Chasing the China Model: A Look at Executive Pay Limits

If you haven’t been living under a rock during the last ten years, you have probably come across at least a few articles discussing the existence and relative merits of the “China Model.” There are literally thousands of things out there to read, from scholarly papers to Op/Eds to blog posts; all are easily accessible via The Google Machine. Many of these discussions focus on the merits of an authoritarian political structure and planned economy insofar as it allows for quick and efficient policymaking. This romantic myth of China’s monolithic Central Government and its ability to legislate on the fly without outside political pressure is nothing more than a pipe dream perpetuated by some who see any system as preferable to the dysfunctional legislative systems of countries like the U.S.

The topic gained even more attention during the darkest days of the Great Recession, when it looked like the West’s financial services sector, the crown jewel of what I guess we can call the “Western Model” (more like the Wall St. Model) might collapse. Panicky folks looked to China, which seemed to be weathering the storm a bit better.

Even more recently, the topic seems to be hot again (Time, China Daily). I’m not so sure why someone decided to hit the “China Model” button again, although as Sino-U.S. tensions rise, perhaps stories that highlight the contrasts between the two become more attractive to editors and government officials.

In any event, when people discuss the inner workings of the Chinese government or economy in this context, the debate often stays way up in rarified intellectual air, and you get these long scholarly pieces about economic development theories, the historical underpinnings of representative democracy, etc.

Absolutely nothing wrong with that kind of discussion, but it’s a bit above my paygrade (for purposes of this blog, my paygrade is zero). Moreover, it’s been a few years since I studied econ development and growth theory, and I have no intention of ever seriously returning to a discipline that requires a working knowledge of calculus. That’s even above my paygrade as a lawyer, which is several orders of magnitude higher than my blogging rates.

Since I have the attention span of a flea, I like to approach the “China Model” debate on an ad hoc basis, using concrete examples of specific policies to garner some insight on the political structure and legislative process.

Help, Help, I'm Being Repressed!

A recent political football that might fit the bill is executive pay curbs and related concerns of widening income gaps. This is a good one since it is a very hot topic in the West, particularly in the UK and U.S., as well as in China. It’s also quite an entertaining subject as well, since discussion involves income redistribution, upward mobility, and class resentment (yes, I know, there I go bringing class into it again).

There are three issues to look at with executive pay limits.

1. Should governments do this at all or simply let the market and corporate governance deal with all compensation issues?
2. If governments have a role, should some firms/execs fall under limit rules? If so, which ones?
3. If pay will be limited, how should governments go about doing it, using what rules and criteria?

These are all important and complicated issues, to which I will probably return in future posts, but for now I just want to take a quick look at the different approaches taken by the U.S. and China on the general policy to see if this is at all instructive on the China Model debate. In doing so, I am artificially, and perhaps inartfully, throwing together these two issues into a single discussion; if this approach doesn’t quite work, well, that’s why we have a comment section.

I Can Haz Obscene Amounts of Cash?

Let’s take a look first at the U.S., where the Obama Administration last year unveiled a USD 500,000 limit on compensation for executives at banks that received TARP money (TARP being one of the bailout programs initiated by the Bush Administration in late 2008).

The political context surrounding this issue includes the Great Recession and the stark reality of these kinds of statistics:

According to the Economic Policy Institute report, in 1965, U.S. CEOs in major companies earned 24 times more than a typical worker; by 2007, they made 275 times more. U.S. CEOs also make far more than CEOs in other advanced countries, the report said. (PolitiFact)

So, people are hurting and they’re pissed off at banks and well-paid executive douchebags. The U.S. government wanted to respond (“I feel your pain”), but they had a few problems.

