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.

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@old.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.

Isn't Will Hutton's logic here just so lovely?

We'd probably have to invent Will Hutton if he didn't already exist for his logical twists and turns are something of a national wonder to behold. On the subject of FIFA he's noticed that it's not the purest of organisations, not as white as the driven snow:

This is a disgrace. Based in Zurich, Fifa is the governing council of world football, with 209 national member football associations. Yet even though it has global reach, power and income, earning $4.5bn this year from the World Cup alone, it is run with less transparency than a car boot sale. Football, and the world, needs better.

The president is elected by a simple majority of the 209 members. There are no checks and balances; no accountability to a governing board; no transparency over key issues such as pay; no protocols for the publication of reports like those of the former New York district attorney, Michael Garcia. Once elected, the president of Fifa can run the organisation like a tribal chieftain, dispensing favours to seek ongoing support from the tribe’s varying factions and brushing off criticism. His position is unassailable.

Well, yes, OK, perhaps being part of an organisation where not everyone accords with the British notions of fair play and honesty might not be all that wise a decision. Possibly we migfht leave then, or refuse to deal with it until it starts to live up to those values we deem important.

It underlines the larger point: we have to live up to our values and make common cause with those who share them. Yet the Conservative party is gearing up to fight the election on a nativist programme of leaving the European Convention on Human rights (ECHR) and moving ever closer to exiting the European Union.

But we mustn't leave an organisation that doesn't accord with British notions of fair play and honesty. Actually, doesn't even agree with the basic and fundamental underpinning of our system of law (as Lord Woolf so notably pointed out). If Hutton didn't exist we would have to invent him, wouldn't we? Otherwise where would we find our logical equivalent of the Red Queen, where an argument means whatever he says it does rather than that plain and honest meaning.

Getting it entirely wrong on fatcat CEO pay

An interesting little piece of research over at the Harvard Business Review. What do people think the difference between worker and CEO pay is and what do they think it should be? The research is interesting it's just that the conclusions people are likely to draw from it are entirely mistaken. The result won't surprise many:

We’re currently far past the late Peter Drucker’s warning that any CEO-to-worker ratio larger than 20:1 would “increase employee resentment and decrease morale.” Twenty years ago it had already hit 40 to 1, and it was around 400 to 1 at the time of his death in 2005. But this new research makes clear that, one, it’s mindbogglingly difficult for ordinary people to even guess at the actual differences between the top and the bottom; and, two, most are in agreement on what that difference should be.

“The lack of awareness of the gap in CEO to unskilled worker pay — which in the U.S. people estimate to be 30 to 1 but is in fact 350 to 1 — likely reduces citizens’ desire to take action to decrease that gap,” says Norton.

It really shouldn't surprise that an awful lot of people are remarkably ignorant about the world that they inhabit.

The error though is in what is then assumed should be done about it. For of course you can already hear the screams (from people like the High Pay Commission) insisting that as the average voter doesn't want there to be this income disparity therefore there should not be this income disparity. The error being that what the CEO of a large company gets paid is none of the damn business of the average voter.

It's the business of those doing the paying: and if the shareholders in a company wish to pay the person managing their business handsomely then that's entirely up to them. Nothing to do with the jealousy of the mob at all.

There is a small coda: some argue that it's the same old interlocking boards that keep raising the CEO's pay, knowing that their own will get raised in turn. The theory that the managerial class is ripping off the owners, the shareholders. It's true that this could happen, principal/agent theory is true. However, if this were true then private equity would be paying their managers considerably less than public companies do as they would not be subject to this rip off. Given that in reality, out here in the world, private equity pays very much better than public companies do then this isn't true either.

On Unite's demand for a £1.50 rise in the minimum wage

Howard Reed has done this particular piece of pencil sucking research for Unite to back up their demand for a rise in the minimum wage of £1.50 an hour. They're very proud of the fact that this would increase the amount of tax paid. Which doesn't really strike us as being all that good an idea really. Hoovering more money out of the wallets of the lowly paid never does sound like a good idea to us but we assume that things are seen differently over in unionland. But in the report they also say this about the macroeconomic effects:

A £1.50 per hour increase in the National Minimum Wage has three potential multiplier impacts on UK GDP: • The wages impact: the increase in net incomes arising from the increase in gross wages should lead to increased consumer demand which has a positive multiplier impact on GDP. • The profits impact: the reduction in net incomes arising from a decrease in profits may lead to reduced consumer demand which would have a negative multiplier impact on GDP. • The public finances impact: the increase in income tax, expenditure tax and NICs receipts and the reduction in benefit and tax credit spending leads to an improvement in the public finances even after taking into account increases in the public sector wage bill and reductions in corporation tax revenue. This means that government spending does not need to be cut as badly as current plans suggest. If the improvement in the public finances is matched by an increase in government departmental and investment spending – so that the overall government fiscal position is unchanged – then there should be a positive multiplier impact on GDP.

