Windfall tax on bank bonuses

All through the financial crisis, the British government has shown remarkable leadership with important policy decisions. Even as the debate on bank restructuring was meandering along, Prime Minister Gordon Brown took the decision to nationalize Northern Rock and set the stage for the bank restructuring programs elsewhere. Similarly, the Bank of England was first off the block with its quantitative easing proposals to inject liquidity into credit starved financial markets. Amidst the ambivalence and confusion among policymakers, the Chairman of FSA, Lord Adair Turner came out in support of Tobin tax on short-term financial market transactions.

In the latest of such bold decisions, the British government has announced its plans to impose an one-time "super tax" of 50% on banker bonuses of more than £25,000 ($40700) on not only British banks but also the London subsidiaries of Wall Street giants. The French government too appear to be following the British lead and looks set to announce a windfall tax on bank bonuses.

Already the French government have entered into an agreement with top executives on voluntary limits on executive compensation. It was agreed that up to two-thirds of bonus payments should be deferred for three years, while a third should be paid in shares of the bank, and that the bonuses would be paid out based on the performances of the bank as a whole and not that of particular trading desks. Switzerland too have announced some loose restrictions on bonuses on executives of the biggest financial firms.

The British decision comes in the wake of massive profits and record bonuses already announced or expected in many financial market firms, who have benefitted from both government bailout assistance and the depleted competition in the aftermath of the sub-prime crisis. Wall Street banks alone are expected to payout more than $26 bn in bonuses this year, with Goldman Sachs leading the way, and in the wake of the British decision, pressure will surely mount on the Obama administration to follow suit. Justin Fox and Paul Krugman have come out in support of such bank bonus tax.

In anticipation of the public uproar, Goldman Sachs, enjoying one of its most profitable years, has announced that it would not award cash bonuses for its 30 senior-most executives this year and also let its shareholders vote on its executive pay decisions. However, these executives would be paid in the form of a special stock ("shares at risk", a form of restricted stock that cannot be sold for five years and includes a clawback option in case their businesses falter down the road) and the shareholder vote would not be binding on the Board. Goldman has already set aside $16.7 billion to pay its workers this year, a figure that translates into roughly $700,000 an employee.

Is Obama administration listening?

Winners and losers from falling dollar

The US dollar has been on a continuous decline since 2002 against a basket of major currencies.



And its impact is nicely captured in this graphic

Innovation lags behind in India

Though India may pride itself as the knowledge superpower among emerging economies, its record in bringing to the market innovative and great products and services falls far short of its major competitors like China and Israel.

The NYT reports that "Indians are granted about half as many American patents for inventions as people and firms in Israel and China... corporate and government spending on research and development significantly lags behind that of other nations... and venture capitalists finance far fewer companies here than they do elsewhere".





Unlike Israel, leave alone the US, whose success with innovations is attributed to the easy access to venture capital funds for small technology start-ups, Indian start-ups do not have similar access to seed capital from angel investors. A general cultural aversion to risk (though this is not so among atleast some communities) taking may also partially explain this deficiency. Much of the Chinese advances with R&D and patents have happened in recent years, with US patentts having taken off since 2006.

Jobs creation policies as fiscal stimulus

Rising unemployment across developed economies has shifted the primary focus of fiscal stimulus measures from propping up aggregate demand to more specifically sustaining and creating old and new jobs respectively. Some of the European economies, most notably Germany, have already in place policies that specifically address the problem of unemployment, and pressure is mounting elsewhere to embrace the same.

With employment being a lagging indicator to growth, it is clear that the unemployment rate will continue to rise, albeit slowly, even if the economy starts growing and it is expected to be years before the unemployment rate returns to normal.

Economists like Paul Krugman have been calling for specifically job creation programs instead of waiting for the fiscal stimulus to trickle down to create jobs. Instead of economic output growth focussed policies, they advocate direct employment growth creation policies.

The United States, with 16 million out of work and more than double that under-employed, is experiencing its worst jobs crisis since the Great Depression, with six times as many people seeking work as there are job openings, and the average duration of unemployment (the time the average job-seeker has spent looking for work) is the highest level since the 1930s at more than six months. This situation is exacerbated by the disconcerting trend over the current decade which has experienced a virtual stagnation in private sector job creation.

The Economic Policy Institute has come up with a five point American Jobs Plan (pdf here) - streghtening safety net, fiscal transfers to state and local governemnts, investments in transportation and schools, public service jobs, and job creation and tax credit - that would create at least 4.6 million jobs in one year.

