Are high executive and banking pay related to results? Or to social value added? Or does executive compensation simply ratchet upwards, irrespective of either? Jeremy Fox reviews work from the High Pay commission, the New Economics Foundation and Ha-Joon Chang suggesting the answers are "No", "No" and "Yes"
If there are any redeeming features of the current financial turmoil, one may be that neoliberal capitalism - the West’s version of how we should organize economic life - finds itself under closer scrutiny than ever before. Notable among recent scrutinisers are the New Economics Foundation (NEF) and the High Pay Commission (HPC) both of which have recently published papers on different aspects of pay and the valuation of work, and Cambridge development economist Ha-Joon Chang who has continued his lonely crusade against Western economic orthodoxy with his “23 things they didn’t tell you about capitalism”.
Perhaps the most immediately provocative of these three is the one that is most narrowly focused: the High Pay Commission’s discussion paper “What are we Paying for?”. The report itself was researched and written by Income Data Services, a subsidiary of Thomson Reuters. In some forty pages of close analysis, it examines whether the senior executives of large UK corporations are worth their pay; and it does so by asking a simple question: to what extent do the enormous executive pay increases that have occurred during the last ten years reflect corporate performance? Company results as reflected in pre-tax profit, earnings per share, year-end share price and market capitalisation provide the benchmarks.
Overall the answer to the question is very little. Using data for the FTSE 350 largest companies, the report shows that between 2000 and 2010, total cash remuneration for executives increased by 133% while Long term Incentive Plan (LTIP) awards - by which executives acquire shares for meeting certain targets - shot up by no less than 254%. These kinds of increases would be questionable even if the companies had prospered and the targets been met. Trouble is they haven’t. Pre-tax profits increased during the period by only 50%, and earnings per share by 73%, while year-end share prices plummeted by 71%.
If such figures cause a narrowing of the eyes, worse is to follow. Chapter seven of the report focuses on the extent to which companies featured in the FTSE 350 in the year 2000 survived as members of this elite group in 2010. It turns out that fewer than half (124) remained on the list throughout the period and these represent only 16% of the total number that appeared on the list at some time. Staggeringly, while top executives of “survivor” companies received average LTIP increases of around 490%, the leaders of “non-survivors” enjoyed LTIP increases of - wait for it - 1,476%. “Taking all the evidence together”, the reports concludes, “our analysis….suggests that a highly rewarding long-term incentive plan is no guarantee of a company’s long-term membership at the table of top-listed companies”.
The last chapter, “Pay for performance in finance”, makes especially lamentable reading. Here the authors concentrate on comparing executive salaries in state-supported banks with those in the non-supported sector. Among a host of dispiriting facts, we learn that executive earnings in state-supported and bailed-out banks “far outstrip” those on offer in the non-state support banks as well as in the FTSE 350 as a whole.
We might add by way of up-to-the-minute illustration that while two of “our” banks have just had their credit ratings downgraded, the CEOs of RBS and Lloyds TSB are trousering more in a year (three to five times more) than the average UK employee earns in a lifetime of work.
Overall conclusion? If the great captains of UK PLC were commanding ships of the line, most of them would be facing courts martial for dereliction of duty. Their pay settlements are not just unrelated to performance; they seem wholly divorced from the world inhabited by the rest of us. In a previous OD article , I suggested tongue in cheek that we might be better-off without most of them. The HPC’s paper offers unwelcome evidence to support that proposition.
“A Bit Rich” the NEF’s monograph on pay and the value of work is a more adventurous, effort than HPC’s sober analysis. Its purpose is overtly evangelical: “…. to shatter some myths about pay and value”, and to show that high financial rewards are by no means necessarily associated with “good societal outcomes”. The challenge that the authors set themselves was to compare the overall value to society of six different service professions, three of them low-paid and three from the top income bracket. They do this by setting average earnings of each profession against the estimated value to society of their activities.
So, for example, while hospital cleaners earn an average of £6.26 per hour (just about the minimum wage), their impact on reducing Hospital Acquired Infections and improving hospital service quality is substantial. In this case, the report estimates that for every £1 paid to a cleaner he or she creates over £10 of net societal value.
At the other end of the pay scale, tax accountants (salary £75,000 - £200,000 plus benefits) earn their living by helping corporations and the super rich to avoid tax. While their work is entirely legal, the report quotes with approval former Chancellor Denis Healey’s quip: “The difference between tax avoidance and tax evasion is the thickness of a prison wall.”
Estimating the amount of money lost to HM Revenue through tax avoidance is far from straightforward, and here the report defers to a tax expert for its figure of £25 billion. Naturally, not all the work of tax accountants centres on avoidance, and the authors take this into account in their calculation of the overall value of the profession. Nevertheless, their conclusion is that for every £1 of value created, tax accountants destroy £47.
At the end of the exercise, we learn that low-paid hospital cleaners, nursery assistants and waste recycling workers add value while tax accountants, advertising executives and unsurprisingly city bankers destroy it.
