Identity crises and overpaid bankers

By Mike Dolan – Analysis

LONDON (BestGrowthStock) – Oversimplified economic credos were hugely responsible for the financial shock of the past decade, demanding greater attention now be paid to more subtle ideas of how employees behave.

It may be that an average worker’s sense of personal identity has as much a bearing on the solutions to the global crisis as any devout belief in the efficiency of markets.

For the myriad causes and effects of the credit crisis, the widespread failure of giant banking corporations in the United States and Europe was the most shocking and far-reaching.

Beyond the public outrage at taxpayers picking up the tab for the bailouts, a more puzzling question has been how chief executives and senior managers of these private institutions could have failed their shareholders so badly.

Alan Greenspan, who as U.S. Federal Reserve chief for 18 years was the prime advocate of the free-market philosophy blamed by many for crisis, has remained adamant that his sole error was in misjudging the behavior of the bankers.

“I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such that they were best capable of protecting their own shareholders,” he told Congress as the crisis snowballed in 2008.

Yet, others are less willing to let him off the hook.

Trust in the efficiency of market mechanisms to safely and optimally distribute money and resources around the globe had become virtually unshakable in many quarters — most alarmingly among policymakers and regulators such as Greenspan.

Allowing banks an ever-freer hand in financial innovation, derivatives, securitization, speculation and cross-border finance was just an extension of that.

In a speech to a conference organized by the Institute for New Economic Thinking this month, Britain’s top financial regulator Adair Turner acknowledged the dangers of what many dub “market fundamentalism” and opined that “good” economics should be not be slave to any monolithic set of ideas.

“For while the simplified pre-crisis conventional wisdom appeared to provide a complete set of answers resting on a unified intellectual system and methodology, really good economic thinking will provide multiple partial insights, based on varied analytical approaches,” Turner said.

NUANCES AND INSIGHTS

So, if a root of the crisis was leaving banks to their own devices in a belief they would act rationally and selfishly, how do experts account for the fact that they patently did not?

The debate on excessive pay and bonuses for bankers remains central to thinking on this.

The scale of the mismatch between UK-based bankers’ wages and the failure of their institutions was shown this week by data from the Center for Economic Performance. It said the increased share alone of total UK wages that bankers received in the decade to 2008 amounted to some 12 billion pounds a year.

With Britain’s general election due on May 6, UK politicians are queuing up to urge pay controls or taxes on bank bonuses.

But economists reckon a better way of viewing the issue is to examine how employees respond to monetary rewards.

2001 Nobel Laureate George Akerlof this year co-authored a book with Rachel Kranston call “Identity Economics.”

Akerlof’s theory is that people make decisions and choices — such as where and how they work — based partly on norms, value systems and their sense of identity and not solely on the direct economic rewards or benefits such as wages or incentives.

Although economists have previously taken behavior and differing tastes into account, their models on workplace incentives have not included a variable of people’s “identity.”

For example, if you feel proud to work for a company and derive personal satisfaction from contributing to work of the organization, you tend to put more effort into that work.

Akerlof then makes a distinction between these sorts of employees, “insiders,” and those who clock in and clock out and care less about the firm, or “outsiders.”

One conclusion is a firm needs to pay an insider less of a bonus to work hard than it needs to pay an outsider — creating an incentive for the firm to invest money in convincing outsiders to have a greater stake in the company’s performance.

The flipside — and this is where the banks come in — is that the more workers are dependent on monetary rewards, the more they are simply going to complete the personal tasks required and care less about the wider firm.

“If you give too much economic reward and incentive, people are just going to game the system and that’s exactly what we’ve just seen,” Akerlof told Reuters at the INET meeting.

This amounts to the creation of more and more “outsiders” meeting personal targets with little interest in the long-term success or the viability of the company at large.

Bankers were adept at meeting personal targets set for them — quarterly sales or profit goals, new products etc — and sealed complex contracts to reap associated short-term bonuses.

But they had no incentive to make sure their work was healthy for the bank, its customers or its society longer term.

“Because firms and other organizations are the backbone of all economies, this new description transforms our understanding of what makes economies work or fail,” Akerlof said.

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Identity crises and overpaid bankers