Open borders or fair wages: the left needs to make up its mind

Posted by on March 25, 2015 in Employment, Euro-zone, GDP, Immigration, Politics, Public Policy | 0 comments

Open borders or fair wages: the left needs to make up its mind

As published in the Guardian on Tuesday 24th March 2015 as part of their ‘Economics – Immigration Special’

Mass immigration increases inequality. This is the unpalatable fact the liberal left in Britain refuses to accept. Markets are imperfect instruments. But it is not necessary to subscribe to free market economic theory to believe that large increases in supply tend to drive down the price. And the price of labour is the wage.

Last Friday, the Guardian front page carried a report from the Office for Budget Responsibility, claiming that higher net immigration increased the UK’s economic growth rate. According to the mainstream theory of economic growth, this is undoubtedly true. Higher growth can be created by sustained increases of either capital or labour.

But underlying the theory is the assumption that supply and demand balance in these markets, that the prices of the inputs are set at levels such that all available capital or labour is in fact employed and does not remain idle. So this “flourishing modern economy” with high immigration celebrated by the Guardian is based on persistent large wage inequalities.

A powerful force in the global economy is driving the increase in inequality that has been seen in western economies over the past few decades. In essence, there has been a massive increase in the effective supply of labour. Over the past three decades or so, China and India have gradually been absorbed into the network of international trade.

This puts pressure on European labour markets. Many call centres, for example, have been relocated to India. But much of the impact of this is indirect, operating via trade flows, and is only really felt by certain sectors of western economies.

Closer to home, the opening up of eastern Europe in the early 1990s has had a strong effect, especially on countries that are their immediate neighbours, such as Germany. Employers soon realised that economies such as Poland and the Czech Republic possessed educated labour forces, whose productivity potential had been suppressed by the gross inefficiencies inherent in planned economies. German companies opened up new production plants in the old Soviet bloc countries in Europe, rather than at home.

The impact on wage rates of this increase in competition was dramatic. Christian Dustmann at University College London has provided clear evidence on the evolution of wage rates in the former West Germany. The 15th percentile of the wage distribution is the level at which only 15% of wages are lower. In West Germany, at the 15th percentile, real wages have fallen almost continuously since the mid-1990s. At the 50th percentile, where half get more and half get less, the reduction has been less sharp.

But the fall had set in by the early 2000s. At the 85th percentile, the mirror image of the 15th, real wages grew strongly, reaping the benefits of the recovery of the economy created by the increase in competitiveness.

It is against this background that New Labour opened up Britain’s borders in the late 1990s. It was a major betrayal of the very people the party purported to represent.

In addition to the global competition from countries such as China, in addition to competition closer to home from the economies of eastern Europe, New Labour allowed direct competition to enter the UK labour market on a scale unprecedented in our history.

Not surprisingly, the distribution of wage rates has evolved in very similar ways to those of West Germany. It is the relatively unskilled in the bottom half of the distribution who have lost out. The liberal elite do not suffer.

Indeed, they benefit because many of the services they consume are provided at lower prices than would have been the case without mass immigration. It is sometimes argued that immigrants do jobs that native British workers are unwilling to take.

Very well then, without mass immigration, employers would be obliged to raise the real wage rate to induce these people to take the jobs.

The effects of this extend to benefit levels. With at least half the population facing at best stagnant and often falling real wages, basic political economy requires benefits to be squeezed as well. Hostility to benefits is strongest precisely in the bottom part of the wage distribution. It is political suicide to increase real benefits in this context, regardless of who is in power.

In the so-called neoclassical growth theory of economics, whether of the pre- or post-endogenous variety, by far the most important source of sustained growth is innovation. The age structure of immigration means that it does make a change to per capita economic growth, but one that is barely perceptible. Moreover, immigrants themselves age eventually, so eventually even this tiny benefit disappears.

A truly modern economy does not rely on more and more capital and labour being fuelled into the machinery of production. That was the old Soviet model.

