There are reportedly 25,000 employees of private security firms in Iraq. Some 80 percent are employed by U.S. firms. It appears that most though not all of these employees are Americans, although I have not been able to locate a statistical breakdown. These employees provide armed guards for U.S. diplomats, journalists, and businessmen that ordinarily would be provided by the military, as well as providing military services (guarding convoys, training Iraqi troops, supplying food, and interrogation) under contract to the Pentagon. There is controversy over both the cost and discipline of these private security personnel.
Privatization is a perennial issue in economics, and it was part of the deregulation movement that began in the late 1970s. The issue reflects the fact that there is no hard-and-fast line between the provision of services by government and by the private sector, and that private provision of services is generally more efficient than public because political interference is less. Conventionally it is thought that only government can provide services that cannot be denied to people who refuse to pay for them, so that efficiency in a broader sense requires public provision of such services. The classic example is national defense. If I install an antimissile defense in my back yard, it will of necessity protect my neighbor as well even if he refuses to contribute to its cost. Because of such free riding, the argument goes, national defense will be underprovided if it is left to the free market.
That is correct, but it does not entail the actual provision of the service by government. The government must tax my neighbor to make him contribute to the national defense, but it can turn the tax revenues over to private companies to provide the actual service. The government already contracts out the manufacture of military weaponry. It could in principle contract out the operation of that weaponry as well. Education is a source of nonexcludable external benefits (everyone benefits from an educated population), so it is properly supported by taxes, but it doesn't follow that we need public schools, and indeed there is a great deal of private education indirectly financed by taxes; maybe all of it could be.
And likewise there is a long history of mercenaries, including the Hessians whom the British employed against us in the Revolutionary War and the "soldiers of fortune" heavily employed in Africa's incessant civil wars. The Pope's Swiss Guards are a mercenary force. Swiss have been mercenaries since the Middle Ages. The French Foreign Legion is a quasi-mercenary force. Part of it rebelled against the DeGaulle government in the early 1960s over his decision to withdraw from Algeria, and disloyalty is a traditional concern about mercenaries, though surely not a concern about American private security personnel in Iraq. Indeed, the term "mercenary" is usually reserved for foreigners; that is why members of the U.S. armed forces today are not referred to as mercenaries even though they are employed voluntarily rather than conscripted. By the same token, however, non-Americans employed by private security companies in Iraq are mercenaries.
Since we have a volunteer army, why should there be any concern about contracting out some or even many of its tasks? Many employees of the Defense Department are civilian; soldiers in a voluntary army are employees rather than slaves; and, as I mentioned, the manufacture of the weaponry is contracted out. Instead of just providing weapons and recruits, why not let the private market provide entire military formations? So Blackwater, one of the leading U.S. security contractors operating in Iraq, might be paid to furnish a tank battalion, complete with tanks and other equipment, officers, and enlisted personnel, to fight under U.S. command alongside army, marine, and national guard battalions.
But that would probably be inefficient, because military units that fight together have to be very closely coordinated, and that is difficult when they have different organizational cultures. (The enlisted personnel of the French Foreign Legion are subject to full military discipline, and the officers are members of the regular French army; that is why I called the Legion only "quasi-mercenary.") The contract security personnel in Iraq do not fight alongside the U.S. military but instead operate in a service or supporting rather than combat role, though not without risk--hundreds of them have been killed and many others wounded.
At first glance it might seem redundant for the military to hire contractors who in turn hire, say, armed guards, rather than to hire the guards directly, as soldiers. Soldiers are paid only between one-half and one-tenth as much as the security personnel furnished by contractors for service in Iraq, although the comparison is misleading because the soldiers tend to be less experienced (most of the private security personnel are veterans) and because pension, medical, housing, and other fringe benefits of soldiers are much more generous. This in itself is odd because if the two classes of worker--soldiers and contract security personnel--are doing the same work, why isn't the structure of their compensation the same? One reason is that for many soldiers the military is their career, while most of the contract security personnel in Iraq are temporary workers. Another is that there are nonpecuniary benefits to military service that are absent from its private substitute, including patriotic pride and the prestige that membership in our armed forces confers.
The difference between temporary and permanent workers is the basis for the principal economic rationale for the heavy use of contract security personnel in Iraq. The military needs "temps." The need is not unique to the military, of course. The private sector has many companies that provide temporary workers on a contract basis to firms that could hire permanent employees to do the work, thus cutting out the middleman. But if the firm's demand for workers fluctuates, it may be cheaper to match supply to demand by contracting with companies that have arrangements with workers available for temporary jobs than to hire additional permanent employees but then lay them off when demand is slack, or to go hunting in the labor market, whenever there is a surge in demand, for qualified individuals who want to do temporary work. In the past, the end of a war or other national emergency that had caused a surge in the number of military personnel has led to large reductions in those personnel, which made a military career economically insecure. In order to place 20,000 additional soldiers on duty in Iraq, the military would probably have to hire a total of 60,000, since soldiers are rotated in and out of Iraq about every three years, and these soldiers might be surplus if the war ended or there was a large withdrawal of U.S. troops. Such fluctuations can be avoided by the use of temps.
