There is a growing consensus amongst the political parties in the UK that something needs to be done to end the huge pay rises of senior executives. According to the High Pay Commission, directors of FTSE 100 companies saw their remuneration packages rise by 49% in 2010. Average private-sector employees’ pay, by contrast, rose by a mere 2.7% (below the CPI rate of inflation for 2010 of 3.3% and well below the RPI inflation rate of 4.6%), with many people’s wages remaining frozen, especially in the public sector. (See Directing directors’ pay.) In 1979 the top 0.1% took home 1.3% of GDP; today the figure is 7%.
But agreeing that something needs to be done, does not mean that the parties agree on what to do. The Prime Minister, reflecting the views of Conservative ministers, has called for binding shareholder votes on top executives’ pay. The Liberal Democrats go further and are urging remuneration committees to be opened up to independent figures who would guard against the cosy arrangement whereby company heads set each other’s pay. The Labour Party is calling for worker representation on remuneration committees, simplifying remuneration packages into salary and just one performance-related element, and publishing tables of how much more bosses earn than various other groups of employees in the company.
So what measures are likely to be the most successful in reining in executive pay and what are the drawbacks of each measure? The following articles consider the problem and the proposals.
Articles
Parties draw up battle lines over excessive executive pay Guardian, Patrick Wintour and Nicholas Watt (9/1/12)
David Cameron’s plans for executive pay may not end spiralling bonuses Guardian, Jill Treanor (8/1/12)
Executive pay: what would Margaret Thatcher have done? Guardian Politics Blog, Michael White (9/1/12)
Businesses tell the PM he’s wrong about ‘fat cat’ pay Independent, Nigel Morris (9/1/12)
Directors’ pay is not the Government’s business The Telegraph, Telegraph View (9/1/12)
I’ll end merry go round of bosses’ pay, says David Cameron Scotsman (9/1/12)
Find a place at the table for public interest directors Scotsman, leader (9/1/12)
Cameron vows executive pay crackdown Financial Times, George Parker (9/1/12)
Q&A: Voting on executive pay BBC News (8/1/12)
Will shareholders crack down on executive pay? BBC News, Robert Peston (8/1/12)
Why didn’t investors stop high executive pay? BBC News, Robert Peston (9/1/12)
Report
Cheques With Balances: why tackling high pay is in the national interest Final report of the High Pay Commission (22/11/11)
Questions
- Why has the remuneration of top executives risen so much faster than average pay?
- What market failures are there in the determination of executive pay?
- What insights can the theory of oligopoly give into the determination of executive pay?
- Compare the proposals of the three main parties in the UK for tackling excessive executive pay?
- To what extent is it in the interests of shareholders to curb executive pay?
- Why may it be difficult to measure the marginal productivity of senior executives?
- To what extent would greater transparency about pay awards help to curb their size?
- What moral hazards are involved in giving large increases in remuneration to senior executives?
Throughout the credit crunch and since then, one of the major problems in the global economy has been a lack of lending by banks. A key cause of the credit crunch and many of the debt problems countries and people face today is because of people living off borrowed money. In the past, credit was so easy to obtain – people could receive a mortgage for more than 100% of the value of their property. However, when more and more people began to struggle to make their monthly mortgage repayments, the banking crisis began and since then mortgage lenders have become increasingly wary about who they lend to and how much.
The Bank of England has said that in the coming months it will become even harder to obtain mortgages, as banks become increasingly wary about who becomes their customer and potential home buyers put off even applying for a mortgage. Although mortgage approvals are at a 2-year high, they still remain significantly below their pre-crisis level. Indeed, the Bank of England said:
“Lenders expected the proportion of total loan applications being approved to fall over the coming quarter with some lenders commenting that they had revised down expectations for households’ disposable incomes and hence the affordability of taking out new secured loans.”
As part of this new rationing of mortgages, lenders are requiring applicants to put down larger and larger deposits and so for first time buyers, getting on to the property ladder is becoming more and more of a dream. The property market has been suffering from this mortgage rationing as house sales are down below their pre-crisis level. The housing market is crucial to any economy, as so many other sectors and hence jobs depend on it. If mortgages remain scarce and the required deposit so high, the UK housing market is likely to remain stagnant and this will certainly prove damaging for the prospects of the UK economy in 2012.
Articles
Mortgage approvals hit new two-year high The Telegraph, Angela Monaghan (4/1/12)
Mortgage approvals up but overall lending weak Reuters (4/11/12)
Mortgage rationing becomes worse, Bank of England says BBC News (5/1/12)
Mortgage demand fell in Q4 2011, say lenders Mortgage Strategy, Tessa Norman (5/11/12)
Mortgage lending still stagnant, Bank figures show BBC News (4/11/12)
BoE: Lending to be tighter in Q1 2012 Mortgage Introducer, Yuan Phoon (5/11/12)
Data
Lending to Individuals Bank of England
Questions
- Why are mortgages being rationed?
