Bonuses: RBS vs. John Lewis

Staff at John Lewis are looking forward to bonuses totalling £200m this year. Everyone thinks this is wonderful, of course, as John Lewis is supposedly a fine example of a 'mutual', a 'partnership' that is owned by the people who work in the organisation.

Staff at the Royal Bank of Scotland, meanwhile, are getting bonuses of £576m. Everyone thinks this is terrible, as the banks are thought 'greedy', not to mention mean to customers who want business loans.

The RBS bonus pot is just over twice that of the John Lewis bonus pot. But RBS has a turnover around 15 times that of John Lewis, £19.7bn compared to just £1.4bn. In terms of the size of the organisation, therefore, RBS bonuses are pretty trifling.

Which is how it should be, given the bank's losses this year. Of course, not all parts of the business make losses, and it is reasonable that staff in the profitable bits should be paid proportionately. Even if some divisions are losing money, you might still want to keep paying them well, depending on how you think things will go in the future, and how much of an investment you have made in hiring and training up those staff members – not to mention keeping them out of the clutches of your competitors.

Bonuses are actually a good way for an up-and-down business like a bank to manage their remuneration. Instead of paying high basic wages and having to lay skilled staff off when things go bad, you can simply slim their bonus, knowing that many or most will hang on in the hope of getting larger bonuses when things turn up again.

But it is interesting that a bank can pay bonuses of less than a thirtieth of its turnover and everyone thinks it's wicked, and a 'partnership' can pay bonuses of a seventh of its turnover and everyone thinks it's a national treasure. Shows you how this argument is all about politics rather than economic and business reality.

A most wonderful example of cause and effect

I have to admit that I just love this story. For it speaks to that terrible problem that we face so often, trying to understand the difference between correlation and cause.

A number of studies have been done over the years trying to work out whether people are insider trading given the specialist knowledge that they have. For example, one such showed that Senators were getting a 12% annual return on their stock portfolios. The conclusion was that yes, they were indeed using their inside information about what laws were likely to be written and how. No prosecutions of course because this wasn't actually illegal but it was pretty clear that the activity was going on.

Using very much the same techniques researchers have had a look at the stock investments of the policemen of that world, the folks at the SEC. And the results do seem to indicate the same sort of conclusion:

In the report titled "The Stock Picking Skills of SEC Employees," researchers found that SEC employees' stock purchases look like your average person's. But when these employees sell their stocks, they appear to systematically beat the market by making sales within weeks of costly enforcement actions by the agency.

The smoking gun evidence is strong with this one. However, it's not actually the correct answer:

The SEC says it has an explanation. "Each of the transactions was individually reviewed and approved in advance by the Ethics office," said John Nester, spokesperson for the SEC. "Most of the sales were required by SEC policy. Staff had no choice. They were required to sell." Nester explained that before staff can work on an issue that involves a company, they have to sell any holdings of stock in that firm. As a result, he said, there shouldn't be any surprise that a sale would precede the announcement of an enforcement action.

I, for one, think this is a magnificent answer. The SEC decides in secret as to whether it will launch an investigation into a particluar stock. An SEC investigation is never, ever, about awarding a company a gold star for being the good guys. So an announcement of an SEC investigation is always, but always, negative for the price of the stock in question. Which means that the staff are forced, no forced!, to sell out of those stocks that might be affected by an announcement of an investigation. Forced simply by being brought onto the team that decides whether there should be an investigation or not.

What other jobs insist as a condition of employment that you do things that would be illegal outside the context of that employment? The SEC forces people to insider trade, the Army forces people to kill people....any other candidates?

I find that I've been a Coasean all along

Anti-dismal has a piece which tells me that, much to my surprise, I've not been a liberatairan, nor a classical liberal, all this time but in one respect at least I've been a Coasean:

Coase’s ‘market supporting’ credentials do not therefore derive from a position that market contracting is always best.They derive from his point that only the ability to try out different organisational settings and subject them to a test of survivability will reveal what structures are most productive. It is the existence of competition between alternative solutions to the problem of economising on the cost of transacting that is important. Planning and market transacting are both potentially helpful (indeed ideally equally so at the margin) and ‘what this mix should be we find as a result of competition’.

