How business lost its influence on right wing parties

This covers ground which others may be more knowledgeable about, so please let me know of any references or sources that I really should read that cover issues central to the discussion below.

When Trump threatens governments that want to tax tech giants, most of which are based in the US, it seems like the familiar story of governments acting in the interest of business. But when Trump imposes tariffs on imports he may be favouring particular firms, but he is also acting against the interests of US trading firms in general.

Brexit is a much more potent example. Brexit is clearly not in the interests of firms that trade. Because Brexit makes the economy as a whole poorer there are not many firms who support it. Boris Johnson, when asked about concerns from business about a hard Brexit, is reported as saying “f*** business”, and following some comments by the new Chancellor, Chris Grey speculates whether “f*** business” is now government policy.

It wasn’t always like this. David Edgerton writes that

“After the second world war, such captains of industry avoided the Commons, but the Conservative party was without question the party of capital and property, one which stood against the party of organised labour.”

That changed after Thatcher, as she reduced the power of trade unions, and Labour began distancing itself from them. Another development that I think began with Thatcher, and is particularly evident in the UK, is a lack of concern about who owns large firms. The importance of this should not be overstated: the ONS estimated that in 2012 just 1% of non-financial firms were foreign-owned, but these firms were large so around a third of value-added was accounted for by foreign owner firms. I suspect the proportion is higher still in the traded sector. But that still leaves plenty of important UK owned firms.

Another important point, and a difference from the US, is that joining the EU meant the UK was no longer in charge of trade negotiations. This ended the extensive and direct contacts between the UK traded goods sector and government that you find in countries not part of the EU. However links between the financial sector and the UK government are strong and effective. In contrast as the financial sector expanded, its links with domestic businesses became less important.

Finally another important development that followed from the Thatcher period was the reduction in taxation of top incomes. This particularly benefited high earners in the financial sector, but it also spread to most CEOs of large companies. According to Piketty, Saez and Stantcheva, this encouraged in the UK and US an explosion in executive pay, distancing the 0.01% or 0.001% of extremely rich individuals from everyone else. This involves the managers of business extracting rent from the business itself. Although this explosion happened in the 1980/90s, the cash increase in remuneration (including bonuses etc) for the median FTSE 100 CEO between 2009 and 2017 increased by 76% to £3.9 million. There are no signs of it ending. 

This meant that CEOs spoke in the interests of both the companies they ran, but also in the interests of very rich individuals like themselves. Before the 2015 UK general election, one of the main concerns of business about a possible Labour government was a potential tax on expensive homes! This helps dilute the pressure business can exert on right wing governments, if those governments make it clear that they will always stand up for the very rich. In 2017 Labour’s campaign slogan was ‘for the many not the few’, so of course the few will always support the Tory party, even when it was making life much more difficult for business. Tax cuts for the wealthy are now a key part of any Republican programme.

In these senses neoliberalism (aka what happened during and after Thatcher and Reagan) created the conditions that helped diminish the direct influence of business on the dominant right wing party in the UK and US, and therefore for much of the time the UK and US state. This was my thinking when I wrote

“Rent extractors naturally seek political defences to preserve their wealth, and the mechanisms that sets in place may not embody any sense of morality, leading to the grotesque spectacle of Republican lawmakers depriving huge numbers of health insurance to be able to cut taxes for those at the top.”

It also means that the finance any party of the right needs can come from money and those that manage business (and extract rent from it), and that can be divorced from the interests of business. This was part of my thinking in talking of a governing plutocracy, and writing:

“It is also a mistake to see this plutocracy as designed to support capital. This should again be obvious from Brexit and Trump. It is in capital’s interest to have borders open to goods and people rather than creating barriers and erecting walls.”

Could a more vocal attack on Brexit by businesses have influenced the vote? It is not clear, because everything is mediated through a largely partisan press and an 'opinions differ' broadcast media. However I think the distinction between the interests of the wealthy and domestic business is important, and goes well beyond an opposition between financial and non-financial firms.