- Why is the housing market so important for the UK economy?
- Which other sectors of the economy employ people whose jobs are dependent on a buoyant housing market?
- Why has the Bank of England said that in the coming months it will become harder to get a mortgage?
- Why would increased mortgage lending be a much needed stimulus for the UK economy?
- Using an aggregate demand and aggregate supply diagram, show how rationing of mortgages and other loans will affect the UK economy.
The history of macroeconomic thought has been one of lively debate between different schools.
First there is debate between those who favour active government intervention (Keynesians) to manage aggregate demand and those who favour a rules-based approach of targeting some variable, such as the money supply (as advocated by monetarists) or the rate of inflation (as pursued by many central banks), or a hybrid rule, such as a Taylor rule that takes into account a weighted target of inflation and real output growth.
Second there is debate about the relative effectiveness of monetary and fiscal policy. Monetarists argue that monetary policy is relatively effective in determining aggregate demand, which in turn affects output in the short run but only prices in the long run. Keynesians argue that monetary policy can be weak in the short run if the economy is in recession. Quantitative easing may simply be accompanied by a decline in the velocity of circulation. It’s not enough to make more money available and keep interest rates close to zero; people must have the confidence to borrow and spend. Keynesians argue that in these circumstances fiscal policy is more effective.
Third there is the debate about the size of the state and the extent of government borrowing. Libertarians, following the views of economists such as Hayek, argue that reducing the size of the state and reducing government borrowing will create a more dynamic economy, where the private sector will expand to take up the slack created by a reduction in the size of the public sector. Their approach to policy involves a mixture of cutting deficits and market-orientated supply-side policy. Economists on the left, by contrast, argue that economic growth is best stimulated in the short term by increases in government spending and that supply-side policy needs to be interventionist, with the government investing in infrastructure, research and development, education and health. Such growth policies, they argue can be targeted on the poor and help to arrest the growing inequality in society.
These debates have been given added impetus by the global financial crisis in 2008 and the subsequent recession, slow recovery and possibility of a slide back into recession. The initial response of governments and central banks was to stimulate aggregate demand. Through combinations of expansionary fiscal policy, interest rates cut to virtually zero and programmes of quantitative easing, the world seemed set on a course for recovery. But one result of the policies was a massive expansion in government deficits and debt. This led to increasing criticisms from the right, and a move away from expansionary to austerity fiscal policies in order to contain debts that were increasingly being seen as unsustainable. And all the while the debates have raged.
The following podcast and articles look at the debates and how they have evolved. The picture painted is a more subtle and nuanced one than a stark ‘Keynes versus Hayek’, or ‘Keynesians versus monetarists’.
Podcast
Keynes v Hayek: The debate continues BBC Today Programme, Nicholas Wapshott and Paul Ormerod (23/12/11)
Articles
Von Hayek Revisited – Warts and All CounterPunch, David Warsh (26/12/11)
Fed up with Bernanke Reuters, Nicholas Wapshott (20/12/11)
Paul Krugman Versus Milton Friedman Seeking Alpha, ‘Shareholders Unite’ (6/12/11)
Keynes Was Right New York Times, Paul Krugman (29/12/11)
Keynes, Krugman, and Austerity National Review Online, William Voegeli (3/1/12)
The Madness of Lord Keynes The American Spectator, Samuel Gregg (19/12/11)
Central Bankers vs. Natural Stock Market Cycles in 2012 The Market Oracle, David Knox Barker (28/12/11)
Now is the time to eat, drink and be merry Financial Times, Samuel Brittan (29/12/11)
Questions
- To what extent is quantitative easing consistent with (a) Keynesian and (b) monetarist approaches to macroeconomic policy?
- What is meant by the ‘liquidity trap’ and what are its implications for monetary policy? Have we witnessed a liquidity trap since the beginning of 2009?
- What are the arguments for and against an independent central bank?
- Explain Milton Friedman’s assertion ‘that it was the Fed’s failure in 1930 to pursue “open market operations” on the scale needed that deepened the slump’.
- What are the implications of growing government deficits and debt for policies to avoid a slide back into recession?
In many parts of the UK, bus services are run by a single operator. In other parts, it is little different, with the main operator facing competition on only a very limited number of routes. Over the whole of England, Scotland and Wales there are 1245 bus operators, but the ‘big five’ (Arriva, FirstGroup, Go-Ahead, National Express and Stagecoach) carry some 70% of passengers. Generally these five companies do not compete with each other, but, instead, operate as monopolies, or near monopolies, in their own specific areas. On average, the largest operator in an urban area runs 69% of local bus services.
