Vince Cable’s moral compass
It is said that you can judge a person by the company they keep. In that case, Vince Cable’s halo has slipped a bit.
His decision to give his support to Compass in its campaign for a High Pay Commission to curb “excessive” pay is bad politically, economically and morally.
Compass is an avowedly socialist campaign group, the primary focus of which is the Labour Party. It is a partisan body that has for some time sought to make Labour even more interventionist, statist and illiberal. Vince Cable should not be giving it intellectual succour.
In addition, the very idea that the government should impose maximum wages upon individuals should be anathema to him both as a liberal and as an economist.
I have written an article on the Institute of Economic Affairs blog explaining some reasons why maximum wage legislation is a bad idea. On the one hand, “There is no reason, functionally or morally, why a person should not enjoy any amount of wealth”. On the other, free economies have a far better reputation for wealth creation, poverty alleviation and even wealth distribution than interventionist ones. So maximum wage legislation is unfair both on an individual and a community-wide basis.
On top of this, Vince’s reason for supporting the High Pay Commission is flawed. In his words “There is no justification for massive pay and bonus awards in financial institutions, the most important of which are guaranteed or owned or have been rescued by the tax payer. Transparency and tax are important but a High Pay Commission looking at both equity and economic aspects is a welcome suggestion too.”
Firstly, the justification for “massive pay and bonus awards in financial institutions” is the same as it always was: it is necessary to attract the best talent. That the industry spectacularly failed in 2007 does not mean that there is no need to chase talent in 2009. What was wrong with the bonus culture in 2007 (and before, and indeed since) was not the size of the bonuses but the behaviour for which they were being paid. Had Compass proposed a Short-Term Gain Bonus Commission they might be on to something, but that is not what they are proposing. In attacking the size of the bonus rather than the behaviour they are rewarding, Compass is off the mark.
It is also not true that “the most important” financial institutions “are guaranteed or owned or have been rescued by the tax payer”, unless he is referring to the Bank of England’s lender of last resort function, which is centuries old and has been exercised without the need for maximum wage legislation for all that time. Only some financial institutions are actually owned by the taxpayer; Barclays and HSBC did not require a bailout and should not be subject to interference. Indeed, Lloyds TSB would be in a far better state had the government not effectively strong-armed it into merging with the bankrupt HBOS.
Of course, the government should not have a stake in the banks. Even if a bailout was necessary it should be reversed as soon as possible. But while the government does own shares in the banks it has a duty to taxpayers to get the best return on its investment. This will require the best talent available in the industry, which means that state-owned banks will need to compete with the rest of the sector by offering pay and bonuses commensurate with market rates. In fact, one cannot escape the feeling that the idea of limiting pay in the private sector is just a means of keeping down the costs to state-owned industries; a case of government being forced to intervene further to address the consequences of its past interventions.
His final point is the one I have discussed at in my IEA blog posting. The “equity and economic aspects” of government intervention are far more harmful to the poor than are the effects of leaving people alone. Free societies are not only fairer than less free ones, with the poorest owning a larger proportion of the nation’s wealth than in more interventionist economies, but they also create more wealth, so that the poor enjoy vastly more absolute wealth in free economies than in command economies.
Maximum wage legislation is a bad idea. It is also a bad idea for the Liberal Democrat’s shadow chancellor to support the socialist wing of the Labour party.
August 26th, 2009 at 8:09 am
I agree that it is jarring to see Vince in close cahoots with the likes of Compass.
But I find it bizarre how naive the IEA-style (econ 101) understanding of markets is, labour markets in particular; you fail to even acknowledge the possibility of monopoly power, rent-seeking, any of that; it is as if, after the first term, the whole class stuck their fingers in their ears and shouted “na na na can’t hear you” rather than learn about some of the rather important wrinkles in the theory – wrinkles that mean the free market does not straightforwardly spit out socially- or even economically-efficient outcomes.
You are all perfectly capable of understanding, to the point of comedic melodrama, the distorting effects of government power in markets – but all the other ways that power intervenes are a mystery to the IEA-viewpoint.
Even the Telegraph sees something odd in banker’s pay:
http://freethink.org/index.php/freethinkers/5-freethinkers/448-high-pay
Look more closely and at least acknowledge that it is more complicated than “I had to pay $100m – it’s what you need to get talent”. I have worked in the City and that is a grotesque simplification of the process.
August 26th, 2009 at 10:51 am
And Liberal Democrats of your persuasion have never given intellectual succour to campaign groups whose primary focus is the Conservative Party?
August 26th, 2009 at 11:32 am
Matthew,
Certainly not! Indeed, the IEA specifically tailors its message to “liberals in all parties” (c.f. their 50th anniversary publication, Towards a Liberal Utopia) and are constantly at pains to point out that they are not partisan.
What other groups did you have in mind? Or was it another example of commenting first and thinking about it later?
August 26th, 2009 at 11:46 am
Giles,
The suggestion that I, other contributors to the Liberal Vision site, or contributors to the IEA “fail to even acknowledge the possibility of monopoly power, rent-seeking, any of that” is so wrong it is absurd. Monopoly power and rent-seeking are two of the most dangerous forces in the political economy today. However, it’s called the political economy for a reason.