As I've mentioned many a time my view is that there are some things that have to be done and that can only be done with the compulsion available to government. There are also other things that are not best solved by the actions of markets unadorned. Then there's everything else where our own voluntary cooperation in markets guided by the price system will do just fine thank you very much. There are two questions that follow from this.

The first is the obvious one of how many things can be left to said market and how many others need to be done by government or without those markets. My basic feeling (which is what perhaps makes me a classical liberal again) is that there's not all that much that has to be done by government and most can indeed be left alone to our own private interactions.

The second is, well, how do we decide? How do we reach some useful definition of what should be left to which mechanism? And it is here that I have been, unknowingly, a Coasean. For my answer has been that we should have a market in methods of organisation and then see what happens. We can adopt the method that seems to work best in any particular situation.

I would go one stage further and add that I am, in some manner, also a Marxist, in that I'm quite happy with the idea that which is done best, how, can change along with the technologies we have available to do them. This is reminiscent of Marx's point about social relations being determined by technology. And I think that this last might be the most important political point of all. We currently regard both education and health care as being something the State must provide. Sure, we tinker with allowing private providers but the general consensus is that the basic services must be both financed and overseen by hte State. And I'm entirely unconviced that this is going to be true going into the future. It might have been true in the past but given the technological changes in both sectors there's no reason at all to think that the social relations might not be changed by technology.

If, for example, online eduational technology continues to improve as it has been then is it really necessary to turn over all children to the monopoly of the teachers' unions for 11 years of their lives?

Another way to put this is that if we assume that both Marx and Coase were right, then both would be telling us that the mix of State and non-State activities should be changing over time. Rather than the current situation where anything once colonised by the State seems to stay there.

The IMF has declared that redistribution is indeed injurious to growth

Much is being made of a new paper from the IMF about the redistribution of income and whether this affects the growth rate or not. The general conclusion being drawn is that it does not. Indeed, there are even findings that redistribution increases the general growth rate. You don't have to wonder what that sort of finding is going to do to our domestic left. I've actually seen one, already, insisting that this means that any level of redistribution, all the way to total equality, will thus increase growth. However, that's not what the paper is actually stating.

John Cassidy has a good over view of it here but even he's not picking up on what I regard as the important phrase:

Redistribution appears generally benign in terms of its impact on growth; only in extreme cases is there some evidence that it may have direct negative effects on growth.

The question here is, well, what's "extreme"? I guess we would argue that killing all the bright people, shipping the more industrious peasants to the Gulag and eliminating the bourgeoisie as a class would count as extreme. But don't forget that there are still significant numbers of peope in British politics who sign up to the analysis behind this program, even if not the specific actions. So it might not be all that extreme.

We might also argue that 98% tax rates on investment income are extreme, 83% on incomes, but that's an extreme that happened within my own adult lifetime. And there are very definitely people who would like to bring that back.

The point I'm making is that even in the terms of this paper there are people here in the UK who still advocate "extreme" policies that would indeed have injurious effects upon the growth rate. And we should not allow them to use this paper as an excuse to argue for those policies: for it's very careful indeed to point out that "reasonable" levels of redistribution might be beneficial. We've still the argument to come over what is reasonable and what is extreme.

Market competition is how we choose whom to cooperate with

Eamonn has alerted me to another one of those books on how cooperation is better than competition. We can all guess how it goes:

But it doesn’t have to be this way. CEOs, scientists, engineers, investors, and inventors around the world are pioneering better ways to create great products, build enduring businesses, and grow relationships. Their secret? Generosity. Trust. Time. Theater. From the cranberry bogs of Massachusetts to the classrooms of Singapore and Finland, from tiny start-ups to global engineering firms and beloved American organizations—like Ocean Spray, Eileen Fisher, Gore, and Boston Scientific—Heffernan discovers ways of living and working that foster creativity, spark innovation, reinforce our social fabric, and feel so much better than winning.