But of course we have temps built into the existing, pre-contracting-out system. They are the members of the National Guard and other reserve units. They are part-time soldiers available for temporary duty in Iraq and other war zones. So a proper cost-benefit analysis of the contracting-out program in Iraq (which has not to my knowledge been conducted) would compare the costs of the contracts with the cost of enlarging National Guard or other reserve formations to a point at which fewer or perhaps no contract security personnel would be needed. The comparison might favor the contractors simply because the private provision of services tends as I said to be more efficient than the public.
There are, however, two residual concerns with the contract approach that should be considered. Both are political. The first is a suspicion that the use of the contractors is motivated not by cost considerations but rather by a political objective of concealing from the American public the extent of the U.S. commitment of troops to Iraq. The U.S. has about 130,000 troops in Iraq at present. The number would be about 150,000 if contract security personnel were replaced by U.S. soldiers; the number of casualties would also be higher. Increases in either number would reduce political support for the war.
The second is that contract personnel are less restrained in their use of force than our soldiers because the U.S. military command is less concerned about misbehavior of contract personnel than misbehavior of soldiers. The contract personnel are not in the chain of command; apparently they are also immune from prosecution by Iraqi authorities. According to one U.S. general, "These guys run loose in this country and do stupid stuff. There's no authority over them, so you can't come down on them hard when they escalate force‚Ä¶They shoot people, and someone else has to deal with the aftermath. It happens all over the place." Yet the military is concerned with maintaining the goodwill of the Iraqi population, and that goodwill is impaired by excessive use of force by any foreign personnel. One might think, therefore, that the contracts would subject the employees to full military discipline--but if this were done, it would be difficult to maintain the fiction that they are not really soldiers and so shouldn't be counted in the total of U.S. military personnel in Iraq. Competition for these contracts should induce the contractors to screen the people they hire, but the screening is likely to be imperfect, and as a result the absence of a credible threat of criminal punishment, whether military or civilian, may indeed create a situation in which contract security personnel are less restrained in their use of force than our soldiers are.
Posner has a fine discussion that covers lots of interesting issues. I will try to extend the analysis in a few directions.
Private security personnel are used throughout the American economy. There are more than 750,000 employees of security companies, which exceed the number of state and local police. Private guards regulate admission to important buildings, such as financial centers, patrol neighborhoods, transport money and guard banks, watch customers in shops to discourage shoplifters and robbery, and offer other kinds of protections services. Their numbers more than doubled since 1990, and grew even more rapidly after 9/11, especially in cities like New York. Posner suggests there are about 25,000 private security employees in Iraq, which is only a drop in the bucket compared to the total number of private security personnel operating within the United States. Since private security companies are often hired for dangerous domestic activities, their role in Iraq is in many respects an extension of their domestic activities.
Israel's use of private security protection in dangerous situations is informative about the kind of responsibilities guards can have. Many suicide bombings by terrorist groups in Israel did succeed in terrorizing many Israelis. They became reluctant to use buses, go to restaurants and movie theatres- food take outs and videos increased a lot, and bus travel declined- and they reduced their congregation in other public places. To alleviate these fears, restaurants, theatres, buses, and other private businesses spontaneously greatly increased their use of private guards to search individuals who entered an establishment or bus, and to watch out for potential terrorists. Evidence compiled for a study of terrorism by Yona Rubenstein and myself indicates that private guards remained cheap despite the large increase in their numbers. They also helped thwart a number of suicide attacks, sometimes at the cost of their lives.
Although private security guards are relatively cheap in Israel, it is not difficult to understand why American security personnel in Iraq are much better compensated than soldiers who serve there. Most of these soldiers signed up when the threat of actually being sent to a dangerous combat zone was pretty small. So their pay was largely determined by other factors, such as training they would receive by serving in the military, their young age, the attractions of military life, patriotism, and so forth. After the Iraq war started they had no choice over whether they went there-if ordered to go they went. By contrast, employees of private companies are older and more experienced, and they have to be induced to go; financial inducements are an important part of the inducement package. Enlistments in fact fell after the war started, so the military then had to offer larger bonuses and other inducements to stimulate enlistments and re-enlistments. These higher military personnel costs are part of the estimates of the cost of the Iraq war by Bilmes and Stiglitz that we discussed in our posting on March 19th.