A modern economy relies instead on innovation. This should be the focus of policy. The potential gains are huge, not marginal and ephemeral.

Do Budgets really matter?

Posted by on March 18, 2015 in Economic Policy, Economic Theory, GDP, Government Spending, Markets, Politics, Public Policy | 0 comments

Do Budgets really matter?

All eyes will be on George Osborne’s Budget today. An immense amount of media attention and serious commentary will be devoted to it. But do Budgets really matter? How much difference would it make if successive chancellors simply did nothing, apart from indexing various allowances and benefits in line with inflation?

From time immemorial, British governments of all shapes and sizes have had to present their finances to Parliament for approval. For centuries, there was a constant struggle between the monarch, who almost invariably wanted more money to pay for the court or foreign wars, and the elected representatives, who were usually unwilling to vote for the taxes such policies required.

After the Second World War, however, the annual ritual of the Budget took on a completely different character. Armed with what were then seen as the insights of Keynesianism, successive chancellors regarded the Budget as a means of announcing policies which would control the economy in the forthcoming year. Even now, Osborne will spend time discussing the short-term predictions for UK GDP growth, inflation and the like. These are now produced by the Office for Budget Responsibility rather than by the Treasury itself, but they still form an important part of the Budget speech.

To be able to make meaningful interventions in the economy and bring about better outcomes over the short term, it is absolutely necessary to have reasonably accurate forecasts. Unless you have a good idea of where the economy is going to be this time next year, you have no clue about what actions to take now to get it into a better place.

It is well-known, however, that economic forecasts are – to put it charitably – poor. Even in the United States, where the economy is more insulated from unexpected external shocks, the record is pretty shocking. The Philadelphia Fed publishes the consensus forecasts made by economists for a range of variables. For GDP growth one year ahead, the forecasts, looking over several decades, are actually on average correct. But this conceals large errors in many years – it is just that, over time, the errors are cancelled out. And the forecasts are particularly bad at capturing tipping points, when there is about to be a boom or a slump.

This was the question the Queen put to the faculty at the LSE. Why had they not foreseen the crisis? To be fair, economic forecasting is a very hard scientific problem, which does not readily admit a solution.

So while the forecasts themselves are questionable, Budgets nevertheless remain important because of the narrative which the chancellor tries to portray about the economy. Nigel Lawson’s Budget of 1988 is rightfully famous. Not because it failed to predict the looming crisis in 1990, but because it set the tone in which enterprise was celebrated, thereby laying the foundations for the long boom of the 1990s. Osborne in 2010 seized the imagination of the markets and persuaded them that the public finances were sound. It is the narrative about the medium and longer term which matters, not the illusion of short-term control.

As published in City AM

Does Miliband understand the importance of incentives?

Posted by on March 12, 2015 in Economic Policy, Economic Theory, Government Spending, Pensions, Politics, Public Policy, Socialism | 0 comments

Does Miliband understand the importance of incentives?

Ed Miliband has long had a problem with voters not perceiving him as “normal”. His famous struggle with a bacon sandwich in some ways says it all. But at a much more important level, he seems to have little or no empathy with one of the most fundamental of human motivations. The most profound insight of economics is that people respond to incentives. When incentives change, behaviour also changes. This certainly does not exclude other motives, such as altruism, but incentives are key to understanding how people make decisions. It is this which Miliband appears unable to grasp.

Consider the political situation in Scotland. A rampant SNP threatens many Labour seats. Yet despite the pleadings of his colleagues, Miliband finds it very difficult to rule out forming a coalition with the Nationalists after the election. In these circumstances, the incentives facing a Labour-inclined voter North of the Border are clear. Voting SNP promises a potentially powerful bloc in Parliament to press the case for extracting even more money from the English. And at the same time, you could still get a Labour government via the coalition route. For all except the truly faithful Labour supporter, incentives in Scotland point to voting SNP.

