Chris Dillow's Blog, page 193

The bosses' pay con-trick

The bosses' pay con-trick is getting worse. The pay of average FTSE 100 directors rose 49% last year, with the average CEO getting £3.86m.

I say this is a con for several reasons.

1. The link between pay and firm performance is asymmetric (pdf). In good times, bosses' pay rises a lot, but in bad times, it doesn't fall so far. In fact, the biggest influence on bosses' pay is not so much company performance as simply the size of the firm. 

2. Big bonuses and performance-related pay are not technically necessary to elicit performance. There's plenty of evidence that bonuses are sometimes ineffective at improving effort, sometimes actually counter-productive, and sometimes inferior to fines .

3. The claim that bosses must be paid a lot because their pay is set in a global market is silly.  CEOs are paid more in the US than UK, and yet few Brits have become CEOs of US firms; one of the very few exceptions was Martin Sullivan who was CEO of, ahem, AIG. Holding down UK bosses' pay is unlikely to lead to a mass emigration.

4. It's not even clear that the average boss has much effect upon corporate performance. Take three facts:

- We know from football that changing coaches has no effect upon team performance. If bosses of organizations as small as 11 men can't turn around performance, what hope do they have for larger organizations? As Warren Buffett said, when a boss with a good reputation takes over a business with a bad one, it is the business that keeps its reputation.

- Jonathan Haskel  and colleagues have found that 80-90% of total factor productivity growth (pdf) comes from plants exiting and entering the industry, rather than from internal productivity growth. This suggests that bosses do less than widely thought to improve organizations' efficiency.

- The death rate of companies is not only high, but statistically distributed (pdf) in a similar way to that of the extinction of species. This suggests that bosses can no more foresee (pdf) or prevent the demise of their firms than species can foresee or prevent their own extinction. Which suggests that bosses know less than we suppose.

In saying all this, I'm not taking a Marxist view. It was, remember, Hayek who told us that central management was flawed because of the impossibility of aggregating dispersed data.

5. The idea that bosses matter, and must be paid accordingly, plays upon our cognitive biases, such as:

- Fundamental attribution error. We assume that individual must be responsible for outcomes, and downplay the role of environmental or situational factors. So if a firm does well, we attribute its success to management rather than a lack of competition or macroeeconomic forces or just luck.

- Outcome bias. We believe that if something happened, it was inevitable. When a company succeeds, therefore, we look for causes - and the fundamental attribution error directs us to management. We forget that success might be due to luck, or to factors outside management's control.

- Salience effects. I'll concede that a handful of managers - Steve Jobs, Jack Welch, Arsene Wenger - can achieve great things. But these are exceptions. Looking at them and inferring that the average manager has great powers is like looking at Kate Moss and inferring that obesity doesn't exist.

Given all this, you might wonder what the real reason is for bosses' high pay. Simple. Power. Bosses , generally, might not have the power to create super-efficient high-performing firms, but they do have the power to extract rents from shareholders and workers. Like some City traders, they must, in effect, be bribed not to plunder the firm's assets. From the point of view of shareholders, the small theft that is a multi-million  pay-packet is better than the large theft of wilful mismanagement.

Employment protection & jobs

Tim welcomes the proposal to scrap workers' protection against unfair dismissal:

It will increase job creation…The harder it is to fire people the less likely people are to take someone on in the first place.

This is common sense.

And common sense is often wrong. Empirical work has struggled to find a link between employment protection laws and unemployment. For example, the OECD has found (pdf) that:

There appears to be little or no association between employment protection legislation strictness and overall unemployment

although it did find that such laws raise long-term unemployment.

And Stephen Nickell found (pdf) that employment protection laws were "negligible and completely insignificant" as a cause of cross-country differences in unemployment in 1980s and early 90s.

So, why is Tim's intuition at odds with the facts?

It's because there are a couple of mechanisms operating in the other direction.

If there were no employment protection at all, workers would gain less from staying with the same firm for a long time. Ceteris paribus, they would therefore have more incentive to leave. This would have two effects:

1. To retain staff, employers might have to pay more. This would tend to reduce employment. To put this in a way Tim would prefer, the incidence of employment protection laws falls upon workers in the form of lower wages.