To my knowledge there is no compelling evidence that American private guards in Iraq have been likely to behave irresponsibly, cowardly, or use excessive force. The relevant comparison would be with the behavior of soldiers in Iraq, and I do not know of such comparisons. Posner quotes a U.S. general on the bad behavior of private security personnel in Iraq, but I would not put a lot of weight on the general's assertions. Most military officers prefer to have security forces under their command, so they are tempted to overstate the performance of their troops relative to that of private security personnel.
To be sure, the military has some advantages over private security forces since the military can impose discipline that is unavailable to private companies, such as military trials, imprisonment, court-martials, and other punishments. On the other hand, private companies are forced to compete against each other for the Iraq and other security business. Competition induces companies to screen their employees and fire the bad apples since the Pentagon will stop using companies that supply ineffective personnel, or personnel that brings bad publicity because of an excessive use of force and other misbehavior.
Incidentally, since I believe private security usually performs very well, I never was convinced by the arguments to federalize employees who search baggage at airports. Private companies would do the job better than a single (monopoly) government employer if the standards of performance were clearly set by the government agency in charge of airport security. As in other sectors, a considerable advantage of private employees over federal government employees would result from the competition of different security companies for the business of providing airport security. I would expect competition among companies to have produced more innovation and greater efficiency in airport security checks than we have received, or will get, with federal employees.
I have been writing about immigration policy for quite a while. Each time I am impressed by how much interest there is in this subject, and the strong beliefs and emotions involved. I will respond to some of the many comments, although I will not do all of them justice.
I strongly believe in either enforcing laws or changing them. I am not happy with the position we face with regard to illegal immigrants. It is not good precedent to ignore immigration laws in deciding how to treat illegal immigrants, but we do that too with tax amnesty opportunities. With so many illegal immigrants here, it is unrealistic to believe we can throw them all out. We should have faced the issue many years ago, as I, along with others, were advocating, but we did not.
So we have to adjust to what we have. I believe amnesty at this time, with a few fines and payment of some back taxes, is probably the best of bad alternatives, but we can take steps to reduce problems with future illegal immigrants. A relatively secure identity card that is needed to get a job, combined with serious fines to employers that hire with workers without these cards, seems like the best available approach.
We should, however, greatly expand the number of legal immigrants accepted. This would include unskilled as well as skilled, but I would put great emphasis on the skilled. This country can easily accommodate and benefit from substantial increases in the number of legal immigrants admitted. To be sure, workers that the immigrants compete against would have their earnings lowered, but that effect would be relatively small, and the gains to others would be far greater- the excess of gains over losses can be easily demonstrated by simple economic analysis.
I do not deny that immigrants come for many reasons: higher earnings, freedom, better opportunities for children, etc. But it is unrealistic to deny that some come to take advantage of free and good medical care, free and good schools for children, and other benefits. Moreover, incentives to come due to the generous entitlements would become much greater if we tried to return to the nineteenth century of unlimited immigration.
To Robert Book, I do agree that the first best might be to deny illegal immigrants access to various benefits. I discussed that in my earlier post on immigration. But that policy has been tried and failed politically. It is hard politically to enforce denying medical and other benefits to sick adults, and even more so, to sick children. So what I taught in Econ. 301 is right, but has to be expanded to take account of political economy considerations.
A common fallacy is to assume a fixed number of jobs, so that if immigrants take some, native-born Americans have fewer. Or if older workers keep their jobs because they work until later ages, younger workers have fewer jobs. The number of jobs that can be created is very elastic, and depends on wages, productivity, etc. What is true is that immigrants will lower the earnings of natives with similar skills. I addressed that issue above.
The comments on my post indicate strong feelings and powerful disagreement, mirroring the strong feelings and powerful disagreement in Congress and in the nation as a whole. It should, however, be possible for Congress to work out a compromise along the following lines:
1. By a combination of sticks and carrots, it should be possible to induce the vast majority of illegal immigrants in this country either to step forward, admit their illegal status, regularize it, and thus enter the path to eventual citizenship (without having to leave the country), or depart for good. The only objections to this course that I can see are "unfairness" to would-be immigrants waiting patiently in the immigration queue--and I do not think the interests of foreigners should weigh heavily in U.S. public policy--and the injustice of "rewarding" illegality (the "amnesty" issue). But illegal immigration is not so serious a crime as to demand obeisance to Kant's claim that even if a society were about to dissolve, justice would require that it execute any condemned criminals. I take a more relaxed, pragmatic view of the dictates of legal justice.
2. By a combination of mandatory biometric ID for all people in the United States (a measure that would have independent value in crime control and terrorism prevention) and heavy penalties on employers of illegal immigrants, future illegal immigration could be largely halted without need to build an expensive Berlin Wall between the United States and Mexico.
