- Executives can be worth a lot to firms. When bad CEOs are sacked or new CEOs who are expected to be good are hired, the firm they work for can become a lot more valuable. Apple lost 5% of its value after Steve Jobs died, about $17.5bn. Microsoft became 8% more valuable after Steve Balmer resigned in 2013 – he represented more than $20bn worth of losses to Microsoft. Angela Ahrendts's departure from Burberry in 2013 wiped £536m off the firm’s value; Tesco became £220m more valuable when its CEO merely announced that he would take an active role in managing the firm. Why? Because CEOs make really important decisions that can make or break the firm.
- Critics of high pay can’t say how much they think CEOs should be paid. The High Pay Centre says it thinks CEOs are paid too much, but how much would be the right amount? They don’t say, and don’t suggest any real way of knowing. They emphasise multiples of employee pay on their website, but there’s no reason at all to think that would be a good way of judging how much a CEO is worth to the firm, and doesn’t even make sense across firms – is the CEO of a giant firm with a low average wage, like McDonald’s or Tesco, less important than the CEO of a relatively small firm with a high average wage, like QinetiQ?
- CEOs might be much more important now than they were in the 1960s. The most interesting question about executive pay is: why has it risen so much since the 1960s compared to median worker pay? There are a couple of different reasons this might be. One, as Scott Sumner suggests, is that CEOs actually are much more important now than they were (so being a good one is more valuable to a firm). Executives’ decisions probably mattered less when the world was less globalized and markets were less diverse – you knew what sorts of appliances and groceries consumers wanted, and your job was to manage capital competently to produce them. Now, even big firms face rapid destruction if they make the wrong call about what sort of products are going to popular in a few year’s time. As Sumner says, “Think how much Sony would have benefited in the past 10 years if it had had the Samsung management team”.
- …But tax and regulation probably plays a role too. Economist Kevin Murphy argues that history of executive pay (particularly in the United States) is only understandable in the context of tax and regulatory changes, like penalties on golden parachutes, a rise in stock option grants caused by changes to tax and accounting rules, and “changes to holding and listing requirements that favored stock options over other forms of incentive compensation”. (NB: This doesn’t mean that these rules are bad or undesireable, but they may help us to understand why executive pay is higher now than it once was.)
- Performance related pay causes executive pay packets to rise on average. Critics of high executive pay often call for pay to be more closely linked with performance – in the form of stock rewards, for example. But as Murphy shows, this actually makes the ‘problem’ of CEO pay even worse, because pay has to rise on average to reflect greater risk. “The payoffs from stock options, for example, are inherently more risky than are payoffs from restricted stock, which in turn are more risky than base salaries.” So the more we try to make CEO’s pay reflect performance, the higher CEO pay will be!
- Employee representation can be bad for firms. The High Pay Centre’s policy prescriptions are quite modest – today they’re calling for firms to include a worker representative on remuneration committees, which doesn’t sound like a big deal. And it probably isn’t. But employee representation on boards can be a very bad thing: according to a Financial Times report on Volkswagen last year, worker representation on the car company’s board turned the board atmosphere toxic, and led to very bad decisions being made. Reform of bad practices was blocked by the employee-supported Chairman, who worked against shareholders and his own Chief Executive to stop jobs from being cut and working time limits from being raised, ultimately harming the firm. Strangely, the High Pay Centre cites Volkswagen as a success story.
- It’s shareholder money on the line. Ultimately, it’s hard to see the public interest argument here. If shareholders are really missing a trick and overpaying their chief executives, who loses out? Well, shareholders, in the form of lower profits. And they’re the ones who stand to gain if they can fix that problem. Unless the High Pay Centre can show that the market is completely broken (and pointing to high pay as evidence for this is circular reasoning) there must be an opportunity for a firm to realize that CEOs are being overpaid, to buck the trend, and presumably to prosper. Why hasn’t that happened yet?
On this idea of stranded fossil fuel assets
We were really very surprised indeed to see this assertion being made:
Fourth, in a fast-changing, post-Paris world, we need a real focus on assets. Oil companies are valued on their reserves: but as clean energy technologies such as solar and wind become cheaper and better, how many of these will ever be extracted? To hit climate change targets, an estimated 80pc of the world’s fossil fuel reserves have to stay underground.
