On Excessive Executive Pay

January 26, 2012

Vince Cable’s been in the news with his proposals for curbing executive pay. These amount to small increases in transparency and shareholder power, and have been vilified by both left and right, normally a proxy for good Lib Dem policy-making. George Monbiot wants to see a cap on maximum pay, set at a level amusingly below that of his editor. The IEA thinks the Government should stay out of the business of executive pay entirely, and that shareholder interference should be avoided.

The Right argues that high executive pay is the result of a newly globalised market for executives pushing up prices. This appears to be based on the assumption that a global market will be competing for a fixed pool of executives, and the expansion of that pool will therefore increase wages paid. It would also imply that executive pay should be proportional to exposure to foreign markets. Let’s test this. As a proxy for exposure to foreign markets, I will use both inflows and outflows of foreign direct investment, and stats for the US as they’re the easiest to come by:

Sources: Forbes/OECD

That looks like a pretty strong correlation to me. Having a cap on wages would only mean that Britain wouldn’t have access to the international executive market. If there is a limited supply of executive talent globally – and the stats appear to indicate that is the case – it’s worth considering why this should be the case. The strength of the market should incentivise more people to try to enter it. An explanation may be that overseas expansion by multinationals pushes out competition, and this combined with overseas merger & acquisition activity would serve to reduce the pool of individuals with global CEO experience. However, having fewer firms in competition for CEOs should also lower CEO compensation.

It may be that barriers to entry are unnaturally high as a result of corporate directors picking people like themselves, in which case Cable’s reforms should have concentrated less on shareholder representation over executive salaries themselves and more on ensuring that shareholders are represented during the shortlisting process. However, it’s clear that while his reforms are welcome, they don’t get at the root of the problem. High executive pay is a global phenomenon, and has little to do with the UK’s corporate governance.

Athena Shrugged

January 19, 2012

Yesterday’s strike by the modern world’s gatekeepers of knowledge was fascinating, both from a professional campaigner’s perspective and for those of us with an interest in how intellectual property rights play out in the modern world. Whether it achieves its aim has yet to be seen, but the language used to describe it by its opponents is indicative. Phrases like ‘an abuse of power’ and ‘cyber-bullies’ are strongly reminiscent of the language used by opponents of trade unions to condemn withdrawal of labour. Indeed, it’s fairly clear that Wikipedia at least was able to leverage its position as a primary source of knowledge for political purposes, in much the same way as the public sector strikes used the withdrawal of public services as a political weapon.

Of course, there is absolutely nothing wrong with this – politics is part of the competition for limited resources, and condemning Wikipedia for using the levers at their disposal is comparable to condemning the film industry for buying access to lawmakers via their trade association, the MPAA. Attempting to define your opponents’ actions in the political sphere as immoral is often a way of attempting to limit their success. The condemnation of campaigning undertaken by tech companies and web services is in many respects a recognition of the failure of the likes of the MPAA to properly engage the public over the changing definition of intellectual property. This failure is hardly surprising, given that the MPAA’s position is unsustainable.

In order to understand why, it’s important to consider why intellectual property rights are valuable in the first place. In enabling people to profit from their inventions, they directly encourage innovation and are arguably a prime driver of economic development. While they are a constraint upon freedom inasmuch as they prevent people from making whatever they want, they are a reward for something so valuable that they are worthwhile constraint.

However, in the digital age, the cost of production of content can be so low that a financial reward is unnecessary to facilitate innovation. The serried ranks of Wikipedia’s editors carry out their work on an unpaid basis for little greater reward than internet glory. Running costs can be covered by donations from those who want to see that service continued, in much the same way as charities function. This model can even apply to more labour-intensive digital products – consider this paean by the New York Times to the video game Dwarf Fortress, whose developer is funded entirely by donations. You cannot recoup costs from donations if you are not the original distributor of a product. No-one is going to donate money to someone who simply copies Wikipedia onto their own website. This new business model makes profiting from IP theft incredibly unlikely. Only the innovator will see a return. It is those innovators who went out on strike yesterday, in response to an attempt to make this new model impossible.

The MPAA’s preferred business model, if enshrined in statute, would put a halt to a wholly new model of rewarding innovation. The net cost to society for doing so may be significant. If the MPAA’s members believe their products are strong enough that people would seek to support their continued production, then I would urge them to let the market decide, and not hide behind regulation.

Today’s announcement by Nick Clegg of measures to facilitate more employee share ownership has been leapt on by Labour media darling Chuka Umunna as an endorsement of Ed Milliband’s ‘Responsible capitalism’ idea. Leaving aside the somewhat audacious claim that Ed Milliband came up with the John Lewis model of business, Umunna’s response demonstrates that Labour have failed to understand the intellectual direction of this Government – and the implications of that for the Labour Party.