3. Reform of immigration law and reorganization of the various agencies in the Department of Homeland Security that administer the law would shorten the queue for legal immigrants (and thus alleviate the "fairness" objection to "amnesty"), adjust the supply of immigrants to the demand of American employers, and switch preferential teratment from foreigners who have family connections in the Unied States to foreigners who have valuable skills.
I will address several good comments. I do not believe that compensation should be tied exclusively to performance because most CEOs, along with other employees, have a preference for a minimum stable income. But I do agree that performance-based compensation should be the major component, especially for large companies. In fact, there has been a sharp growth over time in the share of the total compensation of CEOS that is based on performance.
Several of you confused substantial deviations between compensation and performance during any year in some companies with what determines why average CEO pay increased so much over time-six fold, in fact. That is the main problem I address. Unless the frequency of mismanagement grew over time, the evidence on mismanagement for any year cannot explain the growth in pay over time.
Yes, not only CEOS but other high level executives are much better paid in the U.S. than elsewhere. The reasons for this are closely related to why American CEOS are so much better paid than elsewhere.
Samantha Joy, there is no contradiction between these two sentences: "The usual explanation given by economists for the positive relation between compensation and firm size is that the largest companies attract the best management. Therefore, bigger companies have to pay their CEOS better. [and} ‚Ä¶the relation between pay and (company) size is likely to be sizable, even when top management in different sized companies do not differ greatly in skills and abilities. I want to emphasize the word "greatly". Small differences in ability have large effects on productivity in large companies, and hence have large effects on compensation. This is related to the "superstar" phenomena emphasized by my late colleague, Sherwin Rosen.
Although we blogged on immigration not long ago (see entry for March 6th), immigration reform is currently being extensively discussed by Congress, and President Bush proposed various immigration reforms. We decided to consider the subject once again.
I will defend three reforms. First, the United States can and should greatly increase the number of legal immigrants accepted, with most of the emphasis on skilled immigrants. Second, it is not politically possible to send back the millions of illegal immigrants that are here, but other steps might be taken with regard to their eligibility for various government programs. Third, if a feasible enforcement policy could be worked out, employers should be punished for hiring undocumented workers in order to reduce the incentives for many more illegal immigrants to come here.
The case for expanded legal immigration recognizes the great benefits this country has received from immigrants throughout our history. The unlimited immigration of the nineteenth century is no longer an attractive policy because of the artificial incentives to come created by various entitlement programs. Nevertheless, this relatively unpopulated nation can readily and productively absorb many more immigrants. Skilled immigrants in particular should receive high priority- they do not under present policies- because they add highly valued skills that are well paid in the above ground sector, and they contribute much more in taxes than they receive in government benefits from Medicaid, unemployment compensation, and other government programs. In addition, skilled immigrants commit little crime, they have law-abiding and generally high achieving children, and they supply various services that otherwise might be outsourced to countries like India and China. I would also like to admit legally some hardworking unskilled immigrants, and I will discuss this later.
Unfortunately, I do not see anything in the president's proposal to increase the number of skilled immigrants, perhaps because all the attention is now on illegal immigrants. But skilled individuals deserve a high priority. One approach is to expand greatly the number allowed to enter under temporary programs, such as the H-1B visa program mainly for high-tech workers. But programs for temporary admission are not attractive (for reasons discussed in my March 6th post), and a more desirable policy would provide permanent admission to many more skilled immigrants. More generous admission of these immigrants should be a fundamental part of any overhaul of the United States' immigration policy.
Although the exact number of illegal immigrants in this country is not known, estimates range from about five million persons to close to twelve million. Surely, it is not feasible politically to round most of these up and return them to where they came from. The recent immigrant demonstrations show that this could lead to riots and unrest that would be more destructive than helpful. Moreover, many of these immigrants are well integrated into American life, and it would make little economic sense, as well as be inhumane, to send them back, even if that were feasible. The call by some Republican to send most illegal immigrants back to where they came from seems more like political grandstanding rather than a serious proposal.
So I accept that the vast majority of illegal immigrants are here to stay for as long as they want to. The president's proposal essentially to give permanent residency to illegal immigrants who have jobs involves some face-saving because he wants to deny that he is in effect proposing to give amnesty to immigrants who are here illegally. Still, the proposal is basically a major step in the right direction, for it not only recognizes the impossibility of throwing out millions who are here illegally, but the proposal also makes a valuable distinction between those with and without jobs. That part of the proposal is consistent with the approach taken in the H-1B and other programs that gives preference to immigrants who have jobs.
