I have read many articles recently focused on executive pay and our “bloated” financial sector with a tone similar to that taken by Stiglitz in the excerpt below. While I agree that our economy hardly awards pay in line with productivity, this allocation of blame forgets that many many of this country’s citizens leveraged themselves to hilt with loans from credit cards and multiple mortgages. The national savings rate was briefly negative. I’ve heard the stories of deceptive subprime mortgage salesman with disgusting incentives, but it still takes two to tango. I place at least as much responsibility on the “less informed” for their poor choices as I do the misinformation of snake oil salesmen. That said, our banks need to take a long pause to consider their longterm role in society and act appropriately. Goldman would be very foolish to declare even near record bonuses this year.
“Without any other compass, the incentive structures they adopted did motivate them – not to introduce new products to improve ordinary people’ lives or to help them manage the risks they faced, but to put the global economy at risk by engaging in short-sighted and greedy behavior. Their innovations focused on circumventing accounting and financial regulations designed to ensure transparency, efficiency, and stability, and to prevent the exploitation of the less informed.
There is also a deeper point in this contrast: our societies tolerate inequalities because they are viewed to be socially useful; it is the price we pay for having incentives that motivate people to act in ways that promote societal well-being. Neoclassical economic theory, which has dominated in the West for a century, holds that each individual’s compensation reflects his marginal social contribution – what he adds to society. By doing well, it is argued, people do good.
But Borlaug and our bankers refute that theory. If neoclassical theory were correct, Borlaug would have been among the wealthiest men in the world, while our bankers would have been lining up at soup kitchens.
Of course, there is a grain of truth in neoclassical theory; if there weren’t, it probably wouldn’t have survived as long as it has (though bad ideas often survive in economics remarkably well). Nevertheless, the simplistic economics of the eighteenth and nineteenth centuries, when neoclassical theories arose, are wholly unsuited to twenty-first-century economies. In large corporations, it is often difficult to ascertain the contribution of any individual. Such corporations are rife with “agency” problems: while decision-makers (CEO’s) are supposed to act on behalf of their shareholders, they have enormous discretion to advance their own interests – and they often do.
Bank officers may have walked away with hundreds of millions of dollars, but everyone else in our society – shareholders, bondholders, taxpayers, homeowners, workers – suffered. Their investors are too often pension funds, which also face an agency problem, because their executives make decisions on behalf of others. In such a world, private and social interests often diverge, as we have seen so dramatically in this crisis.
Does anyone really believe that America’s bank officers suddenly became so much more productive, relative to everyone else in society, that they deserve the huge compensation increases they have received in recent years? Does anyone really believe that America’s CEO’s are that much more productive than those in other countries, where compensation is more modest?
Worse, in America stock options became a preferred form of compensation – often worth more than an executive’s base pay. Stock options reward executives generously even when shares rise because of a price bubble – and even when comparable firms’ shares are performing better. Not surprisingly, stock options create strong incentives for short-sighted and excessively risky behavior, as well as for “creative accounting,” which executives throughout the economy perfected with off-balance-sheet shenanigans.”
On the other hand, I am very happy to see that political powers have begun to acknowledge the continuing threat of global trade imbalances to the economy and, to a lesser extent, their role in the crisis we are exiting.
“U.S. Federal Reserve Chairman Ben Bernanke warned on Monday that Asian export-promotion policies and large U.S. budget deficits could refuel global economic imbalances and put efforts to achieve more durable growth at risk if not curbed.” http://www.nytimes.com/reuters/2009/10/19/business/business-us-usa-fed-bernanke.html
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