A Theory of Affluence

The industrial revolution created an enormous surge in affluence. Whereas mankind was engaged in a struggle for existence in the real sense of the word until then, where any slight disappointment in harvests or other conditions could mean the death of thousands, now it seemed that (at least for a considerable part of) men could leave this behind. There is a lot of debate among historians and social scientists as to what made the industrial revolution possible and why it occurred where it did.

Added to this debate is the theory of Gregory Clark, whose recent book A Farewell to Alms (for the NYT review of this book, click here) created a bit of a stir. Clark's argument is that the industrial revolution was possible because people became more, well, I think 'bourgeois' is the best term for it. Clark shows through careful analysis of the available evidence that there was an enormous downward mobility just before and during the industrial revolution, where the higher classes, because of their higher reproductive success, basically pushed out the traditional lower classes from the economic process. These bourgeois classes brought with them a repertoire of less violent and brutish responses than the traditional lower classes which made them suitable for working in standardized manufacturing conditions. This in turn made it possible that (Western) man escaped the Malthusian trap in which population growth exceeds productivity growth. (I am sure I do no justice to Clark's argument, but something like this is the point.) In other words, evolution made man suitable for starting the industrial (r)evolution -- rather than the other way around.

NYTimes.com: The Billion-Dollar Brushoff

A couple of weeks ago I argued that there is no relation between the salary top executives receive and their 'value'. The New York Times argues that there is no relation between severance pay and 'value' or 'merit' either.

The Patriot Act

I read a most interesting article in this weekend's NRC Handelsblad -- one of the few, if not the only, remotely decent newspaper in Holland. The journalist in question had interviewed the head of the organisation responsible for controlling laws, rules and regulations in the area of (personal) privacy, Mr. Jacob Kohnstamm.

The article starts out with a comparison. I will reword it a bit, so as to make you see the point. Suppose that a terrorist attack on two metro stations in Madrid kills 191 persons, wounds several more and causes an awful lot of damage. The Spanish government, supported by its parliament, is outraged and vows to hunt down those responsible where ever they are. Three months later they adopt a law which entitles them to claim (claim -- not ask) all information they want about any international financial transaction from any bank in any country. Don't laugh, because it turns out that they can as the main branch of THRIFT, the company that has the monopoly on the hard- and software for these international transactions is in Madrid. All banks in the world use THRIFT and they do not want to jeopardize their good relations with the management of DRIFT as it would seriously impede business. The management of THRIFT is under extreme pressure of the Spanish government, so they decide to cooperate. They tell all their clients that they should give up all the details on any financial transaction that the Spanish authorities demand, or else THRIFT will be forced to exclude that bank from doing business with them. Within weeks, the first requests from the Spanish authorities for information on the banking details of clients in Mexico, the USA, Canada and what have you come in. Mind you, the authorities of these countries have not been asked to cooperate, nor have the banks in these countries been asked: they have been told. Wouldn't that bother you? And what is such requests came from Poland? Or Russia?

Wouldn't it bother you even more if your bank never told you that it will hand over information on your financial transactions should the Spanish/Polish/Russian authorities happen to ask for it?

And yet this is precisely what has happened in NL, where banks have supplied such details to the US intelligence agencies in more than190 cases for the last four years (see here). Mr. Kohnstamm announced that all banks should explicitly inform their customers if they cannot avoid participating in the world-wide investigation into terrorist financial streams and was also quite outraged that this is happening in the first place. He announced that the NL banks can look forward to some hefty fines if they do not do so asap. He was also very "disappointed" with the Dutch National Bank and the financial authorities because he had been asking them to do this for months. The DNB first played down the impact of the Patriot Act on the Dutch banking system and then flatly refused to cooperate -- which explains why Mr. Kohnstamm has sought publicity for this matter.

I don't know what to think of all this, but Mr. Kohnstamm has a point that the Dutch banks have delivered the issue of privacy protection of your and my finances to the discretion of the CIA without warning their customers that this was happening.

Doesn't that bother you? It does bother me....

Executive Salaries

I am actually quite skeptical of the idea that CEOs of large companies -- large multinational companies -- 'deserve' their larger salaries or that these salaries reflect their 'value'. Look at the usual arguments that are given to defend high salaries (the same arguments are used to defend the idea that some earn 'too much')

1. 'We need to pay high salaries because our CEO has performed really well.'

• This does not explain why you'd need to pay the CEO more than an office clerk who has performed really well.
  

2. 'Our CEO has changed the course of our company such that it performed really well'.

• Assuming that what is meant that without any change in policy the company would have performed worse, it still is a fallacy (to be precise, the fallacy of composition) to argue that it is due to the activities of the CEO. Market forces, other individual, new opportunities all contribute, and while it may be true that without the activities of the CEO no additional revenue would have been realized, it is mistaken to say that these revenues are all up to his activities. (It is like saying that since without ploughing and sowing and weeding your land would not bear any fruit, therefore, all the increase in value is due to the ploughing, sowing and weeding -- as if the fertility of the ground and climatic circumstances were irrelevant).
• But perhaps all that is meant that the base of comparison is how another CEO would have performed under these circumstances. I submit that one will never know how I or others would have managed Microsoft and that therefore Bill Gates' exorbitant salary cannot be justified by reference how I (or others) would have done.

3. 'Our CEO is worth his salary, because if he would get less, he would leave.' of more general 'The salaries of our CEO reflects the scarcity of managerial talent at t his level'.

