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PART 2: The Common Sense of Non-Economics - Anthony de Jasay, Political Economy, Concisely 
Political Economy, Concisely: Essays on Policy that does not work and Markets that do. Edited and with an Introduction by Hartmut Kliemt (Indianapolis: Liberty Fund, 2009).
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The Common Sense of Non-Economics
THE YAKOUBOVICH SYNDROME, OR LIES, DAMN LIES, AND ECONOMIC POLICY*
“Lies, damn lies, and statistics” expresses the widespread, though not quite justified, belief that a series of numbers can be made to convey just about any message. Mendacious promises about what wonders various economic policies can do have a different but equally striking capacity to mislead not only the wide public, but the very perpetrators of the false promises, too. I fondly remember a story that makes this point.
Back in 1970, I spent a few days in Israel. One object of the visit was to find out a little about economic prospects and policies. Inflation was accelerating. I was being briefed by two intimidatingly bright bankers. Talk came round to a highly visible bankruptcy of a well-known businessman—let us call him Yakoubovich. I expressed disbelief that anyone can go bust in an inflationary environment by piling up debt.
“Normally,” I was told, “it would not occur. But if you knew Yakoubovich, you would see how it can happen all the same.” And they told me a number of anecdotes about the gentleman in question to illustrate the point. One of them, I found, teaches a great lesson about economic policy and much else besides.
Yakoubovich is sunning himself in a deckchair by the pool in the gardens of a Jerusalem hotel. In the pool, children are splashing each other, shrieking, jumping in and out, and making a nuisance of themselves. Yakoubovich calls out to them:
“Children, run round to the dining room, they are handing out cookies and sweets!”
The children run off and calm reigns around the pool. In a little while, Yakoubovich gets up, wraps himself in his bathrobe, and shuffles off.
“Yakoubovich, where are you off to?”
“I am going to the dining room, they are distributing cookies and sweets.”
In the Yakoubovich syndrome, someone—typically, a political or financial operator—tells a lie or makes a fraudulent promise that is meant to earn him support. A significant part of his public is gullible and believes the lie. Seeing this, the perpetrator then comes to believe it himself and tries to act on it. The end is disappointment for all.
A characteristic promise setting off the Yakoubovich syndrome is to “give purchasing power to the masses.” The setting is one where the economy is sluggish, crawling along below its potential. The space between the actual and the potential performance is, so to speak, wasted. If actual production were to rise to its potential, untold billions could be distributed to worthy recipients, the wants of the needy could be met, and projects serving the public interest could be promoted.
A beguiling promise is then made to bring about this rise in output by “giving” people the purchasing power to buy it. In his mighty effort to pull the Brazilian economy up by its bootstraps, President Kubitschek (1956-61) simply ordered all wages and salaries in the country to be doubled. Needless to say, prices doubled with wages, and production did not. Today, politicians in and out of government try to boost purchasing power by legislating higher minimum wages, more generous unemployment and retirement pay, and by inciting labor unions to make aggressive wage claims and bullying industry to meet the claims. The implicit argument is that if industry paid higher wages, demand for its products would increase and allow the higher wages to be paid. However, if wage costs increase all round, it is prices that will increase, not output. Demand would then just suffice to purchase the old, unchanged level of output, but not a higher one. If this were not the case, it would be because the old level of output was not in equilibrium and would have increased anyway of its own accord. The idea that higher costs amount to greater purchasing power springs from confusing demand and output at current prices with demand and output in real terms.
Unlike the “purchasing power” promise that boils down to conjuring up something out of nothing, another Yakoubovich lie that promises to squeeze the rich to help the poor does involve real resources and is not devoid of all logic. But it is fraudulent in misrepresenting the resources involved. The only part of the income of the rich that can be taken from them and safely given to be consumed by the poor without upsetting the saving-investment balance of the economy is the amount by which the rich reduce their consumption as a result of the higher tax meant to “squeeze” them. If they maintain their consumption and cut their investment instead, the poor can consume more only at the expense of fewer resources being devoted to investment. The actual result of the higher tax will no doubt be a reduction in both consumption and investment by the rich, with investment being cut more—not a result that would help the poor beyond the shortest of short runs.
A corruption-laden form of the Yakoubovich syndrome is the advocacy of development aid. A small minority in the economics profession is acting as part-time consultant either to donors on matters of development aid or to the governments of the countries asking for such aid. Some quite prominent economists do this as a full-time business, even forming their own corporations to carry it on. We can only guess whether a particular “development economist” is really convinced that aid will not be stolen or wasted and debt forgiveness will not result in the piling up of new debt. Many are no doubt genuinely convinced. But all are interested in aid flows being maintained and increased. Almost inevitably, for the simple reason that few people feel comfortable in pleading day in, day out something they know to be a lie, the interest in aid will in due course generate a belief that aid is in fact a good thing
Both the recipient governments and the donors must be persuaded that the charade of submissions and project appraisals, leading to transfers of vast sums, will in fact yield the cookies and sweets of economic development. In convincing them, development economists convince themselves, too, and are more inclined to act on their wishes than on the evidence provided by the often sad or sordid history of development aid.
One special twist in this reciprocal make-believe calls for attention. Europe is getting seriously alarmed by the rising streams of illegal immigrants entering it by landing in Spain, Italy, and Greece and moving northward. Underdeveloped countries and their advocates now argue that if they were helped to grow out of poverty, their peoples would be content to stay at home and the threat of illegal immigration would ease or cease. The idea is plausible over a time span of several decades, but implausible within our lifetime. Pumping in aid, notably into education, would induce some thousands to stay at home but make hundreds of thousands all the more eager to leave and reach more civilized shores.
WINNING POLICY BATTLES BUT LOSING THE WAR AGAINST ECONOMIC REALITIES*
When the economic history of Europe in the last third of the twentieth century comes to be written, one of its most important threads will tell of the long series of battles in which governments fought against economic realities in order to satisfy the wishes and pander to the illusions of electoral majorities. The period is one where government spending expanded relentlessly from under 40 to over 50 percent of gross national product in the largest countries of continental Europe. (Last year, it reached 53.6 percent in France, provoking solemn promises by the powers-that-be that this time they will really start controlling spending and bring it down to 51 percent by 2010.) Piece by intricate piece, the machinery of the welfare state was put together. An ever more elaborate system of “workers’ rights” was promoted until the labor code grew to several thousand pages—a happy hunting ground for labor lawyers, a minefield for enterprises. Trade union power came to be based, not on workers recognizing that union membership may serve their interests, but on legislation, government sponsorship, and the patronage afforded by the immense administrative machinery of the various social insurance schemes.
The forward march of politics across the domain of economics was widely accepted as justified, mainly for two reasons. One, expressed in such mantras as “Man matters more than the market” or “In democracy, it is ballots that decide, not dollars,” was based on the delusion that markets and dollars have one will, man another, and the two pull in opposite directions. The other reason for welcoming the invasion of government into the economy was, and remains, the conviction that redistribution of income through taxation and targeted expenditure is an act of “social justice,” a good deed and a moral duty.
