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The paradox of thrift and bankers' bonuses

Over the last decade, pay at the top of the UK’s largest listed companies ballooned up to £4.2 on average on average for FTSE 100 chief executives from £1 m between 1998 and 2010, while salaries for workers barely kept place with inflation. Jeremy Bentham (1748-1832) had a huge impact on the world of philosophy, proposing utilitarian value as, ‘the greatest happiness for the greatest number of people works well as a way of doing justice’. This encapsulates why so many members of the general public appear to have a fundamental problem with excessive bonuses for bankers. Whilst people on the left politics-wise do not necessary deny the contribution of bankers to ‘wealth creation’ of the UK economy, many such citizens resent that they appear, along with Premier League footballers, to have levels of pay which represent an excessive contribution to the social value of society. The utilitarian could in fact stress that growth, wealth and GDP contribute much to the happiness of all. These depend upon a functioning banking system. Likewise, banks, in turn, need investment bankers to turn a profit. If those bankers are best incentivised by the promise of large bonuses, then so be it. Indirectly, that makes everyone happier.

Earlier this year, Downing Street appeared to concede defeat in its battle to stop banks paying huge bonuses to their staff; dictating the size of individual bankers’ payments or overall bonus pools was not possible. Instead bank bosses and ministers tried to thrash out a deal that would publicise details of payouts that could reach £7billion this year. The climbdown on bonuses has been a huge embarrassment for Government ministers who had threatened much tougher measures.  The impression conveyed in the UK media that bankers have not been adversely affected by #gfc, and indeed some feel that the bankers have profited. This has been against a whirlpool of accusations and counter-accusations that the taxation policy has been indeed been ‘regressive’. Whilst politicians and economists have latterly been at each other’s necks, both are aware that there is enormous voting capital in ‘getting this right’. Equally in the USA the Obama administration have immersed themselves in a populist attack on wealthy US citizens including corporations.

Rumbling along in the background is a subplot ignited by John Maynard Keynes, an outstanding Cambridge academic, and a Liberal. There has been much discussion about whether Vince Cable, a Cambridge graduate, and a Liberal Democrat, follows in the tradition of Keynes, to some extent fuelled by Cable himelf. Robert Skidelsky, Keynes’ official biographer, has made his concerns patently clear. Cable has extensively studied Keynes for his Doctoral studies. Perhaps playing to the Keynesians last week at the Liberal Democrats’ 2011 Summer Conference, Cable opined that, “Keynes talked about a ‘paradox of thrift’; everyone and every country being individually wise but collectively foolish – leading to a downward spiral”.













The paradox of thrift is a very famous paradox of economics, popularized by John Maynard Keynes, though it had been stated as early as 1714 in The Fable of the Bees, and similar sentiments date to antiquity. The paradox states that if everyone tries to save more money during times of recession, then aggregate demand will fall and will in turn lower total “savings” in the population because of the decrease in consumption and economic growth. However, there have many inward attacks of Keynes’ well-known paradox, not least because of the unwitting conflation of the terms “capital” and “savings”. It is mooted that the classical theory of growth in macroeconomic did not presume that every saver was the ultimate investor of goods, especially in relation to the earlier work of another great economist, Ricardo. Economists have recently been quick to point out that Keynes uses the term “savings” to embrace a ‘hoarding behaviour’, which leads Keynes to his direct proposition of a ‘paradox of poverty in the midst of plenty’. Again, there is a problem with definition, as bankers bonuses might constitute ‘plenty’, but not the growth in the UK economy called ‘pitiful’ by Prof. David Blanchflower, himself a pupil of Keynes.

Should the alleged ‘excessive profits of bankers’ be clawed back by the State for its benefit? David Ricardo is credited with the first clear and comprehensive analysis of differential land rent and the associated economic relationships (Law of Rent). In schools of economic thought including neoclassical economics, land is recognized as an inelastic factor of production. Rent is the distribution paid to freeholders for “allowing” production on the land they control. Of course, corn and money, and farmers and bankers, are not necessarily synonymous.

“As soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they never sowed, and demand a rent even for its natural produce. The wood of the forest, the grass of the field, and all the natural fruits of the earth, which, when land was in common, cost the labourer only the trouble of gathering them, come, even to him, to have an additional price fixed upon them. He must then pay for the licence to gather them; and must give up to the landlord a portion of what his labour either collects or produces. This portion, or, what comes to the same thing, the price of this portion, constitutes the rent of land ..”









There has been a wider issue about whether the ‘differential theory of rent’ is due to strong emotions concerning ‘private property’, but prominent liberals such as JS Mill have proven words and deeds on the issue, through for example  the Land Tenure Act. Adopting a populist stance has always been easy for Vince Cable, and most Liberal Democrats heavily tout that St Vince The Cable was apparently one of the first to predict the banking crisis (as indeed objectively evidenced in Hansard). Whilst a synthesis of the economics is undoubtedly interesting to economist, both new and old, people will want to know what Cable can do about it. The answer is ‘not much’, as the FSA’s code on renumeration is considered ‘good practice’ (but relatively ‘toothless’). Cable wishes also to address the ‘disconnect’ between the excessive pay of top Directors and the performance of these companies, where Cable feels that a schism has developed. Many believe that many senior bankers seem virtually unsackable, which makes an analysis of what level of pay is appropriate for bankers from the “wage curve”. Blanchflower and Oswald (1994) how the existence of a wage curve for a dozen countries, defining the wage curve thus: “A worker who is employed In an area of high unemployment earns le than an identical individual who works in a region of low joblessness”. It would be interesting to know what the views of 31-year old trader, Kweku Adoboli, are towards that. Or indeed, what Oswald Grübel thinks: according to the Wall Street Journal this morning, “Oswald Grübel resigned as chief executive of embattled Swiss bank UBS AG in the wake of a trading loss that cost the bank more than $2 billion and now has cut short the career of a giant of Switzerland’s business community.






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