• This is more interesting as an argument. The idea is that the scarcity determines the 'worth' or 'value' of the CEO, where this scarcity is expressed by the price the CEO can demand for his services. However, again it does not follow. One could argue that this holds under ideal market condition, where there are no insider/outsider effects or friction costs when a firm wants to hire a cheaper CEO of sufficient quality. However, in the real world the 'market' for managerial talent is not ideal. As a result, the price a potential CEO can demand reflects also things other than his or her scarce talent as a manager. Furthermore, it is unclear if there really is a 'market' for these positions as this professor from Harvard Business School whose name I keep forgetting argues.

In short, there are no good moral arguments as to why corporate top brass is entitled to the high salaries they receive. From a moral point of view, differences in reward for labor seem arbitrary. Does this mean that the socialists are right and that, therefore, there is nothing wrong with taxing CEOs heavily in order to 'correct' the income distribution? No, because that would require that there is an uncontroversial criterion that determines what and how much each person is entitled to. If these arguments don't work to justify high incomes, they also don't work to justify lower incomes. Furthermore, people have a prima facie claim to the salary that they receive: you need arguments to take some away from them.

That leaves only two sort of arguments for those who want to do something about these absurdly high incomes:

1. 'If we leave this money in the hands of private individuals they will not do as much good as we, the State, will do with it. Therefore, we should tax the (very) rich.

• Given recent discussions on the efficiency of state sponsored goods and services, it will be tough to convince people of this.

2. People who earn so much money should be praised if they contribute to the common good (e.g., fund a university or a chair in philosophy -- I know of one worthy candidate...) and be ashamed if they don't. In other words, we should encourage Bill Gates to give away chunks of his arbitrarily received wealth and praise him in exchange for his magnanimity. And if he were not, we should speak badly of him as somebody who does not realize that it is all a fluke and that it is the result of social circumstances that he was able to create this fortune. He would be vicious and (what is the opposite of magnanimity).

• Better, although you still have the inequity that the Bill Gates' of this world receiving lavish praise and the hard working hoi polloi will never be able to demonstrate their magnanimity. Virtue -- or at least the opportunity for virtue -- is distributed unequally (and perhaps because of that, unfairly?).

The market for healthcare

There was an interesting discussion over on politics@aqute where comparisons were made between the costs of US healthcare and those of most European countries. (In case you wonder, you ought to get sick in Western-Europe: same care, only much cheaper...). At that point questions were raised about the efficiencies and inefficiencies of the 'market for healthcare'.

Here I would simply want to raise a theoretical point. Why should you think that a market for healthcare could ever be efficient? Here are some considerations why not:

First, there is no single commodity 'healthcare', but a very mixed bunch of goods and services.

Secondly, because of this, you can expect that the 'market' for certain services, is more like an oligopoly or even a monopoly. Think of certain drugs -- even generic ones -- where only a few companies or just one, manufactures them We all know from econ 101 that monopolies and oligopolies are not efficient.

Third, the demand for many of the goods and services under the heading of healthcare is extremely inelastic, perhaps even lexical. When you are confronted with potentially deadly or debilitating afflictions, you are willing to part with lots and lots of disposable income to get cured. Personally, I would fork over €1000 with equal ease as I would pay €1 for a medicine if it is going to save my life.

Fourth, lots of 'healthcare' is not best described as 'goods and services', but exactly as the name suggests: as care. For example, there are 20-odd regimes and methods to deal with secondary diabetes. Doctors spend lots of time with their patients to figure out what suits them best. My sister, a family physician in the Netherworld, told me the following story. She had a male patient in his mid-50s who was diagnosed with diabetes. After explaining the options available, the man told her that he preferred inoculating insulin himself on a daily basis. This involves among other things, day-to-day monitoring of one's own sugar-levels and recording them. After a week, the patient visited her, as agreed before to report on his experiences. It turned out that he had not monitored his sugar-levels at all. Now, IF diabetes treatment were just some service, the obvious conclusion would be that the man apparently does not want the self-inoculating treatment after all and you would suggest a different approach. But for healthcare professionals, here is where the real work starts. For the thing to do now is to figure out why this patient is not monitoring his sugar levels and fine-tuning the treatment given the results of this investigation. In other words, what is required from the healthcare professional now is an attitude of caring for his patient -- not an attitude of a commercial service provider, like a banker or an accountant. Since the nature of the goods to be provided consist of such a large measure of 'care', which is a "commodity' radically different in kind from other goods and services, it seems to me likely to be expected that the 'market' of care functions is radically different way than that of, say, legal advice or financial consultancy. (Nancy Folbre is an economist at the University of Massachussets who has done some work into this aspect of healthcare if I remember correctly).

Finally, the level of knowledge and expertise required to make informed consumer decisions in healthcare is in some case not realistic. My physician offered to prescribe one of two anti-allergy tablets: loratadine or the other stuff (I forgot the name). Both have advantages and disadvantages. How can I know which one to ask for? Also, my physician will perhaps know of some general known side-effects and the overall effectiveness of both drugs, but she does not know about the cost of these things. Nor does she know what works best for me. How is one to make rational, informed consumer decisions in such a situation? More, precise, in situations of asymmetry of information, an efficient price and allocation are unlikely to occur.

Given all these factors, I doubt that an efficient market in healthcare is even theoretically possible and I am not surprised that neither the private sector, nor the public sector are particularly good at organizing 'healthcare' in efficient ways.