Category: Economics 10e: Ch 10

The large bonuses received by bankers, often amounting to more than a million pounds, have been contentious for many years. With the banking crisis and subsequent recession, and with both public and government outrage at the size of the bonuses, many thought that the days of such bonuses were over. But such is not the case. “There has been public disquiet that leading banks – which have been seen as a major cause of the financial crisis – have been receiving taxpayer funds, but are not prepared to change their traditional culture of awarding big bonuses to key staff.”

The following articles look at what has been happening to senior bankers’ remuneration in recent months. But what are the market conditions that allow such rewards to continue? Are they a reflection of the marginal productivity of bankers or of their market power, or what?

RBS to keep paying bonuses despite 1bn first-half loss Telegraph (7/8/09)
Lloyds chief plans bonuses for ‘spectacular job’ in making £4bn loss Telegraph (6/8/09)
CS toxic bonuses are up 17%, but gains can’t be realised for four years eFinancial Careers (7/8/09)
Banks: Look, don’t touch Guardian (8/8/09)
Analysis: The plan’s the thing Times Online (7/8/09)
Cutting our bonuses would hit the taxpayer, says RBS Citywire (7/8/09)
France targets bankers’ bonuses BBC News (7/8/09)
Sarkozy weighs into debate over banker bonuses after BNP Paribas compensation sparks anger Los Angeles Times (7/8/09)
Knotting the purse-strings The Economist (6/8/09)
Pay and politics The Economist (6/8/09)

Questions

  1. Explain why many senior bankers have continued to receive huge bonuses. To what extent is oligopoly theory relevant to your explanation?
  2. To what extent do the size of the bonuses reflect senior bankers’ contributions to (a) the productivity and (b) the profits of their bank?
  3. If bankers are to be paid bonuses, what is the best form for these bonuses to take? Consider the incentive effects in your answer.
  4. Should bankers’ bonuses be regulated and, if so, what criteria should regulators use for determining the acceptable size of bonuses?

Whilst some economists predicted the banking crisis of 2007/8 and the subsequent global recession, many did not. Was this a failure of macroeconomics, or at least of certain macroeconomic schools of thought, such as New Classical economics? Or was it a failure to apply the subject with sufficient wisdom? Should the subject be radically rethought, or can it simply be amended to take into account aspects of behavioural economics and a better understanding of systemic risk?

The four linked articles below from The Economist look at the debate and at the whole state of macroeconomics. The other articles pick up some of the issues.

Will the ‘crisis in macroeconomics’ lead to a stronger subject, more able to explain economies in crisis and not just when they are working well? Will a new consensus emerge or will economists remain divided, not only about the correct analysis of how economies work at a macro level, but also about how to tackle crises such as the present recession?

What went wrong with economics The Economist (16/7/09)
The other-worldly philosophers The Economist (16/7/09)
Efficiency and beyond The Economist (16/7/09)
In defence of the dismal science The Economist (6/8/09)
How to rebuild a shamed subject Financial Times (5/8/09)
What is the point of economists? Financial Times – Arena (28/7/09)
Macroeconomic Models Wall Street Pit (23/7/09)
Macroeconomics: Economics is in crisis – it is time for a profound revamp Business Day (27/7/09)

Questions

  1. Distinguish between ‘freshwater’, ‘saltwater’ and ‘brackish’ macroeconomics.
  2. Explain why economists differ over the efficacy of fiscal policy in times of recession. To what extent does the debate hinge on the size of the multiplier?
  3. Why is the potential for macroeconomics higher now than prior to the recession?
  4. What is meant by the ‘efficient market hypothesis’? How did inefficiencies in financial markets contribute to the banking crisis and recession?
  5. Should economists predict the future, or should they confine themselves to explaining the present and past?

When anyone buys assets – shares, a house, a car or whatever – one important consideration is their likely future value. But the future is uncertain. Your decision to buy, therefore, depends not just on the direct return of the asset (the rate of interest or the pleasure from using the asset) but also on your predictions about the future value of the asset and your attitudes to risk. But with the future of markets so uncertain, or at least the timing of market movements, what’s the best thing to do? The article below considers some of the issues.

The irrelevant future Investors Chronicle (6/4/09)

Questions

  1. Distinguish between ‘risk’ and ‘uncertainty’.
  2. What is meant by a ‘bear’ in the context of investing in shares? Explain why ‘intelligent bears’ would ‘leave some money in the market’.
  3. Faced with uncertainty, why might sticking to a simple ‘do nothing’ rule be the best policy?
  4. If capital markets were efficient in the strongest sense, where everyone has perfect information about the future, would people be able to make large returns on investing in shares and other assets?

The first linked article below is from the American business magazine Forbes. It looks at the economics of football (‘soccer’) signings and, in particular, that of Robinho by Manchester City. In September 2008 the club was bought by an Abu Dhabi investment fund, controlled by Sheikh Mansour bin Zayed Al Nahyan, for £210 million. But does the investment in new players make good business sense?

Also, what should determine whether a club sells a player? The third link below considers this issue. The link is to the Embedding Threshold Concepts (ETC) site at Staffordshire University. ETC was funded by the Higher Education Funding Council for England’s Fund for the Development of Teaching and Learning (FDTL). The site has a number of teaching and learning resources.

City of Dreams Forbes (8/4/09)
Man City beat Chelsea to Robinho BBC Sport (1/9/08)
Selling footballers: the economic viewpoint ETC reflective exercise

Questions

  1. Was it consistent with the goal of profit maximisation for Manchester City pay Real Madrid £32.5 million for Robinho? Was it consistent with the goal of profit maximisation for Real Madrid to sell him?
  2. If Real Madrid had decided to keep Robinho, how would you estimate the cost of doing so?
  3. What difficulties are there in developing Manchester City into a ‘global brand’?
  4. In what sense are the top Premier League clubs a ‘self-perpetuating oligopoly’?

Since Labour has been in power the gap between rich and poor has remained more or less unchanged – a fact that might be surprising given a Labour government and fiscal policies that have become increasingly redistributive in nature. In fact income distribution in the UK has not changed since 1991 according to Office for National Statistics figures. Economists measure income distribution in various ways, but two of the key indicators are the Gini coefficient and the Lorenz curve. For more information on income distribution and some useful data, you may like to download an income data spreadsheet from the IFS (zip file). If you are interested in where you fit into the income scale, then you may also like to try the Institute for Fiscal Studies interactive income model. Why not try a range of different scenarios to see where different levels of income fit into the overall income scale.

UK income gap ‘same as in 1991’ BBC News Online (16/12/08)

Questions

  1. Define the terms (a) Gini coefficient and (b) Lorenz curve.
  2. Using diagrams as appropriate, show how the Lorenz curve will change when income distribution becomes (a) more equal and (b) less equal.
  3. Explain how the value of the Gini coefficient will change as income distribution gets more equal. With reference to the IFS spreadsheet (linked to above) descibe how the Gini coefficient has changed in recent years.
  4. Discuss reasons why income distibution in the UK has stayed the same since 1991 despite a series of redistributive measures adopted by the Labour government since 1997.