1. The U.S. has a free market economy. Maybe not as free as Hong Kong, but compared to a lot of other nations, it’s quite open. Pay limits run counter to free market principles, so any sort of general, across the board pay limits on everyone is a non-starter. I don’t think price controls of any kind have been in effect since the time of high inflation rates under Nixon/Ford, and in today’s political environment, those policies would be denounced today as leftward of Lenin.
2. There just aren’t enough State-owned companies in the U.S., darn it. If there were, the government could make a point of instituting pay cuts or limits quite easily, showing that they care about the suffering of the “little guy” out there in the sticks. If there were more Amtraks out there, the government would have an easy time of implementing a symbolic gesture.
3. When you go after the natural targets, the banks that pissed all over the financial stability of the world and needed a bailout to stay in business, you hit a political wall. These are exactly the guys you want to hold up to the cameras as villains, yet the financial services industry is the largest contributor of funds to political campaigns. That’s quite a dilemma, isn’t it?

So how to sort this all out? Or in other words, when it comes to this particular policy issue, does the outcome say anything about the “U.S. Model” with respect to the government or economy?

Here’s a not very surprising clue. On that tough $500,000 cap, it turns out you can drive a truck through the loopholes:

The cap won’t apply retroactively. If your bank has already received its $45 billion in taxpayer money, there’s no cap on pay.

The cap won’t even apply to all banks that take taxpayer money in the future.

The cap doesn’t apply to all compensation — just to salaries. Banks could still give CEOs huge bonuses, but the bonuses would have to be in the form of restricted stock that couldn’t be sold until after the company had repaid taxpayers.

And finally, and this is perhaps the most troubling, the cap, if finally triggered, would apply only to the top 25 or so executives at any bank. (MSN Money Central)

Greed Is Good (For Me)

Uh, that kind of sucks. As a lawyer, I admire the tremendous wiggle room that some talented folks inserted into the bill – that’s some fancy drafting. As a dirty hippie type, I bemoan the signal Washington is sending out to the rest of the country, which is in effect, we are not even remotely serious about this issue despite our rhetoric. {dramatic pause for cynics to chuckle and roll their eyes knowingly}

For the folks in D.C., the goal was to pass some kind of rule that allows Democrats to say during the next election cycle “We feel your pain and slapped around those naughty fat cats” while at the same time sucking in campaign contributions from financial services execs. Definitely mission accomplished. (Just for the record, Republicans don’t even address this issue in a meaningful fashion.)

So does executive pay tell us anything about the U.S. Model? Well, it certainly is one example of a political system that, at least in some cases, is unable to respond to an issue perceived as significant by the public because of the influence of campaign contributors. Other reforms currently being debated in Washington, including health care, energy and financial services oversight, have all fallen victim to the same problem.

However, does this flaw necessarily suggest that a more authoritarian style of government is a better model to emulate?

OK, let’s turn to the China situation. As the NPC and CPPCC annual sessions get underway this week in Beijing, the income gap issue is front and center, as are related issues like subsidies to farmers, better health care and education benefits.

Doesn’t get any more cut and dried than this, from China Daily:

China recorded its widest rural-urban income gap last year since the country launched its reform and opening-up policy in 1978.

For those of you who are more visually inclined, check out the numbers for the past few years:

Yeah, not so pretty, although at least we’re seeing an overall growth trend.

Unlike the U.S., China has the ability to not only directly put pay limits on execs at State-owned Companies, symbolic of the income gap, but also to indirectly influence a very large number of firms through non-legal means.

Some folks in the West who are passionate about issues like executive pay (I’m not one of them) may no doubt wistfully look at the power of the PRC government, wishing that the U.S. Congress and executive could be better insulated from the influence of campaign contributions and therefore be in a better position to enact meaningful reform. This is one aspect of the “China Model” debate that gets a lot of attention.

But wait a minute, let’s take another look at those income gap numbers. Not only was 2009 a high point in terms of the urban-rural income gap, which I think is a decent substitute for the usual CEO-worker pay gap numbers, but as the chart shows, the widening gap is not a product of the recent recession but a longstanding trend.

