study in the evenings and weekends- from A level to degree standard. Often the best engineers were those who when had finished their apprenticeships and then studied in the evenings for the Council of Engineering Part 2 exams which were equivalent to degrees which enabled them to become Chartered.

Tim,

Thank you for your clarification. The difference between the cost per unit of productivity in the Chinese economy as a whole (including all its clapped out factories and businesses) is very different from the cost per unit productivity in any specific firm which may be either clapped out or not.

The point I was making was that the deployment of a given amount of capital, anywhere in the world will, if competently operated, produce roughly the same output anywhere in the world but the cost of the labour to operate it will vary dramatically.

The high wages of western workers are therefore undermined by the potential for capital to flee by locating new factories or re-locate existing ones in lower wage economies. And workers in low wage economies are not free to obtain higher wages by moving to countries where wages and conditions are better.

Complete freedom of movement would be one solution to this problem but it would tear Western economies apart. Alternatively, western wages could level down to the point at which they become competetive with lower wage economies, again, tearing them apart as living standards fall.

Or, we could make every effort to raise wages (and productivity) and living standards in the developing world. The first step in doing so would be to improve labour conditions simply by preventing exploitative practices.

#40 OK, fair to upbraid me on this. What I perhaps should have said was that it was not the bankers’ greed that caused the crash. The global economy already contained serious imbalances that were nothing to do with the financial sector. I accept that the bankers made this worse and got mighty fat by doing so.

However, I contend that the core underlying problem was a trade imbalance and I further contend that it was the stupidity of the financial services industry (rather than avarice per se) which caused them to do so. As I argued above, I am pretty sure that bankers would have taken the same stupid risks for far less money, so it is not the level of pay that is the problem.

As it happens I am even more skeptical than Rogoff about the degree of benefit to be derived (for society as a whole) from financial innovation. Rogoff cites, as an example of worthwhile innovation, the lower mortgage rates paid by some US homeowners. I am not sure whether he is serious about this since very low interest rates on mortgages (especially the innovative ones) were so instrumental in bidding up the US and UK housing markets as consumers found themselves able to afford greater and greater leverage. Other examples of such innovation facilitated private equity buyouts and securitised risk, which also turn out to have been not entirely benign activities (although I am not claiming that they were always negative).

We need commodity banking to extend credit to businesses and individuals, we may also need some other forms of financial innovation but, by no means all of them. Perhaps if we took the view that the banking sector should stick to the dull stuff that doesn’t require too much leverage. If it did, finance would be simpler and the rewards for doing it would not be so great anyway.

So my point is that I think underlying trade imbalances are more important than financial services. However, if we are going to look at the financial sector, we should look at what it does (and whether that is stupid) rather than obsess about how much bankers get paid.

“The point I was making was that the deployment of a given amount of capital, anywhere in the world will, if competently operated, produce roughly the same output anywhere in the world but the cost of the labour to operate it will vary dramatically.”

Nearly but not quite. What’s happening in the rest of the society around the factory matters: connections to ports, electricity supplies etc….but…OK, for the sake of argument yes.

“The high wages of western workers are therefore undermined by the potential for capital to flee by locating new factories or re-locate existing ones in lower wage economies.”

No, because we’ve already said that average wages are determind by average productivity in an economy. Yes, manufacturing wages might go down as a result of competition in manufacturing from low wage countries but labour can move to the service sector. The average level of wages in the country will not change.

“And workers in low wage economies are not free to obtain higher wages by moving to countries where wages and conditions are better.

Complete freedom of movement would be one solution to this problem but it would tear Western economies apart.”

All three points are true.

“Or, we could make every effort to raise wages (and productivity) and living standards in the developing world.”

Yes….but where do we start? Krugman (and other economists) say that if we raise productivity then wages and living standards will rise as a result. And we know how to raise labour productivity….send more capital for labour to work with. So, to raise living standards in China we should be arguing that capitalists should invest more in China. That’s fine by me but not, I think, what you think is fine.

“The first step in doing so would be to improve labour conditions simply by preventing exploitative practices.”

No. Absolutely not. What you are calling “exploitative practices” are things which increase productivity. Long labour hours, higher pollution levels, less workplace safety….spending to reduce these reduces the output of labour and thus the income that the labourer can earn.