Pensions are another area where neither Miliband nor his political mentor Gordon Brown have shown the slightest sign of understanding the effect of incentives. Miliband proudly proclaims that he will finance a reduction in tuition fees by reducing the tax advantages of putting money into a personal pension scheme. One of Brown’s first acts as chancellor in 1997 was to abolish the tax relief pension funds earned on dividends from stock market investments. This crippled many final salary pension schemes. Pension pots are an irresistible lure for politicians with profligate spending aims. But at a time when life expectancy is rising sharply, it is an act of profound economic illiteracy to reduce the incentive for people to put money away for retirement.

Miliband played a prominent role in the last Labour government, first as a key adviser and fixer for Brown, and then as an MP and member of the Cabinet. Brown was at first an excellent chancellor, keeping us out of the euro and maintaining fiscal probity. But he soon went in for a massive increase in public spending, with entirely predictable results. Workers in the public sector were portrayed as angels, selflessly serving the nation. But they proved only too human, just like the rest of us. They responded to incentives.

The incentive to take advantage of the increases in public spending was strong. The outcome was a huge increase in the pay of the public sector relative to that of the private, even more attractive gold plated pension schemes, shiny new offices, more staff, and endless re-gradings and promotions. Most of the rise in public spending did not go into improving service provision. Instead, it went into subsidising the private consumption of those employed in the public sector.

Like it or not, responding to incentives is a very deep-rooted aspect of human behaviour.

As Published in City AM on Wednesday 11th March

Will the internet lower long-term growth – or do we need to embrace change?

Posted by on March 5, 2015 in Capitalism, Economic Theory, Euro-zone, Markets | 0 comments

Will the internet lower long-term growth – or do we need to embrace change?

Are we doomed to secular stagnation, to permanently lower rates of economic growth? The debate was sparked off nearly a decade before the financial crisis by the top US economist Robert J Gordon. He took a pessimistic view of the impact of the new wave of technology on productivity and economic growth.

The latest contribution is from the Bank of England’s chief economist Andy Haldane. In a characteristically wide-ranging and thought-provoking speech, Haldane argued a couple of weeks ago that internet technology, far from being a stimulant, may be lowering the rate of long-term growth. He points out that, almost incredibly, 99 per cent of all the information ever created has been generated this century. Haldane suggests that this reduces our attention spans, which in turn leads to short-term thinking and decision-making becoming dominant. But growth requires commitment and patience. Human creativity, the ultimate foundation of all advances in living standards, demands time for reflection. Innovation and research are casualties of these trends.

Long-term growth rates reflect the underlying productive potential of the economy. Actual year-to-year growth rates may be above or below the trend, reflecting short-term influences. But there is a strong consensus among economists that, over the long term, growth is determined by deeper factors, such as innovation and the gradual accumulation of human and social capital.

The experience of the EU economies, or more precisely the economies of continental Europe, seems at first sight to support the Haldane thesis. Output in many countries, especially in southern Europe, remains well below the pre-crisis levels of 2007, almost a decade ago. Much more importantly, long-term growth rates have been in decline for half a century. The 1950s saw historically high growth rates, during the “catch-up” period after the Second World War. Essentially, there was an investment boom. The labour forces of these countries remained largely intact, despite war losses, but much of the capital stock had been destroyed. Since then, however, the underlying 20-year growth rate of the EU as a whole has fallen almost continuously. The financial crisis of the late 2000s was simply an overlay of an already firmly-established downwards trend.

But it does not have to be like this. Capitalism is a dynamic, evolving system which responds to circumstances. In the 1970s and early 1980s, the UK floundered and our prospects were gloomy. The supply-side changes of the 1980s, embracing labour market reforms and deregulation, transformed the economy. In the 1990s and early 2000s, Germany inherited our title as the Sick Man of Europe. But, again, major supply-side changes revitalised the country.

The rate of innovation is by no means fixed. Innovation is by definition disruptive. It creates new companies and industries, while destroying existing ones. The willingness of a country to embrace, rather than resist, change is crucial. Jobs for life in a cushioned public sector with gold plated pensions look attractive. But it is this which has crushed the Greeks, and France under Hollande is heading the same way.