A rotten corporate culture

Reports by select committees of MPs after some scandal should be treated with care. There is nothing MPs like more than to take the moral high ground and heap blame on others in front of TV cameras, whether their victims deserve it or not. But in the case of the collapse of Carillion, their condemnation of the senior management, the board and the auditor seem fully justified. When the Institute of Directors say that “effective governance was lacking at Carillion” you know things were very wrong.

Think of the company as a ship. The captain has steered the ship too close to the rocks, and seeing the impending disaster has flown off in the ship’s helicopter and with all the cash he could find. After the boat hit the rocks no lives were lost, but many of the passengers had a terrifying ordeal in the water and many lost possessions, and the crew lost their jobs. Now if this had happened to a real ship you would expect the captain to be in jail stripped of any ill gotten gains. But because this ship is a corporation its captains are free and keep all their salary and bonuses. The Board and auditors which should have done something to correct the ship’s disastrous course also suffer no loss.

To say this reflects everything that is wrong with neoliberalism is I think too imprecise. [1] I also think focusing on the fact that Carillion was a company built around public sector contracts misses the point. (I discussed this aspect in an earlier post.) To say, as the MPs do, that the collapse of Carillion is the result of recklessness, hubris and greed tells us nothing, because many people are bound to be those things if the system provides no incentives for better behaviour. The problem is that the senior managers, the auditors and the Board are not in prison and have not even suffered any financial loss.

In theory the incentive for better behaviour is that everyone except the auditors have lost their job and are unlikely to get another. But executive salaries are now so high that this penalty, if it is applied, is just not strong enough. The former chief executive, who resigned in 2017, earned £1.5m in 2016. (A third of that was in the form of a bonus that could have been clawed back until the remuneration committee made that more difficult in 2016.) Few people would think that never being able to captain a ship again was a sufficient disincentive for the imaginary captain who steered his boat too close to the rocks.

The idea from Econ 101 that CEOs are paid their marginal product is now laughable. Their pay is so high in part because it is set by cosy remuneration committees, but mainly because CEOs have considerable bargaining power over the firm that employs them. This power is intrinsic, so greater oversight by shareholders will do little to change this situation. I wrote some time back that perhaps economists should think about the benefits of a maximum wage, or a return to punitive taxation on CEO type salaries and bonuses. [2] That idea normally provokes shock and horror, but have economists come up with a better idea to offset this market failure at the centre of modern corporations?

As far as auditors are concerned, there is much talk of breaking up the big four. The idea is that in a more competitive auditor environment there would be more opportunity for firms to establish a reputation, and for those that failed to do so to go out of business. I suspect the issues go deeper than that. It would be interesting to know if existing auditors after a high profile failure like Carillion lost market share. It may be that shareholders have insufficient power to ensure the selection of auditors useful for them. If that is the case, there may be a case for giving regulators greater power to act on shareholders behalf.

Ultimately corporate failures are a reflection of how companies are governed. I tend to agree with Will Hutton that the model where the shareholder and more particularly the share price are king is deeply flawed. The term financialisation is a bit like neoliberalism in that it is used by different people to mean different things, but I think it does describe how corporate culture has changed in the UK and US (at least) over the last few decades. We must never forget that the largest disaster in recent times reflecting a rotten corporate culture was the Global Financial Crisis.

Will writes

“My contention is that limited-liability companies, having certain formal privileges and status, should not be the private playthings of transient owners interested only in their own immediate self-enrichment, without any concern for how their profits are made. They should be organisational structures that allow humanity to innovate and then produce to meet the great challenges of any era: in this context profits are made by delivering a noble, moral business purpose, integral to the wider legitimacy of the enterprise.”

The big challenge is to work out the most efficient way of achieving that goal.

[1] What I think is fair to say is that a neoliberal culture is why attempts to address these problems have been ignored for so long. Ed Miliband talked about predatory corporate practices, and the overwhelming reaction was that this made him ‘anti-business’ and ‘too left wing’.

[2] The idea currently being embraced by politicians is to publish firm pay ratios: the ratio of the CEO’s pay to the average employee in that firm. You could cap that as a policy, although it is not obvious to me why CEO’s in firms (in sectors like finance) that have highly paid employees should be allowed to expropriate more from the firm than those with lowly paid employees. However as this is not my area, I am happy to see analysis on the optimal way of removing this distortion within corporations.