2. Workers would have less incentive to invest in firm-specific skills. This would tend to reduce the firm's efficiency and hence prevent it growing.

You might think these are small effects. Maybe. But so is Tim's; firms - being over-optimistic about their ability to spot talent - don't hire workers thinking there's a chance they'll be skivers or no-marks.

Because of these offsetting mechanisms, some research (pdf) has found "an inverse U relationship between employment protection and economic growth":

From the point of view of per capita growth of GDP…employment protection in the early 1990s was too low in countries like Australia, Canada, Denmark, Ireland, Switzerland, the UK and the US

It is, therefore, unlikely that making it easier for firms to sack workers will reduce unemployment - and very unlikely that it will reduce it much. If scrapping employment protection is your best idea for creating jobs, you don't really have any ideas.

Nice doesn't pay

Walter Isaccson's biography of Steve Jobs reveals him to be, among other things, a nasty bully. This raises the question: does it pay to be a git?

A priori, it's not obvious. Being unpleasant might hold you back, because it means you'll lose networking opportunities and the chance to call in favours when you need them. But on the other hand, it gives you the ruthlessness needed to climb the greasy pole.

Luckily, research (pdf) by Guido Heineck tackles just this question. Unluckily, his findings are depressing.

He looked at the correlations between UK individuals' earnings and "big five" personality traits, controlling for other things such as age, education, marital status and region.

And he found that being nice carries a wage penalty. Women in the top 25% of agreeableness earn an average of 11.1% less than averagely agreeable women, and the 25% of most agreeable men earn 7.8% less than average.

Note that it's niceness that is penalized, rather than nastiness that's rewarded; people in the bottom 25% of agreeableness earn no more than average. Heineck says this could be because "agreeable persons are possibly too passive for example in conflict situations or are poorer wage negotiators."

The meek might inherit the earth in the next world, but they don't get much in this.

It's not just niceness that's punished. So too, rather surprisingly, is conscientiousness.

As you might expect, the least conscientious quartile of people earn less than average. Being sloppy in your work costs you money. But there's a penalty for being too conscientious. The most conscientious quartile of men earn 7.1% less than average, and the most conscientious 25% of women earn 8.7% less.

This is not because conscientious people go into routine jobs that are less well paid; these numbers control for industry and occupation. Instead, says Heineck:

A 'too high' standard in getting things done slows down decision processes and/or job performance which might eventually result in lower job productivity.

As the mighty Terry Allen put it: "Don't ever do the best you can do. It's better to be mediocre."

Virtue, then, is not always rewarded. Whether this is a merit of capitalism or a demerit is, however, an open question.

Cameron's lesson from Man Utd

Man Utd's defeat on Sunday contains a warning for David Cameron - one he will almost certainly ignore.

I'm thinking of path dependency - the tendency for a small events to amplify into big ones.

For example, having gone a goal and man down on Sunday, Manyoo chased the game and so left space for Citeh to exploit, thus conceding more. This boosted Citeh's confidence and demoralized United, leading to more goals. A small edge thus ballooned into a large one. United suffered from this on Sunday, just as they benefited from it against Arsenal.

Citeh are not five goals better than United, any more than United are six better than Arsenal. In both cases, what we saw was that a small difference became a large one. Success breeds success.

We see similar things in the history of technology.  The qwerty keyboard, for example, was not, initially, technically superior to others. But once it became widely used, it became even more widely used because it was what people had (arbitrarily) become used to. Bill Gates' detractors say a similar thing is true of Windows operating systems.

It might even be that the ubiquity of petrol-powered cars arose because an initially small advantage over steam cars led to greater investment in petrol engines and thus, eventually, to a massive superiority.

It's not just success that breeds success, though. So does failure. Rogue traders become rogues because they suffer early losses and then, in their desperation to break even, take on reckless gambles which sometimes fail.

What's this got to do with Cameron? Simple. There's another example of path dependency.  Robert Cialdini describes how during the Korean War, American PoWs were asked by their captors to make mildly anti-American remarks. Having made such mild statements, some PoWs would then be easily induced to go further, with the result that they became collaborators. This happened, says Cialdini, because:

Once we have made a choice or taken a stand, we will encounter personal and interpersonal pressures to behave consistently with that commitment…many times a man would change his image of himself to be consistent with the deed and with the new "collaborator" label, often resulting in even more extensive acts of collaboration (Influence, p57, 71)

Good salesmen understand this. They are keen to get small business from customers, because they know that these often lead to bigger orders.

