Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Factoring in the problem of compensation

Here’s something you don’t need telling if you read the tabloids: bankers get paid a lot. Unlike the redtops, however, this fact doesn’t necessarily bother economists. In a well-functioning market economy, people get paid according to the personal contribution they make (in economist speak, they’re paid according to their marginal product). Nonetheless, some issues are of concern as regards bankers’ remuneration.

Overall compensation

This issue is fundamental: if bankers are extremely productive and add large amounts of value for their clients, economists typically have no problem with stratospheric bonuses. If, however, large amounts of bankers’ pay can be attributed to the large public subsidy that banks receive due to their systemic importance, they do have reason to be concerned, for two reasons:

Inequality: The subsidy is effectively a transfer of money from the general taxpayer to bankers. Because bankers are on average much better paid than the average taxpayer, this transfer is from the relatively poorer to the relatively richer. You may be surprised, but economists care quite a lot about equity: all other things equal, economists prefer more equal outcomes and therefore dislike inequality. Thus seeing money flow from poor people to rich people annoys economists (to varying degrees).

Rent-seeking: The bankers aren’t creating much value but are competing for a share of the subsidy. In effect, they’re competing for already

existing resources rather than creating a valuable service. Economists call this rent-seeking behaviour. When people rent-seek, instead of putting their efforts towards creating a good or service valued by the marketplace, they spend their time and effort competing with each other for some existing surplus. For why the term is a bit of a misnomer, see the nearby sidebar ‘Don’t be DUPed, dope’.