Mark Thoma sums up the various fiscal stimulus measures with unemployment reduction priority

1. Tax incentives that impact consumers (payroll tax cut, cash for clunkers, incentives to purchase homes, a sales tax cut, a tax rebate etc) and those that impact producers (tax cuts on business profits, tax incentives that encourage work sharing rather than layoffs or that encourage firms to hire new workers, accelerated depreciation, job creation tax credits, tax cuts or credits that encourage investment etc).

The effect of tax incentives for both consumers and producers on employment is indirect, and hence could fail, especially if the tax cuts are saved and the profits are not re-invested. Work sharing programs (where employers reduce their workers’ weekly hours and pay, often by 20-40% and then government makes up some of the lost wages, usually half) like in Germany are best at preserving existing jobs than at stimulating new employment.

2. Transfers to state and local governments who are faced with strains to their budgets due to declining revenues and increasing welfare burdens. In the absence of alternative source of raising money to tide over the crisis, declines in public sector employment is inevitable.

3. Government spending on goods and services - either consumption or capital investments. Though both increase employment, while consumption spending is easier to get off the blocks, investment spending, especially in infrastructure, delivers greater bang for the buck in so far as it creates some asset. As a specific job creation policy instrument, investment spending is not cost-effective and also slow to implement.

4. Government spending on labor services is the most direct way to create jobs. The New Deal’s Works Progress Administration (WPA) offered relatively low-paying (but much better than nothing) public-service employment during the depths of the Great Depression. They mostly involve work in the local community and hence are easier to implement, and disparaged as "make-work" policy and used only as a last resort. Along with aid to state and local governments, this may be one of the quickest, most direct, and cheapest ways of creating jobs - the Economic Policy Institute proposal estimates that a public jobs program could create one million jobs at a cost of $40 billion per year over a three year time period.

See also this debate about the utlity of specific job creation programs.

Update 1
President Obama's job creation strategy (about $70 bn drawn in from TARP) contains three main elements - tax incentives that encourage small businesses to hire more workers, more spending on infrastructure and other large projects, and rebates for consumers who invest in energy saving improvements for their homes (the so-called 'cash for caulkers' program). Mark Thoma and Robert Reich find it inadequate and more a case of political window dressing than substantial. Their biggest disappointment is over the silence on assistance to state and local governments which are groaning under a $350 billion hole this year and next, and unable to run up deficits they are wildly cutting spending, cutting jobs, cutting contracts, and raising taxes and fees.

Update 2
President Obama has proposed job creation tax credits as part of the direct attack on the growing unemployment problem. Various versions of the tax credits, including payroll tax holidays, have gained circulation in the recent weeks. The Economic Policy Institute has proposed a tax credit (a credit of 15% of expanded payroll costs in 2010 and 10% in 2011) for new job creation over the next two years, which is expected to create almost 3 million jobs in 2010 and over 2 million in 2011. See this summary of such proposals.

Update 3 (10/3/2010)
Mark Thoma has this nicely written moral arguement in favor of financing job creation policies, especially those involving univerally beneficial public goods like infrastructure assets, during economic downturns.

Paradox of choice

Conventional wisdom has claimed that choice, and the freedom associated with it, is always is good thing and the human ability to desire and manage choice is unlimited. However, recent evidence - popularized by Barry Schwartz in his popular book "Paradox of Choice" and a famous jam study by psychologists Mark Lepper and Sheena Iyengar - appears to indicate that too much choice is actually a bad thing, causing decision paralysis and unhappiness. See Barry Schwartz in this TED talk



In the jam study, when faced with choosing (tasting and buying) between jams in displays with 6 and 24 varieties of exotic and high quality jams, though more customers were attracted to the display with 24 varieties, only a small share of customers who visited the larger display actually purchased a jam whereas a much larger share of customers visiting the smaller display purchased a jam.

However, as Tim Harford writes, subsequent experiments on similar contexts (including jam and luxury chocolates) find inconclusive evidence that increasing choice demotivates consumers. He writes, "The average of all these studies suggests that offering lots of extra choices seems to make no important difference either way."

However inconclusive the evidence, I am personally inclined to accept the view that a large choice set does place constraints on human ability to make efficient and optimal choices. As to what constitutes a "large" choice set, it varies across contexts and objects being chosen. The most commonplace examples of abundance of choice leading to sub-optimal outcomes and lower happiness are selection of dress materials (say a shirt) in a large showroom (especially those with multiple brands) and choosing from an a la carte menu in an upmarket restaurant. From numerous such less than happy experiences with such choices, at both cloth showrooms and restaurants, I am personally convinced that "too much choice is bad", at least in some circumstances.