That's from Nigel Wilson, who runs L&G, the UK's largest equity investor. And what surprises us is that it's self-evidently wrong. And yet it's also a very popular view: Mark Carney at the Bank of England has been known to sign on to it. The implication being that if the world won't use fossil fuels off into the distant future, the oil companies have reserves that won't be used in that distant future, therefore the oil companies are worth much less than the market currently says. So, of course, sell now!
But it is, as we say, self-evidently wrong. Shell's reserves look like some 6 billion barrels, BP's some 17 billion. Shell is currently valued at $130 billion odd, BP at $64 billion. We're just not seeing the connection there. With oil at $40 a barrel those valuations should be more like $250 billion and $680 billion.
And it's not even true in theory that the oil companies should be valued at the current oil price times their reserves. That is, even if we do try to value them by their reserves. Rather, they're to be valued at the value of those reserves discounted to net present value using the market interest rate.
A reasonable guess at the market interest rate is the yield on stocks, some 4-5% or so at present perhaps. So, discount something of value in 30 years time to the net present value at a 5% interest rate and......it's worth absolutely nothing today, isn't it, to any reasonable level of accuracy?
This does of course speak to the whole point of Lord Stern's Review. We humans are subject to hyperbolic discounting: we discount things in the far future too much. This is why we must use special, lower than market, interest rates to think about said far future. But if we are going to do that with one part of said future, the damages from climate change, then we really do need to use the same technique when thinking about other parts of that future, the values of reserves. Or, alternatively, we could acknowledge that that discounting at market interest rates has made the future value of those reserves spit in terms of today's corporate valuations and thus the worries over stranded reserves is simply because no one is understanding the settled economic science about climate change.
We are strongly persuaded that it's that latter. For we know that it's terribly unfashionable to do so in either political or agitating circles but we are prepared to take those economic arguments seriously in all their implications. Not to assert that they are correct you understand, but to think through what they are telling us if they are correct.
And if Lord Stern is correct about discount rates, which he is in theory as all economists agree even if there's all sorts of arguments from Nordhaus, Tol, Dasgupta, Weizman and the rest about the details of exactly what the rate should be, then there simply cannot be a problem with the value of far future reserves being incorporated into current fossil fuel company valuations. The assertion that we suffer from hyperbolic discounting means that the net present value of the far future is near nothing: and if the assumption of hyperbolic discounting is not true then climate change is something we should do absolutely nothing about at present.
It is, of course, entirely possible to believe in both: both that we must expend great effort today to deal with climate change and also that the oil companies are grossly over valued for the same reason. It's obviously possible because large numbers of otherwise sensible people do believe it. It is not however logical or reasonable to believe in both at the same time.
Minimum wage debate: still not over
The new round of NBER papers is, as ever, interesting. One of particular interest comes from Jeffrey Clemens at the University of California San Diego. He refreshes the minimum wage debate by dialling in on the effect of hikes (a) during the great recession and (b) on lower-skilled individual aged 16-30, finding a fairly substantial effect on that group.
I analyze recent federal minimum wage increases using the Current Population Survey. The relevant minimum wage increases were differentially binding across states, generating natural comparison groups.My baseline estimate is that this period's full set of minimum wage increases reduced employment among individuals ages 16 to 30 with less than a high school education by 5.6 percentage points. This estimate accounts for 43 percent of the sustained, 13 percentage point decline in this skill group's employment rate and a 0.49 percentage point decline in employment across the full population ages 16 to 64.
The debate is not over, but this does look like a reminder that there's 'no such thing as a free minimum wage hike'.
The coming reversal of inequality
We're consistently told that the current level of economic inequality is unsupportable and that therefore something must be done. You know, that death of capitalism thing and why don't we just all sing Kumbaya together? However, it is rather necessary to work out why inequality has been increasing and even what sort of inequality has been increasing. As it happens global inequality has been falling: the poor are getting richer faster than everyone else so the gap between the top and the bottom is closing. So, that's good from any angle: absolute poverty is being beaten, the sort of thing we worry about, and inequality is reducing, the sort of thing others worry about and we don't. However, inequality within rich countries has been increasing: as before, not something we worry about very much if at all although obviously others do.
