Posted 5:05 PM by Robert

What Europe can Teach Uncle Sam II:
Who Are the Stakeholders? What is the Lesson?

Is the “market share” of companies in compared economic systems a good measure of comparative success? For example, Mr. Hutton compares Nokia with Motorola, suggesting that Nokia is the more successful company: “Nokia's success is legendary; it has 35% of the world market - twice that of Motorola.” But Motorola’s stock price is essentially where it was a year ago while in the same period Nokia’s stock price has lost about one-half of its value.

Sometimes it just doesn’t pay to be popular. Perhaps Nokia shareholders now regret not giving their company’s upper management more stock options. But the whole picture makes one wonder why Mr. Hutton chooses Nokia as a supposedly high-flying example of what Europe has to offer Uncle Sam.

Of course, Mr. Hutton disavows “shareholder capitalism” – so perhaps it is unfair to cite stock performance here. On the other hand, as noted in the prior post on this topic, Mr. Hutton does not make it easy for one to determine just WHOSE welfare should be examined to determine corporate “success.”

But it may be possible to tease out of Mr. Hutton’s obscurationist prose some understanding of what he is up to – at least implicitly. When Mr. Hutton writes that Europe can teach a lesson to “Uncle Sam” or “American conservatives,” he seems to refer to the kind of people who hang around places like the University of Chicago – especially in its economics department and law and business schools. Many of those people advocate policies that are intended to increase aggregate social welfare. And one of the big reasons many of them favor corporate policies that focus on maximizing shareholder returns (that is, “corporate earnings”) is that such returns measure whether a company is the best user of its own resources. Simply put: if earnings are low, the company should be sold to someone who can make those assets yield more. (This is the “market for corporate control” so despised by European intellectuals, among others.) If all companies are generating as much as their resource will allow, a society has gone a long way towards maximizing its overall wealth.

Of course, “Uncle Sam’s” system should not be confused with the actual American economic system. While the actual system has been seriously influenced by “American conservatives,” the capital of the United States lies far from Hyde Park, Chicago, Illinois! Mr. Hutton is rather relaxed with his conflations of actual American systems and those advocated by “American conservatives” – but there is certainly more overlap in this country than there is in Europe, so his informality is not all that confusing.

Continental European (German) law provides that the employees of large companies appoint one-half the members of the companies “supervisory board,” its ultimate policy making body, even when the employees are not shareholders. The board of supervisors appoints the company’s management board. In practice, employees and banks dominate the ultimate governance of large German companies at a policy level, where the banks act through equity stakes, through proxies given to them by small investors, and through bankers’ positions on the supervisory boards. But governance of British companies is more similar to that of American companies (shareholders alone elect the company directors) – so Mr. Hutton doesn’t seem just want to look to the welfare of employees, creditors and shareholders. British law historically also accommodated the activism and strength of British labor unions which restrict management’s discretion, an accommodation weakened under the Thatcher reforms. European labor laws make firing employees difficult and fix many aspects of the employment relationship that in America are dealt with by contract, such as minimum vacation periods. And, of course, widespread direct state ownership and continental tax laws have in the past impeded the “market for corporate control” advocated by “American conservatives,” a market intended to check management’s tendency to run the company for their own benefit. By concentrating board control in banks, the continental system attempts to substitute the countervailing power of institutionalized, professional ownership for a market for corporate control as the monitoring mechanism checking management.

There is a common thread in the above. Mr. Hutton and European law seem to deem a company “successful” if it advances the interests of existing influential institutionalized economic interests: unions, banks, institutional shareholders, existing political parties, established companies, government employees, governments, and whoever else managed to scrape together some presence on the economic scene in the past by whatever means. In particular, a development which would increase overall societal welfare but reduce the welfare of such established interests would be welcomed by “Uncle Sam” but not by the European way or Mr. Hutton. One can certainly see why a society based on “Uncle Sam’s” thinking is often going to be more dynamic and sometimes downright frightening than the comfy European model Mr. Hutton favors. One can also see why the comfy European model is also comfy for antisemites – since one historical, European view of Jews (a view much more prevalent outside of Britain) is as ‘cosmopolitans” who seek to benefit from whatever growth is possible, inside or outside established interests. Indeed, the novel from which this blog’s name is borrowed includes a marvelous mediation on this aspect of non-British European civilization through the medium of Bank Director Leo Fischel of the Vienna branch of Lloyd’s Bank.

What of the question of whether “American conservatives" (“Uncle Sam”) should heed Europe’s “lesson,” as Mr. Hutton advocates. Well, it seems unlikely that the European system, which specifically rejects developments which increase overall welfare unless those developments also enhance the welfare of established interests would provide many good examples for people who just care about increasing overall welfare. Of course, not every development that increases overall wealth will bring material harm to established interests – Nokia seems to be a fair example of that, although the European way eventually seems to have caught up with Nokia, too. Also, many people are focused on the distribution of wealth as well as the creation of wealth, but it sure makes things easier for those folks to have more wealth the spread around in the first place.

