Are the markets wrong about CEO pay and the recovery?

CEO pay has risen by 937% since 1978 in the US, compared to a rise of just 10.2% for the average American worker, according to a centre-left American think tank. That feels like markets must be wrong, but as Scott Sumner points out, when market decisions and our intuitions clash, we’re often the ones at fault:

CEO pay has been controversial for two reasons. It has risen very rapidly in recent years, and it often seems unlinked to performance. But pay is very closely linked to expected performance, which matters when contracts are signed. A few months ago Steve Ballmer resigned as CEO of Microsoft and the stock rose by billions of dollars. More recently, Larry Ellison (sort of) stepped aside from Oracle, and the stock plunged by billions of dollars. This shows that CEOs have a huge impact of stock valuations. Whether the market is rational in believing that is a trickier question, but it’s the job of corporate boards to put people in place that will maximize shareholder value. That means they need to at least try to get the very best, even if it costs a lot of money in terms of higher salary. If they aren’t paying obscene salaries then the board of directors isn’t doing its job.

Back in the 1960s, corporate decisions were much easier. You allocated capital to new auto factories, steel mills, appliance makers, and churned out product for which you knew consumers were waiting. Even IBM was fairly predictable for a time. In contrast, a modern CEO at a high tech firm might find the company quickly destroyed by new technology if he doesn’t keep on his or her toes. Think how much Sony would have benefited in the past 10 years if it had had the Samsung management team. Perhaps an extra $100 billion in shareholder wealth? And that’s also why the finance sector is so much more important today, decisions over where to allocate capital are both more difficult and much more important.

In other words, CEO pay may have risen a lot because CEOs matter a lot more, relative to the average worker, than they did in 1978. You could just deny this, because nobody is ‘worth more’ than others, and so on, but that’s an emotional response. In terms of cold, hard cash, people are.

This might turn out to be wrong, of course – markets misjudged the future returns of a lot of assets in the run-up to 2008, but then, so did virtually everyone else. The question is what, in a world where anyone can be wrong, we can look to as the least-bad way of collecting and judging existent information.

Pundits on Twitter and in the media can make a living by being wrong. Look at, say, the Guardian’s editorial writers or, if you tend to agree with them, the Telegraph’s. Or look at any think tank – except us, of course. Or financial advisors. Pundits don’t really suffer if they add ‘noise’ (a nice word for bullshit) to the sum of information that’s out there, so it’s hard to know if the pundit you’re listening to is telling you what you want to hear, or what’s actually true.

Markets – the people who make financial decisions that are aggregated in stock exchanges and the like – do. If you have a ‘false belief’ as a trader or business owner, you’ll lose money; if you have enough false beliefs, you’ll go bankrupt. And markets are utterly brutal in bankrupting people with false beliefs. We might have a good reason to ignore markets if we know something that they don’t, but if that’s the case, we should be making money from that private knowledge. Doing so will add that knowledge to the sum total of the market’s knowledge.

This is why I’m an optimist. Lots of my friends and people I agree with on nine out of ten issues think that the markets are wrong and that some economic catastrophe is coming. If they’re right, markets are wrong and they should be in line to make a lot of money (he said sarcastically).

So how can I judge? I look at who has more to lose, and who has a better track record. Through that lens, markets come out top – and my doomsaying friends sound just as emotional as their opponents who just can’t imagine why a CEO would be worth paying a lot.

An interesting little story about path dependence

There’s no particular theoretical reason why the Burnley Miner’s Social Club should be the world’s largest consumer of the Benedictine liquer. There’s also no theoretical reason why it shouldn’t be: which is good for the fact is that it is. It’s a useful reminder of two things, the first being path dependence:

A working men’s club in the north of England is the world’s biggest consumer of French Benedictine liqueur, downing 1,000 bottles a year of the alcoholic beverage.

The golden tipple has been a favourite at the Burnley miners’ working men’s social club for more than a century after being popular among soldiers who developed a taste for it during the First World War and drank it to keep warm.

Since then the drink has become a best seller at the 600-member club – which has even introduced a ‘Bene Bomb’ in a bid to keep it popular among the younger members.

There really isn’t going to be any other 600 member club that gets through a 1,000 bottles a year of the stuff. The fist of our wider points being to point once again to the idea of path dependence. Things that happen today are often as they are because of some other thing that happened in the past. Perhaps the Dvorjak keyboard is better than he qwerty, perhaps it isn’t, but the reason we don’t use it today is because it definitely wasn’t better with mechanical typewriters. Qwerty was deliberately designed, for purely mechanical reasons, to stop people typing too quickly. How we do things today is dependent upon things long irrelevant but important at the time we started the activity.

The second of course being that sometimes things just happen. You can see how the Benedictine story started: someone in one of those regiments got ahold of a bottle and told his mates how good it was. A century later it’s still going on. The habit survives just because of that original happenstance and the social reinforcement of it over time. As with driving on the left or the right. Unlike Dvorjak there’s no particular merit to either system, no basic reason to choose one or the other: and different places have chosen differently over the years (Sweden changed over from one to the other in, umm, the 1950s. Sadly, the story about the buses changing sides a week before the cars isn’t true).