Now, it is also highly desirable that there is indeed workplace safety, that there is a green and pleasant land, that there is leisure. However, these are side effects of wealth having been created, so the wealth has to be created first. They are “luxury goods” in the jargon.

Worth pointing out that we actually did this in the 1880s. We imposed the British Factory Acts upon the Indian textile industry (largely because the British mill owners didn’t like the competition) and the Indian textile industry promptly collapsed. Good for the British mill owners and terrible for absolutely everyone else.

“we may also need some other forms of financial innovation but, by no means all of them.”

Excellent. So let us try and design a system by which we can sort those we do want/need from those that we don’t. How about people think up new ideas and then try to interest others in them? If no one’s interested, then no one wants/needs it. If lots of people are indeed interested then we’ve evidence that the innovation is wanted/needed.

Sounds like a plan…..now all we need is a name. How does “financial market” sound to you?

Tim,
I absolutely agree about sending more capital investment to China. I’m really not trying to hold that back.

What I am saying is that the Western labour market is relatively disadvantaged by all sorts of uneconomic encumberances – sensible working hours, workplace safety, healthcare and pensions and so on. This makes the west a bad place to locate new capital investment.

In effect, western worker’s purchasing power is out of proportion to their productivity. Because at the margin (where prices are set) labour is cheaper in some places than others.

But western workers do not want to give up their uncompetitive pay and conditions so, the best alternative is to ensure these uncompetitive conditions (which happen also to be public goods) are extended to as many people as possible. You are right to ask what happens to the neighbours of these newly enriched workers in the developing world. Well, they sell goods and services to them and thus enrich themselves.

I’m not saying that this isn’t happening. I am merely saying that we should be working to accelerate the trend. I will look at the Factory Acts because I am not familiar with them.

As to the question of your model of arriving at a financial market. That is precisely not where my logic takes you. Selling any financial innovation to anyone who would buy it from you is what we had before. This has blown up producing not a gigantic bust and many banks going out of business but a huge round of bailouts. We do not wish to return to the status quo ante. We certainly do not wish to return to the status quo ante with the addition of a massive dollop of moral hazard stemming from the current bailout.

It is therefore legitimate for those who funded the bailout (or took the risk of losses associated with funding the bailout if you are a die hard bull) to say what they will and won’t stand behind the next time around. Splitting investment banks from retail banks might be one avenue, changing accounting standards in order to achieve greater transparency might be another (albeit a fearfully complex one) and there are many others.

If you want to go back to the status quo then you have to come up with an alternative means of removing the moral hazard created by the bailout. A huge wave of fraud prosecutions might do the trick but it would be stupid, vindictive and unlikely to produce results.

I don’t know how to re-regulate finance, but I know that capping pay will achieve precisely bugger all.

PS Demand is not the only arbiter of whether we should allow a company to trade in a product. There is considerable pent up demand for hand guns, cocaine, ivory, weapons grade uranium and many other things. We do not allow such trades because, whilst both parties to the transaction consider themselves better off (the basis of free trade) the negative externalities of these transactions for society as a whole are considered to outweigh the benefits to the participants.

Certain forms of financial innovation can be used to carry out transactions that could be judged to have unpleasant externalities. Since we are in the business of re-organising financial services, now might be a good time to give some thought to this matter.

“But western workers do not want to give up their uncompetitive pay and conditions so, the best alternative is to ensure these uncompetitive conditions (which happen also to be public goods) are extended to as many people as possible.”

No, they’re not public goods. Please look up the definition on wikipedia.

Secondly, this is very odd thinking….we make ourselves poorer by mposing restrictions threfore you must make yourself poorer by imposing he same restrictions?

Finally, no, there is no reason to give up these desirable things. For western world workers are rich….and if they decide they’d like to take a little bit of that extra wealth as increased leisure, a cleaner environment and safer workplaces, then that’s just fine and dandy. That’s the point of the economy, after all, that people get as much as is possible of what they desire.

It really shouldn’t surprise anyone at all that rich people (western world workers) have different desires from poor people (Chinese factory workers for example). In fact, it’s one of the building blocks of whole areas of economics, the heirarchy of wants.

I don’t think we disagree as much as you think but I do think we are at cross purposes. I’d love to straighten it out but, sadly, I need to do some actual work.

Another time


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