If the president's proposed reforms were not to become simply another amnesty program-the previous one was in 1986- that would encourage further illegal immigration, a way must be found to discourage the number of illegal immigrants who want to come. The current policy of returning apprehended aliens is ineffective since the majority of those who are returned simply turn around and come again. Perhaps a wall along the border will help. I doubt if using the national guard to patrol borders (I do not like the use of national guards for that purpose) or many more border agents could greatly stem the tide, given the length of the border with Mexico, and the many persons who specialize in finding new ways to cross over.
Most Americans do not wish to give significant jail sentences to illegal aliens who are apprehended. For there is considerable, although not universal, sympathy for immigrants whose only crime is that they come to this country to seek much higher wages, better working conditions for themselves, and brighter futures for their children.
What then can be done? As I said in my March post, I favor reducing the benefits available to illegal immigrants, which means denying them access to most health, education, and other benefits. But I recognize that it is unlikely if that would be politically feasible or desirable in certain situations, such as for illegals who have school age children, or those who are ill. So I am not optimistic about the feasibility of doing much along these lines.
Clearly, it would help a lot if Mexico developed much faster. Its record during the past several years is pretty good, due mainly to the NAFTA Free Trade agreement, various reforms Mexico introduced to make its economy more flexible, and a booming world economy. Still, Mexico is unlikely to increase its progress sufficiently rapidly to greatly reduce the desire of many Mexicans to come to the United States in the forseeable future.
It would be desirable to increase significantly the number of unskilled persons accepted each year, along with the greater increase in skilled individuals accepted, although neither group should be eligible for entitlement benefits for several years. This policy would reduce the number of unskilled persons who want to come here illegally, but it would not eliminate the problem.
So is stemming further large-scale illegal immigration a hopeless task? Perhaps it is, which is why I titled my previous entry "The New American Dilemma: Illegal Immigration". But an approach that I dismissed in my March post may be worth exploring further. Although the 1986 immigration law barred employers from hiring illegal immigrants, it has not been much enforced because employers argued they were victims of forged social security cards, green cards, and other ID's that would certify employees were in this country legally. An identity card that is hard to duplicate and that would have to be checked by employers at a central clearing house before hiring someone would be the only really effective method of reducing forgery to minor levels. That would have to be combined with sizeable monetary fines for employers who hired employees without the required documentation. These fines should rise with the number of illegal aliens hired, and with whether an employer was a repeat offender.
Even if such an identity and punishment system were introduced and were effective, some illegal immigrants would come here to work for households and at other underground activities. But identity cards would greatly cut back the number of illegal immigrants who would come. That is all any policy toward illegal immigrants can hope to achieve.
I have been surprised at the virulence of the response to the President's proposals for dealing with the problem of illegal immigration. I had not realized there was so much hostility to illegal immigrants, who are mainly from Mexico and Central America. Many Americans seem to regard anything short of expelling the entire illegal-immigration population, which may be as large as 12 million (though my guess is that it is much lower), as a form of "amnesty" that would be immoral because it would reward illegality.
Well, that is what amnesties do; they forgive crimes. But they are a conventional policy tool, and should not be despised. They are particularly common as a means of dealing with tax evasion. Tax evasion is extremely common because it is so difficult to detect. A tax amnesty in effect sells the tax evader immunity from punishment in exchange for payment of back taxes due. The amnesty is attractive to the government because it raises revenue and to the tax evader because it enables him to buy his way out of the risk of being prosecuted should he be caught. It is a mutually beneficial trade. The objection to amnesties is that they increase the incentive to commit the amnestied crime in the future by holding out the prospect of future amnesties. The objection is superficial. The government will (if it is being sensible) trade off the gain in revenue from the amnesty against the future loss of tax revenues that is likely to be caused by the prospect of future amnesties, and so it will set the amnesty "price" at the level that maximizes the net gain in revenue. For example, if it reckons that the prospect of future amnesties will lead to significantly more tax evasion in the future, it can condition the amnesty on the tax evader's paying not merely the back taxes he owes but a substantial penalty as well.
It is the same with an immigration "amnesty," if one wants to describe the President's plan in those terms. In exchange for not risking being deported, illegal immigrants can be required to pay not only back taxes due but also a fine greater than the $2,000 currently proposed. Of course, the stiffer the penalty, the fewer illegal immigrants will step forward and acknowledge their status, and so the less effective the "amnesty" will be. I would not favor a stiff penalty. The Americans who for one reason or another are most concerned about illegal immigration are not much or maybe at all concerned about legal immigration, and so converting illegal to legal immigrants should be regarded by them as a highly beneficial step.
There is antipathy to "rewarding" legal immigrants, who have jumped the queue of people trying to immigrate to the United States--a queue that can take many years to get to the head of legally. But what is the alternative? It is not feasible to deport millions of people from the United States, and those who would like to do this should accept as a second-best solution regularizing the status of the illegal immigrants. Nor is it clear that the people waiting patiently in the queue are "better" people or would be better Americans than the illegals. Many of them may be in the queue not because they want to be Americans but because they want to preserve the option to relocate to the United States should conditions or opportunities in their home country worsen.