“THEY DO NOT TALK BACK”
The future historian of these apparent triumphs over economic reality will very likely single out two phenomena that loomed more and more ominously and in fact began to signal that no matter how the battles went, the war was beginning to be lost. One was the growing severity of job protection policies that made firing employees so difficult and expensive that employers were frightened away from hiring them in the first place. New job creation fell to levels last seen in the Great Depression, for offering employment except on short-term contracts has become an act of reckless audacity. (One small but significant breach in job protection came just the other day when the highest French court of appeal ruled that terminating employees may be permitted not only when the enterprise is making losses threatening its survival, but also when terminating employees is necessary to prevent such losses.)
The other ominous phenomenon was that the high level of unemployment, which would have seemed abnormal a decade ago, has come to be seen as a fact of life. It has resisted the multitude of attempted therapies governments of both Right and Left tried to apply to it. The diminishing band of diehard defenders of the “European social model” still mutter that unemployment is high because the model is not “social” enough, or not European enough, and all will be well when it is made more social and more “harmoniously” European. Meanwhile, it is starting to be noticed that chronically high unemployment has almost wholly drained away the bargaining power of labor in the private sector. Union militancy is now confined to the public sector—essentially, to public transport workers, teachers, and government clerks. Thirty-odd years of socialist economic policies have reduced the mythical, red-flag-waving “working class” to passive impotence.
An anecdote bears eloquent witness to how workers “benefiting” from the “special model” now stand compared to those who are exposed to the “caprice of the market.” Two years ago Toyota set up a car assembly plant in the industrially derelict region of northeast France. More recently, the president of Toyota visited the plant, expressed his satisfaction, and explained that the company has chosen to locate in France rather than in England (which was the runner-up candidate location) because “English workers can afford to talk back, but French workers cannot.”
In fact, under the “European social model” real bargaining has practically ceased. Labor addresses its demands not to the employer, but to the government that may or may not be able to bully the employer into making concessions. Increasingly, the latter is unable to achieve much in the face of the risk that capital and operations will be moved out to central and eastern Europe, Asia, or Mexico. In actual fact, the volume of such movements is fairly modest, but their public echo is deafening and wreaks havoc in politics and the labor movement.
DISCREETLY, BACK TO BASICS
In current labor union language, bargaining hardly exists. In its place have come “meaningful negotiation” in which the employer meets union demands, and “blackmail” in which the employer obtains concessions.
Over the past year, there have been a number of high-profile cases of “blackmail” by European, chiefly German, flagship companies including Siemens, Opel, Bosch, Conti Gummi, and Volkswagen, usually involving the lengthening of the work week and in some cases lower pay for new recruits, in exchange for commitments by the employer not to reduce the labor force or limiting the reduction to a minimum, as well as undertakings not to move production abroad. These cases obviously had a bad press and made much political noise. Unions agreed to them under protest, stressing that the cases were exceptional, involving a small fraction of wage-earners, while for the vast majority industrywide collective contracts remained in force.
In the meantime, there was a mostly unreported groundswell of “blackmail” agreements between small and medium enterprises and their employees that departed from the official industry contracts. They involved longer hours, more flexible working arrangements, wage freezes, or lower pay increases than the industry norm. They were concluded between the enterprise and the works council, whose members were labor union officials who forbore from wearing their union hats. According to some estimates by industry associations, between 50 and 70 percent of enterprises with fewer than five hundred employees have concluded such agreements. Their cardinal feature was a promise of maximum discretion, so as to let labor organizations lose as little face as possible. Apparently, there was little opposition by the wage-earners themselves. Manifestly, there is more understanding and acceptance of realities in Germany than in France and Italy, where labor and the parties of the Left still seem to believe that the basic facts of life can be made to go away if you call them “unacceptable” loud enough.
In 2000, German labor costs were about 25 percent higher than French ones. By last year, the gap had practically disappeared. German forward economic indicators have been perking up since last spring, and unemployment has started to fall significantly even before the “Merkel effect” has come into play. It will be interesting to watch how the other “core” countries of the euro-zone will position themselves over the next year or two. Will they go on winning the policy battles and lose the war, or will they permit a gradual and discreet return to basics?
PAYING OURSELVES MORE OF THEIR MONEY*
Politics has always held the ultimate whip hand over the economy simply by virtue of its power to make laws and its command of the police and the armed forces. However, there were long periods in history when it exercised the whip hand very little. Under oligarchic governments such as the Italian city-states during the Renaissance (and Venice for much longer), or during Holland’s “Golden Century” (the seventeenth), one might even say that politics was used in the service of economic prosperity, rather than the reverse. There was the “brilliant episode” of liberal government in much of the nineteenth century where the most advanced Western governments left the economy almost wholly alone. These periods, though, were the exception rather than the rule. In our own time, with universal suffrage, competitive politics exploits to the utmost the lure for a majority of being able to bend the economy to its purposes. A democratic electoral program is now overwhelmingly an economic program having to do with taxes, trade policy, welfare “rights,” labor law, the regulation of industry and commerce, subsidies, and so forth. To say that most of this is no business of the government would be as sacrilegious, and as sure an election-loser, as to say that the people’s livelihood is none of the people’s business.
MIXED-UP ROLES, MIXED-UP INCENTIVES
By one of those laws that have set the course of Germany after her defeat in World War II, corporate government had to be a two-tier one: the managing board was meant to run the business on behalf of the owners, and above it the supervisory board hired and fired the managing board, determined its pay, and approved or vetoed its major decisions. So far, this was straightforward and in no wise perverse, though it could become a little cumbersome. It was no more fertile ground for cronyism and self-dealing than the single-board system of Anglo-American corporate organization. However, the German system was to be more democratic. The supervisory board was (and still is) a mixed body, with half its members representing the owners, the other half the workers. In practice, the worker representatives are usually, though not necessarily, union officials.
In other words, half of the managers’ own bosses are representatives of the workers the managers are supposed to manage. This is an idyllic state of affairs, and could hardly be more democratic, but it only works in fair weather. It is quite unfit for crises, conflicts, and hard times, when painful, unpopular management decisions are called for but do not get past the supervisory board.
A funny case—if funny is the right word—that bears this out is the scandal at Volkswagen that has been entertaining Germany most of this summer. The management board has bribed a couple of worker representatives on the supervisory board to vote for unpopular measures the representatives’ constituents, the workers, would presumably wish them to veto. For the system to work, responsible people had to be corrupted.
A more general case of mixing up the roles of employer and employee is the state enterprise. The state in many countries owns and runs enterprises in public transport, power generation and distribution, mining and metals, as well as in some unexpected odds and ends. Their tariffs (prices) are a prime subject of democratic politics; raising them is usually no vote-catcher.
From time to time, preferably ahead of some important election, wage claims arise. It is the employees’ role in a market economy to push these claims, and it is the employer’s role to resist them, until a bargained solution reflecting the supply and demand for labor emerges, with or without resort to a strike. However, the state as employer cannot behave like any ordinary employer. After all, its employees are the voters who are its democratic masters. The settlement of the wage claim is an eminently political matter, no less so than the fixing of public transport and utility tariffs. The politically most feasible solution is to bow to the will of the voters, grant the wage claim or most of it, and not pass the extra cost on in higher transport or utility prices. Along the line of least resistance, democracy triumphs, and state enterprises merrily pay out to wage-earners and public transport and utility customers the money of the unknown, invisible taxpayer. That money is all the more impersonal, coming out of nobody’s pocket, as state enterprises first run up deficits for a few years before their depleted resources have to be replenished from the public purse. Very few people see clearly enough, or at all, the relation between the democratic fixing of public-sector wages and prices and the level of taxation.