But why? And the real underlying reason is that in he past few decades we've added a few billion people to the global labour market. That's really what globalisation has done: and it's why poverty and overall inequality are receding. but that has meant something of a change in relation to capital and labour. Roughly the same amount of capital (and this is true of human of financial capital, true of highly skilled labour or pure capital) is being added to vastly more labour. Relative scarcity thus tells us that the returns to capital (again, both human and financial) will rise as against the returns to labour. Given that capital is very much more concentrated in ownership than labour thus inequality rises.
And that's usually the point at which the analysis stops. Something must be done and usually it's tax capital much more so as to give to labour. But the actual point we want an answer to is, well is this going to continue?
No, actually, it's not:
Based on UN population estimates, the number of people in the developed world aged between 16 and 64 peaked in 2010, while the number of people aged 60 and over will exceed the number of children for the first time in 2047, and more than double from 841m in 2013 to two billion by 2050. In the UK, the average age is expected to rise from 40 years in 2014 to 42.9 by mid-2039, when one in 12 people is projected to be aged 80 or over, according to the Office for National Statistics (ONS).
This is not just a rich world phenomenon. It's almost certainly true that we've reached, or are just about to, Peak Labour. From here on in demographic changes mean that labour is going to become more scarce relative to capital, not as in recent decades in glut. Thus we would expect the relative prices to snap back and thus that globalisation induced increase in inequality to go away again.
Meaning, of course, that we don't need to tax the rich into penury at all.
The re-emergence of the hard left
“Always after a defeat and a respite, the shadow takes another shape and grows again." "I wish it need not have happened in my time," said Frodo.
"So do I," said Gandalf, "and so do all who live to see such times. But that is not for them to decide. All we have to decide is what to do with the time that is given us.”
Some Conservatives short-sightedly welcomed the rise of Jeremy Corbyn to the Labour leadership because they hoped it would make Labour unelectable. It might, but accidents happen in politics. What it has done is to put lunatic policies into mainstream discussion. Because of his official status his pronouncements have to be covered by the media as if they were serious viable policy. We now have to listen daily to ideas that were discredited decades ago. Back from oblivion have come the nostrums of state-run businesses and punitive tax rates on those disapproved of. His appointment of like-minded colleagues has dispelled any notion that he might be a coalition builder and someone who can create the compromises that real-world government is built upon. The fanatical zealotry of some of his supporters, and the hatred they exude towards opponents, gives us some idea of the sort of politics that could be inflicted upon the country.
The danger has to be confronted. The ideas and arguments put out in support of extremist proposals have to be shown to be dangerous, impractical nonsense. These have been tried many times and have failed many times. The arguments for free choice, competition and enterprise, have to be made again and won again. We will play a part in that. Some of what we say will be well-known to some of our loyal readers, but it is worth saying it to a new audience who might otherwise be fooled into thinking that the state can run businesses efficiently, or that government can run people's lives better than they can do so themselves.
We will publish a series of posts which remind people of the core principles of why liberty and markets are usually better than governments and state officials at improving people's lives. We will look forward, as we always do, and innovate ideas that can address problems and shortcomings with practical solutions. But we will occasionally look back to the reasons why Socialism failed before, and why it would fail again, were it to be given the chance.
This is what will happen to solar tariffs everywhere, eventually
Interesting news from Nevada: the state now has solar feed in tariffs on a rational economic structure. It's still not all the way there but the structure is now sensible: and this is the way that all such tariffs will end up to. Simply because it's the only rational way, economically, to do it. Instead of getting the retail price for whatever electricity they feed into the grid, panel owners now get:
This summer, NV Energy, Nevada's largest utility and a subsidiary of Berkshire Hathaway , had asked for a rate structure that included a monthly service charge, a demand charge (based on a home's peak demand), and an electricity charge. For homes with solar, it proposed paying 5.5 cents per kWh for the electricity they send to the grid, well below the 11.6 cents per kWh that customers are paying for electricity.
