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 emotionally biased response. In terms of cold, hard cash, people are worth different amounts.

The market’s valuation of CEOs 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 biased as their opponents who just can’t imagine why a CEO would be worth paying a lot.

Two cheers for technocracy

Who needs experts? The minimum wage was once an example of the triumph of technocracy, where decisions are delegated to experts to depoliticise them.

The Low Pay Commission was set up to balance competing priorities – increasing wages without creating too much unemployment. If you were a moderate who thought the minimum wage was a good way of boosting low wages, but recognised that it might also create unemployment, the LPC gave you a middle ground position. (For what it’s worth, I’m an extremist.)

That technocratic settlement also allowed politicians to, basically, safeguard against an ignorant public. By delegating decisions like this to experts, bad but politically popular policies could be avoided. Relatively well-informed politicians could avoid having to propose bad policies by depoliticising them.

Other examples of this include NICE’s responsibility for deciding which drugs the NHS should and shouldn’t provide, and the Browne Review that recommended student fees, which had cross-bench support. The old idea that “you can’t talk about immigration” comes from an informal version of this – everyone in power knew that people’s fears about the economics of immigration were bogus, so they were basically ignored.

But that technocratic settlement now looks dead. Labour has now made a specified increase to the minimum wage part of its electoral platform, following George Osborne’s lead earlier this year. That means that voters will have to choose not just between two rival theories about the minimum wage, but two competing sets of evidence about whether £7/hour or £8/hour is better, given a wage/unemployment trade-off.

Whether voters are self-interested or altruistic doesn’t really matter. A self-interested low wage worker would still need to know if a minimum wage increase would threaten her job; an altruistic voter would similarly need to know a lot about the economics of the minimum wage and the UK’s labour market to make a judgement about what level it should be.

And of course the minimum wage is just one of dozens, if not hundreds, of questions that political parties offer different answers to that voters have to make a judgement about.

In practice this does not happen. Voters are very uninformed about basic facts of politics, and are almost entirely ignorant about economics, which almost everyone would agree would be necessary to make the correct judgement about something like what the minimum wage level should be (even if they didn’t agree on which theories and evidence was relevant). Even the use of rules-of-thumb such as listening to a particular newspaper or think tank (ha) will suffer from the same problems.

Voters, then, face a nearly impossible task. Assuming they are bright, well-intentioned, and believed that it was important for them to cast their vote for the party that would have the best policies, they would have to amass an enormous amount of information to make the right decision on all the questions they, in voting, have to answer.

So voters are trapped. They cannot know what minimum wage rate is best any more than they can know what drugs the NHS should pay for. They are, empirically, very unaware of basic facts, but they would find it hard to overcome that even if they wanted to.

Does democracy make us free? Maybe, but it’s the freedom of a deaf-blind man – we can choose whatever policy we want, without any idea about what those policies will actually do. So, if the alternative is more direct democracy like this, maybe technocracy isn’t so bad.

Some evidence that sweatshops are good for Bangladeshi women

I recently read an interesting paper by Rachel Heath and A. Mushfiq Mobarak, of the Universities of Washington and Yale, which looks at the impact that the garment industry has on young girls and women in Bangladesh. 

The results are quite amazing. According to the study, girls in villages close to garment factories (or sweatshops, as they are sometimes called):

  1. Delay marriage. On average, a young girl living near a garment factory was 28% less likely to get married in the study year than the average Bangladeshi girl. This effect was strongest among 12-18 year olds.
  2. Delay childbirth. On average, a young girl living near a garment factory was 29% less likely to give birth in the study year than average. Again, this effect was strongest among 12-18 year olds.
  3. Are much more likely to go to school. Exposure to garment factory jobs was associated with a 38.6% increase in school enrolment rates. Broken down, this translated into a slightly lower enrolment rate for 17-18 year old girls, who presumably were more likely to be in work, and a considerably higher enrolment rate for girls younger than that.

According to the study’s authors, these findings are probably due to some combination of wealth effects (richer families need to marry off their daughters less early, and can afford to send their daughters to school for longer) and the fact that garment factory jobs reward skills, increasing the value of education.

The paper is an important reminder that sweatshops may provide significant benefits to their employees and the places they are located. They are by no means all good, but they are not all bad either, which well-meaning campaigners against sweatshops would do well to remember. A working version of the whole paper can be accessed here.

Switching mobile networks is easier than switching governments

Unlike lots of people on the right, I like Owen Jones. He’s good natured and often challenges orthodoxy on his own side, and he’s a thought-provoking writer. 

Having said that, I usually disagree with what he writes on economics. His Guardian piece this week, which called for the nationalisation of the UK’s mobile network operators, was a good example. It’s tempting to dismiss it as clickbait, but it represents a train of thought that is increasing in popularity. And if nothing else it may shift the Overton Window.

Jones starts by pointing out that nationalisation of big industries is very popular among the public at large. “While our political overlords are besotted with Milton Friedman, the public seem to be lodged somewhere between John Maynard Keynes and Karl Marx.” 

A fair point. He might also have noted that the public disagrees with him about lots of other things: the obvious example is hanging, where the public is somewhere between Roger Helmer and Oswald Mosley, but there’s also immigration, which 55% of people want reduced ‘a lot’ (and another 21% want reduced ‘a little’). The Great British public thinks the benefits system is too generous by a 2-to-1 margin, and think that ‘politicians need to do more to reduce the amount of money paid out in benefits’ by a 3-to-1 margin. And so on. On these issues, and presumably many others, I assume Jones thinks the public needs further persuasion.

