IEA Blog

Egalitarians are enjoying the financial crisis, digging up old ideas that have long since had their day.

Last week Compass launched its campaign for a High Pay Commission to curb “excessive” pay. There is nothing surprising in this; Compass is an avowedly socialist campaign group. But the idea that the government should impose maximum wages upon individuals is a stupid and extremely dangerous idea.

It is based upon two related errors: that earning more than a certain amount is unnecessary, excessive and even obscene; and that there should be a certain proportion between individual earnings. At the root of these lies the belief that there is a decent amount that people should earn, above which one is earning too much. Its origins lie in a puritanical rejection of wealth. A rich man, as we all know, cannot enter the kingdom of heaven, and when one is seeking to make an egalitarian heaven on earth, there is no room for the rich. Basically, it is institutionalised envy.

There is no reason, functionally or morally, why a person should not enjoy any amount of wealth. Wealth is not limited, after all. There is no lump of wealth than needs to be shared out. If you want more money you can make more money: work harder; take more successful risks; use information more efficiently and effectively than others. To decry another’s wealth because they have worked harder or been more successful is not only unprincipled, it is repugnant.

What is more, this activity does not deprive others of wealth. On the contrary: not only does it create more wealth in total, but – because no man is an economic island – it enriches those around the wealth creator too. Critics like to deride this as “trickledown economics” but it is a simple fact that wealth must be used to purchase goods and services, thus creating better-paid jobs.

It is worth noting here that plenty of people take risks and fail. The fact that the successful risked failure is usually overlooked. If the risk-taker had speculated incorrectly, he or she would have lost everything. Would he or she then deserve our sympathy? Would we then bail them out? If not, then we should not envy their wealth or seek to take that wealth away.

The fact that failure has been bailed out should not distract us. The bailouts that have plunged us into hundreds of billions of pounds of debt and made future inflation likely are not the function of a free society but the result of government intervention. Governments are venal organisations in hoc to special interests. Two wrongs do not make a right. We should never bail out failure. Nor should we seek to limit success.

Having said that, consequentialists might argue that what matters is not the freedom of individuals to enjoy their wealth but the effect that this has on society as a whole. If so, then the case for allowing unlimited individual wealth creation is even stronger. One need only compare efforts at untrammelled egalitarianism with free societies to see what the outcome is for wealth creation, distribution and the living standards of the poor.

We do not even need to mention Communism, which so effectively proved the failure of egalitarian politics that socialists now refuse to accept it as an example. The empirical evidence is far more compelling than that. Two separate studies of economic freedom across the world demonstrate that

• there is a direct correlation between freedom and wealth creation;
• there is a direct correlation between freedom and the absolute living standards of the poor;
• there is no direct correlation between freedom and the relative living standards of the poor.

This last finding may come as a surprise, but the proportion of “national wealth” possessed by the poorest decile in the freest quarter of nations is higher than in less free countries. Their absolute level of wealth is three times the level of the next quarter of nations (and dwarfs that of poor people in even less free countries) and – into the bargain – they enjoy more civil and political rights, and a cleaner environment.

I should note here that the economic freedom indexes cited above focus on a broad range of freedom variables of which government-imposed wage limits is only one. However, economic freedom in general is not a bad proxy for a government’s attitude to maximum wage legislation.

Like all too many anti-free-market organisations, Compass may be seeking to take advantage of the financial crisis and resulting recession to peddle its own pet projects. But these projects are no more justified now than they were three years ago. A maximum wage is misguided and dangerous and would result in lower standards of living, not only (or even primarily) for the wealthy, but also for the poorest members of our society.

Compass, a left-wing pressure group, has added to the continuing squabble over pay by calling for a High Pay Commission. Its proposals have attracted support from a wide range of commentators and politicians, including such a prominent figure as Vince Cable, the Lib Dem Shadow Chancellor.

Compass starts from the proposition that “Out of control rewards fuelled excessive risk taking that brought down the whole economy.” As I have suggested in an earlier blog post, this is highly debatable. I have just been reading the Turner Review, which in March found that “while inappropriate remuneration structures played a role, they were considerably less important than other factors….(such as) inadequate approaches to capital, accounting and liquidity.”

Turner points out that Lehmans’ top managers had invested large proportions of their cash bonuses in the firm, unconsciously foreshadowing the current proposals of regulators and rather undermining the Compass position that there is a simple relation between remuneration schemes, risk-taking and business failure.

Turner’s conclusion was reinforced by the FSA in last week’s report on the feedback to Reforming remuneration practices in financial services. Some respondents to their consultation pointed out that there was in fact very little, if any, empirical evidence that remuneration schemes directly caused the crash. Have readers seen any? The FSA see bankers’ pay as a “contributory rather than a dominant factor” – which begs the question about why they find it necessary to impose a raft of new rules: presumably because of political rather than economic imperatives.

Of course Compass uses the financial crisis and consequent anti-banker sentiment to demand a much wider range of intervention in firms’ pay. Reference is made by one supporter to current differentials “erod(ing) the bonds of common citizenship” and “undermin(ing) the principles of equal opportunity and the recognition of equal worth.” The campaign wants a maximum ratio of CEO pay to that of the average employee in all large firms, and higher taxation on bonuses.

I am as always perplexed in this debate, however, by the absence of reference to individual high earners in areas such as sport, entertainment, the legal profession and so forth. They must constitute at least as large a group of rich people as the CEOs of banks or even FTSE companies. Would a High Pay Commission be invited to deal with them as well? If so it will have its work cut out. Is Sienna Miller worth more than John Terry? Should Sienna’s pay be capped at a multiple of the second assistant focus-puller? Should John’s salary be no more than twenty times that of a youth team player? Discuss.