One lesson a European style emphasis on established economic interests brings home is the significance of subsidies. One might define the extent of the subsidy an interest receives in a particular economic system to be the difference between what wealth the interest actually receives over the wealth it would receive in a system that maximized overall societal welfare. Such a “subsidy” will be hard to calculate absolutely, but in particular cases it is fairly easy to see that a subsidy has increased or shrunk. For example, an industry that is protected by tight import quotas and tariffs is probably receiving a big subsidy. Until the year 2000, "Japanese automakers operating in Europe were constrained by import duties of 10 percent and voluntary export quotas that sharply limited their growth. In France, Japanese companies could claim no more than 3 percent of the market. In Spain, it was zero. In the United Kingdom, the cap was 11 percent, and in Germany the quota was 16 percent. Italy limited Japanese sales to 3,000 cars per year. Yet in Europe's smaller countries, too small to fundamentally influence the balance of power in the overall car market, there were no such quotas. Accordingly, Japanese automakers claimed as much as a third of the national markets in places such as Ireland, Denmark and Finland." Those quotas and “informal arrangements” have now supposedly been lifted, and Japanese car makers now claim about 7-1/2% of the European market – where they claim over 25% of the United States market (where the US auto industry is also subsidized by quotas on Japanese cars).

But it is highly unlikely that the Europe admired by Mr. Hutton could accept Japan’s frankly claiming, say, one-third of its auto sales, thereby seriously undermining many established interests even while increasing overall European wealth. Simply put: the known political realities in Europe (celebrated by Mr. Hutton, for example), forewarn the Japanese from making a full push into that market, and thereby continue to subsidize the European industry notwithstanding any putative termination of import quotas and “informal arrangements.” The subsidies continue precisely because of the European way admired by Mr. Hutton.

A big beneficiary of these past and present subsidies is Volkswagen – another of Mr. Hutton’s purported flagships of European success. Yet, despite such massive subsidies,
Volkswagen’s stock has performed only about as well as that of General Motors, which is the beneficiary of much weaker subsidies – and, in any event, has not been considered a flagship of American corporate success for decades. But even so, GM did generally better than Volkswagen during the long period before the European quotas were lifted.

Another consequence of the odd subsidies the European way creates is its artificial enhancement to European “worker productivity.” As a subsidy to unions and established employee interests, European law imposes very high costs (compared to United States law) on an employer’s decision to hire a worker – especially young, inexperienced workers. One consequence is that an employer will only hire and retain workers who are productive enough to justify such high costs – other workers will become unemployed. Since “productivity” figures generally reflect the output of those who are employed, the European subsidy system tends to artificially enhance putative “productivity.” Mr. Hutton seems to like that, but the failure of higher productivity to result in growth and employment concerns European social planners, some of whom noted, for example:

“Faster economic growth will be critical in creating jobs and assuring the success of EMU. Historically, Europe successfully created jobs when economies were strong. Fast growth between 1986 and 1990 (3.4% annually) added 8.1 million jobs in the EU. Unfortunately many of them disappeared in the slow growth of the 1990s, (1.5% annually). …[W]e believe that EU economies must grow more than 3 percent annually in the first 4 years of EMU: in order to handle growth in the labor force, to accommodate productivity improvements, and in order to reduce the unemployment rate. Anything less would mean a definite risk that the public would blame the EMU for failing to address unemployment.”

International comparisions of worker productivity are tricky. For example, "Gross Domestic Product Per Hour Worked" is a measure of productivity less subject to the artificial enhancement described above. Such figures exist. However, such reports with which I am familiar are considered to be "experimental," carry warnings that they are to be used for detection of trends and not reliable for cross border comparisions, and require acceptance of some rather difficult conclusions. For example, consistent with Mr. Hutton's arguments, the figures linked above rank the French economy as very slightly "more productive" (on a GDP/Hour basis) than that of the United States. But those figures also rank the Japanese economy as vastly less efficient than that of France or the United States. For example, the United Kingdom is defined on that productivity index to be 100, and for the year 2000 France and the US both show up at about 125 - while Japan appears at 90! Perhaps this is true. But one does not easily accept the suggestion that an hour worked by a French worker was almost 40 percent more productive than that of an hour worked by a Japanese worker in 2000. But then that study specifically warns that it is not to be used for cross-border comparisions.