Interspersed with these analyses are summary paragraphs whose purpose is to debunk what the report terms “myths of pay and value”. Numbered from one to ten, the myths include many of the standard defences of neo-liberalism: “we need to pay high salaries to attract and retain talent in the UK”, “the private sector is more efficient than the public sector”, “pay always rewards profitability”, “if we tax the rich, they will take their money and run”, and so on. Since the last of these “myths” has been a recent hot topic both in the country and in the pages of Open Democracy, the NEF response is worth quoting. After pointing out that if the “myth” were true, the wealthiest citizens of high-tax countries like Sweden, Denmark, Norway and France might be expected to reside elsewhere, the report notes that according to the latest Forbes list of billionaires “... all four Norwegians on the list live in Norway, the two Danes live in Denmark, five of the nine Swedes live in Sweden and eight of the ten French live in France.”
How justified are the report’s main conclusions about the societal value of work? At first glance, they appear egregiously simplistic. Two appendices detailing the methodology used in the calculations, however, should give even the most sceptical pause for thought. These together with the authors’ extensive list of references show that they have drawn on a wealth of resources, including the government’s own research, that their assumptions are certainly daring but hardly extreme, and that they have taken pains to explain and justify their reasoning. In the end, the report emerges as a much more convincing account than one might expect.
Its main weakness lies in the stridency of the introductory assertions which give one an impression of being intellectually browbeaten. As a result, I found myself wanting to check every reference and calculation half-expecting to find inaccuracies and distortions that favoured the authors’ convictions. Less naturally sympathetic readers might simply dismiss it, however unfairly, as leftist propaganda, and one could hardly blame them for doing so. In the end, however benign its intentions and ultimately convincing its conclusions, I suspect that A Bit Rich will end up by preaching solely to the converted.
Ha-Joon Chang’s “23 things they don’t tell you about capitalism” is not, as the title might suggest, a diatribe against capitalism of any kind, but a clever, witty survey by a Cambridge economist of why free-market capitalism - the West’s version of how things should work - not only doesn’t do what it says on the tin, but is positively injurious to economic development and to human welfare.
In twenty-three chapters of entertaining exposition, Chang explains why there’s no such thing as a free market, why free-market policies rarely make poor countries rich, why making rich people richer doesn’t make the rest of us richer, why we are not smart enough to leave things to the market (because we can neither obtain nor process all the necessary information), why big government makes people more open to change, why more education is not going to make a country richer, why financial markets need to become less, not more, efficient; and so on.
A few of Chang’s “Things” seem intuitive but many fly in the face of orthodoxies that have become embedded in the thinking of western economists and politicians.
Not the least of these is Chang’s bald statement that governments can and do pick winners. We are supposed to believe that when officials try to buck the market by promoting industries shunned by the private sector and “clearly” beyond a country’s resources the result can only be disaster. Aren’t developing countries littered with white elephants that prove the vanity of such projects? Think again says Chang. He goes on to recount how many of the largest and most famous Korean companies, giants like LG, Hyundai and POSCO - the worlds fourth largest steel company - were all started or steered by the government. Nor is the Korean experience unique. In the second half of the twentieth century, the economies of Singapore, Taiwan, France, Austria, Norway and Finland have all benefited from pro-active government involvement in industrial development. More surprising still is that the US government, that bastion of neo-liberal orthodoxy, has picked most of the country’s industrial winners since the Second World War through its massive R&D support programme for the computer, semi-conductor, aircraft and biotechnology industries among others.
Another incisive Chang observation or “Thing”, one that ties nicely in with the HPC and NEF papers, is that “US (and UK) managers are over-priced”. Today, they are paid around ten times more than their predecessors of the 1960s even though the latter ran companies that by every available measure were more successful. They also receive 300-400 times more than the average worker, up from 30 - 40 times in the 1960s. Neoliberals would argue that in a free market people get paid according to their worth and that the market will punish them for failure, but Chang shows that nowadays executive compensation goes only one way - due north - regardless of company results.
Possibly the most enjoyable chapter of Chang’s book is the one in which he has fun with the venerable figures of US history whose faces appear on dollar bills: George Washington ($1), Abraham Lincoln ($5), Alexander Hamilton ($10), Andrew Jackson ($20). Each of these American greats turns out to have been an anti-free-trader, a died-in-the-wool protectionist whom most contemporary economists would pillory for their primitive understanding of economics. Yet their policies were responsible for propelling a second-rate agrarian economy dependent on slave labour into the world’s greatest economic power. Free trade, in the version being forced on the world by the powerful, Chang asserts, has never been a recipe for economic development, and there is no reason to believe that it ever will be.
Unlike the HPC and NEF papers, Chang does not limit himself to complaining about the status quo. For each of his “Things” he suggests ways of thinking, and specific actions that governments and even citizens can take to rebuild the world economy not simply on more equitable lines but in a way that allies the best aspects of western-style creativity and entrepreneurship with the need for regulation, steerage and a proper respect for human welfare. “Capitalism, yes,” writes Chang, “but we need to end our love affair with free-market capitalism which has served humanity so poorly, and install a better regulated variety.”
How we make that transition remains an open question. Judging by their reactions to the current financial crisis, Western policy-makers remain stubbornly faithful to the neoliberal trajectory. Maybe works like these will induce them - and all of us - to think more seriously about a course correction.
Jeremy Fox is a writer, businessman, and consultant.