Saturday, January 31, 2009

How Much Is An Un-shameful Bonus?

So Obama was furious with 18.4 bn dollar bonuses for Wall Street executives and people quickly join the fray and share the rage.

But, first off, we need to get it, at least conceptually, right on how labor (executive included) should be paid. Economics tells one needs be paid according to their marginal productivity --how much additional value of product one creates once he/she is joining production process. But this is technically difficult. In a joint production, can you really separate the marginal product of your labor and marginal product of, say, the computer that you use?

Thus the best way would be to look at the opportunity cost of hiring you --how much employer are actually willing to pay you, after considering any other best alternative in a competitive market. In other words, the market price. You may enter efficiency wage argument to adjust for some market imperfection, but the bottom line is that market will tell how much you are worth.

Now, enter the government with their bailout plan.

Among other things, what the government does obscures real value of hiring you because some of your marginal product is now provided by the government. Since the government help your company, you seem not as worthless as you actually are --you screw up thing, but somehow the government help you along the way by making your company doesn't go out of business. If the government don't bail your company out, your overspending firms would go bust, and the only way to stay afloat is then to keep your bonuses in check.

But as the government decided to step in, the market is distorted and you are overpaid. This is very much predictable trade off of any government bailout. You give up the ability of market in allocating resources for another objective --like saving the whole financial system.

Whether it is a fair trade is another story. The government -- as now major shareholder of US banking system -- has all the reasons and rights to complain, nonetheless it is surprising that the administration seems not prepared for this consequence of their very own action.

Or maybe it is just a political statement that has to be judged based on its own term. I don't know.

No comments:

Post a Comment