How Neoliberals weaponise the concept of an ideal market

This new book by Colin Crouch will perplex many on the left who simply believe neoliberalism has to be overthrown. Indeed the author starts his book by talking about the Grenfell Tower disaster, which he along with many others believe epitomises the failings of neoliberalism. Yet he writes that the book

“is not a contribution to the demonology of neoliberalism, but an attempt at a nuanced account. Only in that way can we assess its capacity for reform.”

Such an account can of course also be justified on the basis of intellectual curiosity, but in addition the author sees some positive aspects of the ideology: He summarises these as

“the discipline of price and calculation [recognising efficiency and opportunity cost}; helping us appreciate the limitations of democratic government; facilitating trade and reducing barriers to it; and facilitating links among people [reducing national divisions].”

So what exactly is neoliberalism? He defines it as

“a political strategy that seeks to make as much of our lives as possible conform to the economist’s ideal of a free market”

The problems and deficiencies of this strategy come when the conditions required for the free market to be ideal do not hold, and the author’s long discussion of these problems would be useful for any economics undergraduate.

One of these conditions for an ideal market is competition: a free market is an ideal from a social point of view if (alongside many other conditions) each good is produced by a very large number of producers. The author recognises, for obvious reasons, that most neoliberals (as opposed, perhaps, to ordoliberals) tend not to go around wanting to break up monopolies and reduce monopoly power. As a result, he distinguishes between market-neoliberals who might, and corporate-neoliberals who would not. He talks about past competition (that may have resulted in monopoly) and current competition. As Luigi Zingales describes it rather well here, business tends to be in favour of a competitive market before it enters it, but once it has a dominant position in that market it is happy to put up barriers to further competition.

The author goes on to discuss conflicts between corporate and market neoliberalism, and much else besides. I think it is a great book, free from unnecessary jargon that you often find elsewhere. It got me thinking about the concept of neoliberalism again as you can see below. Whether that is a good thing or not, I would encourage you to read the book. The author also of course discusses whether he thinks neoliberalism can save itself. For his answer to that question you will have to read the book.

Now, for what it is worth, are some of the thoughts the book inspired. They go back to the distinction between market-neoliberals and corporate-neoliberals. It seems a little odd to define an ideology as the evangelisation of the free market, and then go on to say most neoliberals happen to exclude a crucial component of that free market (competition) when it suits them. I am quite prepared to believe that some of the people who first wrote about neoliberalism many years ago (and perhaps one or two today) could be described as what the author calls market-neoliberals, but as I have suggested in the past I think neoliberalism has evolved (or if you like been distorted) by ‘big money’ or capital to become a tool for self justification.

As a result, I would tend to suggest a slightly different definition that seems to work quite well today. The definition would be: 

neoliberalism is a political strategy promoting the interests of big money that utilises the economist’s ideal of a free market to promote and extend market activity and remove all ‘interference’ in the market that conflicts with these interests.

This replaces a definition based on following an idea (the author’s market neoliberalism), by one of interests promoting an idea so long as it suits those interests.

This alternative definition seems to fit two cases I have used in the past to question more conventional ideas. Large banks benefit hugely from an implicit subsidy provided by the state (being bailed out when things go wrong), but neoliberals do not worry too much about this form of state interference in the market (whereas economists do). Regulations on the other hand they do complain about. It is a very selective focus on market interference.

The second is executive pay. This is always justified by neoliberals as being something determined by the free market, when obviously it is not. Yet if you pretend that there is a market in executives and salaries etc are set by that market and not the remuneration committees of firms, then you are being a good neoliberal by defending these salaries. This example is interesting because it involves defending one part of ‘big money’ (CEOs or some workers in finance) at the expense of another (shareholders). It is why I do not talk about the interests of capital in my definition. 

Is this alternative definition simply negating the power of ideas and going back to good old interests? Only in part. Interests utilise an idea because the idea is a powerful persuasive tool. There is an obvious lesson for the left here. Because neoliberals promote the concept of an ideal market only when it suits them, so opposing neoliberalism does not necessarily mean opposing the concept of an ideal market. The left should utiliise the same concept to oppose monopoly power, for example. The idea of a free market is too powerful an idea to cede to the other side. 