Yep, standard yadda yadda going on there. We'll all do better with a bit of fluffy group hugs rather than dealing in that awful market competition yucky stuff.

What always gets missed here is that we human beings are a both competitive and cooperative species. And if truth be told, we compete in order to be able to cooperate.

Take a base example, one that is understood by anyone who has ever gone out on the pull. The aim is to find someone to cooperate with: in fact, someone to cooperate the heck out of sometime later in the evening. Yet we all know that we're in competition with everyone else who is aiming to achive the same state of blissful cooperation. We're competing both with the others aiming at the same targets as ourselves and also with the desires of those we wish to cooperate with. And as everyone who has ever successfully pulled knows compromises need to be made, demonstrations of fitness for task performed and in general a not all that genteel pavane of ruthless competition takes place as we sort through those who we would like to cooperate with, those who will consent to cooperating with us and weighing up the best deal we can manage in terms of age, size, energy and cuteness. And of course the men are doing the same to the ladies as well.

Outside the world of cheap nightclubs we're all doing much the same thing. If looking for a long term mate we might change our selection criteria (the likelihood of somone saying yes on the first date might decline in importance) but we are all competing with everyone else of the same sexual orientation for those we desire, as they are with their cohort. Similarly, steel companies are competing with each other to sell to car factories, of course they are. But there's a good reason why it's very difficult indeed to dislodge an incumbent supplier: because the buyer has gone through that competition pahse and is now engaged in cooperation.

And that's actually how much of the economy does operate. Almost nobody is constantly on the look out for a new supplier. Most of us are, most of the time, cooperating with those we have already chosen through the competitive part of the process. And you can't really get the system to work in any other manner. We don't want to give up the competition part, that's how you end up living with the girl you went to primary school with, how the E Germans ended up driving Trabants. And we don't want to continually have the competition either for that would mean putting out to tender the purchase of every office pencil or a marriage record like Liz Taylor. We do need both however: it's just that finding the correct balance can be a little difficult as any middle aged man who visits a cheap nightclub can attest.

Is Ha Joon Chang actually an economist?

At least, is Ha Joon Chang an economist with at least a vague familiarity with finance and public markets? I ask because this piece of his is remarkably naive and ill informed:

According to the stock market, the UK economy is in a boom. Not just any old boom, but a historic one. On 28 October 2013, the FTSE 100 index hit 6,734, breaching the level achieved at the height of the economic boom before the 2008 global financial crisis (that was 6,730, recorded in October 2007). Since then, it has had ups and downs, but on 21 February 2014 the FTSE 100 climbed to a new height of 6,838. At this rate, it may soon surpass the highest ever level reached since the index began in 1984 – that was 6,930, recorded in December 1999, during the heady days of the dotcom bubble.

The current levels of share prices are extraordinary considering the UK economy has not yet recovered the ground lost since the 2008 crash; per capita income in the UK today is still lower than it was in 2007. And let us not forget that share prices back in 2007 were themselves definitely in bubble territory of the first order. The situation is even more worrying in the US. In March 2013, the Standard & Poor 500 stock market index reached the highest ever level, surpassing the 2007 peak (which was higher than the peak during the dotcom boom), despite the fact that the country's per capita income had not yet recovered to its 2007 level. Since then, the index has risen about 20%, although the US per capita income has not increased even by 2% during the same period. This is definitely the biggest stock market bubble in modern history.

Even more extraordinary than the inflated prices is that, unlike in the two previous share price booms, no one is offering a plausible narrative explaining why the evidently unsustainable levels of share prices are actually justified.

I quote at length so that none will think that I am distorting his position.

