Economic liberty is key to societal well-being.

By RYAN STREETER AND ARTHUR C. BROOKS

Wall Street Journal Oct 26, 2009 – link to original

Since the fall of the Berlin Wall 20 years ago, the performance of market economies has been a powerful theme in assessing the health of societies around the world. But free enterprise has come under attack with the global economic crisis, the perceived threat of climate change, and a broader concern—most recently promoted by French President Nicolas Sarkozy—that growth alone does not indicate prosperity.

And at first glance, this year’s Prosperity Index, published yesterday by the Legatum Institute, seems to provide evidence that capitalism is in trouble. The index aims to be a holistic measure of societal well-being, measuring not only things like economic freedom and property rights but also factors such as education, health, and good governance. The Institute found that four of the five most prosperous countries are democracies of Northern Europe: Finland, Sweden, Denmark and Norway—all well-known as high-tax, social welfare states. And while the U.S. and U.K. rank ninth and 12th respectively, France, Germany and Spain are not far behind. Fourteen of the top 20 countries are European. So does that mean capitalism needs to be reigned in as many of its critics consider? Far from it.

Consider the Wall Street Journal/Heritage Foundation Index of Economic Freedom, which measures the key factors in political and economic freedom, such as strength of democratic checks and balances, protection of property rights, enforcement of contracts, ease of starting a business, and of hiring and firing staff. Due to their strongly capitalist systems, Hong Kong and Singapore score very highly in the WSJ index. Their lower personal freedoms and scores on interpersonal trust and community engagement drag them down to 18th and 23rd respectively on the Prosperity Index. Similarly, the top performers of Northern Europe do not do as well in the WSJ Index as they do in the Prosperity Index, since their economic fundamentals are not stellar.

Many people—especially Americans—think of wealth as the basis of health and happiness, too. In other words, market economies with good economic fundamentals drive us to more fulfilling lives. Europeans often counter that a narrow pecuniary viewpoint gives a distorted picture of the human experience. Worse yet, it can lead to the tyranny of materialism. Who is right?

A statistical analysis of both indexes shows that economic prosperity and more holistic indicators overlap significantly, but not completely. It’s no coincidence that the Prosperity Index calls its economic and democracy sub-indexes the drivers of wealth, and implicitly, prosperity. If one strips out the three main economic sub-indexes from the Prosperity Index, one can compile a ranking from the six remaining sub-indexes that have more to do with quality of life than economic growth. Using statistical techniques, one can test how much of the WSJ Index explains the Prosperity Index’s broader well-being indicators. The relationship is statistically significant, with just under two thirds of Legatum’s well-being indicators explained by economic and political freedom.

While free enterprise is not the only important factor explaining national differences in well-being, it probably does explain most of it. This means subverting the mechanisms of free enterprise would not just lead to lower economic growth but also lower social scores. The fact that the Nordic countries do so well in the Prosperity Index has largely to do with the fact that apart from their welfare policies, they also encourage entrepreneurship, free trade, and have stable monetary policies—even as they employ strong rhetoric against capitalism. Finland, Sweden and Denmark all score higher than Switzerland and nearly all of their southern European counterparts on their capacity to commercialize innovation, through factors such as business start-up procedures, business registration rates, and royalties on patents. All of this drives dynamic entrepreneurship, and spurs people to innovate and take risks, as they are more reassured that good ideas will pay off.

U.S. policy makers would do well to note this fact as they contemplate more “European” policies. And as the West contemplates ever tighter regulations on how and where money can be spent, lent and invested, their leaders should remember that economic and political liberty—while not the whole story—play a key role in prosperity. They are the engine driving much of what makes life worthwhile.

Mr. Streeter is a senior fellow of the Legatum Institute. Mr. Brooks is president of the American Enterprise Institute.

Is greed good? Yaron Brook responds

Voices of Reason bog (Ayn Rand Institute) - link to post

Dr. Brook is president and executive director of both the Ayn Rand Institute and the Ayn Rand Center

The answer to this question really depends on what you mean by “greed.” If you mean the pursuit of short-term gratification at any cost, then I do think greed defined that way is bad. And indeed what we’re seeing is some–certainly not as many as the media would lead you to believe–some businessmen, some CEOs are pursuing short-term self-gratification at the expense of long-term profit, long-term happiness, and the long-term success of their shareholders, to whom they owe a fiduciary duty. Ayn Rand would be disgusted by this behavior-but she wouldn’t be surprised. She portrayed this kind of CEO in Atlas Shrugged, in characters such as Orren Boyle and James Taggart.

If by “greed” you mean a long-term, rational pursuit of profit, however, then that in my view is a virtue, not a vice. CEOs should be focused on the bottom line, on long-term profitability, on long-term shareholder wealth maximization. That form of greed is good, and I think the majority of CEOs in America still seek those goals.

Unfortunately, the regulatory system we have today encourages bad CEOs–the Orren Boyle/Jim Taggart type of CEO. The more regulated a business is, the more a CEO has to know how to deal with politicians. He has to be a schmoozer who’s a smooth talker at cocktail parties and knows how to lobby Congress for goodies, rather than a real businessman concerned with the bottom line. Without a regulatory regime, without laws impinging on economic activity, there’s no way for such people to gain an edge through political pull because there’s no political pull to be had. In a truly free market, the people who rise to the top are truly the most capable, the most rational, the best long-term thinkers. There’s no other way to succeed.