Can you name a single monopoly that is not backed by government? I can’t. Even assuming that you use the term loosely to refer to the fact that there are a few major banks (and they are not that few, are they?) this is due to financial regulation. The major barriers to entry into financial markets come from government regulation, while the power of the banking industry is derived largely from its status as a government-backed cartel.
I refer you to some of the IEA papers on Free Banking and Hayek’s paper on the Denationalisation of Money.
Nobody denies that power exists, is uneven and that it enables people to coerce others. However, liberalism – not only but especially through the effects of free markets – provides the framework for limiting the effects of power.
Incidentally, I never suggested that pay should be so high. I said that it was not the size of the pay but for what it was paying (short-term speculation) that may have aggravated the financial meltdown. As I said in the article, “Had Compass proposed a Short-Term Gain Bonus Commission they might be on to something.” Whether banks pay £100m packages is of relevance only to their shareholders, unless we bail them out. And bailing out banks is another policy that Vince supports!
August 26th, 2009 at 2:01 pm
“Can you name a single monopoly that is not backed by government?” But your question comes close to revealing an axiom at the heart of IEA-thinking – monopolies are ALWAYS kept alive by governments? So Google, Microsoft, Standard Oil, . . . no doubt the evidence will get stretched to suit the theory, but it starts sounding like a premise, not a conclusion.
I am talking about monopoly power, not monopoly. You’ve studied your economics, so you know about the ability to charge far above the marginal cost/the indifference point for offering a service. From “efficiency wages” through branding (celebrities) to darker Marxist conspiracy theories about classes clubbing together, there are all sorts of reasons people can get to this point. People can get paid far more than their reserve wage. A salesman can monopolise his contacts, or threaten to take them; a unionised employee can threaten union action. I think we both recognise that this happens – the question is one of degree, whether it explains 5% or 75% of the expanding wage differentials. For me, recent trends suggest the latter. Like you, I doubt the ability of government to manage it better – all I can advocate is progressive taxation.
I like that Hayek paper, by the way – can’t see how it could work though. Money is close to being a natural monopoly.
August 26th, 2009 at 2:06 pm
Incidentally, I don’t agree with the idea that the pay structures caused the crisis. I think it is just convenient for a lot of people to think that – ‘you overpaid bozos brought us all down’. Bonuses are quite a rational way to align pay with incentives. Most are earned in very liquid markets – not sitting on a pile of CDOs.
The problem is much more about the incentives to high leverage at the level of the company. If the leverage ratio had been 1:5 throughout, there would have been no crisis, no matter how the bankers were paid. Debt-equity swaps. IMHO.
August 26th, 2009 at 4:18 pm
Giles,
I agree with you about “the idea that the pay structures caused the crisis”. My point was not that a short-term bonus commission would be a good idea. I simply meant that it would be less absurd and less obviously an example of Compass using the crisis to justify policies they were already (mistakenly) demanding than a high pay commission.
Personally, I think that the recession was an inevitable result of a ballooning money supply, which inevitably leads to asset-price inflation and then crash as people lose faith in the devalued currency and in banks built on money backed by nothing. Innovative credit vehicles certainly made the expansion of credit (and so broad money) easier but they were a symptom of the more fundamental problem with fiat money.
On the question of monopoly, I don’t need “the evidence [to] get stretched to suit the theory” as none of the examples you cite are monopolies. Microsoft is rivalled by Apple, Linux (which is not-for-profit and so should really get the anti-capitalists excited) and others. Google is rivalled by Yahoo, Ask and others. Standard Oil didn’t even monopolise the US market, let alone the world.
When you say “monopoly” what you really mean is “market dominance”: I maintain that no true (i.e. 100%) monopoly exists without state backing. As for monopoly in the looser sense, as Schumpeter noted, market dominance does not matter as long as competition is possible. I don’t need more than one supermarket in my town to keep prices down; the fact that another could set up shop if the existing provider sought to “charge far above the marginal cost/the indifference point” is enough to keep prices in check.
Note, for example, how Microsoft continues to innovate and how Google continues to be free. They hardly fit the standard interventionists model for monopoly dominance and market failure!
On the issue of people being paid above the reserve price, I think that it is called Entrepreneurial Error. If the bankers aren’t really worth £100m, their wages are explained by the mistakes made by management. John Kay certainly thinks so.
Entrepreneurial Error also explains alleged union success at wage bargaining, as does management and union leaders colluding (not necessarily consciously) to make the fight look tough so that when they settle on the market rate union members and shareholders think that their agents have stood up for them.
Finally, on the Hayek paper, I don’t agree that money is a natural monopoly, but I agree that it is unlikely to be denationalised soon. It would destroy government’s ability to debase the coinage (the call it Quantitative Easing these days, but it is still a means of managing government debt). I did have a novel idea for “how it could work”, though. Instead of introducing the Euro, the European Commission should have declared the Free Movement of Currency, requiring all EU members to allow citizens and business to earn, save, trade and pay taxes in any currency they saw fit. The inflators would soon see their currencies fall out of favour. Sadly, as is the European Commission’s wont, they decided to go for centralised monopoly instead. Plus ca change!
