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November 2009 Archive for Economic Sense

RSS By: Matt Bogard, AgWeb.com

Matt's primary interest is in the biotech industry and ag policy.

Thanksgiving: A Lesson In Agricultural Economics

Nov 19, 2009

By Matt Bogard

The first Thanksgiving story provides an interesting lesson in agricultural economics.  Foremost, the celebration was about thanking God for abundance. However, an important aspect is what resulted from a move away from a socialist or common property model of organizing and allocating resources (imposed on them by the Colony’s Sponsors) to a system of private property rights.

Governor William Bradford's comments in 1622 describe the perverse incentives that resulted in the absence of property rights and redistribution of work and wealth:

“The experience that was had … that the taking away of property and bringing in community into a commonwealth would make them happy and flourishing; as if they were wiser than God. For this community was found to breed much confusion and discontent and retard much employment that would have been to their benefit and comfort. For the young men, that were most able and fit for labor and service, did repine that they should spend their time and strength to work for other men's wives and children without any recompense. The strong… had no more in division of victuals and clothes than he that was weak and not able to do a quarter the other could; this was thought injustice."

In 1623, they embraced the incentives of private property and capitalism:

“They had very good success, for it made all hands very industrious, so as much more corn was planted than otherwise would have been. The women now went willingly into the field, and took their little ones with them to set corn; which before would allege weakness and inability; whom to have compelled would have been thought great tyranny and oppression…By this time harvest was come, and instead of famine, now God gave them plenty, and the faces of things were changed, to the rejoicing of the hearts of many, for which they blessed God.”

The first Thanksgiving was a great example of agricultural productivity, given the proper incentives.

 The source for these excerpts can be found within a much longer article at the Foundation for Economic Education here.

Greed, Envy, and Compensation

Nov 15, 2009

By Matt Bogard

To me, we have seen a lot of hypocrisy lately in the public discourse regarding the issue of compensation. The underlying premise for much of the call for capping executive compensation has been that executives are overcompensated. That compensation structures have provided too much incentive for excessive risk taking. When you combine these pay structures with greedy executives, you get all of the problems that characterize the recent financial crisis. Since they had a lot to do with our current problems, they should not be rewarded with generous compensation or bonuses.

I deem this line of thought as hypocritical in the following way. I think much of the popular support for new regulations regarding executive salaries has to do more with envy, than economics (which I will discuss more below). Often political leaders will attempt to exploit envy from below, in order to create a larger movement for social control from above. Envy is just the desire to have more, and often more of what someone else has. Lately, envy has meant begrudging others of what they have and has led to having government take it away. How is that so different from greed?

Are executives really overcompensated? Research from the Journal of Political Economy by Jenson and Murhpy indicated that for every $1000 of value created for a company, executives were only compensated by $3.25. It hardly appears that they are overcompensated. There has also been the criticism that capitalism, and greedy executives, has lead to too much concentration on short term gains without concern for long term outcomes. This too is without merit. Research from the Journal of Applied Corporate Finance indicates that near term cash flows account for only a small percentage of a firm's capitalized market value. Only 18% of share value can be attributed to short term expectations of profits within a 5 year window. Expectations looking 10 years out account for up to 35% of share value. In other words, capitalism, or markets place greater value on long term gains than short term wins.

A major challenge in corporate finance and compensation structures has been to actually encourage, not discourage executives to take calculated risks. A basic principle of finance is that with greater risks come greater returns. A leader that consistently abstains from taking risks will not create value for any organization. Large bonuses and golden parachutes aren't just the product of greed, but are designed to give executives the incentive to take prudent risks and create long term value for their firm and its shareholders.

Is too much risk taking really a problem? Some people claim that deregulation in addition to greed lead to excessive risk taking and our current problem. The only problem with that point is that we have not had a single act of deregulation by congress in well over a decade, and that was during the Clinton administration. But this deregulation ( the Gramm-Leach-Bliley Act) in fact helped create stability in the recent financial crisis, instead of being a source of the chaos. As quoted from the Wall Street Journal ( Oct 18,2008)

'Indeed, it allowed Bear Stearns and Merrill Lynch to be acquired by J.P. Morgan Chase and Bank of America, and allowed Goldman Sachs and Morgan Stanley to convert to bank holding companies to help shore up their positions during the mid-September bear runs on their stocks.'

