Vijay K. Mathur
Published in Standard-Examiner, July 25, 2010, Ogden, UT
Many states like Arizona have passed or are considering laws and/or regulations to stop or curtail illegal immigration. Many conservatives, including Tea Party loyalists, are pushing for increased enforcement at the border of U.S. and Mexico and supporting Arizona's law to stop the flow of illegal immigration from Mexico.
But measures like enhanced border enforcement, passing Arizona-type laws, and other patchwork state regulations will not make much dent in the supply of illegal immigrants. These wrong-headed approaches do not recognize that economic incentives presented by economic opportunities guide the flow of illegal immigrants.
Let us look at some data on illegal immigration. Department of Homeland Security reports that from January 2000 to January 2006 there was a 37 percent increase in illegal immigrants, 61 percent were from Mexico; 61 percent were concentrated in nine states. California and Texas had more illegal immigrants than Arizona. This implies that this problem is primarily of Mexican origin, concentrated in a few states. It has generated disproportionate reaction by politicians without regard to the underlying causes of illegal immigration.
Estimates from the Center of Immigration Studies show that illegal immigrants declined by 13.7 percent from the peak in the summer of 2007 to the first quarter of 2009. This is primarily a result of diminishing job opportunities due to the severe recession. Since most illegal immigrants from Mexico have low skill levels, their unemployment is more sensitive to business cycles. Economists Pia M. Orrenius and Madeline Zavodny, in their recent 2010 study, note that between the first quarter of 2007 and the second quarter of 2009, the unemployment rate of Mexican immigrants rose from 4.2 percent to 11.3 percent, while the rate for non-Hispanic whites increased from 3.7 percent to 7.8 percent. Their study also shows that Mexican immigrants' employment also responds more positively to the economic upswing than that for non-Hispanic whites.
It seems clear that job opportunities in the U.S. relative to Mexico have significant impact on immigration, legal or illegal. In the labor market, wages are determined by supply and demand for labor. In a competitive market (without any controls and interventions), given supply, wages rise when demand increases, and given demand, wages fall when supply increases. Legal or illegal immigration increases the supply of labor, thus pulling down the wages when there is no offsetting increase in demand.
It irritates many natives if their employment and wages are driven down by illegal immigrants who may be paid less than minimum wage, especially in a low growth economy. This irritation increases when illegal immigrants use some of the tax-supported public safety-net programs. However employers, who are always trying to minimize labor cost, have an incentive to hire illegal immigrants who are willing to work more hours at lower wages. An example of this could be found in the non-compliance of E-verify by most Utah businesses since the state law requires only voluntary compliance. I am sure you will not see many employers demonstrating against illegal immigration or lobbying for laws against illegal immigration.
Do immigrants lower wages and employment opportunities for natives? The evidence is not very conclusive. There is some evidence of small downward effect on wages, especially in lower-skilled jobs. However, as long as employment opportunities are significantly better and wages are higher than in Mexico, and employers are not targeted and heavily punished for employing illegal immigrants, illegal immigration from Mexico will continue despite Arizona-type laws and border enforcement.
There is a need for comprehensive reform in immigration laws at the federal level with basic features such as 1) self-financed guest worker program in occupations with labor shortages and where entry fees are a flat percentage of the average wage in an occupation, 2) path to legal status for current illegal immigrant with penalties, 3) comprehensive E-verify data-base for status verification by employers and stiff penalties for employers for noncompliance, and 4) no public benefits to illegal immigrants once the guest worker program is implemented. The Center of Immigration Studies estimates that when all direct and indirect taxes paid and all costs are included, illegal households created net fiscal deficit of $10 billion in 2002 for the federal government, and it is expected to increase close to $29 billion if amnesty is granted.
Perhaps the outcry against illegal immigration will subside when the economy is growing robustly enough so that natives' employment and wage opportunities are better than they are now. Economic growth has a powerful influence not only on economic opportunities but also on the political climate and mood of nations. However, economic growth has to be broad-based to calm the fears of the general population and resentment against immigration -- legal or illegal. Harvard Professor Benjamin Friedman remarks, "the value of rising standard of living lies not just in the concrete improvement it brings to how individuals live but in how it shapes the social, political, and ultimately the moral character of people."
Mathur is former chair of the economics department and is now professor emeritus of economics at Cleveland State University, Cleveland, Ohio.
Friday, July 30, 2010
Monday, June 21, 2010
No simple solution to unemployment
Vijay K.Mathur
Published in Standard-Examiner,Tuesday, June 15, 2010, Ogden, Utah
It is understandable that most Americans are worried about the unemployment rate, and they want the Obama administration to do something about it. However, government is limited in its capabilities to generate employment directly unless it creates public employment. Government can only attempt to stimulate the economy's growth temporarily using fiscal and monetary policy, so that the private sector feels confident enough about the future demand for their products to hire more people. Even if the markets for goods and services grow, employers are reluctant to add to the payroll if there is demand uncertainty and/or lack of financial capital.
Most people cannot understand why the unemployment rate still remains high even though financial markets are doing better, stock market is strengthening, profits are up, and the economy is growing. In 2010 unemployment rate was 9.9 percent in April, up from 9.7 percent in March. If we add discouraged workers who dropped out of the labor force, April's unemployment rate would be 10.4 percent.
At any given time there is always some unemployment because people always voluntarily quit jobs to find better jobs. For example, in the past three months in 2010, the quit rate was higher than the layoff rate. Also, there are unemployed people whose skills are outmoded and hence are not needed in the labor market. Hence, even in a robustly growing economy we will have that economists call natural rate of unemployment (NRU); it is also called full employment unemployment rate without inflation and is estimated around 5 percent to 5.5 percent.
Since the number of unemployed is equal to the difference between non-institutional civilian labor force 16 years old and over, and the number of employed, the data in 2010 shows that from March to April 2010, even though employment increased by 550,000 unemployment grew by 255,000 due to the increase in labor force by 805,000. For unemployment to shrink, employment must rise faster than the increase in the labor force.
The difference between this recession and past recessions before 1990 is that output growth and productivity growth (output per labor hour) were not followed by quicker response in job gains. In fact, job layoffs continued despite the positive output and productivity growth in the economy.
Economist Robert Gordon argues in a recent article that "the rise of immigration, imports, medical care costs, together with the decline in minimum wage and labor union power, have contributed both to a rise of inequality and an increasing tendency of firms to treat workers as disposable commodities." In addition he argues that information technology, which has increased flexibility in the labor market, has enabled businesses to increase productivity during recoveries and reduce labor cost.
