The Krugman Critique of Wall Street Pay Just Doesn’t Add Up

Paul Krugman doesn’t like how much Wall Street gets paid. Neither does most of America. But that doesn’t make big paychecks wrong. Still, in a column today the Nobel winning NYT economist bemoans the fact that Wall Street salaries are on the rise again:

“…the real reason financial firms are paying big again is simply because they can. They’re making money again (although not as much as they claim), and why not? After all, they can borrow cheaply, thanks to all those federal guarantees, and lend at much higher rates. So it’s eat, drink and be merry, for tomorrow you may be regulated.”

This frustration is representative of the sentiment building for months. It has been repeated often. And so too its counter: we have a free market that figures out how much people should be paid. You may not like that baseball players make 100 to 1000 times the salaries of inner-city school teachers–but that doesn’t make it wrong. So too, just because you don’t think Wall Street executives deserve their high salaries doesn’t mean the government–or the New York Times–should change them.

Of course, Krugman has a critique:

“…you might argue that we have a free-market economy, and it’s up to the private sector to decide how much its employees are worth. But this brings me to my second point: Wall Street is no longer, in any real sense, part of the private sector. It’s a ward of the state, every bit as dependent on government aid as recipients of Temporary Assistance for Needy Families, a k a ‘welfare.'”

Here the frustration becomes more apparent. People have been upset for a while about high salaries, but had no legitimate right to curtail them. Now that we the taxpayers are, in effect, the salary provider for Wall Street, we–i.e. the government–should have a right to limit their pay. And this argument kind of makes sense, especially when you look at the list of government aid handed out over the past 18 months that Krugman lists:

  • $600 billion or so already committed under the TARP;
  • Huge credit lines extended by the Federal Reserve;
  • Large-scale lending by Federal Home Loan Banks;
  • Taxpayer-financed payoffs of A.I.G. contracts;
  • The vast expansion of F.D.I.C. guarantees; and,
  • The implicit backing provided to every financial firm considered too big, or too strategic, to fail.

However, consider this: when the government gives Social Security money to seniors, does it restrict how the cash can be used? Do welfare guidelines dictate which brands of soup or paper towels are allowed to be purchased with those taxpayer funds? And even more importantly, do the taxpayers have the power to set the salaries of members of Congress–legitimate (arguably) recipients of taxpayer money for services?

No. It does not necessarily follow that just because we gave them bailout money, we have the power to control them (unless the terms are stated up front as a condition of accepting the money).

Now, that is not to say that the bailout money is a good thing. This is just one of the many complications that come with government intervening in the private sector. There may be perceived short-term problems with the free market. Failure is, after all, not fun. And capitalism promises that some will succeed and some will fail. But there are even more complexities and problems with government money and power entering the equation.

Let’s say there was a right for the government to set salaries. Who decides? On what grounds? With what precedent? Why trust the men in government? How are the guys in Washington different than the guys in NYC–other than the ones in DC have political concerns to deal with? Aren’t there more conflicts of interest in DC? Do they have some special business school training that their peers on Wall Street didn’t get? Or are they the financial experts who didn’t get the higher paying jobs in New York?

Furthermore, what about the companies that haven’t taken federal money? They will continue to pay high salaries while the bailed out firms lose talent to the higher paychecks. Supply and demand of labor runs with price signals too. The only answer at that point would be for the entire financial sector to become subject to the Treasury Department’s power. And how would salaries be competitive from firm to firm with one sources setting them?

It just can’t be done, and the government shouldn’t try. I believe that Secretary Geithner knows this and will try to stay clear of such mire. But others must recognize that the fastest road to recovery is to stop wasting time trying to micromanage an ant farm and letting the system work freely.