But perhaps the biggest “subsidy” lesson Europe has to teach the United States lies in the field of national and international security. During the Cold War, Europe’s defense expenditures lagged far behind those of the United States while Europe’s social expenditures surged far ahead of those of the United States. Europeans argued that such social expenditures were equivalent to American defense expenditures because social expenditures bought security for the lower classes, and therefore security for Europe from the Soviet threat. This argument was always thin and was not advanced in the United States. Once the Soviet Union fell, European defense expenditures fell even further but social outlays did not. Europe presently and for the past fifty years was and is a subsidized free rider in the area of national and international security. The Europeans even managed to turn their subsidized status into an argument for their own subsidization of Airbus, another company admired by Mr. Hutton. The Europeans argued that Boeing’s having received the benefits of American defense industry research justified massive European government financial subsidies provided to Airbus.

But the force of the European Cold War position was that the Soviet Union was a very real threat to the United States. So when the Europeans refused to shoulder their portion of the defense burden, the United States was still better off defending itself. Europe has no such winning position now, and it is hard to see why the United States should continue to provide security assurances of any kind for Europe.

Simply put: It appears that the growing gulf between Europe and the United States as to matters of international and economic relations is probably explainable in terms of the United States coming to realize that Europe has been and is a free rider on America for a very long time – and there is no longer any justification for that subsidy. That seems to be a “lesson” Europe can teach Uncle Sam, although it is not a lesson Mr. Hutton suggests. As Catherine Aird noted: “If you can't be a good example, then you'll just have to be a horrible warning.”

Posted 10:33 PM by Robert

What Europe Can Teach Uncle Sam I:
The Meaning of Success


The Guardian has an article, What Europe Can Teach Uncle Sam, which is worth reading if only as a collection of arguments popularly used by some who believe they see what advantages European society has over America's. The Guardian describes the article as “the second extract from his eagerly awaited new book, [in which] Will Hutton reveals why the American economic miracle is not all it seems.” But the article alone is so sprawling that it merits some substantial unpacking. This post is the first.

Mr. Hutton begins with a paean to Volkswagen, which he describes as organized from top to bottom in ways that “according to the predictions of American conservatives” should have rendered the company “down and out.” The features Mr. Hutton finds most noteworthy in this respect are a highly unionized workforce, an upper management not given many stock options, a major public shareholder (Lower Saxony at about 19%) and, described as most important, Volkswagen’s "shareholders voting rights are limited to 20%, so the company can neglect to promote shareholder value, allowing it to become schlerotic and uncompetitive.” How significant are these factors to what Mr. Hutton sees as Volkswagen's success?

Mr. Hutton clearly views Volkswagen as a successful company. As a preliminary matter it would be nice to know what Mr. Hutton is using as a measure of corporate “success.” He does not even mention earnings. He instead writes admiringly of “market share” in a manner that suggests that Volkswagen is successful because it has large market share in Europe and even a little bit in the United States. (Market share in Europe seems especially important to Mr. Hutton because some of it was taken from American companies.) Being “the most internationalised car company in the world" counts for him as a measure of success, as does having “revived” a near-bankrupt Czech car company. Volkswagen’s “engineering prowess and innovativeness” also seems to count.

Mr. Hutton’s standards of corporate “success” have an odd similarity to the weird measures of value used by the more suspect technology analysts who once hyped e-commerce companies during the dotcom boom and are now in deep discussions with various law enforcement authorities. As one financial journalist described the dotcom valuation phenomenon: “Out went traditional methods used by securities analysis that prized earnings. In came freewheeling measures of worth, like revenue growth, Web site traffic and even customer ‘share of mind.’”

But it is hard to see why such freewheeling dotcom measures of value and success should be taken any less seriously than Mr. Hutton’s favored measures of market share, internationalization, ability to revive moribund foreign competitors and engineering prowess and innovativeness – at least if these measure don’t result in higher EARNINGS. The dotcom experience is worth noting here because in the most painful ways it taught many millions of ordinary investors the dangers of allowing false economic visionaries (“Bezoids?”) to talk them into abandoning earnings or profits as the best measure of corporate success. Indeed, one can almost see Mr. Hutton regarding Enron with admiration because it has moved up to fifth on the Fortune 500 list following the utter devastation of its stock price, a devastation that his approach seems to regard as unimportant.

Perhaps Mr. Hutton disfavors earnings as a measure of success because they have a rather direct link to the “shareholder capitalism” Mr. Hutton disfavors. Earnings are what is left over after a company pays its expenses. Earnings are therefore pretty much what is available to pay dividends on company stock – and over time that pretty much determines the stock’s price. In the United States one often – perhaps normally – sees a company’s stock price used to measure of corporate success. That’s especially true when some (but by no means all) American conservatives are talking, although it’s more generally true for equities fund managers all over the world. But Mr. Hutton's point is that “shareholder capitalism” isn’t what Europe’s success (or, apparently, Volkswagen’s) is about. But then what IS success about for Mr. Hutton?