In all such situations of role reversal and role usurpation, “we” by virtue of our democratic voting power pay ourselves more of “their” money, instinctively feeling good about the result, for we seldom identify “them” as being ultimately “us.”
SQUATTING THE JOBS
It is a perfectly normal aspiration for every wage-earner to be free to leave his job without much ado, but for his employer not to be free to lay him off except with much ado, if at all. The wage-earner wants to own his job, or at least to “squat it.”
Bit by small bit, nearly a century of “socially minded” labor legislation has added various “squatter’s rights” to the employment code, concerning notice, unfair dismissal, and severance pay. The employee has come a little closer to “owning his job.” In the last couple of decades in Western Europe, adding more and more valuable “rights” of this kind has mounted to a paroxysm, and every new step in this direction was naturally sure of majority support. Opposing apple pie and motherhood would be a less certain method of political suicide than opposing job protection.
Obviously, the more securely a worker “owned his job,” the riskier and the less profitable it appeared to employers to offer employment. Thus, ever more comprehensive job protection became one of the prime causes of ever more endemic unemployment.
However, one of the perfectly natural and predictable effects of chronic unemployment is that labor cannot afford to be militant except in the public sector where wages and employment continue to be determined by politics. This is glaringly manifest in France, where strikes and strike threats flourish in public employment, education, and the railways and wages in these sectors keep creeping up, while in the private sector there is dead calm with workers keeping their heads down as they are bereft of nearly all bargaining power. They are relatively content to squat on what they have, grateful for job protection, and utterly oppose any step toward what is politely called “labor market flexibility.” The primacy of politics over economics creates for them a perverse incentive to freeze hiring and firing, though they would no doubt be better off in an “old-fashioned” labor market where movement was free both ways. But then what would be the use of casting and counting ballots?
THE DOCTRINE OF “UNEQUAL EXCHANGE”
Socialist intellectuals squirm when reminded of such basic tenets of Marxist economics as surplus value, the iron law of wages, and the declining rate of profit, tenets that were sacred in the glory days of advancing socialism but that are now kept under glass in the museum of strange ideas.
While the old stuffing of Marxist economics has been knocked out of socialism, two major attempts have been made to replace it with some alternative intellectual content. One was to upgrade the vague and emotional notion of “social justice,” and underpin it with the idea that since “veils” of ignorance or uncertainty hide the future, the rational individual must opt for an egalitarian social order for his own safety (“society as mutual insurance”).
It was then the obvious move to infiltrate the redistributive demands of “social justice” into the capitalist system, which may in other respects remain intact. Germs of this attempt can be traced back to mid-nineteenth-century English thought. It came to full flowering after World War II in the American brand of liberalism and in European social democracy. However, as a positive theory it is feeble. It needs bolstering by normative judgments condemning inequalities except if morally justified. But if we accept these judgments anyway, then we can safely throw away the theory. It is redundant and cannot salvage socialism’s intellectual respectability.
At first sight more promisingly, the other major salvage attempt starts off as a non-normative economic theory (though it does not end like one). The starting point is that though total income is equal to total product, we cannot say that individual income is equal to the individual’s contribution to the product. Each contribution is rendered possible, or is “owed” to, countless past and present contributions by others. Society owes its product to itself. Given that it owns it, it may distribute it among its individual members in any way it chooses by switching on some recognized collective choice mechanism, such as democracy. It can bring about the chosen distribution either by taking the means of production and exchange into “social” ownership or, the more modern way, by using the tax code. The latter proceeding is supposed to preserve the principle of voluntary exchange and the essentials of the capitalist system. Paradoxically, this is a socialist theory of income distribution that states, in effect, that there is no theory of income distribution; it is always what society chooses it to be.
The idea that “every contribution depends on, and is owed to, every other” is a trivial truth. It is tantamount to saying that since you could not work and earn an income if you did not eat, you owe your income to the farmers, processors, and retailers of food. You also owe it to all who helped make you what you are and who in various ways help to keep you going.
You may object mildly (you might indeed object indignantly) that you have squared all these debts when you paid for the food and all the other commercially provided goods and services you used, and when you paid the taxes to finance the goods and services the state provided for you. The distribution of incomes was what it was because the prices of these goods and services, and the taxes, were what they were. Ultimately, all these things (except the taxes—but believers in the social contract would not allow even that exception) were matters of voluntary exchange. Voluntary exchange is a positive-sum game in which there are no losers, no debt is left unsettled, and no room is left for any other distribution that would make everybody better off. Is there anything left for socialism to complain about?
Here, the retreating defender of socialism is driven to the last resort. Exchange may well be voluntary, free of duress in any strict sense, and both parties may well be gainers. Admittedly, the positive theory stops short at this point. Nevertheless, all is not well, and for the socialist it seems imperative to inject a normative judgment into the argument. For even if both parties to a voluntary exchange gain, are their gains equal? Surely, under capitalism there is no mechanism, but under socialism there should and would be one, to restrain the freedom of contract and “correct” exchanges that are “unequal.”
Careful thought is needed to make sense of this claim. In talking of the gains from exchange, are we talking of “utilities” or sums of money? If the former (as economists, at great cost to their discipline, often do), asking whether A’s gain is greater than B’s is as meaningful as to ask which is greater, birdsong or the color yellow. Since the two utilities are quantitatively no more comparable than a tune and a color, any comparison must be made in terms of the values someone entitled to judge such matters would attribute to the two gains. “Society” may or may not be entitled to make such judgments. Under socialism it would, under capitalism it would not be entitled to make them.
The matter is less straightforward if we try to look at gains in terms of money or goods. Suppose that in an economy using two factors of production, labor and capital, the distribution of income is the result of exchanges of one against the other, so that capital is able to use labor, or labor is able to use capital. “Equal” exchange does not mean that the share of wages in national income works out at 50 percent and that of interest and profit also at 50 percent. The reality is more like 80-20, and few socialists complain that the share of wages is unfairly high.
The socialist claim, instead, is that in most voluntary exchanges the poorer party concedes a greater part of the gain to the richer party than he would do if their “bargaining powers” were equal.
It is far from sure that one can define bargaining power, or compare the bargaining power of two parties independently of the bargains they in effect reach. Such comparisons are vacuous unless they can be related to some independent benchmark. For instance, if the going rate for a certain type of job in a certain region is $11 an hour and illegal immigrants are only paid $7 for the same job, it is not nonsense to ascribe the shortfall to their weaker bargaining power compared with that of their employers. The converse could be said of wage bargains at, say, $15 an hour that may occur in the face of excess demand and labor shortage. In both cases, we are supposing the benchmark rate of $11 to represent “equal” exchange and equal bargaining powers—a supposition that is grounded in nothing except perhaps some idea of normalcy under competitive conditions.
There is, however, a set of “abnormal” conditions where the commonsense view would not hesitate to hold that the “bargaining power” of workers is uniformly and permanently weaker than that of the employers. This condition is that of the chronically high unemployment that has prevailed in “core” Europe, notably in Germany and France, with only brief interruptions for three decades. For while under full employment the worst that can happen to a worker if he holds out for better conditions or refuses to accept worse ones is that he has to look for another job, under chronic unemployment the worst that happens to him if he loses his job is arguably very bad indeed.
