Growth, CEO Compensation, and Savings

We wish to show, that excessive CEO compensation is deleterious to an economy.  We show that excess savings is also deleterious, the so-called "Paradox of Thrift."

Prove in the case of the Universal Corporation: UC produces everything. Therefore, all it buys is labor. Thus, all revenue goes either to labor compensation or to capital. We include capital’s share in CEO compensation.  Thus, UC’s employee compensation, minus the CEO’s compensation share c, in the n^th cycle, is R_n(1- c), where R_n is UC’s revenue.  Suppose now everything UC’s employees buy is produced by UC, and UC sells nothing to the CEO. Then UC gets all its revenue by selling to its employees, 

( R_n (1- c) ) plus a portion, R_n e, selling to persons outside the corporation.. Therefore,  

R_n+1 = R_n((1- c) + e);  The growth in revenue, for a given period: DR  =  e – c.  So, where c > e, DR is negative, that is, revenue declines. The CEO of the Universal Corporation, regardless of competence, if paid to much,  is adversely effective. Done.

Now we can include the CEO as an employee, ie someone who buys from UC, if we instead interpret c just as what the CEO does not spend, but saves.  Indeed, this gives us the Paradox of Thrift, when c is interpreted instead as the sum of what all employees, CEO included, save. So, if the portion the employees of UC save is more than the portion sold to people outside of UC, ie if c > e, revenues will decline.

If instead we separate savings into components, labor savings and capital savings, (where investment is a capital expenditure,) s_l and s_c, then if s_l + s_c > e, revenues will decline. If s_c > e, then s_l must be negative, and of magnitude greater than s_c –  e, in order for the corporation to grow in revenue.  That is, labor must dissave if capital saves at a rate greater than the rate of selling outside of UC, for UC to grow.  (This can of course be forced by paying labor less than subsistence.)   

Note, if e is negative, eg if the employees also buy from outside UC, at a rate greater than persons outside of UC buy from UC, the employees of UC must dissave, (both  c and e are negative),  |c| > |e|, in order for the revenues of UC to increase.  In components:  we must have |s_l + s_c | > |e|, where if s_c is positive, s_l must be negative of magnitude greater than  s_c + |e| for there to be positive growth of revenue. 

If we include a third component, call it government, and call UC a nation’s economy, then for positive growth we must have:  s_g + s_l + s_c  > e, or  s_g > e – ( s_l + s_c  ).  If we separate e, net exports, into its components x exports and m imports, we require for growth of revenue

s_g   <  x -- m – ( s_l + s_c ). Clearly, where imports are greater than exports, the problem is exacerbated, and there must be extensive dissavings by government if there is savings by labor and capital. 

We observe, for a system with no net trade, ( x = m ),  s_{g  <} – (s_l + s_c ).  That is, for an economy with no net trade to grow, (net closed,) government expenditures must be greater than private sector savings.  In general, that is, the economy as a whole must dissave.  That is:   0 > s_l + ­ s_c + s_g .This may be made explicit:  The share of growth of revenue,

DR =  – (s_l + ­ s_c + s_g ).

What do we mean by dissave? Savings, of course, may mean putting money into mattresses.  Dissaving implies there must be an input of money, such that more money is spent, by the components of an economy, than is earned. This may be money taken out of mattresses.  This may be money lent by an entity outside of the economy. It may be money added to the supply, as with inflation. Where it is lent by an entity inside the economy, (finance, say, thus s_f) we have the same problem:  We have a change in the relative revenue collected by the components, but the revenue for the whole economy necessarily declines.

With monetary input I, as with inflation, say, we have: I > s_l + ­ s_c + s_g + s_f  as the condition for growth of revenue in a net closed economy.  And in general, allowing for imports and exports: 
I + x – m > s_l + ­ s_c + s_g + s_f  Explicitly, the share of growth of revenue is:  
 DR = – ( s_l + ­ s_c + s_g + s_f ) + I +  x –  m.