It would be desirable in principle to get control of our borders, but it probably is impossible. Our border with Mexico is almost 2000 miles long, and that figure ignores our Pacific Ocean and Gulf of Mexico coastlines, which are proximate to Mexico and Central America. Fencing and patrolling a border sound like straightforward measures, but in practice are extremely costly; imagine the interruptions in the extensive commerce between the United States and Mexico that would ensue from erecting a Berlin Wall, with checkpoints at which vehicles are carefully searched, between the two countries.
If all Americans were required to carry biometric identification, if any clandestine entry into the United States were punished as a serious crime, and if the employment of an illegal alien were made a federal felony with a mandatory minimum punishment of 10 years in prison, the problem of illegal immigration would be solved more or less overnight, and the millions of illegal immigrants would be on their way back to Mexico and Central America (and in lesser numbers to China and other poor countries that supply us with many illegal immigrants). This exodus--this de facto deportation of the illegal immigrant population--would disrupt the economies both of the United States and of Mexico.
Once something is identified as a problem, Americans, not being fatalists, insist that there be a solution. But there is only one worthwhile solution to this particular problem, and it is one over which Americans have little control. The solution is for Mexico and the other poor countries from which illegal immigrants come to become rich. As soon as per capita income in a country reaches about a third of the American level, immigration from that country dries up. Emigration is very costly emotionally as well as financially, given language and other barriers to a smooth transition to a new country, and so is frequent only when there are enormous wealth disparities between one's homeland and a rich country like the United States. The more one worries about illegal immigrants, the more one should favor policies designed to bring about greater global income equality.
A few points in response to many comments on the important subject of the movement left in Latin American governments.
As the statistics provided by someone indicates, Cuba has done very badly since Castro took over. My favorite comparison is between Cuba and Taiwan. These two islands had about equal per capita incomes in 1960 and some similarity in exports. Yet now Taiwan's per capita income is many times that of Cuba's.
A couple of you attributed that to the economic isolation of Cuba by the United States. That may have hurt Cuba somewhat, but for many years it was offset by very generous support from the Soviet Union. Of course, Cuba is not an isolated example-no communist country performed well, either in its economy or in the freedoms of its people.
Let me add that have opposed the American boycott of Cuba. It provides an excuse to supporters of Castro for the economic failures. It is also a bad policy because boycotts are not very successful, and to the extent this one has succeeded, it has hurt the Cuban people.
On Venezuela, of course its GDP is doing well with the very high price of oil-so is the Russian economy, Saudi Arabia's, the Iranian economy, etc. The test will be how Venezuela does when the price of oil falls. I predict that it will do very badly indeed.
I oppose American interference in the crops that can be grown in Bolivia or anywhere else- as I explained in an earlier post on the war on drugs. But that is not the major cause of the problems in the Bolivian economy.
Someone asked about whether any countries in the region introduced significant reforms in their economies. I would mention not only Chile, but also Mexico and Brazil, two very important nations, as well as various Central American economies, and a few others. Most of the reforms have not gone far enough, and the reforms were not always efficiently done, but there were major reforms. The substantial but far from complete reforms in Brazil in my judgment explains why Lula has followed rather market oriented and "conservative" policies.
The media are full of stories about the compensation of chief executive officers of American companies. The theme of the stories is that CEOs are paid too much.
The economics of compensation are fascinating. In the simplest economic model, a worker, right up to the level of CEO, is paid his marginal product--essentially, his contribution to the firm's net income. But simple observation reveals numerous departures from the model. For example, wages vary across the employees of the same rank in the same company by much less than differences in their contribution to the company, and employees who do satisfactory work can expect real (that is, inflation-adjusted) annual increases in their wages throughout their career with the firm, even though their contribution will not be increasing at the same rate, and eventually not at all.
Let us see what sense can be made of the curious pattern of CEO compensation. American CEOs make much more on average than their counterparts in other countries--about twice as much. You might think that this was because Americans at all levels earn more than their foreign counterparts, but this is not so; the difference between U.S. and foreign wages is much smaller below the CEO level. In other words, wages are more skewed in favor of CEOs in American companies. The disparity is related to the fact that salaries are a much smaller fraction of American CEOs' incomes (less than a half) than of foreign CEOs' incomes, with the rest consisting of bonuses but mainly of stock options. Both the fraction of CEO income that is nonsalary, and total CEO income, have been rising, dramatically in the United States, over recent decades. But there is a recent tendency of foreign CEO compensation policies toward convergence with the American practice.