Herein lies the danger for Cameron. The 81 MPs who defied the Tory whip yesterday have become "rebels" or "independent minds". They might therefore behave like this in future. Having gone onto the rebel path, they might stay on it. Tory backbenchers will thus become harder to control.

So, why do I say that Cameron won't learn this lesson.?

It's because of another feature of path dependency. The event that puts us onto a path might be just luck. The mediocre product that is lucky enough to sell well might gain further custom. The team that is unlucky to concede a first goal might chase the game and be caught on the break. And if we are lucky to get a good first job, the training and opportunities it gives us will enable us to have a successful career.

This, of course, is just what happened to Cameron. He was lucky to have the family connections that got him his first job, and this put him onto a good path.

Which is why he'll not learn the lesson. To acknowledge the power of path dependency, Cameron will have to recognise that he owes his success to luck. But this he cannot do, as the privileged are no more capable of seeing their privilege than fish are able to see that water is wet.

Robbie Savage & the EU referendum

Saturday night's Strictly Come Dancing demonstrates the case for having a referendum on EU membership.

What I mean is that any man watching SCD has a dilemma. On the one hand, we want Robbie Savage out, for serial crimes against football and taste. On the other hand, though, we want to keep Ola Jordan in the competition for obvious reasons. [image error]

When we are asked to vote, then, we're being asked to express an opinion about a bundle of things: Ola's merits and Robbie's demerits. And this means that it's hard to interpret the public's preferences; are the couple still in the competition because we approve of Robbie's dancing, or because we love Ola?

This, of course, is exactly the problem with conventional party politics. When invited to vote for a party, we're asked to vote on a bundle of policies and personalities, some unpleasant, like Savage, and some not. And just as in SCD, this means preferences can't be clearly expressed.

This applies to the EU. David Nuttall's claim that 84% of us have never had the chance to vote in EU membership isn't quite right. Anyone over the age of 46 could have voted Labour in the 1983 election, as they wanted to withdraw from the EU. But I suspect Mr Nuttall and other Tories didn't do this, because the Olaesque attractiveness of leaving the EU was bundled up with the Robbie Savage of the rest of Labour's manifesto*.

The case for a referendum is simply that, in unbundling options, public preferences can be more clearly expressed.

So what are the counter-arguments? There are two.

One is transactions costs. Sometimes, it's just too costly to unbundle options.  If we were to vote for or against either Ola or Robbie, SCD would get very complicated. Ola might end up having to dance with Alex (my blog, my fantasy).  The parallel with the EU referendum is not so much the financial cost of organizing it, as the distraction of politicians' time and effort from other tasks.

The second is pressed by Paul. If we give people the option of expressing a clear preference, we also give them the chance to express an irrational one. If we were to vote solely upon Robbie, our views might be affected by irrational hatred (as well as rational hatred). Bundling him up with Ola cools the passions, and allows for a more clear-headed assessment. Analogously, not holding a referendum might allow for a more rational debate, partly by prolonging the length of time over which it is held.

Now, I don't have a view here one way or the other. My point is simply the one that has hitherto gone unnoticed - that there are striking similarities between Robbie Savage and the debate about an EU referendum.

* Actually, the Tory right wasn't opposed to EU membership in the 80s; they were rather late to discover the merits of national sovereignty, but let that pass.

Tribalism vs freedom

"Closing St Paul's? It's elf n' safety gone mad."

We're not being deafened by this opinion. Nor were some traditional defenders of the rights of property owners much outraged by the Dale Farm evictions: compare the Mail's coverage with the generally sympathetic reporting it has given to other people who broke planning laws.

Such double standards are, of course, not unique. Many on the right think that the unemployed should travel to look for work, but want immigration laws to stop them crossing national borders when they do. And in 2008 many of those who had spent the last thirty years telling us to stand on our own two feet and singing the virtues of free markets suddenly discovered the virtues of state aid. As Ross Clark says, "our free market system tends to become rather less free when powerful people are in danger losing money."