In this respect, what Ayn Rand’s philosophy offers is a different view of selfishness–a view of selfishness as the long-term rational pursuit of self-interest, with one’s own long-term happiness as the primary goal of one’s life. When selfishness is looked at in this way, it’s evident that such pursuits as lying, cheating, and stealing are not selfish. They’re not in one’s long-term self-interest and they’re not the way to achieve happiness.

In 1992, Congress intervened in corporate compensation and messed things up. Now it’s the White House’s turn.

By JONATHAN MACEY

Wall Street Journal – link to original

Oct 23, 2009

Executive pay has emerged, once again, as a major issue in Washington. This week Treasury and the Federal Reserve announced new regulations designed to oversee and limit executive pay at thousands of financial institutions. This is deeply ironic, because today’s pay woes are the direct result of prior government intervention.

In 1992, Congress decided it would use the tax code to “improve” (i.e., reduce) executive compensation in publicly traded companies. Its vehicle was the Budget Reconciliation Act, a key provision of which became Section 162(m) of the Internal Revenue Code.

Noting that executive compensation levels had received negative “scrutiny and criticism” from the public, the new law targeted what it called “excessive employee remuneration.” It did so by limiting the ability of public companies to deduct executive compensation for its top employees unless the compensation was paid out in a form that Congress found acceptable. Salary was bad. Stock options were tax favored.

Specifically, corporations were barred by law from deducting as a normal business expense any salary payments of over $1 million. Stock options, however, qualified for the corporate tax deduction without limitation. Much maligned today, stock options then were said to be “performance based” and therefore exempt from the new tax rules.

The new tax law immediately led to a tectonic shift in the way CEOs and other top U.S. executives were paid. Stock and stock options became the dominant feature of executive compensation packages.

The impetus for changing the executive compensation laws back then was exactly the same as it is today. Politicians wanted pay lower and wanted to change the executive compensation model to “fix” the risk-taking proclivities of top managers.

In 1992, the government thought that managers were too risk averse. Stock options were seen as the magic bullet for making managers act more aggressively in the shareholders’ interests. Today, many in Congress are blaming U.S. executives for causing the financial crisis precisely by engaging in “excessive” risk-taking. What they fail to mention is that it was Congress’s own tinkering with the tax code that led to the very compensation packages that incentivized the risk-taking.

Fed Chairman Ben Bernanke asserted this week that “compensation practices at some banking organizations have led to misaligned incentives and excessive risk-taking, contributing to bank losses and financial instability.” Mr. Bernanke promised that the government “is working to ensure that compensation packages appropriately tie rewards to longer-term performance and do not create undue risk for the firm or the financial system.”

Other government interference has made the executive compensation problem even worse. A provision in the 1992 tax law required that executives meet certain “objective” performance measures in order to qualify for incentive-based (tax deductible) pay. In the scramble to come up with objective metrics on which to base executive pay, cottage industry “executive compensation consultants” emerged as the most important architects of executive compensation plans.

The compensation consultants promised to design pay programs that did things like “drive the right behaviors” by corporate management, which meant assuming more risk to maximize shareholder value. Public companies hired droves of consultants to analyze pay schemes and design pay packages that created incentives to maximize share prices. Consultants came to be viewed as essential to boards of directors that wanted to implement appropriate—and tax qualified—performance measures.

The most successful consultants are those who can justify the biggest salary increases for the top executives of the companies that hired them. Researchers at the University of Southern California recently found that the median CEO compensation is $1.5 million in companies not using executive compensation consultants, $3 million in companies that purchase general survey data from such consultants but do not directly retain them, and $4.2 million in companies that retain consultants.

Some companies use multiple consultants. The USC study found that the more consultants a company hires, the more it pays its top executives. About one-quarter of Fortune 250 companies hire multiple compensation consultants.

Activist investor Carl Icahn summed the situation up well when he recently observed on his Web site that “the use of these compensation consultants, gives both boards and CEOs the appearance of legitimacy for their decisions to award massive pay packages to lackluster CEOs, making it appear that these decisions are objective and scientific, which they absolutely are not.”

The government also has tried to regulate executive compensation by requiring greater disclosure of the details of compensation plans. Perversely, this too has contributed to an increase in executive pay.

How so? No self-respecting board of directors is willing to admit that their company’s CEO is below average. So anytime the new disclosures indicate that an executive’s pay is below average in any way, a pay increase is ordered.

Since the early 1990s, government regulation of executive compensation has encouraged greater share-price volatility and risk-taking by U.S. corporate executives and led directly to higher, rather than lower, levels of executive compensation. Nevertheless, the Obama administration is now seeking an even greater role in overseeing and regulating executive pay.

In June, Gene Sperling, a top aid to Treasury Secretary Tim Geithner, told the House Committee on Financial Services that “our goal is to help ensure that there is a much closer alignment between compensation, sound risk management and long-term value creation for firms and the economy as a whole.”

This is just what the regulators told us back in 1992. Current proposals will no doubt result in even higher percentages of executive compensation coming from stock and option schemes rather than from salaries. History teaches that the most profound consequences of new compensation regulation will be unintended. It also teaches that as bad as private ordering may have worked in getting executive compensation right, the results of central planning have been even worse.

Mr. Macey is a law professor at Yale and a member of the Task Force on Property Rights at Stanford University’s Hoover Institution.