Friday, 30 October 2009

Government meddling in bank executive pay is not going to help.

Over at the PBS-NBR website Steven Horwitz points out that Government Meddling in Bank Executive Pay is Not Going to Help. He writes,
The irony is that bank executives weren't the primary cause of the crisis, the very politicians and Federal Reserve who are now on their moral high horse were. Capping executive pay may make them feel good, but the consequences will be that the talent needed to restore confidence in the financial system will not see the lower pay as worth the trouble and will take their skills elsewhere.

More generally such meddling in markets sends broader anti-capitalist signal to the private sector. Other executives and investors, whether or not they were bailed out, will quite reasonably wonder "are we next?" And as they do, we may well begin to see their confidence in the system fall, leading to a broader withdrawal of financial and human capital. Obama and the Fed are playing with fire by flexing their political muscle this way. An understanding of the Great Depression suggests that they will get burned, further scorching an already crispy economy.
History offer some advice here: the economic historian Robert Higgs has argued that investors in the 1930s were hesitant to make investments because they simply did not know what the rules of the game were. Higgs notes that this "Regime Uncertainty" was one of the reasons that the Great Depression lasted so long. The inconsistent policy moves by both the Hoover and Roosevelt Administration as well as FDR's increasingly anti-business rhetoric and policies through the mid-30s led people to not want to take chances on longer-run investments. This lowered the rate of investment just at the time when investment was so badly needed. The recent moves by the Obama Administration and the Federal Reserve to look at what they claim is excessive pay to bank executives is yet another example of contemporary policy makers not learning this simple lesson from the Great Depression. Insofar as these moves increase regime uncertainty they will do nothing to help, and could more likely hurt, the current state of the economy.

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