There are other factors that affect unemployment rate where government role is limited. Skill requirements have changed due to changes in industrial and occupational composition. Manufacturing has declined and service sectors like health, education, information, financial services, business and professional services have gained in importance. For example, the unemployment rate for men in 2009 in manufacturing was 11.8 percent, while it was only 5.5 percent in education and health services.
High teenage unemployment rate (ages 16 to 19) increases the average unemployment rate. It is historically more than double the rate for ages 25 to 44. An increase in average duration of unemployment, which varies across occupations and demographic groups like age, gender and race, also contributes to higher unemployment rate. For example, in April 2009 median unemployment duration varied between 11.6 to 18.4 weeks across occupations and was 14.2 weeks for whites and 19.7 weeks for blacks.
In the absence of public employment in a market based economy, the government's role in a recession is twofold. First, it should provide initial boost to the economy through fiscal and monetary policy when the private sector is hesitant to take risk in expansion plans. Second, it should work on removing policy uncertainties, domestic and international, associated with trade, taxes and regulations. Beyond the short run intervention, it is the private sector which has to respond and hire people. Recently released data from the Bureau of Labor Statistics give us some hope because from April 2009 to April 2010, the hiring rate increased by 4 percent, while the rate of layoff and discharges fell 35 percent in the private sector.
Assuming that the labor force stays at 154 million as it was in April 2010, the economy has to generate close to 7 million jobs to bring us back to the NRU of 5.5 percent. However, policy making is difficult because the estimates of NRU are imprecise. And even if the estimates are close to reality, the role of government is limited especially when it is facing large debt load. In the long run, government may implement policies to improve the educational and skill mix of the labor force to suit occupational changes and remove policy uncertainties nationally and internationally. For a sustained improvement in unemployment, businesses and labor themselves have to take the initiative to bring down the unemployment rate.
Mathur is former chair of the economics department and is now professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He resides in Ogden.
Published in Standard-Examiner,Tuesday, June 15, 2010, Ogden, Utah
It is understandable that most Americans are worried about the unemployment rate, and they want the Obama administration to do something about it. However, government is limited in its capabilities to generate employment directly unless it creates public employment. Government can only attempt to stimulate the economy's growth temporarily using fiscal and monetary policy, so that the private sector feels confident enough about the future demand for their products to hire more people. Even if the markets for goods and services grow, employers are reluctant to add to the payroll if there is demand uncertainty and/or lack of financial capital.
Most people cannot understand why the unemployment rate still remains high even though financial markets are doing better, stock market is strengthening, profits are up, and the economy is growing. In 2010 unemployment rate was 9.9 percent in April, up from 9.7 percent in March. If we add discouraged workers who dropped out of the labor force, April's unemployment rate would be 10.4 percent.
At any given time there is always some unemployment because people always voluntarily quit jobs to find better jobs. For example, in the past three months in 2010, the quit rate was higher than the layoff rate. Also, there are unemployed people whose skills are outmoded and hence are not needed in the labor market. Hence, even in a robustly growing economy we will have that economists call natural rate of unemployment (NRU); it is also called full employment unemployment rate without inflation and is estimated around 5 percent to 5.5 percent.
Since the number of unemployed is equal to the difference between non-institutional civilian labor force 16 years old and over, and the number of employed, the data in 2010 shows that from March to April 2010, even though employment increased by 550,000 unemployment grew by 255,000 due to the increase in labor force by 805,000. For unemployment to shrink, employment must rise faster than the increase in the labor force.
The difference between this recession and past recessions before 1990 is that output growth and productivity growth (output per labor hour) were not followed by quicker response in job gains. In fact, job layoffs continued despite the positive output and productivity growth in the economy.
Economist Robert Gordon argues in a recent article that "the rise of immigration, imports, medical care costs, together with the decline in minimum wage and labor union power, have contributed both to a rise of inequality and an increasing tendency of firms to treat workers as disposable commodities." In addition he argues that information technology, which has increased flexibility in the labor market, has enabled businesses to increase productivity during recoveries and reduce labor cost.
There are other factors that affect unemployment rate where government role is limited. Skill requirements have changed due to changes in industrial and occupational composition. Manufacturing has declined and service sectors like health, education, information, financial services, business and professional services have gained in importance. For example, the unemployment rate for men in 2009 in manufacturing was 11.8 percent, while it was only 5.5 percent in education and health services.
High teenage unemployment rate (ages 16 to 19) increases the average unemployment rate. It is historically more than double the rate for ages 25 to 44. An increase in average duration of unemployment, which varies across occupations and demographic groups like age, gender and race, also contributes to higher unemployment rate. For example, in April 2009 median unemployment duration varied between 11.6 to 18.4 weeks across occupations and was 14.2 weeks for whites and 19.7 weeks for blacks.
In the absence of public employment in a market based economy, the government's role in a recession is twofold. First, it should provide initial boost to the economy through fiscal and monetary policy when the private sector is hesitant to take risk in expansion plans. Second, it should work on removing policy uncertainties, domestic and international, associated with trade, taxes and regulations. Beyond the short run intervention, it is the private sector which has to respond and hire people. Recently released data from the Bureau of Labor Statistics give us some hope because from April 2009 to April 2010, the hiring rate increased by 4 percent, while the rate of layoff and discharges fell 35 percent in the private sector.
Assuming that the labor force stays at 154 million as it was in April 2010, the economy has to generate close to 7 million jobs to bring us back to the NRU of 5.5 percent. However, policy making is difficult because the estimates of NRU are imprecise. And even if the estimates are close to reality, the role of government is limited especially when it is facing large debt load. In the long run, government may implement policies to improve the educational and skill mix of the labor force to suit occupational changes and remove policy uncertainties nationally and internationally. For a sustained improvement in unemployment, businesses and labor themselves have to take the initiative to bring down the unemployment rate.
Mathur is former chair of the economics department and is now professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He resides in Ogden.
Friday, May 28, 2010
Current strategy of drug war is a failure
Vijay K. Mathur
Published in Standard-Examiner, May 27, 2010, Ogden, Utah
An Associated Press story recently concluded that U.S. has spent $1 trillion over 40 years on the war on illicit drugs, but there is no end in sight. The use of illicit drugs like marijuana, cocaine and methamphetamine (meth and/or crystal meth), and the accompanying violence, corruption and adverse health outcomes for the users still continues to grow. It appears that the supply side strategy has not worked.
Basic economic reasoning informs us that in any market, legal or illegal, the price and quantity bought and sold depends on supply and demand. Suppliers are driven by profit motive and are willing to supply more as price rises. The consumers want to buy the product because it gives them satisfaction and they are willing to buy more if the price falls. The transaction between buyers and sellers takes place at an agreed upon price. The price rises if demand increases more than supply and falls if supply increases more than increase in demand. Markets will thrive as long as there is a demand for illicit drugs and profits can be earned.