Now, you might think I'm going to say that this shows that many Tories are just hypocrites.

I'm not. Hypocrisy is ubiquitous. You can find it on the left as well as the right.

Instead, there's another point here - that there's a conflict between tribalism and self-interest on the one hand and freedom on the other.

The problem with freedom is that it doesn't just promote our own interests. It can harm these interests;  laisser-faire required that banks collapse, with unpleasant externalities. And it can promote the interests of people who aren't in our tribe. Freer planning laws help pikeys as well as Daily Mail readers. And the freedom to work where you want is good for foreigners as well as Brits.

This means that the cause of freedom is ill-served by tribalism and self-interest. And because the latter are significant forces in politics, we cannot hope that freedom will thrive.

Occupy, & democracies

Liberty, said John Stuart Mill, "is often granted where it should be withheld, as well as withheld where it should be granted." I've often thought that the same could be said for democracy. And this is how we should interpret the Occupy movements.

What I mean is that if we think of democracy as an information-gathering device, it is used where it shouldn't be and not used where it should. Most of us are either uninformed or actively misinformed about national policies, but democracy operates at this level. And yet we often do have knowledge about our locality or workplace, but local democracy and workplace democracy are weak or absent.

In this context, I'm not convinced by Anthony's complaint that lefties such as the OccupyLSXers "know what people really want even if they don't yet themselves." Such a stance is perfectly reasonable, given that cognitive biases research supports Marx's view that there might well be such a thing as false consciousness and that - partly because of this - actually-existing democracy fails to advance justice or liberty.

 By contrast, I suspect the Occupy movements might be starting to build new foundations for "fourth generation" democracy; as Sunny says, there's more to democracy than voting once every five years. I mean this in four ways:

- Advancing economic democracy. A theme of the Occupiers seems to be a desire for more popular control over the economy. This might take dangerous forms - the market, remember, is a good information-aggregating device - or it might not.

- Egalitarian democracy. A virtue of democracy is not that it leads to good outcomes - it often doesn't - but rather that the "one person, one vote" principle embodies an important aspect of equality. Occupy seems to be taking this further, not just by demanding greater economic equality, but also by demonstrating an egalitarian form of political activity - one undistorted by lobbyists or media prejudice.

- Micro deliberative democracy. The Occupiers are creating an arena in which political questions about economic organization can be asked, and get the attention of the media and Westminster. Such arenas are rare.

- Macro deliberative democracy. In calling hierarchical capitalism into question, the Occupyers are helping to open the Overton window, to influence mainstream politicians into considering issues which have hitherto been little discussed. In this sense the Occupyers are complements for the parliamentary left, not substitutes.

Now, I'm almost certainly taking a rosy view of the Occupyers here. As James says, there's a large element of narcissistic activism among them. But it might grow into something better.

My main point, though, is that the Occupyers are, potentially at least, a force for democracy in the best sense. And insofar as there is a tension between them and parliamentary democracy, so much the worse for the latter. 

Crime, unemployment & peer effects

Crime seems to be rising. The British Crime Survey reports a 2% rise in all crime in the 12 months to June 2011. Although statisticians say this is not statistically significant, the rise in theft from households is significant.

This is just what you'd expect when unemployment is rising. I say this not because  I'm a liberal lefty, but because I'm an economist. The first rule of economics is that people respond to incentives. And when you're unemployed you have more incentive to commit crime. This is partly because you have less to lose - you'll not lose your job if you go to prison - and partly because, being poor you have a higher marginal utility of consumption and thus a stronger desire for money.

This paper estimates that a one percentage point rise in the UK unemployment rate leads to a rise in robberies, burglaries and thefts of around 45,000. And this paper finds that long-term unemployment is strongly associated with violent crime, perhaps because it leads to a feeling of alienation.

All this raises a question. If unemployment raises crime, why has the increase in crime been so small?

It's because something else is going on. The decision to commit crime (or not) is not merely one taken by a rational maximizing isolated individual. It has a social dimension. People are more likely to commit crime if others in their social networks do, and less likely to do so if their peers are law-abiding. If your friends are robbers, there's a high chance you will be too.

These peer effects mean that trends in crime can feed on themselves. If crime falls for several years - as it did in the 90s and 00s - it might continue to do so, because there are fewer "bad apples" to influence others to commit crime.