The world can make a lot more sense if we keep in mind that stuff really does just happen sometimes and the effects can be with us centuries later.

Should we legalise commercial mercenaries?

Vishal was the 2014 winner of the Adam Smith Institute’s Young Writer on Liberty competition.

Commercial mercenary activities have been deemed illegal globally and have significantly dwindled in the 21st century. Legalisation may be useful in the short and long-term.

Currently, the extremist ISIS militants threaten to overthrow the Iraqi government. The Iraqi government requested assistance but limited support was offered. This is partly because we are reluctant to risk servicemens’ lives and spend money. For example, the American and British public may despise ISIS but lack the will to send their own servicemen on such an endeavour; Mercenaries could negotiate their assistance in the conflict for money, debt, natural resources etc. This prevents risking servicemens’ lives and costing taxpayers.

In The Anatomy of the State, Murray Rothbard wrote that wars fought with mercenaries were shorter and had fewer casualties. He quotes the jurist F.J.P Veale who claims that “civilized warfare” flourished briefly in 15th century Italy: “the rich burghers and merchants of medieval Italy were too busy making money and enjoying life to undertake the hardships and dangers of soldiering themselves. So they adopted the practice of hiring mercenaries to do their fighting for them, and, being thrifty, businesslike folk, they dismissed their mercenaries immediately after their services could be dispensed with. Wars were, therefore, fought by armies hired for each campaign… For the first time, soldiering became a reasonable and comparatively harmless profession. The generals of that period manoeuvred against each other… but when one had won the advantage, his opponent generally either retreated or surrendered. It was a recognized rule that a town could only be sacked if it offered resistance: immunity could always be purchased by paying a ransom… As one natural consequence, no town ever resisted, it being obvious that a government too weak to defend its citizens had forfeited their allegiance. Civilians had little to fear from dangers of war which were the concern only of professional soldiers.”

Finally, many NATO member-states are cutting defence spending and enemies have noticed. In future, NATO may find its defensive capabilities severely impaired when a war occurs and it may be difficult to compensate for this lost capacity at such short notice, especially when hostiles have been building their own forces in the meantime. Rushed conscription of civilians hardly compares to contracting seasoned warriors. In those circumstances, Governments struggling to fight public enemies can turn to mercenaries (even foreign ones if foreign governments don’t lend direct support) to pick up the slack.

The ASI is hiring paid gap year employees

The Adam Smith Institute is looking to hire two 18-19 year olds in between A-levels and university as paid gap year employees, working with the think tank on organising events, putting out publications, managing our database, handling merchandise, and running the office.

The role is open to applicants of all political stripes (lively debate is welcomed), and they need have no specific experience. It is, however, crucial that the candidate is open-minded, inquisitive, friendly, eager to learn and curious about politics and think-tanking.

The specific duties will be split evenly across the two successful applicants, and will include:

☻Organising lunches and dinners
☻Keeping a database up to date
☻Selling ASI merchandise
☻Doing secretarial work for the directors
☻Setting up and cleaning up events
☻Mailing publications out to subscribers
☻Logging RSVPs for events
☻Supporting donor relations
☻Meeting a wide range of interesting & important people
☻Learning about social & political science
☻Socialising with the staff
☻Carrying out self-directed research
☻Writing blog posts

Previous interns have gone on to work with the Adam Smith Institute, including the ASI’s current Research Director, Sam Bowman, and Head of Digital Policy, Charlotte Bowyer, who was a Gap Year intern in 2009-10.

The role will pay £700-1000/month (depending on experience), and is strictly limited to students on a gap year. It will last 2-9 months, starting from late October. All applicants will interview with President Madsen Pirie and Research Director Sam Bowman at the Adam Smith Institute offices in Westminster in mid-October and successful applicants will start from late October.

Please send a CV and cover letter of around 500 words to gapyear@adamsmith.org by 13th October

What’s happened to the ‘Bitcoin Revolution?’

Last Tuesday PayPal announced partnerships with the three biggest Bitcoin payment processors, BitPay, Coinbase and GoCoin. Merchants can now accept Bitcoin through PayPal’s Payment Hub platform, although the company hasn’t integrated the currency into its system directly.

With over 143m registered users and $125bn worth of transactions last year this is a boon for the digital currency-cum-payments processor, which currently sees up to 80,000 transactions a day.

It’s also a suggestion that the ‘Bitcoin revolution’ (if it is to happen at all) could be less explosive, more incremental, and far more reliant on existing processes than many might believe.

In many ways the last 12 months have been incredible for Bitcoin. It’s gone from an underground obsession to a mainstream curiosity and the darling of the FinTech world. Huge companies such as Overstock and IBM now accept payment in it, and the currency is on track to attract more VC funding in 2014 than the Internet did in 1995.

Yet for some Bitcoin’s performance has been a disappointment. Despite all the investment and media attention, Neither Bitcoin’s price nor its use have seen anything like the exponential rise anticipated by its biggest proponents.