The prices of illicit drugs may change not only due to changes in their own demand and supply conditions, but also changes in prices of other illicit drugs. For example, if the marijuana price increases relative to cocaine prices, many consumers may switch to cocaine, hence increasing cocaine price as well.
Illicit drug markets are highly profitable. For example, the National Institute of Drug Abuse estimates that powder cocaine typically sells for $100 to $125 per gram, but costs $9 to $40 per gram. Prices and costs vary by locations. As profits increase we expect more entry by suppliers. In fact, wholesale suppliers have an incentive to spread addiction among the general population through an attractive pricing policy so they can increase their retail outlets, because each addict is a potential retailer.
Selling drugs at the retail level becomes an attractive option, especially among those who have less employment and earning opportunities in legal trades. In 2005, a UN report estimated that the worth of global drug markets is close to $320 billion per year. Reducing the flow of the supply by catching a few kingpins in the trade will not stop the flow because their places are filled by others waiting for the opportunity to enter lucrative markets. The risks are great but so are profits. There is also a tendency to use violent methods to monopolize the trade. Monopoly power gives the seller pricing power and a larger market share and hence more profit.
The supply side policy also results in many adverse societal side effects. In addition to law enforcement and judicial costs, it has increased the prison population at huge expense to taxpayers, thus depriving resources from socially beneficial programs. Violence is the natural outcome when competing suppliers attempt to squeeze others out from their markets. Violence also spills over to the general population, thus paralyzing other legal economic activities. An exhaustive review of scientific studies by the International Center for Science in Drug Policy confirms the association of violence and prohibition of drugs around the world.
Corruption of law enforcement personnel, politicians and judicial officials is another side effect of supply side policies. A study in 2008 by Edgardo Buscaglia, Columbia Law School, found that expected severe punishment without eliminating assets and supporting networks of organized crime leaves the criminals with the ability to finance continued and expanded corruption.
What can be done to minimize the drug problem? Make the trade unprofitable, legalize drugs with appropriate regulations on suppliers and consumers just like we regulate medical drugs. Tax drugs and dedicate that revenue and other savings from enforcement, judicial systems and prisons to educate children and adults about the harmful effects of drugs on health and general well being and treat those who are addicted.
The education process has to start early in childhood. Increased competition in the open market will dry up profit to organized crime and at the same time start us on the path of declining demand. The demand-based strategy is not made to condone negative behavior, but rather to change behavior. It is not claimed that this strategy will eliminate the black market in drugs, but it will minimize it. We still have a black market in legal and addictive medical drugs like Ritalin, Oxycontin.
Economist and Nobel Laureate Milton Friedman stated in Hoover Digest in 1998,"Compared with the returns from traditional career of study and hard work, returns from dealing drugs are tempting to young and old alike. And many, especially the young, are not dissuaded by the bullets that fly so freely in disputes between competing drug dealers -- bullets that fly only because dealing drugs is illegal. Al Capone epitomizes our earlier attempt at Prohibition; Crips and Bloods epitomize this one."
Mathur is former chair of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He resides in Ogden.
Published in Standard-Examiner, May 27, 2010, Ogden, Utah
An Associated Press story recently concluded that U.S. has spent $1 trillion over 40 years on the war on illicit drugs, but there is no end in sight. The use of illicit drugs like marijuana, cocaine and methamphetamine (meth and/or crystal meth), and the accompanying violence, corruption and adverse health outcomes for the users still continues to grow. It appears that the supply side strategy has not worked.
Basic economic reasoning informs us that in any market, legal or illegal, the price and quantity bought and sold depends on supply and demand. Suppliers are driven by profit motive and are willing to supply more as price rises. The consumers want to buy the product because it gives them satisfaction and they are willing to buy more if the price falls. The transaction between buyers and sellers takes place at an agreed upon price. The price rises if demand increases more than supply and falls if supply increases more than increase in demand. Markets will thrive as long as there is a demand for illicit drugs and profits can be earned.
The prices of illicit drugs may change not only due to changes in their own demand and supply conditions, but also changes in prices of other illicit drugs. For example, if the marijuana price increases relative to cocaine prices, many consumers may switch to cocaine, hence increasing cocaine price as well.
Illicit drug markets are highly profitable. For example, the National Institute of Drug Abuse estimates that powder cocaine typically sells for $100 to $125 per gram, but costs $9 to $40 per gram. Prices and costs vary by locations. As profits increase we expect more entry by suppliers. In fact, wholesale suppliers have an incentive to spread addiction among the general population through an attractive pricing policy so they can increase their retail outlets, because each addict is a potential retailer.
Selling drugs at the retail level becomes an attractive option, especially among those who have less employment and earning opportunities in legal trades. In 2005, a UN report estimated that the worth of global drug markets is close to $320 billion per year. Reducing the flow of the supply by catching a few kingpins in the trade will not stop the flow because their places are filled by others waiting for the opportunity to enter lucrative markets. The risks are great but so are profits. There is also a tendency to use violent methods to monopolize the trade. Monopoly power gives the seller pricing power and a larger market share and hence more profit.
The supply side policy also results in many adverse societal side effects. In addition to law enforcement and judicial costs, it has increased the prison population at huge expense to taxpayers, thus depriving resources from socially beneficial programs. Violence is the natural outcome when competing suppliers attempt to squeeze others out from their markets. Violence also spills over to the general population, thus paralyzing other legal economic activities. An exhaustive review of scientific studies by the International Center for Science in Drug Policy confirms the association of violence and prohibition of drugs around the world.
Corruption of law enforcement personnel, politicians and judicial officials is another side effect of supply side policies. A study in 2008 by Edgardo Buscaglia, Columbia Law School, found that expected severe punishment without eliminating assets and supporting networks of organized crime leaves the criminals with the ability to finance continued and expanded corruption.
What can be done to minimize the drug problem? Make the trade unprofitable, legalize drugs with appropriate regulations on suppliers and consumers just like we regulate medical drugs. Tax drugs and dedicate that revenue and other savings from enforcement, judicial systems and prisons to educate children and adults about the harmful effects of drugs on health and general well being and treat those who are addicted.
The education process has to start early in childhood. Increased competition in the open market will dry up profit to organized crime and at the same time start us on the path of declining demand. The demand-based strategy is not made to condone negative behavior, but rather to change behavior. It is not claimed that this strategy will eliminate the black market in drugs, but it will minimize it. We still have a black market in legal and addictive medical drugs like Ritalin, Oxycontin.