I have previously written about how the parties of the Coalition are expressly aiming to use Government to overhaul the way in which the public perceives the private sector, by putting the burden of demonstrating the ethical worth of private enterprise squarely on its shoulders. A drive for greater employee ownership must be seen in this context – co-operatives and mutuals have always been perceived as more ethically sound than models of ownership which concentrate more shares in fewer hands. It puts the cost of an ethical stance on the company, rather than enforcing ethics through legislation. In doing so, it reduces the scope for dissatisfaction with capitalism, limiting the political space open to the likes of the Occupy protestors. It overcomes a very specific challenge: if wages represent a falling share of GDP compared to returns on capital, then the way to overcome this is not simply through higher wages, but the redistribution of capital itself. The share of GDP accorded to wages becomes an insignificant issue.

British liberalism has always recognised that the condition for a free society is the consent of all its members. By moving towards a model which places the burden of securing that consent upon business, Clegg is diminishing the space available for a Labour Party that would seek to secure that consent via the State. Labour’s complicity in this may yet be their undoing.

The Adam Smith Institute is – according to its website – a libertarian thinktank. It promotes free market solutions to policy questions, and individual freedom more generally. It does not pretend that it agrees with absolutely everything its namesake believed, but purports to promote his “belief in humanity and the power of freedom”. I would share that belief – but it’s unclear to me that the ASI understands the same thing Adam Smith did by ‘freedom’, and indeed whether the libertarian understanding of freedom has much in common with the kind of classical liberal understanding of freedom that Adam Smith is understood to have promoted.

I’ve been reading through An Inquiry into the Nature and Causes of the Wealth of Nations, and I’ve been pulling out quotes that appear to me to conflict with what could be called a procedural justice version of libertarianism; a version which may not be held by every contributor to the ASI, but nonetheless appears to inform some of their work.  This post, the first in an occasional series, will examine some of the ASI’s work in the context of the actual words of the Master.

I am using the OUP World’s Classics version of WoN. The following is from Book 1, Chapter VIII:

“What are the common wages of labour, depends everywhere upon the contract usually made between those two parties, whose interests are by no means the same. The workmen desire to get as much, the masters to give as little, as possible. The former are disposed to combine in order to raise, the latter in order to lower, the wages of labour.
“It is not, however, difficult to foresee which of the two parties must, upon all ordinary occasions, have the advantage in the dispute, and force the other into a compliance with their terms. The masters, being fewer in number, can combine much more easily: and the law, besides, authorises, or at least does not prohibit, their combinations, while it prohibits those of the workmen. We have no acts of parliament against combining to lower the price of work, but many against combining to raise it. In all such disputes, the masters can hold out much longer. A landlord, a farmer, a master manufacturer, or merchant, though they did not employ a single workman, could generally live a year or two upon the stocks, which they have already acquired. Many workmen could not subsist a week, few could subsist a month, and scarce any a year, without employment. In the long run, the workman may be as necessary to his master as his master is to him; but the necessity is not so immediate.”

Smith is here observing that the freedom of contract between capitalist and worker is, in reality, no such thing. The relative levels of capital each holds distort the negotiation: the capitalist can always afford to hold out for longer. However, within procedural justice libertarianism, freedom of contract is interpreted as absolute: any Government intervention, whether it be through regulation of rights or wages, is an immoral intrusion into a private negotiation.

The above quote appears to indicate that Smith understands that the freedom to make contracts varies between capitalist and worker, in a manner dependent on their relative wealth. This particular freedom appears to be determined less by Government intervention and much more so by possession of capital. Being a strong believer in the power of freedom, I would advocate that some way be found to bring a greater equality of freedom to negotiations between a capitalist and a worker, as an end in itself. I am agnostic as to how this can be achieved, whether it be through the State or through a non-state body, such as a trade union.

However, the Adam Smith Institute has recently put forward a proposal that runs counter to this aim of securing greater freedom of negotiation, which they have dubbed the ‘Self Employment Option’. This calls for greater use of the self-employed status amongst workers, which “sidesteps the burdens not only of PAYE and NI, but also of unfair dismissal, discrimination suits, maternity and paternity leave, statutory sick pay and holiday pay“. The self-employed, being freed from the ‘burden’ of rights, will have less freedom in negotiation than the employed. It is difficult to interpret this in any other way than the ASI having a very different understanding of freedom of contract to Adam Smith.