The irony of it all is that chronically high unemployment is the unmistakable product of the very policies, pursued ever more intensively over the last thirty years, that socialist governments of all hues have put in place to make income distribution more equal, protect the workers, achieve “social justice,” and banish “unequal exchange.” It is thanks to these policies that “globalization,” the export of jobs and the flight of enterprise, has come to present a genuine menace to the ordinary worker. Not for the first time, his avowed advocates are proving to be his worst enemies.
Mr. Claude Bébéar does not sit on the board of every major French corporation, but where he does not, friends of his probably do. He is now the most influential man in French business. Entirely self-made, successful, rich, he is a proven practitioner who does not shy away from theoretical reasoning. Shrewdly and boldly exploiting some grossly erroneous valuations, he has traded a small provincial mutual insurance company through a succession of ever more ambitious mergers to end up with an international insurance giant now named Axa, of which he is chairman and a major shareholder. In outlook, he is a manager first, a capitalist second, and equally sure of himself in both roles.
Written in the form of a friendly debate with Philippe Manière, one of the brightest French economic journalists, he recently published a widely commented-upon book somewhat startlingly titled They Are Going to Kill Capitalism.1 Its central idea is that capitalism today is gravely menaced by the often irresponsible, ill-advised, or perversely motivated conduct of those upon whom it largely depends—corporate directors, investors, security analysts, fund managers, auditors, rating agents, bankers, and lawyers—all of whom are “saboteurs” of the system that nurtures them.
Mr. Bébéar thinks that radical socialism that seeks to do away with the capitalist order is no longer a likely threat. But he considers, no doubt rightly, that even right-of-center governments which try to help the system by well-meaning intervention generally end up doing more harm than good. Politicians do not understand the economy, and their clumsy interference cannot help it. The only real remedy is for the unwitting, selfish, or even mindless “saboteurs” of capitalism to come to their senses, conform to the dictates of ethics, and assume their responsibilities. With the characteristic social piety of the French intellectual, he also calls for a “spirit of solidarity” to ensure that the wealth produced by capitalism should be “equitably shared” (p. 2). He wants less opportunism and more virtue.
Lest we forget, let us spell out clearly that of all types of economic organization, capitalism is the most economical on virtue. Its main strength is precisely that it functions, if not ideally well, at least better than its rivals when people are allowed to pursue their individual interests. Systems that need to rely on people being virtuous, “socially responsible,” and more mindful of the common good than of their own will at best bring about mediocrity and stagnation, at worst disappointment and grief.
Politicians have a hard time understanding this, and French ones are more impervious to it than most. But do managers grasp it? If anyone does, a man of Mr. Bébéar’s record ought to. Yet some of his critique of the selfish and the foolish must leave the reader wondering whether capitalism is meant to serve managers, or the other way round.
SHORT-TERMISM AND OTHER VICES AND FOLLIES
Short-termism, we are told, is one of the bad habits leading modern capitalism astray. A quarter is nothing in a company’s life: quarterly earnings statements are irrelevant or misleading, and investors who react to them are doing themselves and the market no good. Their folly exposes companies to market shocks and may force them to sacrifice the future for the sake of prettier numbers in the next quarterly report. Shares should be bought for the long term. Long-term shareholders should be rewarded with more voting rights and higher dividends.
The logic of these suggestions leads to strange conclusions. The stock market could just as well close down. Shares would only be bought when companies wished to raise fresh equity capital, and they would never be sold. Any stray buyer would push the stock price sharply up and any stray seller sharply down. Markets are narrow enough now, but they would be many times narrower if holders reacted neither to earnings news nor to price movements. Improving prospects in one industry and worsening ones in another would not be reflected in relative price movements and would not promote the flow of capital from one industry to the other. Mr. Bébéar deplores the growing use of derivatives in fund management, because they “artificially boost” (p. 124) the volume of transactions in the underlying stocks. But this is precisely one of their benign side effects over and above their usefulness in redistributing risk from unwilling to willing takers.
Analysts are rightly castigated for their gullibility, poor judgment, and herd instinct. Mr. Bébéar recognizes that they cannot have the experience of seasoned business executives, but still blames them for their reliance on mechanistic analytical tools, when they should be backing the quality of management instead. However, while analysts may be a shabby sort of channel of communication between companies and investors, there is not a better one. Without them, investors would be even more in the dark than they are anyway, and more dependent on rumor.
Speaking as a true manager, the senior author is quite hard on rating agencies and bankers. Standard & Poor and Moody’s only look at numbers and ratios, and far too readily downgrade reputable companies when the numbers temporarily swing the wrong way, instead of regarding the solid worth of the men who run them. Bankers no longer use their personal judgment and knowledge of a client’s business in extending credit and setting interest rates, but rely on the rating agencies. Loan agreements may even include a clause of immediate repayment upon a certain downgrading by the rating agency, possibly precipitating a company’s ruin. Here, Mr. Bébéar is really protesting against the division of labor between rating agency and bank, while his plea for judging persons rather than just numbers could be read as a plea for special treatment for members of the club that would surely provoke accusations of cronyism.
He does not spare lawyers who are “castrating capitalism” (p. 110)— which they probably do. But aren’t corporate officers also to blame for their great deference to the lawyers?—a product of their anxiety about “cover”? It is hard to see how this could be overcome without changing both the managers and the lawyers.
THE WHIRLWIND OF SPECULATION
Nobody seems to like speculators. A defender of capitalism, however, ought to like them, rather than accusing them of generating vicious spirals. A speculator in stocks or currencies hopes to anticipate what the next man, and the one after that man, will do, and seeks to beat them to it. If he thinks there will be a buying spree, he will buy now, and if he expects a selling spree, he will sell now. He will sell what he has bought before the buying spree is exhausted, and buy back what he has sold before the selling spree is exhausted. If his anticipations were right, he will make money, and he will lose money if they were wrong. Obviously, however, if he was right and has made money, by beating the next man to both the purchase and the sale, he will have lifted the price when it was still low and lowered it when it was already high. In other words, if he was successful, he will have smoothed down the swing in the price that would otherwise have taken place. A market with active and successful speculators will be less volatile than it would otherwise be. Contrariwise, if he anticipated wrongly, he will have accentuated the swing and “destabilized” (forgive the trendy word) the market. As Nicholas Kaldor, no apologist for capitalism, has shown in a famous paper, speculators are benign if they make money and harmful if they lose it; but if they lose enough, they are wiped out and the harm stops. There is no vicious spiral, and the Tobin tax is otiose.
In Mr. Bébéar’s book, however, the speculator does not anticipate a movement that is going to take place. Instead, he initiates and causes it. He sells (as a typical manager Mr. Bébéar dislikes bears more than bulls), and his selling sets off an avalanche of other selling, driving the price down to a level where he will buy back low what he has sold high. A man of vast experience of the securities markets seems really to believe that speculators, or at least some of them, have this magic power over the expectations of other market participants. However, if even a single one had such a power, his every move would set off moves by hordes of others in the same direction. The more he speculated, the more slavishly would others follow his infallible lead, the more money he would make, and the more powerful would be the next whirlwind he could set off. Before long, he would own the world. But this is not how the economy really works, and Mr. Bébéar must know it.