Enthusiasts are prone to making eye-watering predictions of Bitcoin’s value, yet its price has been falling in recent months and is down from a peak of $1,000+ in December to around $400 in recent days. Bitcoin transaction volume has also stagnated around 100,000btc/day, a decline from around 250,000 last November & December.

There’s also been little vindication for the more ideological Bitcoin supporters, who view the protocol as a tool with which to challenge power structures and state legitimacy. Wall Street and the banking sector are more interested in harnessing the power of cryptocurrency and distributed ledgers for themselves than in lobbying to protect themselves from the technology. There’s also little indication that central banks (even privately) consider cryptocurrencies a threat to fiat currency. And whilst Bitcoin fans are quick to proclaim its resistance to state censorship, places like China and Russia have done a good job of suppressing its use within their borders.

Yet none of this renders Bitcoin a failure. Whilst crazy price rises no longer dominate the news and public interest may have waned, the past year has seen significant professionalization within the Bitcoin community and the development of a staggering amount of infrastructure.

Actors like the Bitcoin Foundation have worked hard to safeguard the Bitcoin protocol and to provide the currency with a ‘legitimate’ face. Bitcoin conferences now cater to serious investors and carry hefty pricetags to match. Self-styled crypto-consultants and established law forms vie to provide specialized advice, whilst groups like Google Ventures and Barclays Accelerator have their eyes on crypto-entrepreneurs. Whilst basic problems like securing an UK bank account for Bitcoin businesses persist, financial innovation in areas like Bitcoin derivatives which compensate for the currency’s volatility race ahead.

Lawmakers are also starting to take Bitcoin seriously. The UK Treasury has already offered really very reasonable tax guidance on Bitcoin and has a detailed report on it due out this Autumn. The Bank of England’s most recent Quarterly Bulletin labeled Bitcoin a ‘significant innovation’ and remarked that its underlying protocol has the potential to ‘transform’ the financial system as a whole.

This doesn’t guarantee that governments will make the right decisions or regulatory steps. Indeed, proposed legislation like NYC’s ‘BitLicenses‘ threaten to affect Bitcoin companies across the globe. However, in the UK and the USA at least policymakers are seem interested in understanding Bitcoin technology and how it can contribute to society, rather than in controlling the network completely.

This ‘professionalization’ of Bitcoin invokes the ire of some members of the coin community, who regard it as selling out and the establishment of a new, powerful Bitcoin elite. Certainly, companies which pre-emptively comply anti-money laundering and know-your-customer laws applied to other financial services cannot utilize the full potential of Bitcoin technology. However, it is inevitably these boring, corporatized activities-  not transactions fueled by price speculation or clickbait about the Dark Web- that create the chance of a sustainable future for Bitcoin.

It also looks like Bitcoin’s success will be increasingly related to its integration with established payment, merchant and finance companies such as PayPal, Amazon, Apple and Visa. Bitcoin is a disruptive technology with the capacity to bring about huge changes, even within the confines of today’s regulated industries. However, these changes look likely to come with the help and blessing of today’s commercial giants, rather than by a process of immediate disintermediation.

For instance, Bitcoin is much more than the new PayPal, for it’s simultaneously both a currency and a payment processor. Despite this, Bitcoin’s price rallied significantly after a long period  of decline following the PayPal announcement. Whilst the Bitcoin protocol has absolutely no need for an Apple Pay or a debit card to transmit it (in fact Bitcoin was developed to render such third parties obsolete), there’s no denying that it would also work wonders for user adoption. As the Bitcoin ecosystem grows and seeks increasing legitimacy, integration with established companies is a very realistic route to long-term success. In addition these companies have much to gain from embracing Bitcoin early, rather than risk competing with it later.

Understandably, this doesn’t make the ‘Bitcoin revolution’ seem much like a revolution. But for libertarians and free marketeers there’s still much to celebrate. The fact that Bitcoin can reduce payment transactions fees by a couple of percent isn’t all that sexy, but the fact that it could slash the fees associated with remittances to developing countries certainly is. And if established companies like Western Union or M-Pesa can work with a Bitcoin company to speed up this process, so much the better.

There are also innumerable areas (many of which are still in their infancy) where Bitcoin and blockchain technology can work to make the world richer and freer, such as in providing finance for the unbanked , establishing a decentralized internet, or enabling Decentralized, Autonomous Corporations.

Bitcoin is still an alternative to fiat currency, which is great for those anticipating global monetary collapse as well as those experiencing extreme inflation in countries like Argentina. Bitcoin can still be used to circumvent capital controls, give funds to politically outlawed organizations, and to achieve increased levels of financial privacy.

As Bitcoin ‘legitimizes’ and enters the mainstream it is inevitable that the companies and services interacting with it will become regulated. There’s even demand for the legislation, since businesses tend to prefer regulatory clarification rather than to be stalled by uncertainty. However, the beauty of the blockchain is that whilst companies and specific actions can be restrained by law, the underlying Bitcoin protocol cannot be controlled or regulated. This allows for disobedience and experimentation in the shadows. No matter how Bitcoin is taxed, treated or regulated in the open economy, the possibility of a parallel realm where no interaction with the current political and financial system is required- however small- remains as an enduring idea.