This is not a new issue for China, nor should the gap be a surprise to anyone. Commentators often cite Deng Xiaoping’s opening up policies in the late 70s and statements like “Let some people get rich first” as examples of where China went wrong in tolerating a wide income gap.

But Deng was no Gordon Gekko. He realized that the income gap was a danger and should only be tolerated as a temporary measure. In 1992, when on his “Southern Tour,” Deng stated this clearly:

Our plan is as follows: where conditions permit, some areas may develop faster than others; those that develop faster can help promote the progress of those that lag behind, until all become prosperous. If the rich keep getting richer and the poor poorer, polarization will emerge. The socialist system must and can avoid polarization. One way is for the areas that become prosperous first to support the poor ones by paying more taxes or turning in more profits to the state. Of course, this should not be done too soon.

Looking at the latest numbers, the time is way past due. This begs the question: if the Chinese model of government is so enviable insofar as, according to some, it is a towering monolith of centralized political power, why wasn’t the income gap problem fixed years ago?

The easy answer is that economic growth has been prioritized over income equality, at least until the past couple of years. I would argue that these two things are not mutually exclusive and that more could, and should, have been done over the years to minimize the problem while maintaining pro-growth policies, but I suppose that is easier said than done.

In other words, just because a government is “authoritarian,” this doesn’t mean that it can quickly and easily solve socio-economic problems. I would therefore maintain that the persistent, and growing, income gap is at least one piece of evidence that the authoritarian model is not an easy solution to American-style legislative gridlock.

A closer look at one area of pay curbs in China is helpful. The government has specifically begun to address pay in the financial services sector:

While state-owned financial enterprises prepared to release 2009 annual reports and executive salary details in February, the Ministry of Finance (MOF) signaled that new executive compensation regulations would follow soon.

These highly anticipated Regulations on Governing Executive Compensation for Financial Enterprises were expected to revolve around a performance-appraisal system for determining executive salary adjustments above annual base levels. (Caixin)

Well, that sounds quite nice. A system that ties in compensation to a merit-based appraisal of performance. That’s what the public is clamoring for, right? Isn’t this another vote in favor of the “China Model”?

Perhaps, but if all that’s true, why has the new regulation taken so much time to draft? The reason is that banks are not independent institutions in China and, at least in the past, were specifically referred to as “policy banks,” since they were instrumental in implementing economic development policies.

When the government wants to stimulate the economy, like it did last year, the policy banks get the job done, lending to a variety of capital projects around the country. In return for doing so, they are backstopped to some extent by the government with respect to risks like Non-performing Loans.

So when it comes to assessing bank executive performance, one cannot simply take a look at the balance sheet or stock price — there’s a lot more going on at any given time. Moreover, it’s not even easy to define exactly what “compensation” is at a State-owned institution, as a Caixin source points out:

One analyst recently noted that since bank executives remain under the authority of the Communist Party, they generally enjoy a variety of benefits through the current system. These benefits are comparable to market-oriented salary increases.

Apologies for the length of this post. Let me try to wrap this up, hopefully with a semblance of coherent thought, or at the very least a trite, oversimplified conclusion.

The “China Model” debate, in one of its most frequent incarnations, takes the form of Western commentators and theorists waxing romantic over the efficient decision making process of the PRC government, insulated as it is from public opinion and the corrupting influence of campaign contributions. This of course is a pipe dream that includes several erroneous assumptions about the way the Chinese government functions. Authoritarian-style government and a planned economy sounds awesome when you’re trying to push a specific policy, but it’s slightly more complicated than it may appear from the vantage point of a think tank in Washington, D.C.

Is one “model” better than the other? That to me is almost beside the point. Keep in mind that the “China Model” debate is all about developing countries. No one is suggesting that the U.S., for example, adopt a Chinese style of government. The big question is whether an up-and-coming nation, say in Africa, has anything to learn from China, and to what extent are specific institutions, laws and economic structures here more worthy of emulation than their counterparts in the West. That discussion is a waste of time if based on faulty assumptions.