Share price is not the only possible measure of a company’s success or even size. For example, the concept of “enterprise value” – essentially a company’s debt plus its equity – is often used to measure the overall value of a company. Debt and equity are just ways of financing a company, and the actual value of the company should be the sum. This approach might be suggested by the Miller-Modigliani Theorem, which says that absent tax and bankruptcy effects the enterprise value of a company with a fixed business plan is not changed solely by its debt-equity mix. But Mr. Hutton surely wouldn’t be any happier with the success of a company being measured by how its creditors and shareholders prosper than he would with a focus on shareholders alone. Creditor welfare is no more coupled to market share, internationalization, ability to revive moribund foreign competitors and engineering prowess and innovativeness than is shareholder welfare. For that matter, the same may be said of the welfare of the company’s employees, and the welfare of the people in the towns and cites where the company has facilities. "Stakeholder capitalism" theorists normally write about a company's employees as "stakeholders" whose welfare should be considered in corporate governance - and German corporate law reflects that concern by mandating employee representation on a company's "supervisory board." But Mr. Hutton's criteria don't seem to do that.

In fact, there appears to be NO identifiable group of actual, living human beings whose welfare has a clear relationship with any of Mr. Hutton’s suggested badges of corporate success. In his excitement, Mr. Hutton seems to be advocating a curious kind of stakeholder capitalism that forgot the stakeholder. Mr. Hutton's capitalism also diverges from basic principles of European corporate law. Perhaps he means to suggest that Volkswagen is so far gone by conservative American lights that they think it should just be dead - and therefore incapable of any activity whatsoever. But surely Mr. Hutton can't believe that, since even American capitalists know that state owned companies in communist countries didn't all just collapse, and those companies were organized much worse than Volkswagen. Goodness, even the American postal service doesn't just collapse! And if the point is that by conservative American thinking Volkswagen should be dead, then why this odd mix of crtiteria? Why not just say "some people still work at Volkswagen, you know" or "some people have heard noises coming from inside a Volkswagen building, and lights go on in there at night." No, Mr. Hutton has chosen his criteria as badges of corporate SUCCESS - of vital existence, not just continued existence.

In short, it seems that to defend the European way, Mr. Hutton has omitted both the Europeans and their law.

Next time: Finding the people and the law Mr. Hutton forgot.

Posted 3:40 PM by Robert

Why Own Your Home?

Many governments encourage home ownership. But even with government financial incentives, home ownership is highly questionable as a financial investment.

For families with children, there may be another kind of non-financial return to the home ownership investment. It seems that there is support for the belief that "children living in owned homes math achievement is up to seven percent higher and reading achievement is up to six percent higher, [all else being equal]. ... [T]he measure of a child's behavior problems is up to four percent lower if the child resides in an owned home. Existing literature suggests that these youths' greater cognitive abilities and fewer behavioral problems will result in higher educational attainment, greater future earnings, and a reduced tendency to engage in deviant behaviors." These results purport to adjust for many factors that influence the decision to own a home. That is, concerns such as "rich people tend to own rather than rent" are supposedly already taken into account by the study.

Posted 9:56 PM by Robert

Moral Rights

"Moral rights" denotes a collection of certain rights of artists to control the fate of their works, especially the personal and reputational, rather than monetary, value of the work.

Historically, the laws of continental Europe have recognize pretty wide moral rights. Moral rights were not particularly recognized in American law, but that has been changing recently to some extent. Congress passed the Visual Arts Rights Act of 1990 (VARA) which provided rather limited “attribution” and “integrity” rights (which are types of moral rights) for certain narrowly defined classes of artistic works. Also, nine states enacted laws recognizing some moral rights prior to VARA.

When a recent work of art is to some extent threatened, the media often buzz loudly but briefly with stories about "moral rights" (as happened when Richard Serra's "Tilted Arc"was moved from its original downtown New York site a few years ago). But do moral rights do anything significant to help artists?

William Landes, an insightful economist who teaches in the University of Chicago Law School has looked into the matter pretty seriously in a recent paper, and his answers are a mix of the sadly predictable and the rather surprising.

Predictably, Mr. Landes finds that these laws may actually harm artists by adding contracting and transaction costs in the art market, although these costs are usually trivial because collectors have a strong self-interest in preserving the works in good condition. But he finds that the costs to artists may be large for certain types of works likely to be subject to destruction or alteration in the future - such as site-specific works and works installed in buildings.

Surprisingly, Mr. Landes finds that the state laws seem to have had no significant effect on artist earnings but a positive and significant effect on the number of artists living and working in the state.