This is rather tautological.  With a fixed money supply,  total revenue cannot increase, and any quantity of money taken out of the system leads to a decrease in revenue.  Since nominal profit requires an increase in revenue, a fixed money supply will, in the best of circumstances, result in an average nominal corporate profit of zero, unless there is dissavings. Some might argue that the policy of the wealthy for the past 35 years has been a forcing of dissavings on labor, (and government,) from which they have taken their profit. This is manifest by the fact that the share of wealth of the 1% has increased from around 20% of the total economy to around 40%. The share of wealth of the rest of society has correspondingly decreased from around 80% to less than 60%, and all but 10% is concentrated in ownership by the next 19%.  80% of the population of the United States combine to own only 10% of its assets.

PS:  The diagram is actually kind of a joke.  It's really a copy of the backward bending labor supply curve for an individual worker, a janitor say, who, when 'paid to excess,' is expected to produce less, in particular, work fewer hours. (This effect somehow is not thought to apply to CEO's.) While true for the CEO of  the Universal Corporation, in an economy it is only true for the sum of all CEO's.  Any individual corporate CEO, of course, gets nowhere near the compensation necessary to have a deleterious effect on the economy, (though he still might be expected to produce less if overcompensated.)   But that the sum of all CEO compensation, the sum of all compensation to the wealthy, may be harmful lies the problem, which we discuss in my next post.

Import (Trade) Certificates: Some Problems and Solutions

Import (Trade) Certificates: Some Problems and Solutions

In our previous post, we suggested import certificates as a solution to the European debt problem.

While the idea of import certificates seems attractive, there are details that may have to be worked out. Here are several possible problems, with some solutions.

Consider the market, say, for 1-1 import certificates, certificates giving the right to import $1 worth of goods or services for every $1 worth exported. although it could be any ratio. Suppose the markets for goods were such that anything imported by the issuing country could be sold. If the certificates were perpetual, holders would tend to hold on to them, waiting for the highest price a foreign producer would be willing to pay, which could be quite high. Imports, then, would be below a level which was advantageous to the importing country. Certificates might tend to accumulate, until there was a sell off, leading to a boom-bust cycle of importation.

Suppose instead they had expiration dates, like options. 90 days, 6 months, 1 year. Then there might be a chronic shortage of imports. Or, instead of expiring, they could revert to the government, which could auction them off.

Or the certificates, instead of going to the exporter, could simply be retained by the government, which then sold them at auction. Howard Richman in

http://seekingalpha.com/article/203422-how-import-certificates-could-balance-trade-and-budget

recommends this, as well as targeting the certificates at those countries which exhibit mercantilist practices against the US. If they were targeted at any country which persisted in having a surplus with the US, they would be just as effective as untargeted ones. Attempts to route trade trough other countries would bring these countries to surplus, and then trade certificates could be issued against those countries, too.

Richman, in his article, also discusses the legal implications with respect to WTO agreements. The fact is, the adoption of import certificates would spread, and render those agreements redundant. (We should also expect resistance from the WTO, since they would be rendered redundant.) Since the universal adoption of import certificates would result in all nations having a balanced trade budget, discussions instead would revolve around bilateral differences in allocation, if temporary imbalances were seen as beneficial to one country or another, eg, to capitalize an export industry in one of the countries.

They might constitute a barrier to growth of trade, since any country with an increase in imports, need not be assured a corresponding increase in market. But under these circumstances, exporters to a particular country could be issued import certificates targeted to that country. That country would then be assured an increase in market, and so would not be discouraged from increasing its imports. It could exchange these rights with other countries, for import certificates from them. And this brings us to another option. The import certificates could be sold along side the exports of goods or services. Thus the foreign importer would acquire the right to export to that country, to sell as he chose. There would thus be no barrier to expanding trade, since each country, on expanding imports, would be assured of the rights to a market for its own exports. It would not be assured of the market itself, of course, as there might not be one there for what it produces. However, the country is better off than before, because it has rights to a market that someone might produce for, and it can exchange these rights to a market for what it produces.

At the level of producers, this might get very complicated. So, the import certificates follow the exports to the importing country, whose government acquires the rights. Then the problem of the allocation of rights to producers becomes a domestic one for each country. (This would in fact be the default situation, since any government could just tax the certificates away from its importers.) Each country’s own government would be the clear cause of any woes resulting from trade.