What we're seeing now is the interplay of these two forces: higher unemployment is tending to raise crime, but the favourable peer pressures caused by a lack of crime recently is tending to reduce it.

And herein lies a danger. If further rises in unemployment lead to more crime, then we could get a further rise in crime, as the peer effects arising from there being more criminals magnify the initial  increase in crime.

Markets, emotions & logic

Sometimes, I'm amazed by how people can see things so differently from me. Mark Wallace gives an example:

Armed with logic, statistics and evidence the [free market] Right thought for too long that it didn't need emotive arguments…
But we need to speak from the heart and get a bit emotional about markets, too.
And there is an emotional case to be made.

What strikes me here is that I had always thought that the case for free markets was, primarily, an emotional one. The notion that people should be free to buy and sell (legitimately acquired) property as they wish is, for me, a powerful, emotional, intuition.
I'll go further. I have a lot of sympathy for Deirdre McCloskey's view that free markets are a moral system. As she says in Bourgeois Virtues, "no other system has been more free from dominance, acquisition and  calculating behaviour". Remember: the archetypal market character is not the boss of a big firm - who is a rent-seeking bureaucrat - but the fruit & veg stall-holder.
By contrast, Mark's claim that free marketeers have been "armed with logic, statistics and evidence" seems to me to be over-confidence of Dunning-Kruger proportions. For example, the idea that scrapping minimum wage laws - a bete noire of some right libertarians - will create lots of jobs is just stupid. Nor is there statistical evidence that a generally "free" labour market will create lasting full employment. According to Feinstein's numbers*, UK unemployment averaged 4.1% in the free market 1860s compared to 1.4% in the Keynesian 1950s. This matters, because any system of ideas that has little to say about the biggest economic issue must be greatly flawed.
In this sense, if Mark is correct, right libertarians have been 100% wrong.
* Statistical Tables of National Income, Expenditure and Output of the UK 1855-1965. Not webbed, I'm afraid.

An old fart writes

Last night, I went to see Noah and the Whale - don't ask - at Leicester University. And whilst I wasn't the oldest person there, I felt a little out of place among students young enough to be my children.
Which raises a thought. Don't we under-estimate the extent to which the generations are foreign to each other?
 Put it this way. A typical university student today was born in 1992. To him, Thatcher's premiership seems as distant as Harold Macmillan's did to me in the early 80s. And the miners' strike is as far from him as the Suez crisis was from me. Those people who talked of Macmillan and Suez in the early 80s seemed like remote old farts to me. So don't I seem an old fart to today's young people?
Or put it another way. I was a graduate trainee during the crash of October 1987. I remember a couple of our firm's greybeards - there weren't many - walking round the dealing floor saying something like "Call this a crash? You should have been here in 74. We thought the market was going to become worthless." Wise as these words were, they weren't greeted with universal acclaim. 1974 seemed like ancient history to us know-all twentysomethings. But 74 was only as far from 1987 as 1998-99 is from today. I regard the events of that period - the collapse of LTCM and the tech bubble - as lively memories which influence my attitudes even now. But to a young trader they are the same remote history I thought those greybeards were prating about.
I could go on. People of my age, and older, grew up in the Cold War. The fear of nuclear annihilation was, for us, a very real one. This puts Islamist terrorism into a different context than younger people have.
I suspect that one reason why some older folk are more sceptical about climate change than young ones is that they remember talk of global cooling in the 70s, which (over?) cautions them against believing in global climate projections. And then there are the differences that arise from my generation regarding the internet, "free", and social networking as novelties whereas today's students see them as familiar things they grew up with.
Now, this is not to say that there need be hostility between the generations. As that young whippersnapper Laurie says, "The struggle going on across the world is not between old and young, but between the possessed and the dispossessed." But it does, I suspect, mean there is the danger of mutual misunderstanding. After all, our formative experiences make us who we are, and these are very different between a 40-something and a 20-something.
There's something else. If someone had suggested in the late 70s a Saturday night TV show in which teenagers competed to sing songs written years before they were born - in the 1950s say - they'd have been taken away by the nurses. And yet millions watch such an equivalent show now.
As I say, foreign.