Ryan Bourne: The Conservatives must stop this populist nonsense on high pay

Ryan Bourne is the Economic and Statistical Researcher at the Centre for Policy Studies. You can follow him on Twitter at @RyanCPS.

Ed Miliband might be suffering from low personal ratings, but he’ll take immense satisfaction from the recent direction of the public discourse. You’d think with unemployment at 2.64m and the original deficit reduction plan abandoned, Conservative MPs would be all guns blazing for supply-side reforms such as tax cuts and deregulation. Instead, over the past week they’ve been clambering over themselves for a good old bit of populist high pay bashing – on both executive pay and the 50p tax rate. So evident has this jump to the populist view been, Miliband himself has now had to jump to the idea of worker representation on remuneration committees and another increase in the bank tax to satisfy his own supporters.

Tory MPs have been keen to invoke the legacy of the ‘Iron Lady’. Apparently ‘she would not have stood for rewards for failure’ seen at boardroom level. Margaret Thatcher certainly believed in the power of the free-market and competitive pressure. In one sense, therefore, those of us that believe in free-market economics should welcome strengthening of shareholder power over executive pay and improvements in transparency – these things make the market work more effectively.

My problem with the way it is been handled is the divisive populist rhetoric. Exaggerated myths and some dodgy interpretations of economic theory have been used to justify the ‘need for action’. Below, I set out five key myths that have been used by Conservatives in attacking high pay:

MYTH 1: High pay is uniquely a FTSE 100 “problem”

The Income Data Services report, which showed that FTSE 100 directors’ pay had increased by 49% over the past year, provided the trigger for action on this issue. Apparently, the lack of link between reward and performance in these companies meant that ‘something had to be done’. But if this was an issue of principle, it is unclear why Government would stop here. In reality, a range of other industries pay relatively unsuccessful people huge amounts. Football, film, private equity capital, and many senior government tiers are all well paid, with little apparent link to performance.

MYTH 2: High pay is a “market failure”

The above view that pay should be linked to performance has led Cameron and others to characterise high executive pay as a ‘market failure’. Pay is not, and never will be, merely a reflection of performance, because it is determined by a whole host of supply and demand factors. In fact, once these are controlled for, most studies show a relationship between pay and performance. I am sure that many would be quite happy for the pay of the Monetary Policy Committee to be determined by their inflation forecasting record, or the Chancellor on meeting his deficit reduction target, or surgeons for their results in saving lives – in reality, though, most recognise that there any many other factors which determine pay.

Therefore, as Len Shackleton so succinctly argued for the IEA, the use of the term ‘market failure’ is inappropriate here.  In reality, ‘market failure’ is explained by economists in situations relating to limited information, the abuse of market power or technical issues associated with external costs and benefits.

MYTH 3: The recent Income Data Services report shows that high pay is out of control

The headline figure of a 49% increase in average remuneration for executives is of course correct – but it is misleading. As I warned on the morning the report came out, “the reporting of the average figure here is likely to be strongly influenced by a small number of large increases, and so may not be the most appropriate measurement. In most examinations of pay, the median value is used, which avoids the disproportionate influence of extreme high and low data points…the median increase of total earnings was much smaller than the average figure, with increases by 16% over the past year.”

Yes, this is still much higher than average earnings growth nationwide, but is a much lower figure. What’s more, base pay for them rose by just 3.2 per cent, and bonuses 13 per cent – meaning that most of the increase was driven by incentive plans and options which are strongly linked with performance.

MYTH 4: Executive pay is going up whilst the value of companies is stagnant

But why were incentive plan and option rewards high when the economy performing so badly? The answer is that the economy and the FTSE 100 performed ok in most of 2010. As Manifest has highlighted, FTSE 100 earnings per share were up 39 per cent, and the FTSE 100 went up by 9 per cent in that year. Because performance has to be assessed before payments are made – i.e. there’s a year’s lag – the increased pay in 2011 reflects reward for performance in 2010.

MYTH 5: All this is evidence of ‘crony capitalism’

There is certainly a debate to be had in this country about the negative effects of crony capitalism, and free-market conservatives should lead the charge to fight it. But the assumption that cronyism between directors on boards of different companies has resulted in high executive pay has been shown to be codswallop by new statistics also published by Manifest. They showed that of the 1005 directors in FTSE companies surveyed: 88 per cent hold one directorship, 10 per cent hold two and 2 per cent hold three or four. As Allister Heath has shown, only 5 per cent of FTSE 100 executive directors also serve as non-execs on boards of other FTSE 100 companies and only a small number sit on other companies’ remuneration committees. More broadly, if we want to tackle crony capitalism this seems a curious place to start. Let’s look at the lack of transparency between state and energy companies over the effects of climate policies, taxpayer funded trade union activities, the power of big businesses lobbyists, and actually pressure the Government for more action on bonus payments in the banks which we actually own.

One thing is for sure with all this: slamming executive pay won’t create jobs. Much of the language used has been the sort of divisive class warfare you’d expect from the Labour Party. The overriding goal from here should be economic growth and job creation stimulated by a rigorous supply-side agenda. Indeed, further regulation of the private sector brought on by crowd-pleasing is the last thing we need.