The whole thing seems to take on an aspect of barter. Countries have rights to markets they might not want, looking for someone with rights to markets they do want, who might not want the rights to the markets they do have. But in fact there is already a market for much the same thing, and that is the currency exchange market.

What could go wrong? Well, a country with substantial debt is eventually going to want to issue import certificates to a value less than its exports. In this way it can pay off its debt. That means its going to have to trade with countries which issue it certificates to value more than its exports. Its debt holding partners have to allow themselves to be repaid. See the example below.

A country wanting to indulge in mercantilist practice is also going to want to value the certificates it issues at less than a dollar for each dollar exported. Were all countries to engage in this practice, or even enough countries to engage in this practice, world trade, and the world economy, would contract. What would be good for one, would be bad for all. But how would one discourage individual perpetrators? The desire to expand one’s economy, at the expense of others, should not be rewarded, nor allowed to wreak havoc with the world’s economy. Now a valuation of its import certificates at less than the value of its exports, would be a clear signal of mercantilism. It would be anti-social behavior, though not aimed at anyone. But of course, it would be aimed at each country in its particular, since it is to each country that it is issuing its certificates to. That is, it would be saying to each country that it wishes to take advantage of it, to exploit its trade to grow at that country’s expense, by forcing a trade deficit on that country in particular.

Each country would be taking it ‘personally,’ and have the individual choice: To allow itself to be exploited, or to retaliate against the mercantilist country, say by issuing trade certificates against that country which were similarly valued at less than the value of the export.

Actually, retaliation would not be necessary. Suppose country A is issuing import certificates at a 1 to 1 value, one dollar of import certificates with each dollar of exports. Then any country B which issued certificates against country A of, say, $.90 per dollar exported to country A, would automatically see its trade with country A contract. That is because at the next round of trade, country A would only be able to export $.90 worth of goods to country B, and thus country B would only receive certificates to export $.90 worth of goods to country A. The next round country A would only be able to export $.81 worth of goods to country B, and that is all the certificates country B would receive. And so on.

In order for trade to maintain at the same level, country A would have to issue certificates to the value of $1.11 per dollar worth of goods exported. Then when country A exported $1 worth of goods to country B, Country B would return with $1.11 worth of goods, and the right for country A to export another $1 (90% of $1.11) worth of goods. So the situation would remain stable. Country A would actively have to allow itself to be exploited. It would have to cooperate in going into debt.

So, what is the import certificate that we are now talking about?

It is issued by each government. It is a right to import a specific quantity of goods or services into the country of that government. It is issued. for one of that country’s exporters, (perhaps to that exporter,) and it goes along with the export to the government of the country of destination. That government, depending on its domestic policies, may do with the certificate as it wishes. It may be allocated. It may be auctioned. It may be bought, sold, or exchanged.

It is 1 to 1, the right to $1 of import for each dollar of export, (eventually, in the case of debtor and creditor nations.)

We have discussed some of the alternatives, and the problems attendant on each. Some country A may issue them domestically. But that does not give any incentive to country B to import from country A. Not only does country A giving the certificate to country B give country B the right to trade with country A, but the incentive to do so, since it assures the rights to a market for its own producers. This type of import certificate constitutes a reward from country A to county B for buying from country A. How could country B complain?

Trade Certificates: Solution to the European Debt Crisis

Trade Certificates: Solution to European Debt Crisis

Here’s a nice discussion of the European debt crisis:

http://streetlightblog.blogspot.com/2011/09/estimating-cost-of-eurozone-crisis.html

It’s the third of three articles on the thing, so click on the blog title to access the rest.