But I do agree, that excessive risk taking did have a huge role to play in the current crisis. Market interest rates check excessive debt accumulation and risk taking. However, the artificially low, socially planned interest rates of the fed upset these natural checks and balances. Risky projects that did not offer a return high enough to offset risks under market interest rates, became profitable at new artificially lower interest rates. Businesses took on more risks and more debt than market fundamentals otherwise would have supported, and suddenly we have the makings of a rational bubble and the inevitable crash that followed. Implicate greed and risk taking if you will, but don't take it so far as to blame salaries and deregulation in the process.

What are the effects of our current stance on salaries? Now, of all times is when we need the best talent to lead us back to positive returns. If we really want the bailed out companies to ever be in a position to repay taxpayer dollars or regain their independence from government control, we need the top leaders to put them in that position. We won't get off cheap doing it. Already Bank of America is having trouble finding executives willing to be their CEO at the government imposed $500,000 pay cap. ( Wall Street Journal Nov 14, 2009).

Having not addressed the root causes of the financial crisis, and implementing more regulations that decrease risk taking, decrease compensation, and decrease investment incentives will only prolong the crisis and lead to stagnant long term growth.

If greed has ever been a problem, then it will be our envious regulatory response that keeps us from solving it.

References:

'Most Pundits Are Wrong About the Bubble-The repeal of Glass-Steagall has helped us weather the storm.' Wall Street Journal, Oct 18,2008. Charles Calamiris.

'BofA Hits Pay Snag in its CEO Hunt.' Dan Fitzpatrick. Wall Street Journal, Nov 14,2009.

Michale C. Jenson and Kevin J. Murphy."Performance Pay and Top Management Incentives," Journal of Political Economy, 98 No. 2 (April 1990) p. 225-264.

J.R. Woolridge, "Competitive Decline: Is a Myopic Stock Market to Blame?" Journal of Applied Corporate Finance, Spring 1988. p. 26-36

Earth Liberation Front: Resistance

Nov 09, 2009

By Matt Bogard


The following is an excerpt from a recent interview of Craig Rosebraugh regarding Earth Liberation Front's magazine 'Resistance.'  (here on Eigene Weekly's Next Big Thing blog)

"This movement realizes that when governments and politicians refuse to act to protect the planet, it is up to all of us to step in and protect our home. And the only logic way that this protection may occur is to understand the primary force driving environmental destruction. That force is economic; it is the financial incentive that corporations and governments have when they clear-cut old growth forests, when they pump out gas-guzzling vehicles, when they destroy mountain tops and communities for coal, when they lay gas and oil pipelines across landscapes and ecosystems, when they genetically alter the natural world, when they pump toxins into the air, into the water and soil. It is the profit motive that is driving environmental destruction. So it only makes logical sense to work to directly remove that profit motive from these entities so they either are persuaded to stop their harmful practices or go out of business."

Among other things, he is linking profits and biotechnology with environmental destruction. It is annoying that these same 'stories' continue to be told. They are like myths that it seems we must continue to debunk over and over again.  This time, we have a combination of myths about modern agriculture and the general misunderstanding of profits and our market system.

Removing the profit motive is the very last thing that one would want to do if long term sustainability is the goal. It was largely the profit motive that led to the production of biotech crops, and adoption by farmers. Sure we are all motivated by things besides profit, but the market system helps to coordinate our decisions, so that our choices are compatible and resources are used efficiently in a world of scarcity. And guess what, as so much evidence has indicated, farming is more sustainable than ever! While the agriculture industry may be one of the best examples of how markets and profits can lead to sustainable outcomes, the basic principle holds true across many other industries as well. I guess Mr. Rosebraugh has never heard of ‘The Invisible Green Hand.'

He goes on to perpetuate more propoganda about what 'democracy' is and how our founders lied to us about what this country is 'really' supposed to be about- how corrupt we have been since our inception in 1776- but that will have to come later. I post a lot of things critical to the functioning of government vs. markets, but him and I are nowhere near on the same page on that issue.

Of course, considering ELF as the source, we would not expect their publications to be considerate of all of the evidence, it's not like they are TIME magazine or anything.

Reference:

Mercatus Policy Series Policy Primer No. 7. ‘The Invisible Green Hand.’ October 2008

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