One can speculate about the causes of some of these differences. Stock options and other incentive-based compensation methods impart risk (variance) to CEOs' incomes, which reinforces the risk inherent in the fact that a CEO's human capital (earning capacity) may be specific to his firm, so that if he lost his job because his company had been doing badly (perhaps for reasons beyond his control), he would take a double hit--lower pay as the company declined and lower pay in his next job. Because business executives (as distinct from entrepreneurs) do not like risk, they demand a higher wage if the wage is going to have a substantial risky component. This may explain some of the difference between American and foreign CEO compensation, but surely not all or even much of it--especially since job turnover at the CEO level is actually greater in Europe than in the United States.
Another possible difference is that stock ownership tends to be more concentrated abroad than in the United States. The more concentrated it is, the more incentive shareholders have to monitor the performance of their firm's managers because they have more at stake. The more effective that monitoring is, the less need there is to create incentive-based compensation schemes: the stick is substituted for the carrot.
Cultural factors may be important. European countries in particular are more egalitarian than the United States, suggesting that envy is likely to play a bigger role in compensation there. Astronomical ratios of CEO to blue-collar wages in the same company cause little resentment in the United States compared to what they would cause in Europe, though wide disparities between workers at the same level does engender resentment here even if the disparities track differences in productivity.
Envy might reduce average incomes at the same time that it reduced variance in incomes, if the more generous compensation of American CEOs merely reflects the greater contribution that they make to their companies' success. But there are two reasons to doubt this, and thus to suspect that American CEO incomes are padded to some degree. First, the most significant "incentive" component in these incomes--stock options--are not well correlated with the CEO's contribution to the value of his company and thus of the value of its stock. Many things move a company's stock besides the decisions of its CEO. To tie a CEO's income to the value of his company's stock is a bit like tying the salary of the President of the United States to the U.S. GNP.
Second, the choice of stock options as the principal method of providing nonsalary compensation to CEOs seems related to the fact that traditionally the income generated by these options, unlike salary or bonus income, was not reported as a corporate expense. Of course security analysts and stockholders large enough to follow closely the affairs of the companies in which they invest can calculate the expense of stock options, but the ordinary public cannot, and this is important because even in the United States envy is a factor that can influence policy and public opinion. A spate of recent articles has explained the ingenious devices by which CEO compensation that would strike the average person as grossly excessive is concealed from the public, and these articles, along with well-publicized corporate scandals, may place some downward pressure on CEO compensation. Companies cannot afford to ignore public opinion completely, because adverse public opinion can power legislative or regulatory measures harmful to a company or an industry.
It might seem that, provided the shareholders--the owners of the company--are made aware of the actual compensation received by the CEO, competition will drive that compensation down to approximately the level at which the CEO is just being paid his marginal product, with appropriate adjustment for risk. But given the size of companies, the cost to a major company of even a grossly overpaid CEO is so slight when divided among the shareholders that no shareholder (assuming dispersed ownership) will have an incentive to do anything about that excess expense.
What about the board of directors? Their incentive to minimize what from the overall corporate standpoint is only a minor cost is also weak, and may be offset by rather minor economic and psychological factors. The board is likely to be dominated by highly paid business executives, including CEOs, who have a personal economic interest in high corporate salaries and a natural psychological tendency to believe that such salaries accurately reflect the intrinsic worth of their recipients.
Becker in his comment on this post (below) cites an interesting paper by Gaibaix and Landier which argues that the increase in CEO compensation is a function of the growth in the market value of firms. The basic idea is that the CEO of a more valuable firm is more productive, since if he increases value by say 1 percent the increase in absolute value will be greater the more valuable the firm is. If there are two equally skilled managers and one manages a grocery store and one manages IBM, the manager of IBM is probably creating greater value.
The theory is too new to evaluate with any confidence. I am somewhat skeptical because rapid increases in CEO compensation should attract more talent to management, and the resulting greater competition for CEO positions should dampen the increase in compensation.
An alternative explanation for the correlation between firm value and CEO compensation, one that is consistent with the evidence that such compensation is often excessive from an efficiency standpoint, is that the greater the firm's market value, the easier it is to "hide" the compensation of the top executives. Suppose that a 10 percent increase in value is associated with a 3 percent increase in CEO compensation; then the percentage of the firm's value that is going to the CEO will have fallen. This may be one reason why many mergers fail to increase earnings per share, although the overall value of the enterprise will be greater after the merger (there will be more shares): the increase in overall value enables the CEO to increase his compensation regardless of whether he will be creating greater value as the manager of the larger enterprise.
The answer to the question of whether American CEOS are overpaid is clearly "yes" for those who earn large bonuses and generous stock options when their companies are doing badly, either absolutely or relative to competitors. Business Week has had an annual list of the most overpaid CEOS relative to the performance of the companies they head. A number of well-known companies usually top that list.