THEY WON’T KILL CAPITALISM
The rogue’s gallery of “saboteurs,” fools, cowards, opportunists, and other normal specimens of the human race won’t kill capitalism. Perhaps they won’t enhance its reputation, but capitalism never enjoyed a very high reputation in the eyes of the general public. It always deserved a higher one than the one it did have, if only because no rogues’ gallery could ever stop it from performing reasonably well its basic function of delivering the goods.
It would indeed be nice if all whose job it is to keep the capitalist system going became more virtuous, more wise, more competent, and more responsible. We may wish and even work for this. But, pace Mr. Bébéar and others, let us by no means spread the altogether false belief that capitalism’s survival depends on this wish coming true.
WHEN THE ECONOMY NEEDS MORALS*
Like the road to hell that (as all know) is paved with good intentions, the road to economic stagnation and relative poverty (as all do not know), is paved with policies. Some, such as the “legal” work week, price and rent controls, or “job protection,” are counterproductive, wrongheaded if not downright asinine. Others, such as compulsory social insurance or the sharply progressive taxation of income and inheritance, serve purposes that well-meaning public opinion thinks are both rational and just, that help build voting coalitions the government needs, but whose true economic cost is so pervasive and diffuse that it is never really perceived. Finally, there are policies aimed at mitigating the unforeseen side effects of other policies or at achieving particular results in, say, regional development, research, the pattern of foreign trade, or the support of certain industries, that may look quite reasonable if regarded in isolation, but whose cumulative weight disturbs and distorts the work the price system is to do in keeping the economy on an upward path tolerably close to its potential.
The sum total of all the policies in being is a cause of general under-performance. Even if every policy had a positive effect on its own limited target (which may be too much to hope), there would still be a negative diffuse effect on the economy as a whole due to deviations from the path of least resistance. But that would little by little weigh down activity without most people having much insight into why this should be happening. There will be a frenzied and increasingly desperate piling up of social policy, employment policy, industrial policy, energy policy, transport policy, measures for the young, for the long-term unemployed, for the unskilled, for small business, and for any number of other worthy causes. Little or nothing will be achieved.
Those who have followed the history of the French “social model” since its origins after 1975 are familiar with the details of such processes. Italy, Germany, and the Scandinavian countries provide similar, albeit less stark, examples, though with one major difference: each, in its own manner, has recently at least tried to reverse the process and dismantle part of its towering policy edifice. European countries of the former Soviet bloc have also done some good demolition work. If this dismantling persists and gathers momentum, all may yet be well. The present article deals with the opposite scenario where no dismantling has started, or where it fails to gather momentum.
Generally, the trouble begins with public opinion waking up to the near-absolute primacy of politics over economics that characterizes advanced countries since World War II or so. In the nineteenth century and the first decades of the twentieth, public opinion was convinced that there were iron laws no government could transgress without risking catastrophe. Property belonged unconditionally to whoever held title to it, and could not be violated without the social order collapsing. Budget deficits could not be allowed to persist in peacetime, for printing money meant inflation and the spoliation of small savers. Wages and profits had their own natural levels and could no more be fixed by decree than the weather. These beliefs did not provide complete protection for benign economic equilibrium, but they helped.
Partly as a result of the widespread teaching of vulgarized economics, it came to be understood that none of these iron laws had actually to be respected, except perhaps in the very long run when we are all dead. People saw that everything that was politically feasible or indeed necessary could be done to the economy without the sky crashing down on them. A democratic government always had the whip hand over business. The freedoms of property and contract could always be curtailed by appeal to the public interest.
The proliferation of policies that seemed a good idea at the time was to shape the economy to perform as politics dictated. The objective was to establish “social justice” by redistributing the income once the economy has obediently produced it. Policy proliferation and redistribution are the obvious consequences of the primacy of politics. After a lapse of time that is quite short by historical standards, the result is clear. Each policy works to some extent, but their sum total brings overall failure.
At this point, the realization is dawning that, like a sick body saturated with an array of wonderful drugs to which it can no longer respond, the economy will not improve by subjecting it to a further overdose of remedial measures. Above all, historically high unemployment seems to have become chronic. It threatens the whole social order and, more importantly, the political survival of whatever shade of government happens to hold office. Desperate measures are suggested: the “available” work must be shared by ordering everyone to work shorter hours; business must be allowed to hire but forbidden to fire; it must be obliged to invest its profits rather than distribute them to fat cat shareholders; it must also be forbidden to delocalize to lower-cost countries; indirect taxes must be used to penalize imports; the state must pay the wages of young people in their first year of employment; and so forth. Some of these harebrained ideas are actually tried out, but either prove unenforceable or just do not work.
In the last resort, the cry then goes up for more social responsibility, more morals. In a normally functioning capitalist economy not pulled and pushed off balance by the politics of policies, the need for morals is at a minimum. Most economic agents are called upon to do only what is “incentive-compatible.” This jargon term, regrettably part of the language of economics, means that the butcher and the baker best fulfil their role if they maximize their profit (or otherwise act in their best interest). The exception is the principal-agent relation, such as that between the employer and his employee, the owner and the manager, or the citizen and the state. Such relations are only partly or not at all incentive-compatible and leave a need for supervision and ingenious incentive-creating contracts. Egalitarian arrangements and command economies are both almost totally incentive-incompatible.
Instead of having to rely on morals, a normal capitalist economy works well if, and because, “honesty is the best policy”—namely it pays best. Deviation from the honest norm—shirking, free-riding, short-changing, making shoddy goods, stealing, or embezzling—might pay even better, but may trigger legal, economic, or social retribution. The best policy is the honest one if the expected present value of retribution is greater than the gain from any dishonest option. (The expected present value of retribution depends on the agent’s subjective probability of being caught, on the pain of the punishment, on how soon it may be suffered, and the rate at which the agent discounts the future. Unsettled social conditions favor the dishonest option, as does slow justice and a high personal discount rate. Dishonest people are believed to discount the future at extravagantly high rates.)
Unlike a healthy capitalist economy, the near-bankrupt welfare state requires morals in the strict sense. It asks many of the most decisive economic agents to act against their own interests. Wealthy families or ambitious entrepreneurs must not emigrate to reduce their tax burden—doing so would be a betrayal of solidarity with their fellow countrymen. Top executives must not accept salaries and bonuses that would make them as rich as pop singers or football stars, but should limit their earnings to some moderate multiple of what their workers get. Firms must maintain the payroll and not throw their employees on the dole as long as the company is still profitable; only serious loss could justify laying off defenseless workers. Managers must manage in a “socially responsible” manner and not in the sole interest of the owners. (Interestingly, this demand is made in the name of morals, though if the manager does not run the business in the owners’ sole interest, he is betraying his mandate and is in effect a thief who steals on behalf of “society.”)
It is perhaps obvious, but it will do no harm to spell it out, that none of these alleged moral imperatives are pertinent in an economy that runs freely and has not been nearly suffocated by ill-advised attempts to use politics for improving economics. Workers, above all, are not menaced by chronic unemployment which strips them of bargaining power and leaves them to the mercy of a largely imaginary and axe-grinding moral code of economic conduct.