The problem with this joint statement, that both the UK and US stock markets are grossly over valued relative to the domestic economies is that, well, the US and UK stock markets are not actually reflective of the relative domestic economies. The perceptive will have noted that we are in a period of globalisation in fact:

This optimism is not just because the U.K. economy is showing signs of improvement -- the Office for Budget Responsibility upgraded its forecast for gross domestic product growth in 2013 from 0.6 percent to 1.4 percent -- there is an international aspect to the optimism. After all, 80 percent of earnings by FTSE 100 companies come from overseas, according to Credit Suisse.

And:

S&P 500: 2010 Global Sales, analysis recently released by Howard Silverblatt of Standard and Poor’s, shows that the percentage of sales from S&P 500 companies that report results from foreign operations show that overseas sales grew to an estimated 46 percent in 2010. That number was in the 30 percent range just a decade ago, according to data collected by the Bureau of Economic Analysis.

I don't claim that either of those percentages are wholly accurate nor canonical. Only that somethiing near a majority of S&P 500 earnings come from outside the US and the vast majority of FTSE 100 such from outside the UK. Making a comparison of these indices with the respective domestic economies a truly horrible piece of misvaluation.

For we are indeed in this era of globalisation and that global economy is growing like gangbusters as hundreds of millions, billions, climb up out of that historical peasant destitution. Meaning that the capitalist types are celebrating, according to your preference, either the money that can be exploited out of these newly rich or the money that is being made by aiding them in becoming the newly rich.

Then we come to the truly absurd:

The result, unfortunately, is that stock market bubbles of historic proportion are developing in the US and the UK, the two most important stock markets in the world, threatening to create yet another financial crash. One obvious way of dealing with these bubbles is to take the excessive liquidity that is inflating them out of the system through a combination of tighter monetary policy and better financial regulation against stock market speculation (such as a ban on shorting or restrictions on high-frequency trading).

Blimey. Robert Shiller's just been awarded the Nobel in economics partly for his pointing out that in order to prick a speculative bubble you want people to be able to go short in said asset. Banning shorting makes it only possible to bet long, increasing said bubble.

I would have hoped that an economist at Cambridge would at least be conversant with these two points....

Climate change will cause 22,000 murders apparently

There's an interesting new piece of research that tells us that climate change is going to cause an extra 22,000 murders in the US over the rest of this century.

Between 2010 and 2099, climate change will cause an additional 22,000 murders, 180,000 cases of rape, 1.2 million aggravated assaults, 2.3 million simple assaults, 260,000 robberies, 1.3 million burglaries, 2.2 million cases of larceny, and 580,000 cases of vehicle theft in the United States.

Hey, it's peer reviewed so it must be true, right?

Unfortunately I rather doubt that it is true. Looking at an earlier version of the same paper gives me the reason why.

However, there is no obvious cross-sectional relationship between the temperature zones and crime rates.

So let's just walk through what has been done here. There's a well known connection between temperature and crime rates. Warmer summer evenings lead to more boys out on the stoop with their beers and that mixture of boys and beer does indeed lead to more public crime. Gary Becker has written extensively on this very subject. So, great, we might then assume that if the world gets warmer then there will be more crime: just as we see when temperatures rise today.

However, this is an error: humans don't actually act that way as anyone who has moved from one climactic region to another will know. We adapt very quickly indeed to local conditions. Yes, sure, warm weather for the region leads to more beer stooping. But it is the variation in that local weather that leads to it, not the temperature itself. What might lead to outepils (as the Norwegians put it, outdoor beers,) in Moscow will be a very different temperature from one that will lead to the same in the Algarve as I know from personal experience. A temperature in the latter that will have me in three layers of clothing by the wood fire would in the former have me near naked and worshipping this strange yellow thing in the sky.

It isn't absolute temperature that counts here, it's the variance of temperature in a location. As the paper itself tells us, when it points out that there's no relationship between average temperature in a place and the crime level. It's when things are hotter than normal in a location that crime rises. So, if all temperatures rise over a century then we get the same variance and it is as if everyone has moved south a few tens of miles. And as there's no relationship between moving south a few tens of miles and the crime rate we cannot expect climate change to increase said crime rate.