Given this lack of competition and potential abuse of monopoly power, the Office of Fair Trading referred local bus services in Great Briatin (excluding London) to the Competition Commission (CC) in January 2010. The CC has just published its final report. Paragraph 5 of the summary to the report states:
We concluded that there were four features of local bus markets which mean that effective head-to-head competition is uncommon and which limit the effectiveness of potential competition and new entry. These features are the existence of: high levels of concentration; barriers to entry and expansion; customer conduct in deciding which bus to catch; and operator conduct by which operators avoid competing with other operators in ‘Core Territories’ (certain parts of an operator’s network which it regards as its ‘own’ territory) leading to geographic market segregation.
And paragraph 8 states:
We decided on a package of remedies with three main elements to address the AECs [adverse effects on competition] that we found. First, the remedies include market-opening measures to reduce barriers to entry and expansion, thereby reducing market concentration and providing an environment in which competition is likely to be sustained. By reducing barriers to entry and expansion, we also expect it to become harder for operators to sustain a coordinated outcome. Second, the remedies include measures to promote competition in relation to the tendering of contracts for supported services. Third, we made recommendations about the wider policy and regulatory environment, including emphasizing compliance with and effective enforcement of competition law.
The following articles look at the findings of the report and at the potential for improving the service to passengers, in terms of quality, frequency and price.
Articles
Competition regulator outlines bus market shake-up The Telegraph (20/12/11)
Bus market not competitive, Competition Commission says BBC News (20/12/11)
Passengers ‘need more bus rivalry’ Press Association (20/12/11)
Competition Commission publications
CC sets out Future Destination for Bus Market Competition Commission News Release (20/12/11)
Bus Market Inquiry: Final Report, Case Studies and Appendices Competition Commission (20/12/11)
Local Bus Services: Accompanying Documents Competition Commission (20/12/11)
Questions
- What are the barriers to entry in the market for local bus services?
- In what circumstances are local bus services a natural monopoly? Is this generally the case?
- In a non-regulated bus market, how could established operators use predatory pricing to drive out new entrants?
- How may offering reductions for return tickets reduce competition on routes where there is a large operator and one or more smaller ones?
- What practices can established large operators use to drive out smaller competitors?
- Go through the four reasons given by the CC why head-to-head competition in local bus markets is uncommon and in each case consider what remedies could be adopted by the regulator or by local authorities.
- Which of the remedies proposed by the CC involve encouraging more competition and which involve tighter regulation?
Original post (19/9/11)
The Independent Commission on Banking (ICB), led by Sir John Vickers, has just delivered its report. Central to its remit was to investigate ways of making retail banking safer and avoid another bailout by the government, as was necessary in 2007/8.
The report recommended the ‘ringfencing’ of retail banking from the more risky investment banking, often dubbed ‘casino banking’. In other words, if the investment arm of a universal bank made a loss, or even faced collapse, this would not affect the retail arm. The ringfenced operations would include banking services to households and small businesses. Wholesale and investment banking would be outside the ringfence. As far as retail banking services to big business are concerned, these could be inside the ringfence, but details would need to be worked out about precisely which banking services to big business would be inside and which would be outside the ringfence.
The ICB was keen to stress that the ringfence should be high and that the retail arm should be both operationally and legally separate from the wholesale/investment arm. The ringfenced part of the bank should have a capital adequacy ratio of up to 20% (above the Basel III recommendations), with at least 10% of liabilities in the form of equity. Capital could only be moved from the ringfenced arm to the investment arm of the bank if this did not breach the 10% ratio.
The ICB report also recommends measures to increase competition in banking, including making it easier to switch accounts, greater transparency about the terms of accounts and a referral of the banking industry for a competition investigation in 2015. The cost to the banking industry of the measures, if fully implemented, is estimated to be between £4m and £7m.
Because of the requirement in the report for banks to build up their capital and the danger that a too rapid process here would jeopardise the expansion of lending necessary to underpin the recovery, banks would be given until 2019 to complete the recommendations. Moves towards this, however, would need to start soon.
Update (19/12/11)
In December 2011, the government announced that it would accept most of the ICB report, including separating retail and investment banking. It would not, however, demand such stringent capital requirements as those recommended in the report.
The following articles examine the details of the proposals and their likely effectiveness. The later articles examine the government’s response.
Original articles (some with videos)
Audio podcasts
ICB report and press conference
Later articles and webcasts
Questions
- Explain the difference between a capital adequacy ratio and a liquidity ratio. Will the Vickers proposals help to increase the liquidity of the retail banking arm of universal banks?
- Does it matter if equity capital in excess of the 10% requirement for retail banking is transferred to a bank’s investment arm?
- What risks are there for a bank in retail banking?
- What are the advantages and disadvantages of bringing in the measures gradually over an 8-year period?
- Does it matter that the capital adequacy requirements are higher than under the internationally accepted standards in Basel III?
- Assume that there is another global financial crisis. Will the proposals in the report mean that the UK taxpayer will not have to provide a bailout?