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Friday, October 01, 2010

Regulation and reward

This post is stimulated by an exchange on twitter as to why we are bothered about bankers being paid stacks, whilst seemingly less worried about football players and entertainers being paid similar amounts. This post fails to address that specific question.

Banks are rich because they handle money and take a little charge at each transaction, also they rent out money which attracts few overheads. Footballers and entertainers are rich because wealthy organisations realise that to sell a football team or a film requires a star. Doctors and lawyers are rich because they have rare skills that people are willing to pay well for, the costs of poor legal advice or poor medical advice are loss of wealth or life, respectively, and their lack becomes rapidly obvious.

Pay does not measure a person’s value. Pay measures how much money an employer believes an employee is worth to them, if the employer is also the employee this judgement may be flawed. In some cases this is easy to determine, in other cases it is not. If I look at the company I work in, higher salary goes with greater responsibility for people and greater budgets. In the case of patent attorneys, who are relatively well paid, then it goes with a marketable skill. Scientists doing science are paid acceptably, the company is clear that they are not paid more because there are not local jobs for scientists which pay better.

We’ve recently gone through repeated rounds of “How much are  you paid compared to the Prime Minister”, exclusively directed at other public sector workers. This is ridiculous. It’s usually inaccurate as well: the typical figure quoted for the Prime Ministers salary is £142,500; however he will also receive an MP’s salary of £65,738. In addition to this he has use of an apartment in central London at Number 10 and a country house, Chequers. As Tony Blair has demonstrated, the Prime Minister can also expect substantial financial rewards on leaving the position, through speaking fees, directorships and so forth that are based largely on their position of former prime minister (see here and here). The Prime Minister is also entitled to receive half of his salary as pension after he has left office, although Gordon Brown waived this payment.

People make the money they can under the situations they find themselves. I’m sure we’ll all argue that that’s not we’d do personally but let’s assume that we’re all special. Do you own up if you’re under-charged or you receive more change than you deserve or if the electrician offers you a lower price for cash? Viewed in this light the MP’s expenses scandal is nothing unexceptional. Looking at what they were up to I can easily imagine that we’d find exactly the same distribution of abuses if the expenses scheme where I work were regulated in the same way. A whole bunch of people would claim to the limit in an entirely “legal” way; a few would claim less through incompetence in milking the system and a few would act in ways that were basically fraudulent.

What’s the message of this post?

In terms of regulation: don’t rely on the goodwill of man to obtain a favourable societal outcome. Although that might work for some chunk of the population it won’t for a substantial fraction and so the scheme will fail.


twaza (@wassabeee on twitter) said...

Ian, you have explained very nicely why financial reward does not (and cannot) reflect merit.

However, as I hinted but could not explain on twitter, I do think that there is an important difference between football and banking.

If a football manager bet all the club's assets, and more, on buying players who all turned out to be duds, the club would be allowed to fold, go under, be bankrupted. The players, managers, coaches, and board would all be seeking alternative employment, probably in alternative occupations.

However, banks that bet the country on dud investments aren't allowed to fold, go under, be bankrupted. Instead, the taxpayer and economy in general pick up the bill. In rescuing the banks the government pumps a LOT of money into the economy. The banks involved in quantitative easing charge a lot for their services.

So, bankers get rewarded for running their companies and countries into the ground. They then get rewarded again for the part they play in quantitative easing. And the banks would never dream of paying for the limitless insurance that the country gives them.

Bankers are the prime example of where "reward reflects risk" should be read ironically - bankers are rewarded for letting other people take the risk.

SomeBeans said...

@twaza your comment treats the banks as a monolith, which they aren't. In the US many banks have been allowed to go under including Lehmanns. In the UK the tax payer owns a substantial chunk of Northern Rock (who in some senses was not one of the casino style banks, and could be seen as a good employer in the NE).

I think I wrote this because it seems to me a lot of bile is directed at the banks, and a belief that somehow they have it in their power to make everything better. Whilst I see them as acting as dumb animals according to their nature.