But the concern in the media and in Congress over CEO pay is not motivated by some bad apples like these, but by the huge increase in the typical CEO pay in the US during the past 25 years. The total real compensation (that is, compensation adjusted for increases in the price level) of CEOS in larger publicly traded companies during this period grew a remarkable six fold, where compensation adds together regular pay, bonuses, stocks awarded, the value of stock options, and payouts from longer term pay programs. A big but not the only component of the increase is due to much greater use of stock options. Since median fulltime real earnings during the same period only just about doubled, the gap between pay at the top and the average pay of employees widened enormously. It is hard to resist the widespread perception from these trends that CEOS and other top executives are being increasingly overpaid.
The case against the pay of American CEOS looks even more powerful by recognizing that the typical American company head receives greater total compensation than company heads in Great Britain, Canada, Japan, Spain, and in pretty much all developed countries. Clearly, American CEOS are much better paid than CEOS elsewhere, even when per capita incomes of the countries do not differ by very much.
Yet competition for top management can explain the rapid rise over time in the pay of the average American CEO. To understand how competition works in the management market, consider the strong and stable relation at any moment between the total compensation of CEOS at publicly traded companies, and the size of the companies they head. For every 10 per cent increase in firm size, measured by the market value of assets, by sales, or by related variables, compensation increases by about 3 per cent. This "30 per cent" law held during the 1930's, and has held for every succeeding decade, including right up to the present. Note that stock options and other forms of compensation than salaries and bonuses were unimportant until the 1970's, so this relation is not due to the rapid growth of options and compensation through shares of stock.
The usual explanation given by economists for the positive relation between compensation and firm size is that the largest companies attract the best management. Therefore, bigger companies have to pay their CEOS better in order to discourage them from going to head smaller companies. It is also socially efficient to have the best mangers run the largest companies because their greater skills then have a bigger influence since they would manage a larger amount of labor and capital. The efficient combining of better managers with larger companies in a competitive market for top managers would imply a positive relation between firm size and the total compensation package. This analysis does not explain why the 30 per cent rule holds, but it suggests that the relation between pay and size is likely to be sizable, even when top management in different sized companies do not differ greatly in skills and abilities.
We need two additional facts to explain the sharp rise in pay over time, and the much higher pay in the United States than other countries. The first is that the average size of large American companies has grown in real terms about six fold during the past twenty-five years, regardless of how "large" is measured, as long as the same measure is used consistently over time. The other important fact is that the largest 50, 100, or 500 American publicly traded companies are much bigger than the largest companies in other countries.
Clearly, if large companies pay more, and if the average size of companies has grown sharply over time, average compensation would also grow, even if the value of the increasingly generous granting of stock options and equity shares were fully understood by stock markets and boards of directors. It is also possible to understand why average compensation grew about as rapidly as average company size, although the argument here is more complicated (for the details of this argument, see Xavier Gabaix (MIT) and Augustin Landier (NYU), "Why Has CEO Pay Increased So Much?" unpublished, April 17, 2006). The allocation of better managers to larger firms, and competition for these managers among companies of different sizes, means that companies in say 2006 would have to pay more for their CEOS than even the same sized companies did in 1980, although much less than six times as much. The reasoning is that the 2006 companies of a given size are competing against relatively larger companies than comparable size companies did in 1980. Using this analysis, Gabaix and Landier are able to explain why total compensation of the average CEO of larger companies grew about six fold along with the six-fold growth in average company size during the past several decades.
The same argument explains why compensation of American CEOS is much higher than that of CEOS in other countries. Since average firm size is much lower elsewhere, their pay would be more like that of pay in the US in 1980 or 1990 than the pay of CEOS in today's much larger American firms. As the market for top executives becomes increasingly global, the pay of CEOS in other countries would rise, and that of CEOS in America might fall. For example, to attract Carlos Ghosn, a Brazilian working in France, to turn around Nissan, a seriously ailing company, Nissan had to pay him not at the low Japanese CEO levels, but at the much higher levels found in other countries.
I believe that the explanation based on the allocation of CEO talent largely is behind the explosion in compensation of American CEOS during the past several decades. Yet at the same time, some American CEOS are obviously grossly overpaid since they have mismanaged their companies, and still receive exorbitant compensations. But mismanagement is not new and probably has not become so much more important over time. So I am suggesting that the rapid growth of compensation of American CEOS, and its premium over compensation of CEOS in other countries, is not mainly due to a growth in the degree of excess payment of executives in the United States. Rather, on this interpretation, the main cause of the increase in pay is the greater challenges and opportunities facing executives who manage much larger combinations of resources.