Surveying the heady rewards of boardroom service, the late John Kenneth Galbraith wrote: “The salary of the chief executive of the large corporation is not a market award for achievement. It is frequently in the nature of a warm personal gesture by the individual to himself.”
Public fury about City bonuses reflects a widespread belief that the whole banking sector operates like that. The G20 summit of finance ministers and central bankers, which is being held in London this week, is likely to dwell on the issue. There are signs of recovery in the financial system and the global economy. But it is easier for policymakers to inveigh against highly paid bankers than to judge confidently how far the recovery extends.
The French and German governments are outdoing each other in devising proposals to cap bankers’ pay. Gordon Brown could perform a useful service within the G20 by opposing such populist and fanciful schemes. The G20’s task is to prevent financial instability from contaminating the wider economy. It is not to hinder the banking sector from operating competitively.
As the credit crunch turned to full-blown financial panic last autumn, Mr Brown shed his domestic troubles and sought to rescue the global economy. The Government’s ambitious plan to recapitalise the banks and take public stakes in them in return was well conceived. But Mr Brown’s notion of a “new international financial architecture” never extended beyond a slogan.
Other European governments have, however, seen the opportunity to propose tough new regulation. President Sarkozy of France expresses dismay at the “return of bad habits” in banking and promises to “moralise capitalism”. He is holding out the prospect of legal curbs on bankers’ pay unless the banks agree to a code of conduct. Angela Merkel, the German Chancellor, insists that traders should wait at least four years before receiving most of their bonuses.
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There is a problem in bankers’ pay. The search for short-term trading profits often generated large rewards, but there was no commensurate penalty for failure. It is sensible for banks to adopt deferred compensation schemes, so that bonuses are paid out over a period of years and are tied to some measure of risk-adjusted profits.
But legislation to cap bankers’ pay is not the answer. It is bound to introduce distortions. Recall the incomes policies of the 1970s. If employers wished to reward staff, they would do it in benefits rather than in cash. An army of accountants devoted themselves to schemes to get round pay limits. And bankers are adept at inventing ways to minimise tax liabilities. Encouragement of deferred compensation schemes, by requiring lower capital reserves from banks that implement them, is a better approach than statute.
The French and German proposals are not primarily about the reform of a dysfunctional financial system. They aim instead to hobble the City. That would inevitably play to the advantage of Paris and Frankfurt. Mr Brown should not mistake Mr Sarkozy and Ms Merkel’s supposedly principled stand for anything other than a landgrab for the financial services industry. Lord Turner of Ecchinswell, chairman of the Financial Services Authority, may regard much of banking as “socially useless activity”, but there is a strong economic case for having a financial sector that is bloated.