We reduce it to the producer-consumer problem. See:http://anamecon.blogspot.com/2010/05/greek-debt-and-producer-consumer.html

But Kash describes the crisis per se is a result of the sudden cessation of capital flows from the center of the Eurozone to the periphery. These flows had to cease, and probably suddenly, some time, as the debt imbalance inevitably piled up. Kash also notes a fair percentage of those flows were for investment. The periphery countries weren’t exactly squandering the money, but that really doesn't matter, except to make the tragedy more poignant. He suggests shared responsibility for the crisis. Yes, the central countries have to pay. Actually, have already paid, they just have to swallow their losses. Making the peripherals pay is just going to make them less able to consume German surplus production. In fact, the peripherals have to achieve a trade surplus. Germany will have to find other markets for its surplus. Inflicting pain on the periphery, except to the point where they have to live within their means, is graceless. Of course, the entire process of- inflicting surplus production on them has reduced their ability to do this. The same thing has happened to the US with its trade deficit. Its ability to live within its means, actually the means itself, its industry, has been compromised.

Now Greece borrowed a lot of foreign money. That money had to be, eventually, spent on foreign goods. Or else they would still have it, in cash, and be able to give it back. We observe that debt, if you don't have the cash, must be ultimately be payed with goods, services, or assets. Nothing else will do.

So what is to be done? Austerity works for households. For nations? You might think. But the problem is deflating a nation's economy destroys productive components while it is reducing consuming elements. Indeed, the productive elements need the consuming elements to continue consuming unless they have compensating export opportunities. For it is only by exporting that the deficit country can pay back the debt, but will the surplus countries allow this to happen? Or instead is the deficit country is forced to sell assets, which worsens its ability to pay in the future?

In fact, the entire process, in the absence of any debt forgiveness, has a dubious- morality. The surplus country lowers prices, drives businesses in the deficit country out of business. See:

http://anamecon.blogspot.com/2010/04/effects-of-unbalanced-trade.html

Runs up the debt in the deficit country, then buys up the deficit country's assets. Moral? Or a form of war?

Greece, for instance, had a significantly deteriorating trade balance since about 1990. It seems to be a self-reinforcing thing. And now its assets are being sold. Germany's trade surplus has been increasing steadily since 1990. Is it buying Greek assets?

We recommend the introduction of import certificates, to force a balance of trade, and pay off reasonable debt. See: http://seekingalpha.com/article/203422-how-import-certificates-could-balance-trade-and-budget

Or for a brief description on import certificates, see: http://en.wikipedia.org/wiki/Import_Certificates

Rather than the targeted certificates, we merely encourage all deficit countries to phase in general certificates, not aimed at any country. Indeed, once the process starts, certificate trading will quickly become the norm, since deficits will be forced and focused on those deficit countries which do not practice it, and trade wars will ensue between surplus countries.

Better than selling the farm. Certificates could be phased in, to prevent economic trauma. The goal would be exporters would be issued 1 euro worth of import certificates for each euro they exported. This certificate would allow the importation of 1 euro worth of goods or services. These certificates could be bought and sold. For the deficit country, these could be phased in, starting near the percentage of deficit. Thus, for a country with a 30% trade deficit, they could be originally issued at 1.25 euro worth of imports allowed, say, for each euro worth of export, and then reduced in periodic increments until one euro of import per euro worth of export, at which point trade would be balanced. In fact, if this were practiced by Greece, eventually their trade and capital flows would each be balanced. Problem solved. To pay back what is already owed, eventually Greece must have a trade surplus, so it would, for a while be issuing certificates allowing say .9 euros of imports for every euro worth of exports. This would force it to have a 10% trade surplus, with which to pay back its debts. It also implies that they willl be consuming at less than their production, which is the point of the austerity process. Of course, the process would take longer than any interest on the loans Greece presently owes to compound to unpayable heights. Do the Germans have any intention of allowing Greece to pay them back, since this would damage their own economy? Or are they instead after Greek assets?

But Greece can be the master of its own fate, if it so chooses. With a little help. And so can the US.

And the peoples of the Germanys and Chinas of the world will have to consume to their ability to produce.

Meanwhile, with each country issuing trading certificates, international trade wold be balanced on a nation by nation basis. No country could be claimed to exploit its surplus to cripple the economy of another, and expand its own economy at the other country's expense. All countries would have to live with in their means. And the benefits of otherwise free trade could be enjoyed at a maximum sustainable amount.