Bosses, power & ideology

Fraser Nelson attempts to defend the 1%. I have problems with this. He writes:

If a banker could be found to make RBS so successful that it could be sold at a £20 billion profit for the taxpayer, would they be begrudged, say, a £20 million pay-packet?

This begs the question, in the proper sense of the phrase. In practice, it is impossible to find such a banker. The belief to the contrary reflects several cognitive biases and ideological positions, such as:

 - An underweighting of Hayek's scepticism about the possibility of managing complex organizations in which knowledge is inherently dispersed:

 - An ignorance of the role of organizational capital. Boris Groysberg has shown (pdf) that managerial "talent" is not portable. What determines the success of a hire is not the individual's skill, but rather the match between his skill and experience and the organization's needs.

 - An underweighting of environmental factors, one of which is luck. For example, the best hope of RBS's share price rising is that not so much that good management turns the company around but rather that investors become more risk-tolerant and the risk of a financial crisis recedes, so that its share price rises. This point widens. The market can occasionally sustain poorly-run companies, at leat for long enough for their CEOs to take out millions.

In this sense, demand for managers - and hence their pay - is inflated by the fundamental attribution error and pot hoc ergo propter hoc fallacy which combine to create a faith in "strong leaders" who can transform organizations. And as padeophile priests know, if people have faith in you, you can get away with anything. Bosses can therefore extort millions for mediocre or even disastrous performance.

Fraser's question-begging continues:

Had Fred Goodwin’s mania at RBS been spotted earlier and he had been paid £2 million to go quietly, it would have been money well spent.

But it wasn't spotted. And there's a reason why it wasn't. Management skill is not like sporting or musical skill; it cannot be observed directly by outsiders. We have therefore a problem of asymmetric information. This too gives bosses power, especially as it is combined with the aforementioned biases. And money flows to power.

The market for managers, therefore, is one that's rigged by ideology and information failure. 

But does this matter? After all, the market sometimes rewards mediocre musicians or writers so why should we worry if it rewards bad bosses?

One reason is that bosses don't just get money but power, as politicians and the media defer to them. Another reason is that faith in leaders has an enervating effect. If we're looking to leaders (in business or politics), we are apt to lose the ability to take control of our own affairs; this is the converse of Tocqueville's point, that the virtue of democracy is that it "spreads throughout the body social a restless activity, superabundant force, and energy never found elsewhere."

Now, you might think I'm making leftist points here. I'm not sure. For one thing, New Labour was cringeingly deferential towards bosses. And for another, many rightists should, in principle, support what I say. Hayekians should be sceptical of central organization; no rightist should support market failures; and boss culture militates against good Thatcherite virtues of self-reliance. Why then, should the right be so supportive of bosses? It surely can't be because they simply want to defend inequality, can it?

Another thing: I wish Fraser wouldn't repeat that silly trope about to the top 1% paying so much income tax. If inequality is high enough, the rich can pay a disproportionate amount of tax even if the tax system is regressive.

Comments

[Anonymous]

Great stuff, Chris !

[Paul Collins]

What a load of cobblers.

"If inequality is high enough, the rich can pay a disproportionate amount of tax even if the tax system is regressive"

Or the "rich" could just up-sticks and move to a country that isn't run by complete vindictive idiots.

Please define "If inequality is high enough". Is it if people are starving on the streets and we have a few people that make Bill Gates seem poor? Is it if "the rich" all have a nice home and "the poor" don't get to live in Belgravia?

Your comments about capital, management and skill transfer show that you couldn't run a whelk stall.

[Chris E]

Paul -

Your seeming ignorance of basic ratios makes me wonder what sort of whelk stall you run.

"If inequality is high enough, the rich can pay a disproportionate amount of tax even if the tax system is regressive"

To see why this could be true imagine the following, a UK in which 1% of people earn 90% of the income, and 99% earn the remaining 10%. That 1% could still pay 80% of the tax (seemingly disproportionate) and yet the tax system would be regressive (the 99% would pay a greater proportion of their income as tax than the 1%).

[Luke]

Paul, you say that Chris "couldn't run a whelk stall."

True, he probably couldn't, because he's an economics journalist. He has limited (if any) experience of the retail shellfish business, and (possibly) limited aptitude for it. A whelk stall runner on the other hand probably couldn't write articles on economics for Investors' Chronicle.

And going further, assume Chris is incapable of running a whelk stall, even after a bit of practice. That would only go to prove his point about the non-transferability of skills and the importance of organisational capital.

And why does everyone think running a whelk stall is so easy?

[james c]

Yes, Fraser Nelson is talking rubbish. He usually does, so I assume that is what his paymasters want him to do.

[roundhead]

Good point. It is simplistic to say that if individual A is present in a firm and that profits rise by £20m, this is due to the sole contribution of individual A. If one believes this, one should surely also believe that if, instead, profits should fall by that same amount, individual A should be liable to pay back £20m. If this were indeed possible, the individual would then want to take out - through the salary - an implicit insurance contract with the effect that the amount of the bonus received in good times is commensurate with the required penalty in bad times.

[dha]

The structure of corporations with anonymous shareholders who own but do not manage the company or even observe its activities in great detail is artificial.

Naturally most companies would be owned by banks that manage them directly (which is true in Germany but illegal in Britain) or by their employees as partnerships (which used to be the case for investment institutions but is no longer the case).

The limited liability corporation is a grotesque invention of statism.

[Luke]

"The structure of corporations with anonymous shareholders..."

There is a register of shareholders for UK cos. That is a public document - for a small fee, less than £10. Imperfect I'll grant, since some shares are held by nominees. But not anonymous. You may be thinking of the civil law version- societe anonyme. Exactly how anonymous they really are I don't know.

[Sue Marsh]

If a cleaner makes a hospital so safe deaths are reduced do they deserve a million pound bonus?

If a refuse collector saves us from rabies and rats and cholera, do they deserve a million pound bonus?

And on and on.....

[Neil Wilson]

The whole basis of marginalism is utter bunkum. But they have to keep defending it since it is the sole basis by which capitalism is justified in its rawest form.

We all know that certain people get more than they deserve based on their efforts, including footballers, and most people get less.

The market completely fails to distribute effectively.

[MrVeryAngry]

@NeilW
Nope. What we do not have is a 'market'. What we do have is cronyism, and that is what fails to deliver effective distribution, self evidently, as it is cronyistic. Fred Goodwin was a product of cronyism. If you want proof just look at the career of Hector Sants.

[Emergenteconomics]

Chris, this post is brilliant: crystal clarity to Nelson's woolly rhetoric.

[Keith]

Nelson could equally say that Feudal Lords must have deserved their enormous income for providing security to the peasants... it is the same reasoning. Nature may control the productivity but human customs control the distribution.

Most organisations just muddle along until some disaster strikes and forces a reorganisation. Equating rewards for bosses with merit is unconvincing Paul collins is the one who seems to lack worldly wisdom. Comforting fairy tales to bolster the over paid.

[Danny]

Good article. But I disagree with one point. I don't think the problem with Goodwin - and other bad managers - is one of asymmetric information. That would imply Goodwin knew he was hopeless but used his informational advantage to bargain for higher pay. I'm moe inclined to think that Goodwin and other (bad or good) managers believe their own publicity.

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