Paul Ormerod

As Published in City AM, Wednesday 4th March 2015

Popular culture is the driving force of inequality

Posted by on February 26, 2015 in Capitalism, Economic Theory, Employment, Executive Pay, Inequality, Networks, Socialism | 0 comments

Popular culture is the driving force of inequality

The Oscars have come and gone for another year. Winning an Oscar is very often the basis for either making a fortune, or turning an existing one into mega riches. Jack Nicholson has an estimated worth of over $400 million, and stars like Tom Hanks and Robert de Niro are not far behind.

Even winners who lack the instant recognition of these stars do not do too badly. Cuba Gooding Jnr has recently starred in the American civil rights film Selma. But after his 1996 Oscar for a supporting role in Jerry Maguire, he became notorious amongst film buffs for appearing in movies which were panned by critics and which tanked commercially. This has not stopped his wealth rising to an estimated $40 million.

The Premier League has provided us with another example of success apparently reinforcing success. Its recent TV deal with Sky and BT Sports is worth over £5 billion. Along with investment banking, soccer is one of the few industries which practices socialism, with almost all the income of the companies eventually ending up in the hands of what we might call the workers. The year immediately prior to the financial crisis, 2007, still represents a high point in the annual earnings of many people. But the average salary of a Premier League player has risen over this period from some £750,000 to almost £2.5 million.

At one level, films and football seem to provide ammunition for the sub-Marxist arguments of people like Thomas Piketty, arguing that capitalism inevitably leads to greater inequality. The rich simply get richer. This conveniently ignores the fact that over the fifty years between around 1920 and 1970, there was a massive movement towards great equality in the West, in both income and wealth.

During the second half of the 20th century, a profound difference in communications technology opened up between the world as it is now and all previous human history. Television by the 1960s had become more or less ubiquitous in the West. Vast numbers of people could access the same visual information at the same time. The internet has of course enormously increased the connectivity of virtually the whole world.

These advances in technology have altered the way in which people respond to information. The importance of social networks in influencing the choices made by individuals has risen sharply. The economic model of choice in which rational individuals carefully sift all the available information is no longer even feasible in many situations. Almost all click throughs on Google searches, for example, are on the first three sites which come up. It is simply not possible to work through the thousands, or even millions, of sites which are offered.

This means that self-reinforcing processes are set up. Things which become popular become even more popular, simply because they are popular. And because of communications technology, we know what is popular. In popular culture, a rapidly growing sector of the economy embracing both films and soccer, high levels of inequality of income are inevitable

As Published in City AM on Wednesday 25th February 2015

Crocodile tears for the poor

Posted by on February 19, 2015 in Economic Policy, Economic Theory, Employment, Inequality, Politics, Public Policy, Socialism | 0 comments

Crocodile tears for the poor

INEQUALITY is now a buzzword in Britain. Scarcely a week goes by without a new publication by an academic or journalist lamenting the levels of poverty facing swathes of the population. They are bolstered by a complicit metropolitan liberal elite, who shed crocodile tears for the poor, while ruminating on the current situation.

Unfortunately, much of the work coming out of universities can hardly be described as scientific. Rather, it could be described as “advocacy research”. In other words, research that is carried out with the intention of providing evidence and arguments that can be used to support a particular cause or position. And too often, the taxpayer is left financing such activity.

However, a new book on poverty, Breadline Britain, deserves to be taken more seriously. The authors, economist Stewart Lansley and academic Joanna Mack, wrote the first version in 1983 when they were producers at ITV’s current events programme, Weekend World. Over the next three decades, they continued to collaborate on the topic.

Lansley and Mack make the startling claim that one in three households now suffer from poverty. Their method of calculating this figure is intriguing. Instead of wrestling with intricate statistical methods, they simply go out and ask ordinary people what they consider to be the basic necessities for a decent standard of living. On this basis, the percentage of households lacking three or more of the items listed has risen from 14 per cent in 1983 to 30 per cent now.

