Does this count as socialism? Maybe it’s fascism.

Geoffrey Manne —  4 February 2009

Oh, those monikers always confuse me.  So much seems to hang on the right label. When does government intervention in the economy become so extreme that it is appropriate to label it socialist?  Here at TOTM we’ve had this discussion before.

But these labels are unhelpful–what matters is the economic effect of regulation.

Call it “toast,” or call it “eggplant,” or just call it ill-advised, but in a few minutes Obama appears ready to announce that the US government will now set salaries for bank executives.  As Thom pointed out recently, of course, the banks have brought this on themselves to some extent.  As Thom said,

Look, I agree that private firms that get in bed with the government open themselves up to all sorts of meddling in their affairs and that it’s appropriate for the government to exercise some measure of control over the firms it subsidizes.

And I agree–it’s hard to suggest that the banks’ new overlord doesn’t have the right to do whatever it wants to manage its new charges.  The problem is that with power comes responsibility, or so they say.  Just because the administration can cap bank salaries at $500,000 and prohibit severance pay doesn’t mean that it should.

The need to manage the politics here is almost certain to bungle the economics; the desire to punish and an undercurrent of class warfare is almost certain to damage what remains of the teetering financial industry.

Why would Ken Lewis settle for a $500,000 salary when he can make millions at a hedge fund? What precedent will this set not only for government meddling in executive pay in the economy more broadly (rumors of Obama’s support for mandatory say on pay are gaining strength) but governance contracts more generally? Ken Lewis may stick around for a little while because the public opprobrium of leaving Bank of America for something so crass as money will itself be costly. But the ramifications for the executive labor market generally–and for corporate governance generally–are staggering.  I’m pretty sure this isn’t socialism. Or fascism. But it’s definitely not a good idea.

My own take on some of the important implications of this is laid out in an earlier series of posts at TOTM, collected here and in my Hydraulic Theory article. Capping salaries (and some perks, as I understand it) will ensure that the water flows in a different direction.  Certainly there will be “pool effects,” as I describe in my article (the limitations on pay will attract a qualitatively different type of person to executives ranks, not necessarily for the better).  Unless all categories of perks are covered, there will also be behavioral effects (Ok, so executive jets are out, but what about nicer offices?). Has anyone thought through this? Do the pointy heads (now 50% pointier!) advising government know how to run the entire financial industry? Probably not.  It’s politics, of course, which is why I marvel whenever anyone suggests that the government can do a better job at . . . anything.  For a lot of people, the prospect of Barack Obama and Larry Summers running the world is a glorious one.  I think this is a mistake.  As impressive as they are, they are not immune to politics (and how!) and the strangling limitations of limited information.

Man, I hate eggplant.

UPDATE: It’s official: The camel’s nose–and head and body–is under the tent:

The administration also will propose long-term compensation restrictions even for companies that don’t receive government assistance, Obama said.

Those proposals include:

• Requiring top executives at financial institutions to hold stock for several years before they can cash out.

• Requiring nonbinding “say on pay” resolutions — that is, giving shareholders more say on executive compensation.

• A Treasury-sponsored conference on a long-term overhaul of executive compensation. (emphasis added)

Geoffrey Manne

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