Apart from the forementioned examples, it is fair to say that when making choices on not so simple objects like insurance or savings policies and financial products, complex electronic products, etc, the revealed preferences of people indicates that more structured choice leads to more optimal and happier outcomes. As Stephen Dubner writes, "So even if jam studies of the future prove inconclusive, it still seems wise to streamline choices whose complexity might otherwise hamper a good outcome". Paternalistic "nudges" may lead to optimal and happy outcomes in such circumstances.

Update 1
Benjamin Scheibehenne, Rainer Greifeneder, and Peter M. Todd conducted a meta-analysis of 50 published and unpublished experiments, depicting the choices of 5036 consumers, that investigated choice overload and found that consumers generally respond positively to having many choices. They find that the overall effect of choice overload was virtually zero.

Update 2 (13/11/2010)

Christine Benesch, Bruno S. Frey and Alois Stutzer have a new working paper which finds that "heavy TV viewers do not benefit but instead report lower life satisfaction with access to more TV channels. This finding suggests that an identifiable group of individuals experiences a self-control problem when it comes to TV viewing."

The climate change imperative

The Global Climate Change summit at Copenhagen involving 192 nations is underway amidst intense speculation about the prospects of binding commitments by the biggest economies on greenhouse gas emission reductions and financial aid for developing countries to more aggressively climate change.

Encouragingly, in the days leading upto the summit several countries, including China, Brazil, United States, India, Indonesia and South Africa, have announced new voluntary, unilateral, non-legally binding, quantitative emissions targets. However, instead of committing to either direct emission reduction targets, as in the Kyoto Protocol, or peak emission dates, the developing countries, who will form the major share of new emission in the coming years, they have sought the cover of the more debatable emission intensity targets.

It is debatable about whether emission intensity targets, to be achieved through measures like mandatory energy efficiency standards for vehicles and appliances, compulsory green building code, switch to clean coal technology, afforestation etc, can achieve the purpose of limiting carbon emissions in a meaningful manner. Total emissions can keep increasing as emissions intensity improves, especially in the case of emerging economies whose economy and emissions are likely to grow much faster than any improvements (or rate of decrease) in emissions intensity. For example, it has been found that while since 1990 the carbon dioxide intensity of the US economy fell by 20%, its GDP (and presumably emissions) grew by 46% over this period, leaving a net increase of 17% in carbon dioxide emissions.

While China has pledged to reduce its emission intensity (or the amount of carbon emissions per unit of GDP) by 40-45% and India by 20-25% of 2005 levels by 2020. Brazil has committed to a 36 per cent decrease in emissions from a "business as usual" projection by 2020, while South Africa has said its emissions will peak by 2025. In a proposed new domestic climate law, the US seeks to reduce emissions by about 17% for the same period.

Martin Wolf, one of the most incisive commentators on global economic issues brilliantly sums up the global warming challenge facing world leaders before the Copenhagen summit,

"Tackling the risk of climate change is the most complex collective challenge humanity has ever confronted. Success requires costly and concerted action among many countries to deal with a distant threat, on behalf of people as yet unborn, under unavoidable uncertainty about the costs of not acting."

He gets in a few numbers from the International Energy Agency's (IAE) World Energy Outlook (WEO) and the European Climate Foundation's assessment of the pre-Copenhagen pledges to place the greenhouse gas emisssion mitigation challenge in perspective.

1. The WEO talks about the need to "decarbonise" growth to limit atmospheric concentrations of CO2 equivalent to 450 parts per million, the level believed consistent with a global average temperature increase of about 2°C.

2. It notes that energy-related CO2 emissions have increased from 20.9 gigatonnes (Gt) in 1990 to 28.8 Gt in 2007, and forecasts CO2 emissions, on this "reference scenario", at 34.5 Gt in 2020 and 40.2 Gt in 2030 (at an average rate of growth of 1.5% a year over the period). The developing and emerging countries are expected to account for all the projected growth in energy-related emissions to 2030, with 55% of the increase coming from China and 18% from India alone.



3. In order to stabilize emissions at a ceiling of 450 parts per million of CO2 equivalent, the total emissions will have to be kept at just 26.4 Gt by 2030, instead of the 40.2 Gt of energy-related emissions under the reference scenario. A briefing paper from the European Climate Foundation shows that even on the most optimistic view, the pledges made in advance of Copenhagen falls short by about a third of the reductions needed by 2020 for a pathway to a ceiling of 450 parts per million of CO2 equivalent.