Bonus culture

Diane Coyle has an excellent article in the FT about an apparent puzzle. Why do executives get incentive bonuses (extra pay on meeting some target), but most workers do not? Her article is based around a classic paper by Bengt Holmstrom and Paul Milgrom. Their basic argument is that incentive pay linked to specific targets works (it increases effort) when tasks are simple and effort can be easily measured. However if tasks are complex, and only some aspects of performance can be accurately measured, incentive pay can distort the allocation of effort between those tasks, leading to undesirable outcomes. As Diane says “pay structures not only incentivise effort and direct risk-taking, they also determine the worker’s allocation of effort between different tasks.”

So target related bonuses make sense for workers conducting simple tasks where effort can be easily measured, but are a bad idea for workers undertaking complex tasks where only some aspects of performance can be measured. To quote Diane:

“Indeed, the best arrangement would seem to be the opposite of the pattern we observe now. Corporate executives and senior bankers doing complex jobs involving many impossible-to-monitor activities are the last people who ought to be paid via an incentive scheme; while bonuses for fast-food workers or shop-floor employees make more sense.”

The implication she draws is straightforward: the bonus culture for corporate executives and senior bankers should end. But this leaves us with a puzzle: why did this bonus culture arise in the first place? Perhaps bonuses created something beneficial that we are missing.

Here is a simple conjecture, based on another paper by Piketty, Saez and Stantcheva which I discussed here. They note that increases in executive pay are strongly correlated with reductions in the top rate of income tax. Their explanation notes that executive pay is the result of bargaining between the executive and the firm. The executive has a lot of bargaining power (what successful firm wants their CEO to quit), but whether they choose to use it depends on the reward from doing so. If top tax rates are low, the rewards are high.

The executive still has to convince their firm to pay them more. What better way to do this than to suggest they get paid a lot more only if the company is successful. In the climate of the 1980s and 1990s in the UK and US (when the income share of the 1% took off) that argument would have seemed pretty convincing. My conjecture therefore is that bonus pay became endemic among executives and senior bankers not because it was more efficient for the firm, but because it was a useful tool in a bargaining game. [1]

This argument completely reinforces Diane’s conclusion. Executive bonuses are a way for senior management to extract rent from their firms, which is a quick way of saying that these high salaries redistribute money from everyone else to themselves. A consequence was that they reduced efficiency by diverting the executive’s attention to just hitting specific targets. One final thought, as we in the UK are obsessed with Brexit right now. It was the EU that passed laws limiting bonuses in the financial sector, and it was George Osborne that spent the UK public’s money trying to stop that law coming into effect.

[1] Bonuses can play a useful role in small firms where revenues are volatile, as Chris Dillow notes. That argument hardly applies to the CEO of a large multinational.  

Neoliberalism

The term ‘neoliberalism’ has become so ubiquitous that some might think that it has lost all meaning, beyond a useful catch-all for everything some people on the left dislike about current social and economic trends, or more specifically for those on the left to be rude about those on the centre-left. That is in my view far too dismissive, but the reasons for both the use of the term and confusion over its meaning have real historic and cultural roots.

I know what I mean when I (occasionally) use the term neoliberal. Neoliberalism is a political movement or ideology that hates ‘big’ government, dislikes any form of market interference by the state, favours business interests and opposes organised labour. The obvious response to this is why ‘neo’. In the European tradition we could perhaps define that collection as being the beliefs of a (market) liberal (although that would be misleading for reasons I give below). The main problem here is that in US discourse in particular the word ‘liberal’ has a very different meaning. As Corey Robin writes, neoliberals

would recoil in horror at the policies and programs of mid-century liberals like Walter Reuther or John Kenneth Galbraith or even Arthur Schlesinger, who claimed that “class conflict is essential if freedom is to be preserved, because it is the only barrier against class domination.”

So in this US line of thought, neoliberalism is an adaptation of a position on the left towards the ideas of the right.