This is simply the way that it has to be, in the end at least. Leave aside any concerns about whether it should be yet or not and consider the underlying economics of this. The grid needs to exist if we're to share power at all. And thus it needs to be paid for: a standing charge doesn't seem like a bad idea as a method of paying for such infrastructure. And the size of that charge needs to be determined by peak drawdown (or perhaps feed in to it) as that is what determines how the grid is built.
And then, yes, everyone should be paid the current value of what they are feeding into said grid. And with solar that's only ever going to go down. As there's more solar on the grid then of course there's more of the grid that is all producing at the same time: that's how sunshine works across geographic areas. In the end, instead of being paid the wholesale price for power people are going to be paid the marginal price for power at that time. Something that the more the technology becomes as a percentage of total supply is only ever going to go down.
This isn't just a "Har, Har, Hippies!" argument: the only economically rational manner, in the long run, of paying for a grid that contains solar, or indeed any other local and or intermittent source, is going to be this one. A charge for the grid, scaled to the size of the connection, with production gaining moment by moment marginal value, consumption possibly based again on that marginal value. It's really going to change how things are done: and if we don't move to something like this then the system is going to go bankrupt instead.
Thus, obviously, it is going to happen: the only question is when.
Isn't this just fascinating?
Just so surprising who it is that is complaining about business rates:
The archaic business rates system is putting off international companies from coming to Britain, the boss of the UK’s biggest shopping centre owner has argued. David Fischel, chief executive of Intu, has told the Telegraph that the business rates system is “absolutely putting off international retailers from coming to the UK”.
Actually, no, not surprising at all. Intu is a real estate investment trust. Essentially, it owns commercial property and pays out the income to investors. Given this structure it is those investors who actually bear the economic burden of business rates in lower payments from the company. Business rates are not perfect, the tax should be levied on the value of the undeveloped land plus whatever permissions there are to do something with that land, rather than the value of what is built upon it. But even so, they're still a close approximation to a land value tax and as such a pretty good tax. And they're incident upon the landlord, which is where such taxes should be incident.
So, there isn't actually all that much surprise: Mr. Fischel's call is "Don't tax my people, tax some other bugger".
Spanish fashion group Inditex has been introducing more of its brands to the UK market, such as Pull & Bear and Stradivarius, but the Zara owner is said to be looking carefully at its investment return, with business rates a rising cost.
Zara tends not to own property, but to lease it. Thus rates are not incident upon Zara, but upon the landlords from whom it leases. We can indeed prove this too: when business rates were reduced in Enterprise Zones rents went up to compensate. Or rather, as is the way of such things, currently rents are depressed by the tax take of those business rates. Which is, again, precisely where we would like the incidence of the tax to be.
Mr Fischel called the rates system “a monster – in essence it’s an inflation-linked Government bond attached to our property assets”.
Yes, yes, it is. And that's what it's supposed to be too. It's one of the few pieces of the tax system which actually does exactly what it says upon the tin. We must get our tax revenues from somewhere and land value taxation is the least distorting manner of doing so. Thus why we do, and should, tax in this manner. The rents being received by the shareholders in Intu are exactly what we are trying to tax. And they are also what we are taxing. Sure, obviously, it is Mr. Fischel's job to complain about this but that doesn't mean we should pay him any mind as he does so.
The law can be a funny thing
This is a fun little case, rather appropriate for today given last night's excesses. Yet there's something profoundly wrong about the final dispensation:
Drink driving charges against an American woman have been dismissed based on an unusual defence: her body is a brewery. The woman was arrested while driving with a blood-alcohol level more than four times the legal limit in New York state. She then discovered she had a rare condition called "auto-brewery syndrome", in which her digestive system converts ordinary food into alcohol, according to her lawyer, Joseph Marusak.
We are aware that this can indeed happen.
The rare condition, also known as gut fermentation syndrome, was first documented in the 1970s in Japan, and medical and legal experts in the US say it is being used more frequently in drink driving cases.