THE POLITICAL ECONOMY OF FORCE-FEEDING*
In Mauritania, many parents caring for their girls’ future well-being send them at a tender age to board with women specializing in fattening them up by amiable but relentless force-feeding. Like most African men, Mauritanians prefer them well rounded, and a girl who frankly bulges has a good chance of finding a rich husband, while a slim girl may have to content herself with being found by a poor one. Money may not make the girl happy, but the parents are nevertheless following a kind of economic rationale in having her force-fed. One does not know whether the rich husband will be nicer or on the contrary nastier than a poor one would be. With even chances of either outcome, rational choice must opt for the rich husband, for happy or unhappy, the girl will at least be more comfortable in the rich household.
There is a remote analogy between parents force-feeding their daughters with food and states force-feeding the children of their subjects with compulsory education. In both cases, compulsion is motivated by benevolent paternalism, though one might think that there is more excuse for parents acting paternalistically than the state doing so in loco parentis. However, the analogy stops here anyway. In particular, the results are not analogous at all.
According to statistics compiled by the European Commission, public expenditure on education by the twenty-seven member states amounted to 5.09 percent of the area’s gross national product, with private expenditure by families and nongovernment institutions adding a mere 0.64 percent. The corresponding figures were 8.47 and 0.32 in Denmark, 5.12 and 2.32 in the U.S., 6.43 and 0.13 in Finland, 5.29 and 0.95 in Britain, 4.60 and 0.91 in Germany and 4.25 and 0.61 in Spain. The low proportion of money freely spent on buying education compared to public spending on force-feeding it to captive consumers is striking.
There is a wide enough consensus in Europe that public expenditure on education, on a rising trend in nearly every country, must go on rising and is never high enough. Most people believe that more spending means better education and do not see any clear link between their taxes and more public spending. Nobody feels the marginal cost of more education, and many do not realize that the marginal return, in terms of better-educated young people, may be very little indeed. Except perhaps in the case of Finland where high expenditure goes hand in hand with Europe’s best average scholarly performance, there is no significant correlation between spending and educational results.
The sums involved are huge. Only “ill care” (euphemistically and misleadingly called health care, though its agenda is the treatment of illness rather than the preservation of health) absorbs a greater share of national incomes. The return on this vast outlay is poor and shows little or no improvement with time. Functional illiteracy among school-leavers in the state-run sector runs at around 15 percent. Many countries, with France in the lead, forbid selective admission at secondary and at university entry level as inegalitarian (though some selection is taking place surreptitiously). The result is that in each class, a number of hard cases prevent the rest from learning and the teacher from teaching. British education is good at the top end, thanks in large part to the 160 grammar schools that were spared in the devastating postwar reforms to bring in equality of opportunity, and that practice selection, but below that level standards are abysmal. State schools not only fail to teach their conscripted pupils basic knowledge but also fail to educate them to habits of regular work, discipline, and civilized conduct.
In defense of the schools, it is said that parents no longer do their share of educating children as they used to do. This is undoubtedly true, but then taxpayers did not use to pay five percent of national income to maintain schools in order that compulsory education should accomplish both what parents no longer do and what privately financed schools used to do in the past.
School attendance in most European countries is mandatory and free of charge from between five and seven to fifteen or sixteen years, usually with a further two years that may be mandatory, optional, or a part-time mixture of the two. In a recent speech Britain’s prime minister Gordon Brown announced plans to extend the general school-leaving age to eighteen, though it was not clear whether this would be mandatory. University education is still optional everywhere in Europe, but there is a tendency to transform it into a “right” the young “ought to” exercise and to have the general taxpayer bear most of the cost.
More and more, education is taking the form of a “nonexcludable” public good that has the peculiarity that a certain age group is not only free, but actually compelled, to consume it. Moreover, this age group tends to be extended as the school-leaving age is prolonged. This is done in the firm belief that it will do a deal of good both to the young personally and to the national economy as a whole, making the cost well worth bearing and the force-feeding justified. However, a suspicion is spreading that this belief is illusory and that the material and moral payback may in fact be nil or negative.
Who, or what, is at fault? Everybody, and everything, is probably the right answer. One obvious structural fault springs, paradoxically, from the virtual shutting off of the normal producer-consumer conflict in the state sector. In private schools the producers, namely the teachers, must willy-nilly exert themselves to satisfy the customers, namely the pupils’ parents. In state schools, the customers are captive. They do not pay (or so it seems to them at the level of each particular school) and must either consume what is provided or passively resist it. Whether they do one or the other, the jobs of the teachers are little affected. Teachers’ unions behave accordingly and fight tooth and nail against attempts to inject some producer-consumer conflict and competitive effort into education by the use of school vouchers. In Europe, school vouchers have been and remain out of the question. Some teachers’ unions, especially in France, also combat and seek to restrict apprenticeship for being a form of “child labor” that would reduce school attendance. They just succeeded in reversing a government decision that would permit apprenticeship from the age of fourteen; the age limit is now back at sixteen.
However, the root cause of failure lies deeper than teacher indifference, left-leaning prejudice, and bureaucracy. It lies in universal compulsory enrollment in a system that cannot educate under the same roof both the willing and the unwilling, the hopelessly dumb and the downright hostile. Probably no system can really do so, but if there is one that has a chance, it is one that demands only voluntary effort from the young and guides those unwilling or unable to make it, to channels that call for different kinds of endeavor and aptitudes. In one word, education as an obligation does not work, or at any rate does not work well enough to make it worthwhile. It needs gradually to be turned into a privilege provided only for those willing and able to draw from it all the benefit it offers, but withdrawn from those who abuse it or prove unable to use it.
The late James Coleman, an eminent Chicago sociologist, used to teach that it is good for children to be raised within mixed age groups and dangerous to have them grow up within same-age peer groups. For him, the small farmer family where young and old worked at their different tasks on the same farm, and the community of master and apprentices in the workshop, were the ideal educational environments. Adolescents thrown together in the school and “hanging out” together after school ran a high risk that too much of each other’s company would coarsen them and make them form gangs where outrageous behavior earned them peer admiration.
This is perhaps the right juncture to remember the sinister story of compulsory social regrouping on a wildlife reservation in East Africa. The elephant population was growing too dense. To relieve the pressure, substantial numbers of young elephants were captured and placed several hundred miles away in an area where only a few elephants lived. After a while game wardens in that area began to find corpses of rhinoceros crushed to death by unexplained blows or pressures. The mystery of these deaths was solved when gangs of up to a dozen young elephants were observed chasing rhinos at full gallop. Catching up with one, they overturned and stomped it to death. It was concluded that being forcibly taken out of their family environment and thrown together with their peers had turned them into coarse, wanton hooligans.
I will stop short of insinuating that force-feeding the young with education some of them are unwilling or unfit to assume, and extensions of the school-leaving age that divert many young people from timely apprenticeship and natural transition into working life, are turning them into replicas of rogue hooligan beasts. Things are not as bad as that, but very much worse than the advocates of ever more, ever longer, and ever more expensive compulsory education keep on imagining. Their dream of turning out well-behaved and highly knowledgeable young people destined to have a better life than their parents, while by the same stroke creating a huge positive externality in the form of a “knowledge-based” superproductive economy (such as was set as the medium-term objective for the European Union at its 2003 Lisbon summit) is proving to be just that, a dream. Awake to reality, less paternalistic and less coercive means may be adopted, whose use runs into less resistance.