Contrary to some perceptions, the term neoliberal was not a US invention, but was first used by Rüstow, as this excellent account by Hartwich and Sally sets out. It was designed to be a ‘third way’ between socialism and a German version of capitalism. It was adopted by a group that later became the Mont Pèlerin Society, which included Mises and Hayek and Milton Friedman, but it would be a great error to view that group as some kind of united intellectual conspiracy. As Hartwich and Sally remark, it is “named after the location as the participants could not agree on anything else”. The group was sufficiently diverse that the idea of what we now call a social market economy can also trace some of its roots to this group.

One of the disagreements in the group was over the problem of what we might call ‘corporatism’: the domination of markets by a small number of large firms or cartels that is a long way from the ideal of a perfectly competitive market. Rüstow saw that as a problem that was inherent to capitalism and required a strong state to prevent it (an idea that is central of what we now call ordoliberalism), whereas Mises thought corporatism is the result of state intervention. (Economists would just say that both are potentially true and it all depends, which is one reason why many economists find it hard to talk about ideologies that involve their own discipline.)

From this group we have the term neoliberal being adopted as a modification of European liberalism and (for some at least) it involved a move from the right to the left. I think the clearest way of thinking about the Mont Pèlerin group is that it was a group that had in common a dislike of communism, but out of which different ideologies emerged, including ordoliberalism and neoliberalism as we understand these terms today. I am tempted to argue that what we now call the neoliberal element of the Mont Pèlerin discussions placed such an emphasis on their dislike of the state that they were prepared to ignore the market imperfections that a state could correct.

I think this alone would be a good reason for the use of the term neoliberal rather than, say, market liberal. Neoliberalism as most people use the term seems quite relaxed about departures from the ideal of a market as seen by economists. A clear example, as Chris Dillow points out, is CEO pay. When people argue that CEO pay ‘should be left to the market’ they mean something very different from ‘be determined by the market’. The role of any market in determining CEO pay is marginal compared to most ordinary workers: pay is set by remuneration committees who reference to the pay of other CEOs.[1] What ‘left to the market’ actually means here is ‘no state or union interference’.

Yet this example also tells us that dismissing neoliberalism as a non-existent ideology is wrong. How often have you heard people arguing that CEO pay should be left to the market, and this assertion has gone unchallenged? This common acceptance of ‘left to the market’ really meaning ‘no state or union interference’ suggests something like an ideology at work. Other commonly used language, like taxpayers money (by which is normally meant income taxpayers) rather than public money, or wealth creators for the 1%, does the same.

Attitudes to the state, both on the right and centre of politics, are very different to those I (distantly!) remember from the 1960s. The ability of the state to achieve economic goals is today routinely denigrated. Part of the reason for the success of Mazzucato’s The Entrepreneurial State (apart from it being a very good book) is that it points out how creative and wealth creating the state can be. What would have seemed obvious in the days when we put a man on the moon today needs to be argued case by case.

This is why I do not think it is a problem that few today would describe themselves as neoliberal. Indeed that may be part of the greater problem as perceived on the left: neoliberal ideas have become so commonplace, not just on the right but also the centre of politics, that no self-identification by label is required. But there may be another reason why few call themselves neoliberal, and that is because if we try and regard it as a coherent and consistent set of beliefs it can very quickly be shown to be inadequate and confused. Commonly held beliefs do not have to be coherent and consistent.

This is where many accounts on the left go wrong. Rather than seeing ‘left to the market’ as a deliberately misleading shorthand for no state or union interference, they think neoliberalism involves a devotion to free markets, or worse still (see this piece by George Monbiot for example) they equate neoliberalism with unbridled competition. While that might have been true for some of those at Mont Pèlerin, it is no longer true of neoliberalism today.

The reason is obvious enough. Neoliberalism has been adopted and promoted by monied interests on the right, and that money often resulted from what we might call today crony capitalism. So, for example, there is a big difference between promoting competition within the NHS (which some research suggests works if done in the right context, such as fixed prices), and the privatisation of health contracts. Privatisation is neither necessary nor sufficient for competition. To describe the promotion of competition within the NHS as neoliberalism is confusing and alienating.