Economist and Nobel Laureate Milton Friedman stated in Hoover Digest in 1998,"Compared with the returns from traditional career of study and hard work, returns from dealing drugs are tempting to young and old alike. And many, especially the young, are not dissuaded by the bullets that fly so freely in disputes between competing drug dealers -- bullets that fly only because dealing drugs is illegal. Al Capone epitomizes our earlier attempt at Prohibition; Crips and Bloods epitomize this one."
Mathur is former chair of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He resides in Ogden.
Sunday, May 9, 2010
Myths about public debt
By Vijay K. Mathur
Published in Standard-Examiner, Ogden, Utah, April,28, 2010
Since the enactment of the stimulus package, the Obama administration is under attack by conservatives and tea partiers for increasing public debt. If the administration had not injected public spending to offset the precipitous decline in private spending, the economy would have faced depression and worsened debt situation. Some concerns are valid, however many advanced by tea partiers and their sympathizers are not grounded in reality.
The most common myth is that government debt should be treated the same as individual debt. Public debt arises when the government accumulates budget deficits, an excess of spending over revenues. Budget deficit is financed by the Treasury selling Treasury securities (bonds, for simplicity) to anyone who wishes to buy them. Interest income on bonds is highly reliable source of income to many buyers, including those who are retired. Interest rates on Treasury securities also serve as a benchmark for other interest rates.
Assume for a moment that only Americans buy those bonds. Hence, even though the government incurs the liability of debt, Americans are asset rich. When bonds mature, the government pays the face value of those bonds to investors by issuing new bonds to raise money. One can also sell those bonds before maturity at their market price.
What if we are also indebted to foreigners, such as China? If China dumps our bonds they will suffer as much from lower bond prices in their portfolio and decline in dollar value as we will. I do not see this happening. Chinese and others invest in the U.S. because it is a safer, more profitable investment and at the same time it supports our imports and their exports. Moreover, if we stop constantly climbing on the import-consumption escalator and start saving and exporting, we can reduce our foreign debt. Tea partiers should campaign for "buy, produce and export American."
What if the public does not buy Treasury bonds? Federal Reserve and other government agencies would continue to buy Treasury bonds. In addition, money can be raised by increasing taxes, although seldom done and not advised in recessions. And, public debt allows the public to defer tax liability and, at the same time, earn interest on asset holdings. It is the economy's health which ultimately matters to make our bonds a good investment.
In recessions, when private spending declines, the federal government must fill the gap by increasing public spending to stimulate economic activity. Deficits, and hence public debt, will shrink when the economy is on a robust growth path. Deliberate action to reduce the deficit should be postponed until the economy has fully recovered.
Another myth is that public debt will bankrupt the U.S. Bankruptcy implies that the debtor can not meet the demands of creditors. Besides the authority to raise revenues from taxes, as long as investors are willing to buy Treasury bonds, U.S. government can always meet creditors' demands. If the accumulation of public debt is used to make the economy grow, as stimulus has done, bankruptcy is a non-issue.
Often repeated myth by politicians, partly because of its impact value on the electorate, is that debt is a burden on our children and grandchildren. If our children and grandchildren pay our debt, they will pay a large fraction of the debt to themselves and to other children and grandchildren. If they also pay to foreigners, then wealthy foreigners will divert at least part of their income to us by buying our goods and services as well as bonds. We have to save more and become more competitive in the world market to increase our exports and hence lessen our children's foreign obligations. Using debt to invest in technologically advanced infrastructure, education, research will provide benefits to current and future generations and will lower future accumulation of public debt in the process.
Real adverse affects of public debt arise when it crowds out private investment by increasing interest rates, contributes to higher inflation (although inflation also lowers debt liability), and/or necessitates a substantial increase in tax rates, thus causing the economic growth to decline. Another real effect, where there is no consensus among economists, could be reduced national saving. So far we have not faced these adverse effects even though debt has increased since 2008. Once the economy is on a firm growth footing we can start reducing (not eliminating) public debt by strategically reducing spending to the point where it does not pose any real threats to the economy and at the same time provides a cushion to handle future contractions.
Why is zero public debt not a good idea? Complete elimination of public debt deprives people and investment funds an assured source of income and a benchmark to other debt instruments. As opposed to taxes, public debt, with no side effects as outlined above, does not discourage private capital formation and provides continuity in funding government projects beneficial to society.
Rather than fearing public debt, it would be more productive to intelligently discuss in town-hall meetings how the nation should invest its private and public resources to renew our economy and to effectively compete in the world market, and at the same time improve our and future generations' standard of living.
Mathur is former chair of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He resides in Ogden.
Published in Standard-Examiner, Ogden, Utah, April,28, 2010
Since the enactment of the stimulus package, the Obama administration is under attack by conservatives and tea partiers for increasing public debt. If the administration had not injected public spending to offset the precipitous decline in private spending, the economy would have faced depression and worsened debt situation. Some concerns are valid, however many advanced by tea partiers and their sympathizers are not grounded in reality.
The most common myth is that government debt should be treated the same as individual debt. Public debt arises when the government accumulates budget deficits, an excess of spending over revenues. Budget deficit is financed by the Treasury selling Treasury securities (bonds, for simplicity) to anyone who wishes to buy them. Interest income on bonds is highly reliable source of income to many buyers, including those who are retired. Interest rates on Treasury securities also serve as a benchmark for other interest rates.
Assume for a moment that only Americans buy those bonds. Hence, even though the government incurs the liability of debt, Americans are asset rich. When bonds mature, the government pays the face value of those bonds to investors by issuing new bonds to raise money. One can also sell those bonds before maturity at their market price.
What if we are also indebted to foreigners, such as China? If China dumps our bonds they will suffer as much from lower bond prices in their portfolio and decline in dollar value as we will. I do not see this happening. Chinese and others invest in the U.S. because it is a safer, more profitable investment and at the same time it supports our imports and their exports. Moreover, if we stop constantly climbing on the import-consumption escalator and start saving and exporting, we can reduce our foreign debt. Tea partiers should campaign for "buy, produce and export American."
What if the public does not buy Treasury bonds? Federal Reserve and other government agencies would continue to buy Treasury bonds. In addition, money can be raised by increasing taxes, although seldom done and not advised in recessions. And, public debt allows the public to defer tax liability and, at the same time, earn interest on asset holdings. It is the economy's health which ultimately matters to make our bonds a good investment.
In recessions, when private spending declines, the federal government must fill the gap by increasing public spending to stimulate economic activity. Deficits, and hence public debt, will shrink when the economy is on a robust growth path. Deliberate action to reduce the deficit should be postponed until the economy has fully recovered.