So, I'm afraid that I think the prediction will fail. Nicely done paper and all that but missing that one crucial point I fear.

And now to be seriously speculative. We here in Central Europe (I've been working all winter just a few hundred miles from the Ukraine) have been having a very warm winter indeed. The jet stream has meant that the weather meant for here has been arriving in the Southern US and vice versa. They get the ice storms and we don't get what we consider to be a proper winter at all. And have a look at the pictures from Maidan Square. There's nary a sign of snow. And there is a good reason why the response of an experienced cop dealing with a riot to the question "What help would you like?" is "A really decent rain or snow storm. Possibly both".

I agree this is indeed very speculative but I do think that Yanukovich would have had a better time of it in a more normal winter.

I'm not sure I agree with Gregory Clark on social mobility

Gregory Clark (who you should remember from the excellent "A Farewell to Alms") has some new research out looking at the historic rates of social mobility. A good summation of that is here, in the NY Times. Worth reading that but the short version is that social mobility has been very low across societies and history. The current day is not real change from those historical numbers.

It's not quite clogs to clogs in three generations, more like that in three centuries.

However, while I accept the result that he's found and also think it most interesting, I'm not absolutely sure that it's entirely right. The problem, to my mind, comes from the method he's used to work all of this out.

He looks at surnames, marks out certain surnames at certain points in time as being markers of either upper or lower class, then looks at how those markers change over time. Do formerly lower class names move up into the upper classes? Do upper class names decline in social place? The answer is yes but it takes time, those centuries.

Any number of possible explanations come to mind: family networks, genetics, inheritance of goods and opportunity. But the one thing that I worry about here is that the study of surnames is by definition the study of male lineage. And that strikes me as a problem.

For example, Middleton, under Clark's system, is not going to be recorded as one of those names that made the leap from middle class to royalty. Nor, as has happened in the past, those of the meteoric rise of Amy Lyon or Nell Gwynn. Yes, OK, those are exceptions (and I am not placing the former Ms. Middleton in the same class as the two grande horizontales) but I have a feeling that it's not quite that much of an exception.

I have a feeling, but cannot prove and have no idea how you would prove, that social mobility through marriage is something rather more common in women than it is in men. Thus by looking solely at surnames Clark is underestimating that social mobility. Capturing it accurately for men but perhaps not for women: or rather, capturing it accurately for the descendants of men but not for the descendants of women.

As I've been saying for some time now, measurement is important

As above, I've been shouting for some time now that measurement is an important problem in our economy. More specifically, many of the things that we are told are problems seem to fade away once we actually measure what is going on properly. For example, the gender pay gap, when we rummage through the numbers, turns out to be actually a motherhood pay gap. Perhaps this is still a problem but it's most certainly a very different one from simple discrimination upon the grounds of gender. We're told that health inequality in this country is down to income inequality: and those presenting the measurements entirely refuse to acknowledge that it is more complex, for health inequality itself can lead to income inequality. Similarly, we're told that income inequality in the UK is absurdly high: without anyone being willing to adjust for the different cost of living in different parts of the country and thus measure the only thing we might even possibly care about, consumption inequality.

The details of what we measure and how matter deeply. Which is what makes this little broadside from The Economist so interesting:

BRITISH businesses have always underinvested, haven’t they? Experts from Michael Porter to Michael Heseltine to Will Hutton all agree. The idea is so old and so widespread as to be received wisdom.

Seeing Will Hutton described as an expert is painful but yes, they do all say that.

But is this truism really true? Over the last decade, researchers have gradually reached a surprising conclusion: when you take into account intangible investments, such as software development, product design and training, British businesses aren’t investment laggards after all.

OK, that is interesting.

The UK turns out to be one of the leading investors in non-R&D intangible assets: things like product and service design, organisational investment and branding and marketing. This is perhaps unsurprising given the size of its services sectors: service industries typically invest more in other intangibles than on physical capital or R&D.