Of course, like any measure of relative poverty, it is open to the valid criticism that in material terms the poor are far better off than they were. But it does serve as a useful reminder of the different qualities of life which are on offer in the UK today.

A key point in the book is that poverty is far from being confined to those on benefits. A rising proportion of the poor are in work. The authors cite the usual suspects of zero hour contracts and the spread of low pay. But there is one fundamental driver of these changes in labour markets which they do not face up to – namely, mass immigration.

Under New Labour, Britain’s borders were effectively opened completely. While the party was in power, immigration added more than 3m to our population. At the time, we were invited to believe that this would have no effect on real wages. Equally, we were assured that immigration was vital in combatting the effects of an ageing society. Critics such as Bob Rowthorn, then head of the Cambridge economics faculty, were pilloried for making the obvious point that immigrants themselves get older.

Unsurprisingly, the increased supply of labour has driven down real wage rates at the lower end of the market. And the imperatives of politics means that benefit levels have had to follow suit.

If Lansley and Mack are right, as the inequality debate persists, we must acknowledge the part that the liberal elite’s advocacy of mass immigration over the past two decades has played in impoverishing the indigenous working class.

As published in City AM, Wednesday 18th February 2015

Shouting at the supply-chain: is there a better way?

Posted by on February 12, 2015 in Capitalism, Economic Theory, Inequality, Markets | 0 comments

Shouting at the supply-chain: is there a better way?

EVERY year, the supermarkets hire substantial batches of high-flying graduates to work in their buying departments. The urban mythology is that these expensively-educated young people are paid to shout down the phone, browbeating suppliers to offer yet more discounts.
This hectoring seems to be at the heart of the recent decision of the Groceries Code Adjudicator to investigate Tesco, following allegations that the company delayed payments to suppliers and unfairly handled payments for shelf promotions. These particular complaints may prove groundless. Yet they don’t exactly serve to diminish sentiment that Britain’s large firms can act as ruthless short-term profit maximisers, squeezing their supply chain for every penny. Of course, even if that is the case, we could simply see it as being part of the workings of the free market, in which the most efficient survive. But given the relative sizes of our corporate giants and most of their suppliers, there is an inherent imbalance of power at play.

So how else could these supply chains be managed? Milk is a topical example, in which the much-maligned Tesco, along with Marks and Spencer and Waitrose, is cast as the good guy. It established long-term contracts with suppliers, in which the dairy farmers are probably getting around 30p a litre for milk. Amid allegations that supermarkets are using milk as a loss leader in price wars, other farmers are believed to be receiving as little as 20p a litre – below the cost of production. The National Farmers Union warns that many will be driven out of business; over the past decade, nearly 10,000 dairy farmers have left the industry.

Another answer can be found in many extant markets that function in more sophisticated ways, flying in the face of the simple economic textbook injunction of “slash costs and maximise profit”.

A 2012 paper by Alan Kirman of the University of Marseilles and Nick Vriend of Queen Mary, London, demonstrated this by studying Marseilles’ wholesale fish market. They obtained a data set documenting every single transaction that took place in the market, across a number of years. At the time, there were about 40 registered sellers, and around 400 regular buyers. The prospective buyer approaches a seller and says what he or she wants, and is quoted a price – crucially, no prices are advertised. The price quoted is on a take it or leave it basis, and there is no bargaining.

You would be forgiven for wondering how these non-conventional features translate into business. But for every type of fish, and across the market as a whole, the classic downward sloping demand curve is seen. A higher average price means less is bought. And in a reciprocal process, buyers become loyal to the sellers who offer them the highest utility. In turn, sellers tailor their products and services to these loyal buyers, who prompt higher gross revenues.

There is a lesson here for larger companies. Developing such longer term relationships may enable value to be created in the supply chain – in contrast to the conventional model, in which it is well and truly squeezed out.

