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Friday, May 31, 2013

QE and the priming of the World Economy

Steve Keen has a super post explaining why QE does not work or explaining how in fact it is supposed to work. At the same time, world worries about the effect of impending withdrawal of QE. But my focus is somewhat different.

Can the QE be expected to create a global turnaround?
I would say no. The reason I am keep a small probability open is because theoretically it is possible but quite a long shot. If you look at Prof. Keen's first cut model, the Banks need to buy assets (he calls it stocks but assets is better term) from the economy. This creates money supply which allows producers access to capital, employ people and therefore give consumer access to income and therefore spending power leading to pick up. As you will note, this is not quite that simple.

In principle, I would say the current model of QE will work if banks make tremendous profits and spend it priming the spending cycle to create employment and resulting spending. Now you realize that to effect that kind of priming, bank profits will have to soar and corresponding banker salaries have to push far northward. All in all, not happening.

The purchase we get from this type of QE per dollar of traction gained by the economy is fairly low.

What kind of QE WILL work?
Any QE which will create jobs with certainty of income over reasonable period of time, say 15 years, will be adequate. The exact amount of income does not matter so long as it is above a bare threshold and so long as it is decently correlated with nature of job. Even when so provided, the purchase from such QE will come over 3 year period provided there are correlated reforms in market place to protect the income from malicious extortion using penal mortgage rates or credit card frauds etc.

For the record, any kind of job will do but jobs which build future capability will be more valuable than crude "dig-a-hole-fill-that-hole" jobs. The benefit from these jobs will be a bonus. Ideally, you want the population to work on the next big thing. At the moment it is not clear what that thing is - it is most likely green and blue.

What has the current QE achieved?
One may ask if the current QE is totally useless. It is not. The crisis of 2008-2009 was result of three things freezing together - an over-leveraged consumer, a credit-starved producer, non-functioning market. The present QE worked on easing the producer, though at a great cost. Sadly, it has not quite helped with over-leveraged buyer or not much has been done to fix the market. Further the over-leveraged consumer is going to bear the burden of easing of producer through higher taxes limiting his ability to spend for quite some time. In effect, the current QE has eased the producer at some cost to the consumer.

My approach would have been different. I would have focussed on the jobs and when income stabilizes the credit would have automatically flowed to productive quarters. The benefit of this approach was its moral compass was pointing correctly. Government was taking care of people rather than focussing on the corporates, returns on credit would have been available where it was productive. Where credit was lent inappropriately it would have been marked down by players themselves because of inter-firm rivalry. And in the process, the overall expenditure would have been lower.

What kind of recession are we in?
The worst kind! No, it is not smaller than the Great Depression rather it is quite larger than that. We are at the threshold of global realignment of geographical dispersion of production and consumption. The ideal world we imagined when we studied "competitive advantage of nations" will come to bear if each of the nation acts prudently. This cannot happen in the current environment of mistrust and currency wars. We need sanity to prevail - and usually, it doesn't and usually this kind of thing results in a real war. On that somber note I leave you, let us pray sanity prevails and politicians do the right thing.

Thursday, May 23, 2013

What is a fair Pay?

Knowledge@Wharton has really so-so article about what is fair vs unfair pay. But this post is not about why the article lacks depth per se but it is about what really decides fair vs unfair pay. And to this end, we will rely on the model discussed in Understanding Firms - A Manager's model of the Firm.

We will take two aspects from the book, first relates to ESK (Effort-skill-knowledge) profile for every job and second relates to profile of employee when she works on Firm's transaction chain, namely scout, commando, bureaucrat. As I explained in the book, employees perform dual functions. They work IN the firm's transaction chains and they work ON firm's transaction chains. In the first function, their work is classified as ESK profile. In the second function, their work is classified into "roles" such as scouts, commandos and bureaucrats. 

First about ESK profile
First it is common-sense to understand that an E-dominated job will pay vastly lower than K dominated job and S-dominated job will lie somewhere in between. Now, any given job has a combination of ESK requirements and thus has a ESK profile. It is here that the confusion starts. You can immediately see that this is a 3-D surface plot and the nature of surface is not clear. 

Thus a job with high effort and knowledge requirement cannot be equal to effort job + knowledge job. In other words, when you expect a high-knowledge job to supply effort, you pay higher for the same effort than when it is supplied by someone who does not offer the high-knowledge part. Thus it makes sense to carve out the E-type part and make someone else do that job. This is the benefit of specialization.

Let us think of an example. (With reference to Ironman) A scientist at Stark industries who is as brilliant as Tony himself will have a high K profile. But when you compare Tony and that scientist, Tony Stark comes with equally high K profile along with strong E and S profile as well. That makes Tony Stark more valuable than that scientist. (We are assuming this comparison way before Tony becomes Ironman.)

Another example can be that of surgeon. A surgeon works in S-K profile with both equally highly demanding. Therefore it is only fair his compensation is quite high.

Next about employee roles
When you consider employee roles, there is even more confusion. Usually, employees have a favoured mode of operations, that is to say they have a natural inclination to be either scout OR commando OR bureaucrat. However, considering the bargaining power equation across the transaction chain and the nature of transaction on which the employee is working demands a certain role from the employees. When employee supplies such a role to such a transaction, she contributes positively to firm's bargaining power. 

Any addition to firm's bargaining power is easier to perceive in terms of financial returns and is thus rewarded substantially. However, the share of rewards are not commensurate with the contribution to the bargaining power by various employees. Thus, a person winning a deal often gets more credit than a person who creates conditions within delivery side to win such a deal.

In our earlier example of Ironman, when Tony Stark is faced with a problem of lack of resources (in the cave for example), he re-wires the entire transaction chain, creating it all by himself, operating in a strong scout-commando combo-role. This makes Tony Stark truly superior to all other employees. Now Tony Stark gets higher compensation not only because he can be scout-commando but because he knows that he needs to be scout-commando and supplies that role. Thus it is not the role per se, but the aptness of the role to the situation that is valuable.

What firm values vs. what is valuable to the firm
We know and understand that firm pays more for what it values more. But there is a difference between what a firm values and what is valuable to the firm and firms do not always value what is valuable to it.  

Quite often, employees know what is valuable to the firm but firm is unable to recognize it. This is because of lacunae in leadership rather than anything else. In this case, the employee making a valuable contribution feels that he is unfairly compensated.

Some times the reverse is also true, that employees think certain this is valuable but in larger scheme of things it is not that valuable to the firm. This is problem of expectation matching at employees side but even this is a lacunae in leadership.

Relativity of fair compensation
Fair compensation also depends on relativity. Whatever the firm's stated policy, the employees know who is paid what in approximate. Further, employees also know the relative performance of people in the team. If firm rewards are not in line with relative performance a feeling of unfairness develops. No one compares his compensation with that of CEO directly, you compare your compensation with someone who has performed better than you and to some other who has done relatively poorly. If the compensation satisfies the hierarchy of performance employees feel it is fair.

Secondly, employees also compare compensation of others with others. So they will compare compensation of A(a not-so-high-performer in their eyes) with that of B(a star in their eyes) and check if the fairness holds. If they feel this is unfair then they ascribe unfairness to their own compensation even though in isolation they may feel their compensation is fair. To make this point clearer, employee is happy to receive his compensation for the year but becomes unhappy when he goes out and interacts with others.

Thus, fair compensation is not as simple as K@W makes it sound. It is way more complex. But you know better now!