And while that is also interesting it is not, as they say, surprising.

So let us strip this back to basics. The country with perhaps the largest services sector of any economy anywhere (absent various microstates) invests more in the sort of intangibles that services require and less in the sorts of tangibles that not-services require. We don't need to even consider cause and effect here to see that this is a pretty trite observation.

Which brings us to a non-trite one. Those very people (Heseltine and Hutton especially) who insist that we must indeed plan our economy, with the aid of both accurate information and the wisdom of their good selves, are entirely ignorant of this important fact. The UK does not invest less in business than other countries do. Rather, it invests in a manner consistent with the industrial base that it has.

Which brings me back to measurement being important. If those who would manage us are ignorant of the facts then we're not going to be well managed, are we?

Or, as we might put it, Will Hutton just ain't an expert, is he?

Unemployment pay increases unemployment

One of the sadder things I've seen over the past few years has come from a coterie of left leaning US economists. They have been insisting that the extension of unemployment benefits (usually in the US they are only payable for 26 weeks, it was extended to 99) has had no effect on the unemployment rate. This is of course untrue:

Extending the maximum length of benefits beyond 26 weeks made highly educated unemployed people “more ‘relaxed’ and more patient in selecting jobs,” wrote Lei Fang and Jun Nie in a new working paper, “Human Capital Dynamics and the U.S. Labor Market.” Had unemployment benefits not been extended, they estimated, “the unemployment rate during the 2010-2012 period would have been 0.5 percentage point lower than the actual level.”

The full paper is here.

The high U.S. unemployment rate after the Great Recession is usually considered to be a result of changes in factors influencing either the demand side or the supply side of the labor market. However, no matter what factors have caused the changes in the unemployment rate, these factors should have influenced workers’ and firms’ decisions. Therefore, it is important to take into account workers’ endogenous responses to changes in various factors when seeking to understand how these factors affect the unemployment rate. To address this issue, we estimate a Mortensen-Pissarides style of labor-market matching model with endogenous separation decisions and stochastic changes in workers’ human capital. We study how agents’ endogenous choices vary with changes in the exogenous shocks and changes in labor-market policy in the context of human capital dynamics. We reach four main findings. First, once workers have accounted for and are able to optimally respond to possible human capital loss, the unemployment rate in an economy with human capital loss during unemployment will not be higher than in an economy with no human capital loss. The reason is that the increase in the unemployment rate led by human capital loss is more than offset by workers’ endogenous responses to prevent them from being unemployed. Second, human capital accumulation on the job is more important than human capital loss during unemployment for both the unemployment rate and output. Third, workers’ endogenous separation rates will decline when job-finding rates fall. Fourth, taking into account the endogenous responses, unemployment insurance extensions contributed 0.5 percentage point to the increase in the aggregate unemployment rate in the 2008–12 period.

There really shouldn't be any surprise at all about this as Richard Layard has been pointing out for decades now:

There is ample evidence that unemployment (and employment) is affected by how the unemployed are treated. Other things equal, countries that offer unemployment benefits of long duration have more unemployment (and less employment). This is because employment depends on the effective supply of labour.

Extending the period of time for which unemployment benefits are paid is quite obviously going to increase the amount of unemployment that there is.

This does not, in any manner, mean that those benefits should not have been extended. It's entirely possible, for example, to claim that the pain and grief prevented by the extension is greater than that caused by that uptick in the unemployment rate caused by it. It's possible to make the opposite argument as well and your conclusion should at least depend upon a combination of your priors and the evidence put in front of you.

But my complaint is that that certain set of economists has been ludly proclaiming to the world that the extension cannot increase unemployment. Therefore no one has been working with the correct facts about the problem under discussion. And I'm afraid that I regard that as more than a little sad. Yes, I know, I'm just showing how naive I am even at my advanced age: but I really would prefer it that professional knowledge was deployed as professional knowledge, not twisted to feed the rabble in politics.