August 26th, 2009 at 4:18 pm
Now, was that last comment longer than the original article?
I’m sure there’s a rule about that!
August 26th, 2009 at 4:50 pm
On the last, we agree (!) – in fact, when this story came out about shopkeepers adopting the Euro I noticed that Tories deplored the news, in blatant contradiction of their supposed belief in economic freedom. I therefore deplore those who accuse you of being a force for Conservatism (yes, Huntbach, you know who we mean) – it’s authoritarian instincts are utterly opposed to real liberalism.
On Monopoly, I think it exists as much as Perfect Competition does – as an abstract ideal that the world only really tends towards. Even the state’s monopoly on violence is only approximate, as my children keep reminding me. It’s funny how over on Liberal Conspiracy it is the non-existence of Perfect Competition that is asserted instead. So MSFT tends towards monopoly, meaning for me that their incentives are skewed that way – considerable innovation going into activities that do not produce the benign outcomes we hope for from free markets.
And my attempts to pay low wages to derivatives salesmen was hampered by a tendency towards monopoly – the same semi-literate, semi-numerate crew would turn up at other companies with 10% of the client base attached – not 100%, but enough to get them well over their reserve wage.
I agree with your prognosis on supermarkets. But that ‘could set up’ is sometimes missing. I don’t think Bob Diamond’s packet is much constrained by the risk of another person setting up as head of barclays investment banking – once in place, he attains certain monopoly benefits.
I find your account of the cause of the crisis interesting – I would ask for more views, such as whether the current QE might only inflate asset prices and have no useful effect on AD/NGDP – but I may wait for the post on Liberal Vision instead.
I have considerable sympathy with the Entrepreneurial Error view. Bonuses are paid by shareholders, on the whole. It inspired my somewhat sarky response to ‘Gandhi’ earlier:
http://www.liberal-vision.org/2009/08/17/vine-cable%E2%80%99s-%E2%80%9Csolution%E2%80%9D-to-high-pay%E2%80%A6another-quango/#comment-1916
but it moves the issue on to – why are the banks able to make so much money?
August 27th, 2009 at 2:55 pm
according to uk polling report
http://ukpollingreport.co.uk/blog/
ComRes also found 65% of people agreeing with the idea floated by Compass that there should be a “high pay commission to curb excessive pay and bonuses”.
All those people you describe on your IEA blog as “repugnant” with “Basically, it is institutionalised envy”
I think trickle down economics has had a long enough trial period, I think we need a bit more trickle up economics.
August 27th, 2009 at 3:22 pm
Tom,
I described the attitude as repugnant, not the people. Blame the sin and not the sinner.
“Trickle-up” economics? That would be regressive taxation, I take it. An interesting idea, but I don’t think it’ll catch on!
Giles,
Back when I had my own blog (and the days were long and the I was young and carefree) I wrote lots about the cause of the crisis . All now unavailable, sadly.
My fear with QE is that it will create ( is creating?) an mini-boom that will result in a second crash as soon as it is withdrawn. Hell, even the Keynesians have heard of double dip recessions!
More easy money provides entrepreneurs with more false data leading to more bad investments. Even if we don’t get a new dip in a few months time, we will certainly have sown the sees of the next recession. This will be massively aggregated if governments use inflation to ease their financial woes. It is all-too-tempting to inflate away the national debt. We’ve seen it many times before.
Hyperinflation may sound like a far-fetched scenario, but even Alan Greenspan, himself no stranger to absurdly-loose monetary policy, has predicted double-digit inflation in the coming years!
“Why are the banks able to make so much money?” Well, they do provide a very useful service. But financial regulation perpetuates the oligopoly and prevents new start-ups from rivalling them. And they have a licence to print money, of course. If you and I were allowed to make money from thin air like the banks do, we’d soon be living like kings!
August 27th, 2009 at 4:19 pm
Tom
it is interesting how your views differ from Congdon, or Scott Sumner who is the monetarist I follow most closely – both seem to think that a combination of 100% credibility and money market operations can allow the Bank to achieve whatever level of NGDP growth it wants, and in fact that the Bank could have stopped the recession starting at all.
I am more Keynesian on that: money really does become inert during financial panics. Capital matters a lot, and everyone was out of capital. Not sure whether it puts me in your camp (Austrian?) though – I didn’t feel that this country had all that much malinvestment: house prices were high because of the (government-abetted though unwillingly) Nimbyism driving housing supply far too low to respond to the signal.
The US is another story.
If Alan G really believes that, he could make a killing in the inflation-adjusted bond market. It strikes me that inflation hawks have to abandon a fair degree of efficient-market belief at present . . . Sumner is at least consistent here, saying “look what the market is telling you. You need to inflate more”.
His debate with John Cochrane, who I think takes your view, is well worth watching
http://www.finreg21.com/channel-21/interviews/monetary-policy-discussion
I agree about the banks creating money – this is why they make so much, that and the implicit taxpayer insurance. I’ve got a CiF piece impending on that.