Another myth is that public debt will bankrupt the U.S. Bankruptcy implies that the debtor can not meet the demands of creditors. Besides the authority to raise revenues from taxes, as long as investors are willing to buy Treasury bonds, U.S. government can always meet creditors' demands. If the accumulation of public debt is used to make the economy grow, as stimulus has done, bankruptcy is a non-issue.
Often repeated myth by politicians, partly because of its impact value on the electorate, is that debt is a burden on our children and grandchildren. If our children and grandchildren pay our debt, they will pay a large fraction of the debt to themselves and to other children and grandchildren. If they also pay to foreigners, then wealthy foreigners will divert at least part of their income to us by buying our goods and services as well as bonds. We have to save more and become more competitive in the world market to increase our exports and hence lessen our children's foreign obligations. Using debt to invest in technologically advanced infrastructure, education, research will provide benefits to current and future generations and will lower future accumulation of public debt in the process.
Real adverse affects of public debt arise when it crowds out private investment by increasing interest rates, contributes to higher inflation (although inflation also lowers debt liability), and/or necessitates a substantial increase in tax rates, thus causing the economic growth to decline. Another real effect, where there is no consensus among economists, could be reduced national saving. So far we have not faced these adverse effects even though debt has increased since 2008. Once the economy is on a firm growth footing we can start reducing (not eliminating) public debt by strategically reducing spending to the point where it does not pose any real threats to the economy and at the same time provides a cushion to handle future contractions.
Why is zero public debt not a good idea? Complete elimination of public debt deprives people and investment funds an assured source of income and a benchmark to other debt instruments. As opposed to taxes, public debt, with no side effects as outlined above, does not discourage private capital formation and provides continuity in funding government projects beneficial to society.
Rather than fearing public debt, it would be more productive to intelligently discuss in town-hall meetings how the nation should invest its private and public resources to renew our economy and to effectively compete in the world market, and at the same time improve our and future generations' standard of living.
Mathur is former chair of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He resides in Ogden.
Thursday, March 25, 2010
Utah should undo its liquor monopoly
By Vijay K. Mathur
Published in Standard-Examiner, March 24, 20010, Ogden, UT
Recently, Utah media reported that the state of Utah had a banner year in liquor sales, taxes and profits to the state general fund in 2009. The Utah Department of Alcoholic Beverage Control (UDABC) is very jubilant about its performance. Along with liquor monopoly, perhaps the state would consider monopoly in the gun market to protect its citizens from harm from guns.
The constitutional right to bear arms does not prohibit state monopoly in guns. We all have heard NRA's comment about gun control that guns do not kill people, people kill people. Could we apply the same logic to alcohol use? Alcohol use does not kill people but people who abuse alcohol kill people. Where is the logic behind state liquor monopoly?
Like the gun business, we should have a free market in the liquor business, with some degree of regulation for public safety. However, my intention in this article is to discuss state liquor monopoly in Utah and not gun control.
A competitive market, where there are many buyers and sellers of product, is the most efficient market structure. In a competitive market, sellers can not fix prices or quantities. The efficiency of perfect competition assures us lower prices than any other market structure, assuming no "market failure" due to, for example, spillover benefits and costs, barriers to entry, asymmetric information. When markets fail, it requires regulation. "Natural monopoly" is also deemed as a failure of competitive market, and hence it requires regulation.
Natural monopoly arises when, due to the product-technology, cost per unit of output falls as output increases. Decreasing per unit cost threatens competition, hence results in a monopoly. Therefore, such products require regulated monopolies, as in cable television, electricity production, and natural gas business.
Regulation is intended to lower prices and increase output at levels beneficial to society, as well as assure monopolies a fair return on investments. Liquor sales do not fit the natural monopoly model based upon cost structure.
Hence, there are some questions which need to be addressed.
Is private retail liquor monopoly inefficient? The answer is yes. A profit maximizing unregulated monopoly, where there is a single seller, controls prices or quantities, which thus control prices. This results in higher prices and lower quantities sold, causing what economists call "dead-weight loss" (DWL). DWL represents a net loss in social value of output to all (not captured as gain by any one) due to inefficiencies. Additional social loss occurs when monopoly spends resources to keep its monopoly power. Exercise of monopoly power is against antitrust laws.
Is state monopoly worse than private monopoly? The answer is yes. Private monopoly is always threatened by entry of new businesses to undermine the monopoly power of the incumbent when there are no or lower barriers to entry. Examples of barriers to entry are large upfront costs of entering into business, legal barriers, regulatory barriers, implicit threats by an incumbent to make the entry of potential entrants unprofitable. On the other hand, state liquor monopoly faces no threats of entry and hence the state has no incentive to lower its monopoly price.
Is the state monopoly guided by motives other than profits? Even though the official reason is that it is not guided by profits, UDABC always brags about how much profit it is generating for the state's general fund. In 2009 it generated $60 million to the fund, almost double the amount of 2000, in addition to state tax revenue and funds for the school lunch program.
What are other possible motives for state liquor monopoly? It is claimed that it is aimed at protecting young people from alcohol abuse and perhaps reducing violence, traffic fatalities and other costs to society due to alcohol abuse. First, there is no evidence that adverse consequences of alcohol abuse will be worse if there is a competitive private market with sensible regulations and enforcement. Second, Pacific Institute of Research and Evaluation reports that underage drinking "is widespread" in Utah. In fact, the percent of 12th graders reporting use of alcohol is greater than those using cigarettes (not a state monopoly). Third, MADD reports that underage drinking cost $324 million (most of it due to violence) to the citizens of Utah in 2007, almost six times the profit to the state's general fund. Fourth, alcohol related motor vehicle crashes resulting in injury and deaths increased almost 12 percent from 2001-2006, close to 2 percent per year.
If morality is the issue with liquor consumption, according to the "Word of Wisdom" of the LDS church, it makes more sense to privatize the market, like with tobacco, coffee and tea, and enforce some targeted common sense regulations to protect society from harmful effects of alcohol abuse; at the same time it will promote efficiency in the market for liquor. Thus the state will gain enough tax revenues with business growth to subsidize different programs.
Mathur is former chairman of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He resides in Ogden, UT.
Published in Standard-Examiner, March 24, 20010, Ogden, UT
Recently, Utah media reported that the state of Utah had a banner year in liquor sales, taxes and profits to the state general fund in 2009. The Utah Department of Alcoholic Beverage Control (UDABC) is very jubilant about its performance. Along with liquor monopoly, perhaps the state would consider monopoly in the gun market to protect its citizens from harm from guns.
