Tuesday 23 July 2013

Can consequences this foreseeable really be unintended?

Imagine this as an intermediate microeconomics exam question. Suppose the government were to bar firms taking government contracts from paying their highest-paid employee more than three times what they pay to their lowest-paid employee. What consequences might you expect ensue?

Here are a few, for starters:

  • There would be a rapid shift towards outsourcing of tasks performed by lower-paid workers. An economic consultancy company would hire a temp service to provide secretarial services and would contract with a janitorial services provider rather than have secretaries and janitors on staff. A construction company would have a rather tougher time - they'd be more likely to split into several component parts all selling services to a central agent who contracts with the government. So there could be a shoveling services company, a truck driving company, and a project management and procurement company. You'd have fairly flat payscales within companies, but large differences in salaries across companies. This would be inefficient, but it would likely be the best they could do given the rule.
  • Universities running consultancy arms for contract research by academics would have to run those as more explicit external shells. The government throws millions of dollars at the University of Otago for ban-everything studies under HRC grants. If they can't disguise the hourly rates in the contracts to make it look like the researchers are just putting in tons of hours, they'd have to put the contracted lecturers and profs onto part-time contracts with the University, where salary scales would range from the guys who mow the lawns to the people who teach brain surgeons how to be brain surgeons, and have a separate consultancy company where everybody earns a lot. 
    • If we think that Universities are under contract for government already in the whole teaching-students business, then they'd just have to run the same outsourcing arrangement suggested above. Or, think of it this way: would YOU want to have your brain surgery conducted by somebody trained by somebody earning three times what you can make mowing lawns? 
  • Now suppose that the policy were more comprehensive than I've suggested: they also work hard to look through these kinds of contractual setups and bar firms from putting in tenders for government contracts where it looks like they've done this.
    • It would be almost impossible to police. Some companies already find it optimal to contract with a professional maintenance services company rather than do things in-house; others like doing things in-house. Who's to say which organisational decisions were motivated by the rule and which derived from other considerations?
    • If they could do it, then you'd effectively have the end of government contracting-out for services except on very minor scale. The whole thing seems designed to kill private-public partnerships like:
      • Having specialist companies tender to construct roads rather than having some Ministry of Public Works do all the construction for the government (and losing the efficiencies of competition and private tendering);
      • Contracting in external experts for assistance rather than keeping a bunch on government staff. This sucks in a small country where you might need particular kinds of experts only infrequently.
That's just a start; other very foreseeable rather bad consequences are left as an exercise for the reader. For starters, think about incentives to acquire human capital.

Nobody would be daft enough to suggest such a thing though, right? Nope.
The Government should stop giving contracts - and knighthoods - to companies that pay their bosses more than three times their lowest-paid workers, an economist has suggested.
Who? Maybe some crank consultant? Nope. The University of Victoria at Wellington's Geoff Bertram. 

I caught this over the weekend but hadn't gotten around to blogging it; glad to see David Farrar and Matt Nolan caught it too. Matt only thinks Bertram's being "reasonably disingenuous"; I'm less charitable. 

To advocate policies like this, as an economist, and to pretend that a great big bucket of awful wouldn't ensue pretty directly, is worse than disingenuous. Bertram gets to grandstand about what a caring guy he is, let his followers believe that horrors wouldn't ensue, and just trust in that no government would be batty enough to implement the policy. This kind of policy advocacy smells more of charlatanry than of economics. I really really hope that the Herald has quoted him incorrectly as I can't believe that any economist could seriously think this a desirable policy. Care about inequality all you want, but the appropriate levers are tax and redistribution policy, not wage mandates.

If Bertram weren't misquoted, I've a few questions for him.
  1. Salary differences within government are often well in excess of the 3:1 ratio he recommends. The Prime Minister doesn't make a lot of money in the grand scheme of things, but he makes well over three times the lowest-paid government worker. Even if the lowest government salary paid anywhere in the system were $40,000, that would constrain the highest salary to $120,000. The Prime Minister earns $419,000. I expect a substantial part of the higher echelons of government earn well in excess of $120k. The base salary for a backbench Member of Parliament is $144k. Should we extend his preferred 3:1 rule to all of government, or just to contractors? 
  2. If he only wants it to apply to contractors, on what basis does he make that distinction?
    • Note that, if it applies only to contractors, the main large effect of the rule would be to end outsourcing of government work. We'd have a massive expansion of the civil service and an end to what benefits come from competitive tendering. I would put 20:1 on that Bertram's rule, in this interpretation and if enforced, would have this consequence. It is so obvious an effect that it kinda has to be something that the policy proponent wants to have happen. So, Geoff, if this is how you want it, why didn't you just call for a ban on outsourcing and an expansion of the civil service?
  3. Private hospitals provide services under contract for government. This would end pretty quickly under Bertram's rule if it applied only to contractors. But suppose it's comprehensive and applied also to government hospitals. Geoff, do you prefer:
    1. That the people who cut the grass, and the cashiers at the cafeteria, get salary increases so that nobody is earning less than a third of what the country's top brain surgeons earn? This may have consequences for the overall health budget and the overall quantity of services that the health system can provide. Or,
    2. That the people who fix the brains get pay cuts so that none of them earn more than three times what the people who cut the grass earn? This may have consequences for the quality of brain surgery. 
I weep for the quality of thought on the left in New Zealand. Australia gets Andrew Leigh. We get, well, this.


  1. Amen. I sat through a Living Wage seminar last night and trying to have a bit of fun i asked if a Living Profit for private firms was a goer as well ... no one picked i was being ironic ...

  2. My immediate thought was to wonder whether the good Prof Bertram had ever been offered a salary more than three times higher than the lowest-paid employee of Vic Uni? And if so, had he accepted it? Hypocrisy much?
    He could, I suppose argue that his intention was for cleaners and the like to receive a massive salary boost. Sure, as long as the university can screw the money out of students or rejig their wage bill to provide more equal distribution I suppose that is fine.
    Sadly, I suspect years in academia haven't removed Dr Bartram's belief in the the rarely-sighted Magical Money Tree.

  3. Yikes! I was Unplugged over the weekend so missed this. What Geoff doesn't realise is that he's calling for bad policy all 'round. The private sector will pay for better experts than the public sector and successfully rent-seek as a result.

    Also, pay rates for consulting firms is a flexible concept. A shareholder employee could be paid three times someone else and also share in firm profits. How will we police that?

  4. iirc the proposal included the staff at the company picking up the outsourced work.

  5. I am not so sure about the quantitative argument here. Some people earn 50 times the average salary. Our Prime Minister gives his salary away to a trust that is blind to him. The guy makes me proud to be a New Zealander

  6. Bollocks if you pay less than a living wage your business is being subsidised somewhere. Take a few less overseas holidays and pay a decent rate. No excuses.

  7. Quinn, you're conflating two things that really really have to be kept separate.

    If you put the burden of social policy on the firms that hire lower-productivity workers, you discourage the employment of those workers. If you instead handle it through the tax and redistribution system, you put it on the aggregate tax base. The policy you support will hurt the people you are trying to help, relative to having support through various wage supplement programmes like WFF.

  8. This is the same Vic Uni lecturer that believes the top salary allowable in NZ should be about 75-80k. Which funnily enough is right around his salary. So that answers the questions about the brain surgeons, he'd suggest they go down. Which means they will simply leave the country. Well done, and I'd hope none of you need brain surgery once all the good doctors leave!