It isn’t necessarily that the public really is bloodthirsty or xenophobic or anti-poor or quasi-Marxist; it’s that the public is extremely uninformed about most things. How could you judge whether we needed more or less immigration if you thought we had more than twice as much immigration as we actually do? How could you judge whether the railroads should be nationalised or not if you did not know that passenger numbers had doubled since privatization, after decades of decline under the state?

Jones claims that mobile phone networks are an inefficient natural monopoly, without any real reasons given. This claim is untrue. The UK has four competing mobile networks (Vodafone, O2, Three and EE, which was formed by a merger by T-Mobile and Orange) and dozens of aftermarket “mobile virtual network operators” that lease wireless spectrum from those four networks (GiffGaff and Tesco Mobile are two popular examples). None of these networks are unusually profitable and all spend enormous amounts on marketing. Try spending a day in a city without seeing at least one advert for each company. This is not the behaviour of monopolistic industry!

(There are a couple of other frustrating errors in the piece. For instance, a typical £32-a-month 24-month contract can get you an iPhone worth £550, not a device worth £200 as Jones claims.)

Yes, signal blackspots are annoying. (Take it from someone who spent his teenage life having to walk into the garden to send a text message.) And mobile networks’ customer service really does suck sometimes! But Jones is comparing reality with an ideal where resources are infinite. Since resources are not infinite, we have to have some way of deciding what imperfections are tolerable. 

For example, as annoying as blackspots are, the optimal amount of coverage is obviously less than 100%. The phone networks reckon they cover around 99% of the population, and as frustrating as it is when you’re in that last 1%, the marginal costs rise dramatically when you try to cover that last 1%. We could cover them at great cost, meaning that we have less money to spend on other important things elsewhere. The question is one of priorities.

Ultimately, the important question that Jones does not answer (or ask) is, compared to what? Private sector firms might be irritating sometimes. Unless you can show that nationalised firms would be less irritating and better overall, that doesn’t tell us anything about what we should do. 

There are lots of examples of nationalised firms that were absolutely terrible. Tim remembers waiting three months for a landline when the GPO ran the phones; and then there is the huge drop-off in rail passenger numbers under British Rail, followed by an equally huge recovery after privatisation:

GBR_rail_passenegers_by_year

The fact that the state funded some of the scientific research that led to the iPhone doesn’t mean that we’d have better phones if we nationalised Apple. (It might be a case for state funding for scientific research that is released into the public domain, though.) As Tim says, “The State can be just as good as the market at invention, the creation of really cool new technologies. But it’s terrible compared to the market at innovation, the getting of that new technology into peoples’ hands so that they can do cool and interesting new things with it.” 

Economies of scale exist, as Jones suggests, but so do diseconomies of scale. Firms can be too big. And when you have a single network (whether it’s privately or publicly owned), customers lose all ability to ‘exit’ a firm that is giving them a bad service, so the only recourse they have is at the ballot box. 

Which brings us back to the first problem with Jones’s piece: politics is a complicated business about which we know little. If we don’t like what we’ve got, we have to hope that a majority of other voters agrees with us – and even if we’re right, they may not be informed enough to agree with us. 

It’s a lot easier to switch mobile phone providers than it is to switch governments. Ultimately, it’s that pluralism and freedom of exit that drives improvements in markets, and tends to make governments relatively bad at doing things. For all the mobile network industry’s problems, the question is: compared to what?

Goodbye, Green Belt!

Last night BBC London News aired a short film I took part in about the Green Belt. As part of a series of ‘authored’ pieces about various solutions to London’s housing crisis, I suggested that we should allow construction on the Green Belt around London to increase the supply of developable land.

Cheshire-htg-fig-1Land, as Paul Cheshire likes to point out, is the key. The graph above shows how closely house price rises have tracked land price rises. Land-use restrictions on the Green Belt are quite strict: under the National Planning Policy Framework, local councils face a very high burden of proof to approve new developments on Green Belt land. If they were made less strict, then the supply of land and housing would increase and the price of both would fall.

I usually think of people who want to preserve the Green Belt as being motivated by financial considerations. If you own your house, you don’t want its value to fall, so you have a strong incentive to oppose any measure that will increase supply. Perhaps a large proportion of people involved in campaigns to ‘protect the Green Belt’ own their own homes. (And if not, that would certainly falsify this view.)

But filming with the BBC made me realize that this explanation is too neat and too unfair. The preservationist I interviewed, Dr Ann Goddard, was not preoccupied with preserving the value of her home – she believed, as many do, that relatively unspoiled natural areas are valuable and important to protect from development. The meadow she took us to was very pretty and I would regret losing places like it as well. Throughout our conversation Ann made it clear that her idea of England was entwined with its image as a ‘green and pleasant land’, not just somewhere for endless suburban sprawl.

Much of that greenery is worth keeping, but I suggest that the question is not ‘what’ but ‘where’. Since Green Belt land rings cities, it is much more difficult for city slickers to access than, say, gardens or parks. And lots of London already is covered in gardens or parks – more than half, according to one estimate. Allowing London to expand outwards would eat away at the Green Belt, but also allow more people to have gardens and for more (and bigger) parks to be built.

I also realized how important symbols can be: to Ann the meadow we went to WAS the Green Belt. If we’d taken her to a piece of intensive farmland (34% of the Green Belt around London) maybe she would have cared less about the prospect of that being turned into a village. And I wonder if focusing on intensive farmland is the key to changing people’s minds. In the end, if the battle over the Green Belt is about ideas and symbols rather than pocketbooks, a change of language might help us.