HOSTILE TO WHOM?*
“ECONOMIC PATRIOTISM” TO RESIST “MARKET DICTATORSHIP”
Over the last year or so, cross-border bids for the control of high-profile corporations in one country by interests in another have multiplied. An unusually high proportion of such bids have been unsolicited by the directors of the target corporation. They have either been rejected by them to start with, or have bypassed them altogether and were addressed over the directors’ heads directly to the shareholders. With a mixture of naïveté, cynicism, and hypocrisy that leaves sensible people breathless, such bids are called “hostile.” Though seldom if ever asked, it is surely pertinent to ask: hostile to whom?
When the state-controlled Chinese oil company CNOOC tried to buy Unocal and the all-cash offer looked attractive enough to make it likely that the requisite proportion of shareholders would accept it, the furious noise in Congress and the media reached a pitch quite out of proportion to the intrinsic importance of the affair. China was going to undermine U.S. national security, divert “essential” energy supplies from the American consumer, and so forth. The political climate became so stormy that CNOOC was frightened away and Unocal was picked up at a somewhat lower price by Chevron. Some cool heads have reckoned that the Chinese offer overvalued Unocal, but happily American economic patriotism saved the Chinese from overpaying.
When the Dutch bank ABN Amro tried to buy the Italian bank Antonveneto in the face of board opposition, wheels within wheels started to spin, submerged power networks were activated, and the prolonged legal and financial battle ended with a resounding scandal and the forced resignation of the governor of the Bank of Italy. Some took the subsequent buyout of Banca Nazionale del Lavoro by the French bank BNP Paribas for a capitulation of the Italian national interest.
When all too audible stage whispers expertly spread the word that Pepsico was preparing to make a “hostile” bid for the French yoghurt and mineral water firm Danone, a “national champion,” President Chirac, personally vowed to “resist the attack” and defend the brave French yoghurt against the brazen invader—though the bluster had little substance in it for lack of any clear legal power to stop Pepsico from making the offer and the Danone shareholders from accepting it. The prime minister solemnly appealed to “economic patriotism,” called upon French companies to “padlock their capital structure” to make changes of control less easy, and initiated legislation giving the government powers to ban control passing to foreign hands in eleven “strategic” sectors of the economy.
Among a handful of other examples of “hostility,” Mittal Steel’s offer to buy Arcelor is creating the most emotion. Mittal, the world’s biggest steel producer, is legally European but is 85 percent controlled by the Indian Mittal family. Arcelor, the world’s No. 2, is European in legal domicile, management, and ownership. Mittal is downmarket, Arcelor is upmarket and proud of it. Its shareholders may choose to sell out to Mittal all the same, which the French and Luxembourg governments deem an intolerable “dictatorship of the market” and are angrily trying to block. The attempt is mainly bluster, but the rhetoric accompanying it is as ugly as it is confused.
Objectively, “hostile” offers are hostile only to the sitting management and related vested interests. However, when they are cross-border, they are invariably styled as attacks upon the host nation of the target company. When Dubai Ports is trying to buy the worldwide port installations of Peninsula & Orient, including those in five U.S. east coast ports, it is threatening American national security and must be stopped, though Dubai Ports would not replace American customs and port security personnel by Arab terrorists, and could not if it would. Likewise, when the Italian power utility Enel sounds as if it were planning to make a “hostile” offer for the Franco-Belgian power and water utility Suez, Paris quickly rushes through a shotgun marriage that preempts the possible Italian bid in the name of French “energy security.” Presumably, there was a danger that Enel would pay big money for the Suez power stations in order to shut them down and plunge France and Belgium into darkness. However, the most inane pretext will do to brand perfectly bona fide transactions “hostile,” especially if the widely hated stock market is involved in it.
PROTECTING THE PRINCIPAL-AGENT DILEMMA
The result of “economic patriotism” is to curb the liberty of owners to use their assets as they see fit within agreed liability rules. This includes the liberty of selling assets to the highest bidder who thinks he can make more productive use of them and will bet money on his belief. The cost of curbing this liberty is best understood by considering the principal-agent dilemma.
There is a general presumption that it is efficient for principals to delegate certain functions to agents and pay them for carrying out the tasks so delegated. The archexample is owners of corporate equity confiding management to professional boards of directors. In democratic political theory, the citizenry is supposed to confide to the state the task of managing society. In any principal-agent relation, the incentives guiding the principal partly overlap but in part also conflict with the incentives pursued by the agent. The corporate director and the shareholder both prosper when the company’s profits rise and its prospects improve. However, the director is also interested in getting the most fabulous compensation package, the most secure tenure, the least stress and conflict, and also in empire-building that puts sheer size ahead of profitability. Analogous contradictions can be found between the interests of citizens and their state when the observer takes off the rose-tinted spectacles of democratic theory.
These are the costs of agency, and the dilemma of the principal-agent relation consists in this: you cannot reap the efficiency gains of agency without bearing its costs. The balance between the two depends in large part on the agency contract. The principal may seek contract terms that will minimize the conflict between his incentives and those of his agent. In politics, constitutions are attempts to frame such a contract, and we know from modern history how successful they have been. In business life, the great shift in managerial compensation from fixed salary to stock options in the last two decades of the twentieth century was another such attempt. Despite much and gross abuse and self-dealing, stock options have had some success in bringing owner and manager interests closer to each other. The recent accounting reforms have put a brake on such tendencies. In any event, it is logically impossible to frame an agency contract which would completely eliminate agency problems without effectively transforming the agent into the principal and losing the efficiencies yielded by the allocation of special tasks to specialists.
It is this dilemma that the “hostile” bid is designed partially to resolve. “Economic patriotism” is unwittingly combating this design, especially if carried out by foreigners or other outsiders not recognized by the domestic establishment of “cozy crony capitalism” which would, if it could, perpetuate the principal-agent dilemma.
THE MARKET FOR CORPORATE CONTROL
It is of course the height of absurdity to term offers made by buyers to sellers as “hostile” or “friendly.” They are neither. The seller is free to accept or reject them. They may be hostile, though, to the sellers’ agent who may lose his tenure if the seller accepts the bid. He can protect himself against this risk in two ways. One is by populist appeals to public opinion, legislative and regulatory maneuvers, “poison pills,” and the like. The other is by brilliant managerial performance that gets so close to the ideal of long-run profit maximization that no one thinks he can make much better use of the assets by wresting control of them from the sitting directors.
The branch of theory dealing with the value of corporate control was grafted onto the theory of the firm by Henry Manne.1 It would be impertinent to try and give a capsule summary of his short, seminal article here. Suffice it to say that the control premium offered by a bidder will lie in a gap, if any, between the company’s market capitalization under its sitting management and the present value of all future earnings the bidder expects the corporate assets to yield under the best management he can appoint. The bigger the gap, the bigger must the agency problem be. Equally, however, the bigger the gap, the stronger is the incentive potential bidders have to try and buy the corporate control. If potential bidders are not deterred by regulatory twists, poison pills, and appeals to patriotism or good manners, the sitting management must strain to “increase shareholder value” (as the current jargon has it) by better performance as well as by inspired rumors of impending bids so as to reduce the remaining gap between the current value of the company and its expected value to a rival, i.e., the control premium the rival would be willing to pay. Discouraging bids is to encourage sloth and inefficiency. Until this is better understood, agents will rise high on the backs of principals.