The constitutional right to bear arms does not prohibit state monopoly in guns. We all have heard NRA's comment about gun control that guns do not kill people, people kill people. Could we apply the same logic to alcohol use? Alcohol use does not kill people but people who abuse alcohol kill people. Where is the logic behind state liquor monopoly?
Like the gun business, we should have a free market in the liquor business, with some degree of regulation for public safety. However, my intention in this article is to discuss state liquor monopoly in Utah and not gun control.
A competitive market, where there are many buyers and sellers of product, is the most efficient market structure. In a competitive market, sellers can not fix prices or quantities. The efficiency of perfect competition assures us lower prices than any other market structure, assuming no "market failure" due to, for example, spillover benefits and costs, barriers to entry, asymmetric information. When markets fail, it requires regulation. "Natural monopoly" is also deemed as a failure of competitive market, and hence it requires regulation.
Natural monopoly arises when, due to the product-technology, cost per unit of output falls as output increases. Decreasing per unit cost threatens competition, hence results in a monopoly. Therefore, such products require regulated monopolies, as in cable television, electricity production, and natural gas business.
Regulation is intended to lower prices and increase output at levels beneficial to society, as well as assure monopolies a fair return on investments. Liquor sales do not fit the natural monopoly model based upon cost structure.
Hence, there are some questions which need to be addressed.
Is private retail liquor monopoly inefficient? The answer is yes. A profit maximizing unregulated monopoly, where there is a single seller, controls prices or quantities, which thus control prices. This results in higher prices and lower quantities sold, causing what economists call "dead-weight loss" (DWL). DWL represents a net loss in social value of output to all (not captured as gain by any one) due to inefficiencies. Additional social loss occurs when monopoly spends resources to keep its monopoly power. Exercise of monopoly power is against antitrust laws.
Is state monopoly worse than private monopoly? The answer is yes. Private monopoly is always threatened by entry of new businesses to undermine the monopoly power of the incumbent when there are no or lower barriers to entry. Examples of barriers to entry are large upfront costs of entering into business, legal barriers, regulatory barriers, implicit threats by an incumbent to make the entry of potential entrants unprofitable. On the other hand, state liquor monopoly faces no threats of entry and hence the state has no incentive to lower its monopoly price.
Is the state monopoly guided by motives other than profits? Even though the official reason is that it is not guided by profits, UDABC always brags about how much profit it is generating for the state's general fund. In 2009 it generated $60 million to the fund, almost double the amount of 2000, in addition to state tax revenue and funds for the school lunch program.
What are other possible motives for state liquor monopoly? It is claimed that it is aimed at protecting young people from alcohol abuse and perhaps reducing violence, traffic fatalities and other costs to society due to alcohol abuse. First, there is no evidence that adverse consequences of alcohol abuse will be worse if there is a competitive private market with sensible regulations and enforcement. Second, Pacific Institute of Research and Evaluation reports that underage drinking "is widespread" in Utah. In fact, the percent of 12th graders reporting use of alcohol is greater than those using cigarettes (not a state monopoly). Third, MADD reports that underage drinking cost $324 million (most of it due to violence) to the citizens of Utah in 2007, almost six times the profit to the state's general fund. Fourth, alcohol related motor vehicle crashes resulting in injury and deaths increased almost 12 percent from 2001-2006, close to 2 percent per year.
If morality is the issue with liquor consumption, according to the "Word of Wisdom" of the LDS church, it makes more sense to privatize the market, like with tobacco, coffee and tea, and enforce some targeted common sense regulations to protect society from harmful effects of alcohol abuse; at the same time it will promote efficiency in the market for liquor. Thus the state will gain enough tax revenues with business growth to subsidize different programs.
Mathur is former chairman of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He resides in Ogden, UT.
Thursday, March 4, 2010
Wrong time for deficit reduction
By Vijay K. Mathur
Published in Standard-Examiner, Feb 21, 2010
Budget deficit increases have been ignored by politicians and policy wonks on both the right and left from the 1970s, with the exception of a brief period of surplus from 1998 to 2001. Budget surplus during 1998-2001 turned into budget deficit starting in 2002.
In terms of our capacity to pay determined by GDP (Gross Domestic Product) there was 354 percent increase in the proportion of budget deficit from 2001 to 2008. Now, when the country has just missed another great depression and is still not fully recovered, we hear a battle cry by some politicians and deficit hawks against budget deficits and public debt. We did not hear the same concern in peacetime, when the economy was humming in the latter part of the 1980s, and before the recent severe recession.
It seems that our political leaders are ignoring the bigger picture of deficits and public debt. They are either unwilling and /or unable to put the current deficit in historical context. According to Congressional Budget Office (CBO), actual deficit as a percentage of GDP was 4.9 percent in 2008 and after reaching the projected peak of 8.9 percent in 2009, it is expected to decline to 1.2 percent in 2015.
During the Great Depression, budget deficit at the start of Roosevelt's administration in 1933 was 4.6 percent of GDP and after peaking to 5.48 percent in 1934, it declined substantially until the start of the WWII build up in 1939. It should also be noted that in 1930's the Federal government was not saddled with enormous liability of mandatory spending as it is today.
According to CBO, mandatory spending (only on Social Security, Medicare and Medicaid) is expected to increase to 86 percent of total spending in 2015 from 79 percent in 2008. It leaves little room to cut spending, given the unwillingness of many conservative politicians and tea party-goers, to change current laws to modify these spending programs and taxes.
According to the study in November 2009, by economist Gary Richardson in the online journal The Economist Voice, "red" states "that typically support Republican presidential candidates -- and that send the bulk of Republican representatives and Senators to Washington, D.C. -- are the states that receive the most in expenditures relative to the taxes their citizens pay." These are the same states where we hear the loudest complaints against taxes and higher spending. Spending and tax policies are not right vs. left issues, because we all have a stake in a fiscally sound government and a health economy.
We are all interested in reducing deficits because they may pose problems when the economy is growing and both private consumption and investment spending are growing robustly. For example, in a growth economy close to full employment, persistent deficits may aggravate inflation and may dampen economic growth by crowding out private investment. The decrease in capital stock due to the reduction in private investment also increases income inequality as it decreases productivity of labor and thus wages. Since national saving must balance investment and net exports, budget deficits may reduce national saving and hence investment and/or net exports. The decline in net exports implies sale of assets to foreign countries and thus leakage of investment returns. Deficits also transfer income from domestic wage earners to Treasury bond holders, domestic as well as foreign.
CBO projects decline in gross public debt as a percentage of GDP from 85% in 2010 to 78% by 2015. Despite this hopeful sign, once the economic recovery is assured with jobs our political leadership must be willing to raise some taxes and significantly reduce growth in mandatory and discretionary spending, to put the economy on the long term path of fiscal balance. Persistence in accumulated deficits, even during robust and stable economic growth, put us on a risky path and may make the fiscal policy impotent during the next economic crisis.