More generally, it is a huge error to think that because neoliberalism invokes a highly selective and distorted view of basic economics, the left must therefore oppose mainstream economics. It is a huge error because using mainstream economics is an excellent way of challenging neoliberal ideas. Take the example of banking. At first sight the financial crisis was simply a failure to regulate a free market. But it was a market which included what is to all intents and purposes a huge state subsidy, which is that if the market goes wrong the state (either directly or through its central bank) will come to the rescue. Here state interference in the market encourages lack of competition: only those too big to fail could be sure of support.

For this and other reasons (natural monopolies and other forms of rent seeking), the financial sector embodies many of the things that those who first used the term neoliberalism were opposed to. It is important that those who use the term neoliberalism today recognise this contradiction. It does not mean that using the term neoliberalism to describe the dominant ideology is wrong, but it is a mistake to assume the ideology has not be moulded/adapted/distorted by those in whose interest it works. These changes have made it intellectually weak at the same time as making it politically strong.

[1] This is very similar to how pay was determined under UK ‘incomes policies’ in the 1960s and 1970s. Here the state would set up a committee that would fix the pay of some group of workers with reference to the pay of comparable occupations. At least in that case, however, some of the reference occupations may have had pay that was actually market determined!

Bonus Culture

The comments I received on my post about a maximum wage were interesting for many reasons. In this post I just want to focus on one common misperception. This is that a maximum wage, because it interferes with the market, must be distortionary and therefore something that should tend to be avoided. This in turn assumes that the actual economy approximates the competitive efficient allocation students learn about in Econ 101, which is what neoliberals would like people to believe.

To see why this might well not be true when it comes to high pay, I want to briefly discuss a paper (NBER version here) by Roland Bénabou and Jean Tirole, which has the title of this post. I will try and make my discussion as non-technical as possible.

The basic idea is as follows. Jobs involve two types of activity or output, one of which is measurable and one is not. To reflect this, pay involves two components: a fixed component, which the worker always gets, and a performance element (the bonus) which depends on the worker’s measured output. The firm wants the worker to undertake both types of activity, so it sets the appropriate relationship between the two elements of pay to make sure the worker puts the right amount of effort into each type of activity. I will talk about what these two types of activity might be in practice below.

So far, so good. But now we add an information problem. There are two types of workers: the ordinary and the talented. The talented worker is much better at producing the measurable output. The firm cannot tell the two types apart, but it would naturally like to attract some of the more talented workers. One way it can do this is to offer two types of remuneration package: a ‘low bonus’ type and a ‘high bonus’ type. Talented workers will be attracted to the high bonus package, because their talent means that they can achieve high measured output (and therefore high pay) with relatively little effort.

This is useful for the firm, but it creates a problem. The bonus payment is now doing two jobs: allocating worker effort between activities, and attracting talented workers. In these circumstances, the bonus payment can depart from its efficient level. In particular the paper shows (p13) that in a competitive labour market, bonus payments designed for talented workers will be too high, in the sense that they lead to these workers putting too much effort into the measured activity, and too little into the other activity.

So what might these two activities (one measurable, one not) be in practice. The paper suggests, for measurable activities, things like sales, output, trading profits, and billable medical procedures, and for immeasurable activities things like intangible investments affecting long run value, financial or legal risk-taking, and cooperation among individuals or divisions. So the problem is that, in an effort to attract talented workers, the firm over incentivises effort on achieving tangible short term goals at the expense of work on intangible, longer term objectives.

The relationship to my discussion of a maximum wage should now be clear. To quote from the paper: “Turning to policy implications, we show that a cap on bonuses can restore balance in agents’ incentives, and even re-establish the first best, as long as it does not induce employers to switch to some alternative “currency” to screen employees.”

If you want to think about how this idea relates to alternative models of executive pay and competition for talent, I would encourage you to read section 1.1 of the paper, which is not too technical. The paper also contains a lot more that will be of interest to economists.