As published in City AM on Wednesday 11th February 2015

Can Game Theory Help the Greeks?

Posted by on February 5, 2015 in Economic Policy, Economic Theory, Euro-zone, Politics | 0 comments

Can Game Theory Help the Greeks?

Game theory is a big topic in academic economics. It is scarcely possible to graduate from a good university without exposure to its abstruse logic. So perhaps the Greek government, replete with economists, is using game theory to plan its tactics. Or is Chancellor Merkel herself being briefed with calculations carried out deep in a hidden bunker stuffed with game theorists?

The subject was invented in the 1940s by John von Neumann, one of the greatest polymaths of the entire 20th century. He made major contributions to the development of both the computer and the atomic bomb. But it is for his game theory that economists remember him. It appears to offer a rational, calculable way of dealing with uncertainty.
The United States military poured huge resources into the topic, using some of the best minds in the country, shortly after the Second World War, once the Soviet Union acquired nuclear weapons. Both the Americans and the Russians could be assumed to be rational in the sense of preferring to avoid a nuclear exchange. But, lacking certainty about the strategy of the opponent, might the best action be to launch a pre-emptive strike? This is the whole essence of game theory. In the jargon, you either play a co-operative strategy, or you defect. In other words, you either live with the nuclear stand-off, or you get your retaliation in first.

To co-operate or to defect, that is the question. The game being played in the current Greek tragedy is a multi-player one, but the principle is the same. The Greek government hints at a willingness to defect by cosying up to Putin’s Russia, scaring the NATO establishment. From a Greek perspective, the statements of hardliners in, for example, the European Central Bank is equivalent to a policy of defection being played against them. No concessions, according to this strategy.

This fundamental insight of game theory does tell us something about the world. Cartels, for example, are difficult to sustain. Although members benefit by keeping prices up, by playing a co-operative strategy, there is the constant temptation for individuals to defect, to believe that they can steal an advantage by going it alone. Even OPEC has not been immune from this pressure.

Beyond this important general contribution, game theory does not offer much guide in many practical situations. There are now literally tens of thousands of dense mathematical academic papers which try and obtain the optimal strategy. Even the brief bits of English in the articles would be incomprehensible to non-specialists. But the final answer has not yet been found.

Perhaps the biggest weakness is that game theory requires clear and distinct rules of the game. In the current Euro crisis, it is not even clear that the players are in the same game. For Greece, it is a one-off, they want to change policy in their own country. For the ECB, IMF, Germany, if they co-operate in this, the worries are about the next game in the sequence against Spain, Italy or whoever. Politics is a better guide than economics.

As published in City AM, Wednesday 4th February 2015

Birthday parties and the NHS: We Need More Markets

Posted by on January 29, 2015 in Economic Policy, Government Spending, Markets, Politics, Public Policy | 0 comments

Birthday parties and the NHS: We Need More Markets

Many outrageous things happened around the world during the course of last week. But, judging by both the level of popular interest in the story and reaction to it, the most heinous was the decision of a mother to send an invoice to the parents of a boy who did not turn up to her son’s birthday treat. A demand for £15.95 was slipped into his schoolbag after he missed the outing to a local ski centre.

The adverse sentiments seem to be partly based on the feeling that it was inappropriate to introduce the principles of markets – a price was charged – into purely social relationships. Hostility to markets is a very widespread phenomenon. Many people get apoplectic at the idea of markets being introduced into the NHS. It was actually the post-war Labour government which began the process in 1951, charging for teeth and spectacles. But why let facts get in the way of a faith? Firms which fill gaps in the market by providing loans to high credit risk individuals are regularly pilloried for the rates of interest which they charge.

But the whole history of progress is based upon the gradual spread of markets across the range of human activities. In the distant mists of pre-history, humans were organised into tiny, self-sufficient groups in which markets were unknown. As the American anthropologist and best-selling author Jared Diamond points out in his latest book, The World Until Yesterday, life was pretty unpleasant. Nasty, brutish and short, as a famous philosopher once said.