There are two ways to reduce public debt. First is to reduce budget deficits. Second, the economy has to grow faster than the interest rate we have to pay on the debt. CBO projections give us some hope on the growth front.
Projections show that during 2011-14 inflation adjusted GDP growth rate will be slightly higher than the interest rate on 10-year Treasury notes. But growth rate projections will not materialize if we cut spending programs to promote new investments at this time.
The recovery is fragile, and private markets are plagued with uncertainty of recovery. The call for deficit reduction and cuts in spending at this time, specially meant to promote investment, invites either very slow recovery or outright decline in growth rate and thus deprives our children and grandchildren of wealth and good life in the future.
Mathur is former chairmen of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He resides in Ogden.
Published in Standard-Examiner, Feb 21, 2010
Budget deficit increases have been ignored by politicians and policy wonks on both the right and left from the 1970s, with the exception of a brief period of surplus from 1998 to 2001. Budget surplus during 1998-2001 turned into budget deficit starting in 2002.
In terms of our capacity to pay determined by GDP (Gross Domestic Product) there was 354 percent increase in the proportion of budget deficit from 2001 to 2008. Now, when the country has just missed another great depression and is still not fully recovered, we hear a battle cry by some politicians and deficit hawks against budget deficits and public debt. We did not hear the same concern in peacetime, when the economy was humming in the latter part of the 1980s, and before the recent severe recession.
It seems that our political leaders are ignoring the bigger picture of deficits and public debt. They are either unwilling and /or unable to put the current deficit in historical context. According to Congressional Budget Office (CBO), actual deficit as a percentage of GDP was 4.9 percent in 2008 and after reaching the projected peak of 8.9 percent in 2009, it is expected to decline to 1.2 percent in 2015.
During the Great Depression, budget deficit at the start of Roosevelt's administration in 1933 was 4.6 percent of GDP and after peaking to 5.48 percent in 1934, it declined substantially until the start of the WWII build up in 1939. It should also be noted that in 1930's the Federal government was not saddled with enormous liability of mandatory spending as it is today.
According to CBO, mandatory spending (only on Social Security, Medicare and Medicaid) is expected to increase to 86 percent of total spending in 2015 from 79 percent in 2008. It leaves little room to cut spending, given the unwillingness of many conservative politicians and tea party-goers, to change current laws to modify these spending programs and taxes.
According to the study in November 2009, by economist Gary Richardson in the online journal The Economist Voice, "red" states "that typically support Republican presidential candidates -- and that send the bulk of Republican representatives and Senators to Washington, D.C. -- are the states that receive the most in expenditures relative to the taxes their citizens pay." These are the same states where we hear the loudest complaints against taxes and higher spending. Spending and tax policies are not right vs. left issues, because we all have a stake in a fiscally sound government and a health economy.
We are all interested in reducing deficits because they may pose problems when the economy is growing and both private consumption and investment spending are growing robustly. For example, in a growth economy close to full employment, persistent deficits may aggravate inflation and may dampen economic growth by crowding out private investment. The decrease in capital stock due to the reduction in private investment also increases income inequality as it decreases productivity of labor and thus wages. Since national saving must balance investment and net exports, budget deficits may reduce national saving and hence investment and/or net exports. The decline in net exports implies sale of assets to foreign countries and thus leakage of investment returns. Deficits also transfer income from domestic wage earners to Treasury bond holders, domestic as well as foreign.
CBO projects decline in gross public debt as a percentage of GDP from 85% in 2010 to 78% by 2015. Despite this hopeful sign, once the economic recovery is assured with jobs our political leadership must be willing to raise some taxes and significantly reduce growth in mandatory and discretionary spending, to put the economy on the long term path of fiscal balance. Persistence in accumulated deficits, even during robust and stable economic growth, put us on a risky path and may make the fiscal policy impotent during the next economic crisis.
There are two ways to reduce public debt. First is to reduce budget deficits. Second, the economy has to grow faster than the interest rate we have to pay on the debt. CBO projections give us some hope on the growth front.
Projections show that during 2011-14 inflation adjusted GDP growth rate will be slightly higher than the interest rate on 10-year Treasury notes. But growth rate projections will not materialize if we cut spending programs to promote new investments at this time.
The recovery is fragile, and private markets are plagued with uncertainty of recovery. The call for deficit reduction and cuts in spending at this time, specially meant to promote investment, invites either very slow recovery or outright decline in growth rate and thus deprives our children and grandchildren of wealth and good life in the future.
Mathur is former chairmen of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He resides in Ogden.
Sunday, January 24, 2010
CEOs' compensation needs overhaul
By Vijay K. Mathur
Published in Standard-Examiner, Ogden, Utah, Jan 9, 2010
Most people are aware of complaints by politicians and general public about corporate CEOs' outrageous compensation, especially in large corporations. Economist Arantxa Jarque reports in his paper in the Richmond Fed's Economic Quarterly, Summer, 2008, that the average compensation of CEOs in the top 500 corporations in the U.S. was $15 million in 2007. That was 300 times the average pay of workers. Even the severest recession in recent memory and the dismal managerial performance in the financial sector have not prevented companies from awarding large bonuses to executives.
There are no standard benchmarks which can be used to evaluate the performance of executives. The concern is with compensation (salary, bonus with stock options, stock grants, retirement benefits, severance payments and other deferred payments) for executives in large companies. According to a study by C. Frydman and R. Saks, median CEO pay rose 54 percent from 1970-79 to 1980-89, but it jumped to 125 percent from 1990-99 to 2000-2005.
The question therefore is what determines the compensation of CEOs in large corporations? Various determinants have been investigated to explain CEOs' compensation, for example, sizes of the corporations, rates of return on stocks (dividends and change in stock prices as a percent of stock prices), market values of the companies (values of assets and stocks), and competition companies face in the market. But, aside from measurement problems, there is no unambiguous agreement on uniform standards of performance to base compensations.
CEOs are principal agents (hired managers) who represent shareholders' (owners') interests. Therefore, part of their compensation is for managerial and organizational abilities. However, there is one problem. CEOs, possessing critical information, may have different interests than the interests of shareholders. Hence they may not disclose complete and accurate information to shareholders in order for them to make important decisions good for the health of the corporations. Hence the problem shareholders face is to design a compensation package which provides the incentive to CEOs to maximize shareholders' value.