4. About the costs of delaying abatement action, the IAE argues that if the aim is to limit greenhouse gas concentrations to 450 parts per million, every year of delay in moving towards the required trajectory adds an extra $500bn of costs to the estimated global cost of $10,500bn.

5. The reductions in emissions secured by switching the US fleet of sport utility vehicles into cars with European Union fuel economy standards would cover the emissions from providing electricity to 1.6bn people now without access.



Wolf outlines three criteria for effective climate change policies that span the full range of mitigation alternatives - reduce demand, expand renewables, invest in nuclear power, develop carbon capture and storage, switch from coal to gas and protect forests

1. Carbon must be flexibly priced as a function of events that affect global warming and over a long time horizon. He favors a tax over cap-and-trade for this in view of its relative stability.

2. In view of the facts that the marginal cost of abatement is smaller in developing economies and that they cannot be made to bear the burden of those abatements, it is important that in any policy "where the abatement occurs must be separated from who pays for it".

3. All available technological innovations must be adopted. However these technologies may need large-scale subsidies, since merely raising carbon prices would only reinforce the position of established technologies.

A policy brief by the Bruegel think-tank comes to the similar conclusions about the challenge ahead on climate challenge, especially on technology use

1. Both public intervention and private initiative are indispensable - governments must initially redirect market forces towards cleaner energy before market forces can take over;
2. climate change policy should combine a carbon price with high initial clean-innovation R&D subsidies - the carbon price would need to be much higher if used alone;
3. policymakers must act now - delaying clean innovation policies results in much higher costs;
4. developed countries must act as technological leaders in implementing new environmental policies and should smooth access to new clean technologies for less-developed countries.

Robert Stavins has an op-ed where he draws attention on the need to stabilize the total stock of emissions by around 2050 by following a gradually tightening emissions stadards regime that relies on technologies that are less energy intensive and through long-lasting global institutions. He advocates a policy of "common but differentiated responsibilities" that acknowledge the fact that developed countries are responsible for the accumulated stock of historic emissions and emerging economies will be responsible for the major share of newer emissions. He favors "an international portfolio of domestic commitments, whereby each nation would commit and register to abide by its domestic climate commitments, whether those are in the form of laws and regulations or multiyear development plan".

See also this (current levels and impact of Kyoto), this (positions of major members), and this (scince and politics of climate change over time).

Update 1
See this debate on assistance to developing countries for adopting cleaner technologies.

Update 2
See this nice summary of the four views on climate change - denialists, sceptics, warners and calamatists.

Update 3 (10/4/2010)
Excellent essay by Paul Krugman that captures all dimensions of the climate change debate. He classifies the debate on action to combat climate change as that between those like William Nordhaus (with their Dynamic Integrated Model of Climate and the Economy, DICE) who argue in favor of a gradually tightening emission standards and those led by Martin Weitzman and Nicholas Stern who advocate immediate action in view of the non-negligible possibility of catastrophic consequences if things continue unchanged.

The former, which combines models of climate change with models of both the damage from global warming and the costs of cutting emissions, have been described as advocating a "climate policy ramp" of increasing controls. Krugman calls the later "climate policy big bang" - Nicholas Stern, an economist at the London School of Economics, argued in 2006 for quick, aggressive action to limit emissions, which would most likely imply much higher carbon prices. He writes,

"The policy-ramp advocates argue that the damage done by an additional ton of carbon in the atmosphere is fairly low at current concentrations; the cost will not get really large until there is a lot more carbon dioxide in the air, and that won’t happen until late this century. And they argue that costs that far in the future should not have a large influence on policy today. They point to market rates of return, which indicate that investors place only a small weight on the gains or losses they expect in the distant future, and argue that public policies, including climate policies, should do the same.

The big-bang advocates argue that government should take a much longer view than private investors. Stern, in particular, argues that policy makers should give the same weight to future generations’ welfare as we give to those now living. Moreover, the proponents of fast action hold that the damage from emissions may be much larger than the policy-ramp analyses suggest, either because global temperatures are more sensitive to greenhouse-gas emissions than previously thought or because the economic damage from a large rise in temperatures is much greater than the guesstimates in the climate-ramp models."

About Krugman's own position,

"So what I end up with is basically Martin Weitzman’s argument: it’s the non-negligible probability of utter disaster that should dominate our policy analysis. And that argues for aggressive moves to curb emissions, soon."

Contrasting faces of development

On the one hand, whatever the present troubles, this spectacular transformation cannot be denied and has few parallels...



Chinese cities like Shenzen are the only comparable examples...



But they sit with examples like the equally spectacular devastation of Kabul.