Labour Market

Beware the lure of executive pay caps

The Labour Party wishes to restrict the pay of ‘fat cat’ executives. This is a policy which is apparently highly popular with the public, even though it brings no direct benefit – unless you believe schadenfreude adds significantly to people’s welfare.

One way Labour plans to curb high pay is to impose a 20 to 1 ratio from the highest-paid to the lowest-paid in the utilities it intends to renationalise. This may make it difficult not only to recruit and keep high-quality executives, but also specialists and highly skilled people further down the scale, whose salaries would also be squeezed as pay structures are inevitably compressed.

This is likely to raise a whole set of problems for these sectors, but at least they are contained within the sector and the public will ultimately be able to judge the effects on performance.

A bigger worry is that Jeremy Corbyn has made it clear that he wants to apply this pay restriction to businesses which bid for public sector work.

Mr Corbyn says that his government would ‘extend [this restriction] to any company that is awarded a government contract. A 20:1 ratio means someone earning the living wage, just over £16,000 a year, would permit an executive to be earning nearly £350,000. It cannot be right that if companies are getting public money that can be creamed off by a few at the top’.

It remains to be seen how exactly this could work. Mr Corbyn clearly has in mind such bêtes noires as Capita and G4S, whose business largely consists of work for the government and whose sometimes-poor performance has not prevented their CEOs from receiving pay packages worth many millions.

However, government outsourcing is a market worth well over £100 billion annually. Politicians may have in mind the railways, social care and prisons as areas where rip-off merchants lurk, and which ought not to be outsourced. But outsourcing involves a huge range of services from accounting to advertising to pest control which the government cannot conceivably provide for itself.

These services are provided by hundreds of companies, large and small.

To this might be added billions of pounds of government procurement – everything from nuclear submarines to office furniture, from hospital beds to paperclips. If Labour is serious about this, presumably identical restrictions will be placed on companies providing goods as on those providing services. The same reasoning applies.

But for many of these businesses the government may only account for a small part of their revenue. How would they react to Mr Corbyn’s policy?

Firms which are not heavily committed to providing goods and services to the public sector would surely tend to avoid this kind of provision rather than have their pay structures dictated by, and presumably intrusively monitored by, a government regulator.

The result would be that competition for government procurement would be reduced. Prices would therefore tend to rise, and in some cases, government might even find that no private providers would be forthcoming at all. This could create temporary shortages of service providers, forcing the government to take services in-house at higher cost. They might have to buy goods from overseas suppliers rather than domestic firms.

Those providers who stayed on the government payroll would gain an artificially more secure market which would dampen their incentive to innovate. Their bosses would be paid less, so tax revenue would fall.

A double whammy for the taxpayer, then, having to pay more to compensate for the loss of income tax receipts and higher costs for government services.

As so often, policies which give politicians and activists a warm glow of self-satisfaction seem likely to end in extra costs and no obvious benefits.

Editorial and Research Fellow

Len Shackleton is an Editorial and Research Fellow at the IEA and Professor of Economics at the University of Buckingham. He was previously Dean of the Royal Docks Business School at the University of East London and prior to that was Dean of the Westminster Business School. He has also taught at Queen Mary, University of London and worked as an economist in the Civil Service. His research interests are primarily in the economics of labour markets. He has worked with many think tanks, most closely with the Institute of Economic Affairs, where he is an Economics Fellow. He edits the journal Economic Affairs, which is co-published by the IEA and the University of Buckingham.

2 thoughts on “Beware the lure of executive pay caps”

  1. Posted 20/11/2018 at 12:52 | Permalink

    If the plan follows the usual structure of insisting that all firms supply the information with penalties for not doing so, that would present yet another unreasonable burden for the smaller business.

  2. Posted 20/11/2018 at 13:25 | Permalink

    The pay of all private sector employees is determined by the votes of the shareholders, who, up until now have not been active enough. A useful improvement would be to reinforce their power within all limited companies.

    In the public sector there is no limiting factor, like profitability, which would curb pay. This why senior local government employees have significantly increased their salaries beyond all reason. The chief execs of many councils have salaries in excess of the PM, yet their performance is abysmal.
    A limit here would in my view be very effective.

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