Diamond has a wealth of evidence from areas like New Guinea, where primitive forms of human social structures survived almost until the present day. Contact with other small bands of people was largely based upon the principles of rape, pillage and murder. Strangers were intensely feared and liable to be killed on the spot.

As a species, it took us many thousands of years to start to work out that, in order to benefit from what other groups could produce, it was better to use markets and trade rather than invade and loot. In modern times, societies which have tried to suppress markets, like Stalin’s Soviet Union, Mao’s China and contemporary North Korea, have merely perpetuated grinding poverty for the masses. On a much less serious note, Ed Miliband’s pledge to buck the market and freeze energy prices has just left him looking foolish.

The real problem with the birthday party was that the bill was sent after the event, without prior consent of the participants. Places on the trip were limited, and telling people in advance that no shows would be charged would have been an efficient way to ration scarce resources. Otherwise, the only sanction would be social disapproval. And social norms are always open to exploitation by free riders. An example is in the NHS, where a modest charge to visit a GP would go a long way to reducing pressures on surgeries. Most people behave reasonably, but a minority abuse the system. We need more markets, not less.

As published in City AM on Wednesday 28th January 2015

Bring Back Cedric the Pig!

Posted by on January 22, 2015 in Capitalism, Corporate Structure, Economic Theory, Employment, Executive Pay | 0 comments

Bring Back Cedric the Pig!

Executive bonuses are back in the news. The Goldman Sachs pot of £8.3 billion has been prominent. German executive pay has overtaken that in the UK for the first time. Top management seems to have no shame. Some bad publicity today, but the fat cheque remains safely in the bank account.

How one longs for the days of Cedric the Pig! This was the unfortunate nickname bestowed upon Cedric Brown, the Chief Executive of British Gas whose salary was increased by 75 per cent to £475,000 at the end of 1994, at a time when the company was making staff redundant. This works out at just over £700,000 at today’s prices. We can usefully contrast this with the remuneration package of Iain Conn, the newly installed Chief Executive of Centrica, parent company of British Gas. We read on the Centrica website that his basic salary is £925,000. Well, perhaps not an indecent amount more than poor Cedric. But the text goes on ‘to provide continuity of incentive opportunity prior to new arrangements being established two transitional awards will be made’. ‘Continuity of incentive opportunity’ means he could be in line for share awards of up to three times his base salary, plus pension contributions and ‘other benefits’.

Compared to many leading companies nowadays, the remuneration committee of Centrica has acted with a certain amount of restraint. Last year, the average FTSE Chief Executive was paid 143 times the salary of their average workers.

Perhaps economic theory can be used to justify these various payments? An essential component of any basic course in economic principles is the so-called marginal productivity theory of wages. ‘Marginal’ here does not have its everyday meaning in English, but is a piece of scientific jargon. It means the additional value contributed to the firm by a particular worker. According to the theory, the massive increases in executive remuneration over the past two decades or so are entirely justified. People are paid what they are worth. Certainly, this sentiment is prominent in corporate justifications for pay packages. World class individuals are needed, who can deliver world class performances.

There are many practical criticisms of this description of how pay is determined. Yet even within the abstract confines of economic theory itself, it cannot be justified. Economics has no theory with which to explain the distribution of income. This result, which required many pages of maths to prove, was established as long ago as the early 1970s. The lineage is impeccable. Gerard Debreu received the Nobel Prize for his work on equilibrium theory, and Hugo Sonnenschein went on to become President of the free-market oriented University of Chicago. But only high level graduate students, once they have been thoroughly socialised as economists, are taught these theorems.

The simple fact is that executive pay is almost entirely determined by social values and norms. The sense of restraint, of noblesse oblige, which characterised much of Britain’s post-war history, has vanished. Until top management learns to behave respectably again, the problem will remain.

Paul Ormerod

As published in City AM on Wednesday 21st January