MANNESMANN’S COURTESY COULD PROVE RARE*
Now that the Mannesmann-Vodafone contest is behind us it might be a good time to pause and consider what just took place and what the implications are for Europe. Many see in the outcome a watershed event. Mannesmann, a large German engineering concern that has grown into a spectacularly successful multinational telephone business, was after all the indisputable champion among continental Europe’s giant corporations. By conventional wisdom, it should have been invulnerable to takeover attempts. Yet late last week, its management ended a three-month battle for control with Vodafone Airtouch by extracting terms beyond which Vodafone could not have gone.
According to the deal, the Mannesmann owners will walk away with 49.5 percent of the future Vodafone-Mannesmann. In exchange, the Mannesmann board renounced all recourse to the abundance of obstructive tactics it could have used, and recommended the Vodafone offer to its shareholders.
The first point I’d like to raise deals with language. The vocabulary used in the media was about what we could have expected. Throughout the long contest, journalists routinely spoke in terms of Mannesmann “falling victim to a hostile bid” if its board accepted any alternative that did not preserve Mannesmann as an independent corporate entity. It seems extraordinary that this language again passed unchallenged. But then it always does whenever a bidder addresses a corporation’s shareholders without first securing, by golden handshakes and reassuring undertakings, the consent of its management and sometimes of the labor unions and the government as well.
HOSTILE TO WHOM?
In what way or to whom were this and similar bids hostile? Who exactly was the victim? Some of the managers, possibly, and some of the employees, if the transfer of the company’s control is to improve efficiency and increase total wealth rather than merely pander to the vanity and megalomania of the bidder. But the idea that managers own their offices and employees own their jobs, to such effect that they are “victims” of “hostile” acts if they lose them, is surely strange.
Stranger still is the fact that so few in the media and among the broad public find it strange. Jobs are matters of contract; if they are to be protected, the protection must be embedded in the terms of the contract, not added later by lobbying and the propagation of spurious claims of rights of tenure. A corporation is owned by its owners. An offer for their shares is no more hostile to them than is the offer for any other piece of property to its rightful proprietor. What is indeed hostile is any claim to the contrary.
Perhaps the negotiated acceptance of the Vodafone offer is a first portent that things are no longer seen in Europe in the confused fashion that confused language promotes. Linguistic obfuscation on the part of mostly leftist journalists may have (let’s hope) reached its limit. Perhaps owners, even in continental Europe, and even of large prestigious corporations, will now be allowed to own.
But this is far from certain. The second-largest “hostile” bid after Vodafone’s was last year’s three-way fight for supremacy in French banking. The managers of Société Générale and Paribas wished to merge the two banks; Banque National de Paris, or BNP, the same size as either of the others, tried to impose a merger of all three under its leadership. The contest took several months and provided classic examples of how corporate boards and governments now pay lip service to free capital markets, while doing their best to thwart them.
The management at the two defending banks, Société Générale and Paribas, showed pained astonishment and anger at having BNP appeal over their heads to the shareholders. They tried to have BNP’s offer set aside, an action they knew was lost in advance but one that it took the courts months to deal with. The French government, for its part, set in motion one of the civilized world’s most involved and opaque regulatory machineries to ensure that they would end up with the kind of three-way merger it wanted.
Paris sought to create one of the world’s biggest banks, an idea that had irresistible appeal to the national ambitions of the French bureaucrats. The highest mandarins of the Ministry of Finance did little to conceal their determination to see BNP through to victory. They even tried to force the governor of the Banque de France, Jean-Claude Trichet, to browbeat the protagonists into agreement on the ground that a contested takeover threatened the stability of the nation’s banking system.
The objective was to forestall shareholder self-determination by securing a deal among the respective managers. They were to deliver “their” banks to a tripartite superholding. The French government therefore fiercely warned off Banco Santander Central Hispano from supporting SocGen by buying its shares in the market.
When all else failed to deliver the solution that national grandeur demanded, the government froze the whole process, expecting the “victims” to get the message and comply. In response to warnings that investors were getting disgusted with his high-handed treatment, the then finance minister Dominique Strauss-Kahn (who, facing corruption charges, has since resigned) confidently and grandiosely declared: “The French state is not quoted on the stock exchange!”
In the end, bewildered shareholders sold Paribas to BNP while Société Générale stayed independent. There is of course no telling what the outcome would have been had managers and government not tried to usurp the owners’ role. It is unlikely, though, that the result would have been exactly the same.
The novelty of the Mannesmann case was that right from the outset the chief executive, Klaus Esser, said he would fight by Marquess of Queensberry rules, and throughout he did what he said he would do. He declined to use the tempting opportunities he had to restrict shareholder sovereignty. He could no doubt have provoked government interference, nationalist attacks in the media against the foreign invader, and labor-union agitation. He also had strong weapons in Mannesmann’s by-laws.
Above all else, Mr. Esser could have invoked an obscure provision of German company law which offered every chance of leaving an un-completed Vodafone-Mannesmann merger indefinitely mired down in the courts. This provision, untested and hard to interpret, fitted this particular case like a glove. It would have been ideal both to keep the lawyers of the two parties profitably employed for many years and to keep Mannesmann independent even if a majority of its shareholders had wanted it to merge. In the end, falling in with part of his supervisory board, Mr. Esser made peace and settled with Vodafone, getting a rather better price for his shareholders than the original, “hostile” offer. At no time did he try to stop them disposing of their property the way they saw fit.
Until the next test case and the next after that, however, we can only guess whether he could have done so if he had been prepared to use foul means as well as fair. Time will tell, because there are plenty of European managers only too willing to use legal subterfuges, appeals to the national interest, and local welfare to put across the notion that owners have no more say, and perhaps rather less, than anybody else connected with the business. It is too soon to feel confident, but perhaps one could start hoping that the Mannesmann case does indeed mark a turning in this road.
[* ]First published by Liberty Fund, Inc., at www.econlib.org on September 4, 2006. Reprinted by permission.
[* ]First published by Liberty Fund, Inc., at www.econlib.org on February 6, 2006. Reprinted by permission.
[* ]First published by Liberty Fund, Inc., at www.econlib.org on September 8, 2005. Reprinted by permission.
[* ]First published by Liberty Fund, Inc., at www.econlib.org on September 6, 2004. Reprinted by permission.
[* ]First published as “Capitalism and Virtue: Politicians Do Not Understand the Economy, but Do Managers?” by Liberty Fund, Inc., at www.econlib.org on June 2, 2003. Reprinted by permission.
[1. ]Claude Bébéar and Philippe Manière, Ils vont tuer le capitalisme (Paris: Plon, 2003).
[* ]First published by Liberty Fund, Inc., at www.econlib.org on June 14, 2007. Reprinted by permission.
[* ]First published by Liberty Fund, Inc., at www.econlib.org on November 5, 2007. Reprinted by permission.
[* ]First published by Liberty Fund, Inc., at www.econlib.org on March 6, 2006. Reprinted by permission.
[1. ]Henry Manne, “Mergers and the Market for Corporate Control,” Journal of Political Economy 73 (1965): 110-20.
[* ]First published in the Wall Street Journal Europe, February 10, 2000. Reprinted by permission.