We're even aware that that first known case concerned an American man in Japan and boy, didn't he have a hard time proving it.
During the long wait for a diagnosis appointment, Mr Marusak arranged to have nurses monitor his client for a day to document she drank no alcohol, and to take several blood samples for testing. "At the end of the day, she had a blood-alcohol content of .36 without drinking any alcoholic beverages," he said. He added the woman also bought a Breathalyser and blew into it every night for 18 days, registering around .20 every time.
Clearly, this is not the woman's fault so yes, we entirely agree with the idea that all charges should be dismissed. We are rather in favour of the idea of mens rea after all. However, this to us seems entirely wrong:
The woman is now free to drive without restrictions
Because we don't in fact have laws against drinking before you drive. This is not some puritan (however often people seem keen to take it in that direction) restriction of the joys of booze. This is law against driving while drunk, on the very sensible Millian grounds that in doing so you are a danger to others. And it doesn't matter how one becomes drunk, one is still that danger.
So the correct answer here is that, without fault of course there should be no punishment. But if ingesting carbohydrates is going to get someone pissed (which is the specific problem here) then someone to whom this happens should not drive: because they're pissed.
Someone could have gone blind from indulging too much in teenage manipulation, they could have gone blind as a result of unsuccessfully defusing a terrorist bomb and saving many lives in doing so. We still don't let them drive: because they're blind. They why is not the point, the danger is.
It would appear that our Chancellor does not understand microeconomics
This should not be taken as a good sign really. Evidence that the person setting the economic policy for the Kingdom doesn't quite understand economics shouldn't be so taken:
Airport retailers could be forced to pass on millions in VAT discounts on duty free to passengers under a review announced by George Osborne. The Chancellor said that it is "simply unacceptable" that some retailers are failing to pass on savings to customers and instead using VAT relief as a "windfall gain".
For the shops don't end up with that extra cash as a windfall or profit. It actually all flows through to the landlord in rent. As it will in any such situation of course.
In fact, it's been said that Heathrow should actually be paying planes to land there they make, as an airport, so much money from funneling people through the shopping areas.
That there's a tax discount, or should be, is true, but given that it is only available on a few select pieces of land then the benefit of it is going to flow through to those who own those few select pieces of land. David Ricardo published 198 years ago: we should all understand this by now.
Steve Masty: an obituary
Stephen J Masty, a longtime friend of the ASI, died on December 26th in London. He was one of the first friends I made when I taught philosophy and logic at Hillsdale, and was one of my most engaging and witty students. He went on to study at the University of St Andrews, and came down to help us out in the early days of the Institute. He was a talented cartoonist, and designed some of our graphics.
He moved to D.C. to work as a columnist with the Washington Times and as a speechwriter to several key Republican leaders. He was noted in the D.C. political and media community as a talented writer and witty raconteur.
He did a spell in Afghanistan with the Mercy Fund, producing leaflets and cartoons to help people, especially children, cope safely with the dangerous debris left after the Soviet withdrawal. He went on to spend much of his adult life as a development expert, working on projects in South Asia and Africa, as well as in the Middle East. He wrote and directed development movies, and one of his privatization video songs, recorded by local celebrity Captain John Komba, reached the top of the Tanzanian music charts!
In the early 1990s he managed the American Club in Peshawar, accompanying on his guitar some of the satirical songs he had written. He became a legend in the region, as he later did in Kathmandu, for his eccentric charm and bonhomie.
When in the UK, he made the Savile Club his home, and was well known and well liked by the other members. Some of his cartoons of them adorn the Club's walls, alongside pictures by Augustus John and others. He wrote novels, children's cartoon books, and movie scripts, and eventually took out British citizenship. It was characteristic of him that he had a letter in the Times that very week complaining about "foreigners coming to take our jobs!"
He led a colourful life, surviving a Taliban siege of Kabul and an earthquake in Kathmandu. He leaves us with many fond memories of good times spent together. The ASI has lost a talented and valued friend.
(the photo shows Steve in DC between two other ASI supporters)