In the current system there is conflict of interest when CEOs are involved in recommending members to the board of directors, consultants to the compensation committees who decide CEOs' compensation. The Wall Street Journal reported on Dec. 15,2009, that in addition to the widening salary gap, the gap is also widening in pension plans of executives and employees.
The claim that bonuses and stock options are meant to compensate CEOs for the risk they take in maximizing shareholders value has not produced desired results. In fact, we have recently witnessed awards of large bonuses despite the financial meltdown in the banking and financial sector and enormous losses suffered by employees and shareholders. Stock option grants, where CEOs benefit from the spread between the granting price of the stock and market price, have been manipulated and misused.
Shareholders must take an active interest in the decision making process of corporations. In Europe stock holders are already taking an active role in many of the decisions of corporations, especially mergers and acquisitions -- one of the strategies CEOs use to maximize their own compensation and power.
However, most mergers fail and/or are unprofitable. Professor Dennis Mueller found in his major study on profits in 1980s that the more diversified a company, greater is the difference between "actual and potential recorded profits."
Thus the question arises, what is the best standard for CEOs' compensation? Professor Henry Mintzberg of McGill University argues in his opinion piece in WSJ of Nov. 30, 2009, that CEOs should not be paid bonuses in the form of stocks and options. They should get competitive salaries and be entitled to the same benefits, commensurate with their salaries, as other employees.
I propose the following:
* (1) CEOs' compensation should be based upon competition for talent in the international market place, because large corporations compete globally and the average worker in those corporations is subjected to international competition. At present American CEOs' compensation on average is way above the compensation of CEOs in other advanced countries.
* (2) Stock grants, vested in five years, should be a greater proportion of total compensation and be redeemable at prevailing market prices.
* (3) Retirement plans should be the same for all employees and no golden parachutes for CEOs.
* (4) CEOs should have no role in the choice of directors and/or consultants which determine their compensation.
* (5) Boards of directors, who are supposed to monitor CEOs' performance for shareholders, must also be stakeholders in the corporations they serve.
* (6) Shareholders must have a limited role in the decisions on CEOs' compensation.
Legislation will not solve this problem. Ultimately, corporate structure's survival and success depends upon the emergence of responsible corporate leaders who look beyond their narrow self-interest and work for the interest of their shareholders and employees.
As Professor Mintzberg states, "all this compensation madness is not about markets or talents or incentives, but rather about insiders hijacking established institutions for their personal benefit."
Mathur is former chairman of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He is also adjunct professor of economics at Weber State University. He resides in Ogden.
Published in Standard-Examiner, Ogden, Utah, Jan 9, 2010
Most people are aware of complaints by politicians and general public about corporate CEOs' outrageous compensation, especially in large corporations. Economist Arantxa Jarque reports in his paper in the Richmond Fed's Economic Quarterly, Summer, 2008, that the average compensation of CEOs in the top 500 corporations in the U.S. was $15 million in 2007. That was 300 times the average pay of workers. Even the severest recession in recent memory and the dismal managerial performance in the financial sector have not prevented companies from awarding large bonuses to executives.
There are no standard benchmarks which can be used to evaluate the performance of executives. The concern is with compensation (salary, bonus with stock options, stock grants, retirement benefits, severance payments and other deferred payments) for executives in large companies. According to a study by C. Frydman and R. Saks, median CEO pay rose 54 percent from 1970-79 to 1980-89, but it jumped to 125 percent from 1990-99 to 2000-2005.
The question therefore is what determines the compensation of CEOs in large corporations? Various determinants have been investigated to explain CEOs' compensation, for example, sizes of the corporations, rates of return on stocks (dividends and change in stock prices as a percent of stock prices), market values of the companies (values of assets and stocks), and competition companies face in the market. But, aside from measurement problems, there is no unambiguous agreement on uniform standards of performance to base compensations.
CEOs are principal agents (hired managers) who represent shareholders' (owners') interests. Therefore, part of their compensation is for managerial and organizational abilities. However, there is one problem. CEOs, possessing critical information, may have different interests than the interests of shareholders. Hence they may not disclose complete and accurate information to shareholders in order for them to make important decisions good for the health of the corporations. Hence the problem shareholders face is to design a compensation package which provides the incentive to CEOs to maximize shareholders' value.
In the current system there is conflict of interest when CEOs are involved in recommending members to the board of directors, consultants to the compensation committees who decide CEOs' compensation. The Wall Street Journal reported on Dec. 15,2009, that in addition to the widening salary gap, the gap is also widening in pension plans of executives and employees.
The claim that bonuses and stock options are meant to compensate CEOs for the risk they take in maximizing shareholders value has not produced desired results. In fact, we have recently witnessed awards of large bonuses despite the financial meltdown in the banking and financial sector and enormous losses suffered by employees and shareholders. Stock option grants, where CEOs benefit from the spread between the granting price of the stock and market price, have been manipulated and misused.
Shareholders must take an active interest in the decision making process of corporations. In Europe stock holders are already taking an active role in many of the decisions of corporations, especially mergers and acquisitions -- one of the strategies CEOs use to maximize their own compensation and power.
However, most mergers fail and/or are unprofitable. Professor Dennis Mueller found in his major study on profits in 1980s that the more diversified a company, greater is the difference between "actual and potential recorded profits."
Thus the question arises, what is the best standard for CEOs' compensation? Professor Henry Mintzberg of McGill University argues in his opinion piece in WSJ of Nov. 30, 2009, that CEOs should not be paid bonuses in the form of stocks and options. They should get competitive salaries and be entitled to the same benefits, commensurate with their salaries, as other employees.
I propose the following:
* (1) CEOs' compensation should be based upon competition for talent in the international market place, because large corporations compete globally and the average worker in those corporations is subjected to international competition. At present American CEOs' compensation on average is way above the compensation of CEOs in other advanced countries.
* (2) Stock grants, vested in five years, should be a greater proportion of total compensation and be redeemable at prevailing market prices.
* (3) Retirement plans should be the same for all employees and no golden parachutes for CEOs.
* (4) CEOs should have no role in the choice of directors and/or consultants which determine their compensation.
* (5) Boards of directors, who are supposed to monitor CEOs' performance for shareholders, must also be stakeholders in the corporations they serve.
* (6) Shareholders must have a limited role in the decisions on CEOs' compensation.
Legislation will not solve this problem. Ultimately, corporate structure's survival and success depends upon the emergence of responsible corporate leaders who look beyond their narrow self-interest and work for the interest of their shareholders and employees.
As Professor Mintzberg states, "all this compensation madness is not about markets or talents or incentives, but rather about insiders hijacking established institutions for their personal benefit."
Mathur is former chairman of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He is also adjunct professor of economics at Weber State University. He resides in Ogden.
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