Reed also looks at the number of jobs that will be lost from that rise in the minimum wage and, hey presto, finds that more will be created than lost. He manages this by taking the lowest estimate of unemployment to be created he can find and the highest one for the number of jobs to be created available.

Hmm. Think we'll file this report in the policy based evidence making file, that round one under the desk, shall we?

UKIP is on the right track to beat low pay

Certain policies proposed by UKIP this morning remind us how far away the party platform is from a classically liberal agenda. However.

In the kick-off to their party conference, UKIP has also announced that its general election manifesto will raise the personal allowance threshold by £3,500 pounds:

At its party conference, which has begun, UKIP will also promise to raise to £13,500 the amount people can earn before paying any income tax.

In a plan to win the "blue-collar vote", Nigel Farage's party will pledge to fund the changes by leaving the EU and cutting UK foreign aid by 85%.”

(At present, the) 40p rate is payable on income from £41,866 to £150,000, with the "additional rate" of 45% paid on anything over £150,000.

“Under UKIP's plans, everyone earning between about £44,000 and £55,000 would pay income tax at 35p. Those earning more will pay 40p, with the additional rate scrapped. “

Despite other policy failings, UKIP's commitment to raising personal allowance surpasses the coalition's and should be heavily applauded.

This is the first policy of 'party conference season’ that properly addresses the root of the cost-of-living crisis and provides a simple, effective solution to relieve the tax burden on low-income earners.

For years, the Adam Smith Institute has illustrated the pointlessness in taxing workers out of a living wage, to then compensate their low income with government handouts and benefits. The Labour party’s recent pledge to raise the minimum wage to £8 an hour threatens to put more young, unskilled workers out of jobs, while still taking away a substantial potion of income from anyone who happens to benefit from the small pay raise.

A hike in minimum wage is a symbolic gesture at best, that continues to tax away - or destroy - low-earner incomes. A raise in the personal allowance threshold, however, gets more money into the pockets of those earners, creating no dangerous side effects in the jobs market.

With both the Liberal-Democrat and Conservative Party Conferences ahead of us, we can only hope both party leaders will continue to embrace an increase in personal allowance and match UKIP’s threshold; or maybe even one-up them. (National Insurance cuts, anyone?)

Colin Hines and the Magic Money Tree

It had to happen of course: once people started talking about unconventional monetary policy then there was always going to be someone who espied the Magic Money Tree. And it's Colin Hines who has:

It was heartening to hear Ed Miliband say in his speech that tackling climate change is a passion of his and that solving it could be a massive job-generating opportunity (Report, 24 September). The inevitable question of how to pay for this can be tackled by writing to Mark Carney, the governor of the Bank of England. He is on record as saying that if the government requested it, then the next round of QE could be used to buy assets other than government debt. Miliband said that the Green Investment Bank would be used to fund green economic activity and so Labour should allow it to issue bonds that could then be bought by the Bank using “Green QE”. Similarly, local authorities could issue bonds to build new energy-efficient public homes funded by “Housing QE”.

The Bank has already pumped £375bn of QE into the economy, but with little tangible benefit to the majority. Imagine the galvanising effect on the real economy of every city and town if a £50bn programme of infrastructural QE became the next government’s priority. This could make every building in the UK energy-tight and build enough highly insulated new homes to tackle the housing crisis. It would provide a secure career structure for those involved for the next 10 years and beyond, massive numbers of adequately paid apprenticeships and jobs for the self employed, a market for local small businesses, and reduced energy bills for all. Such a nationwide programme would generate tax revenue to help tackle the deficit, but in an economically and socially constructive way. Best of all it would not be categorised as increased public funding, since QE spending has not and would not be counted as government expenditure. Colin Hines Convener, Green New Deal Group

Wonderful, eh? We can have everything we want, and a pony, without ever having to pay for it!

Hurrah!

The problem being that Hines (and there are others of that ilk out there too) hasn't grasped the difference between the creation of credit to reduce interest rates (what QE does) and the creation of base money to spend into the real economy. That second has rather different effects: as the Germans found out post WW I, the Hungarians post WW II and the Zimbabweans more recently. It creates hyperinflation, those last having it to such a bad extent that they kept printing until they'd run out of the real money necessary to buy the ink to print the play money.

I do not, note, claim that £1 billion or £50 billion or even £500 billion of this "Green QE" will inevitably produce inflation of 1000 % a day. I do however claim that use of this Magic Money Tree will, given the way that politics works (which politician doesn't like spending money she's not had to find through taxation?) will inevitably lead to hyperinflation. For the thing is we've tried this experiment before, many a time, and that is always what does happen.

Simply not a good idea.