The general point I want to make is this. We can think about the minimum wage as an unfortunate interference in the market which can nevertheless be justified on equity grounds, or as a means of reducing poverty. However we can also see it as a way of increasing the efficiency of the economy, because many employers of low paid workers can exploit their monopoly power to pay wages that are below the efficient level (monopsony). Exactly the same may be true of the maximum wage. It could be that top pay is inefficiently high because executives have monopoly power, or it could be as this paper suggests because the firm wants to attract unobservable talent. I see no reason to presume that the dramatic increase in top pay reflects increases in the productivity of those workers.

  

If minimum wages, why not maximum wages?

I was in a gathering of academics the other day, and we were discussing minimum wages. The debate moved on to increasing inequality, and the difficulty of doing anything about it. I said why not have a maximum wage? To say that the idea was greeted with incredulity would be an understatement. So you want to bring back price controls was once response. How could you possibly decide on what a maximum wage should be was another.

So why the asymmetry? Why is the idea of setting a maximum wage considered outlandish among economists?

The problem is clear enough. All the evidence, in the US and UK, points to the income of the top 1% rising much faster than the average. Although the share of income going to the top 1% in the UK fell sharply in 2010, the more up to date evidence from the US suggests this may be a temporary blip caused by the recession. The latest report from the High Pay Centre in the UK says:

“Typical annual pay for a FTSE 100 CEO has risen from around £100-£200,000 in the early 1980s to just over £1 million at the turn of the 21st century to £4.3 million in 2012. This represented a leap from around 20 times the pay of the average UK worker in the 1980s to 60 times in 1998, to 160 times in 2012 (the most recent year for which full figures are available).”

I find the attempts of some economists and journalists to divert attention away from this problem very revealing. The most common tactic is to talk about some other measure of inequality, whereas what is really extraordinary and what worries many people is the rise in incomes at the very top. The suggestion that we should not worry about national inequality because global inequality has fallen is even more bizarre. 

What lies behind this huge increase in inequality at the top? The problem with the argument that it just represents higher productivity of CEOs and the like is that this increase in inequality is much more noticeable in the UK and US than in other countries, yet there is no evidence that CEOs in UK and US based firms have been substantially outperforming their overseas rivals. I discussed in this post a paper by Piketty, Saez and Stantcheva which set out a bargaining model, where the CEO can put more or less effort into exploiting their monopoly power within a company. According to this model, CEOs in the UK and US have since 1980 been putting more bargaining effort than their overseas counterparts. Why? According to Piketty et al, one answer may be that top tax rates fell in the 1980s in both countries, making the returns to effort much greater.

If you believe this particular story, then one solution is to put top tax rates back up again. Even if you do not buy this story, the suspicion must be that this increase in inequality represents some form of market failure. Even David Cameron agrees. The solution the UK government has tried is to give more power to the shareholders of the firm. The High Pay Centre notes that: “Thus far, shareholders have not used their new powers to vote down executive pay proposals at a single FTSE 100 company.”, although as the FT report shareholder ‘revolts’ are becoming more common. My colleague Brian Bell and John Van Reenen do note in a recent study “that firms with a large institutional investor base provide a symmetric pay-performance schedule while those with weak institutional ownership protect pay on the downside.” However they also note that “a specific group of workers that account for the majority of the gains at the top over the last decade [are] financial sector workers .. [and] .. the financial crisis and Great Recession have left bankers largely unaffected.”

So increasing shareholder power may only have a small effect on the problem. So why not consider a maximum wage? One possibility is to cap top pay as some multiple of the lowest paid, as a recent Swiss referendum proposed. That referendum was quite draconian, suggesting a multiple of 12, yet it received a large measure of popular support (35% in favour, 65% against). The Swiss did vote to ban ‘golden hellos and goodbyes’. One neat idea is to link the maximum wage to the minimum wage, which would give CEOs an incentive to argue for higher minimum wages! Note that these proposals would have no disincentive effect on the self-employed entrepreneur. 

If economists have examined these various possibilities, I have missed it. One possible reason why many economists seem to baulk at this idea is that it reminds them too much of the ‘bad old days’ of incomes policies and attempts by governments to fix ‘fair wages’. But this is an overreaction, as a maximum wage would just be the counterpart to the minimum wage. I would be interested in any other thoughts about why the idea of a maximum wage seems not to be part of economists’ Overton window.