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Economists don’t have much time for the concept of power. It’s too non-quantifiable. It can’t be written in equations. It’s hard to model. But it may be the best way of understanding today’s economy.
Executive pay is a good place to start. Thirty years ago, a FTSE 100 chief executive earned on average 20 times the salary of an average worker in his company (and it always was a him). Today the figure is 129 times. (And it’s still almost always a him.) A conventional economist would want to understand this in terms of the marginal productivity of chief executives relative to the marginal productivity of workers, and of the supply and demand of top talent.
But these explanations simply don’t fit the evidence. Measured by profits or share prices, corporate performance on average has not improved by anything like the increase in executive pay, whose rise has had no relationship to the movements of stock markets. And there is no evidence at all that such pay results from a scarcity of talent – many of those who have cleaned up over the last three decades have exhibited mediocre performance (which is why they tend to stay in post such a short time) and there is no let-up in the conveyor belt of directors waiting to replace them.
A much more plausible explanation for the rise in top pay is the structure of corporate governance. The remuneration committees which decide pay packages are made up almost entirely of other directors. This creates a self-serving system in which one group of directors pays another exorbitant salaries, and these then act as the ‘competitive benchmark’ for the next round. In other words, it is the power of directors as a group to set their own salaries that determines their level and growth.
Classical economics had a name for this. It was ‘rent extraction’: the appropriation of value in excess of that required to reward effort. But it was one of the ideas that disappeared when the neoclassical school – focused on marginal analysis and competitive markets in equilibrium – came to dominate the discipline. Which was rather convenient for those who took the rents.
Rent extraction derived from excessive power is most clearly seen today in the financial sector. One of the most extraordinary economic facts of recent decades has been the persistently high costs of financial services. As Thomas Philippon and Guillaume Barzot have shown, the cost of financial intermediation – what the financial sector charges the rest of the economy for its services – has barely changed over the last fifty years. Yet in that same period the productivity of these services has been transformed out of all recognition by new technologies, and the sector has become much larger.
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