April 08, 2007
Employee Ownership Through ESOPS:A Bad Bargain-BECKER
Recently Sam Zell, a leading Chicago businessman, arranged to buy the Tribune company, owner of the Chicago Tribune, Los Angeles Times, other newspapers, and many TV and radio stations. Aside from the low price that he paid, which reflected the rapidly declining fortunes of the print media and conventional TV stations, the most noteworthy aspect of the deal is that he plans to take the company private through the creation of an ESOP, or employee stock ownership plan.
The number of American ESOPs has grown substantially during the past 30 years, and they are currently estimated to hold more than ½ trillion dollars in assets and cover over 10 million workers. Probably the main reason for their growth is that ESOPs had during this period sizeable tax advantages that include deductibility from federal taxes not only of the interest payments but also of much of the principal used to finance creation of an ESOP. The argument made for these special privileges is that employee ownership is a good thing for workers that should be encouraged, but is that true?
In reality, the creation of an ESOP is often a management tool to fend off unfriendly takeover bids. This was certainly the case behind the pilot-led ESOP created by United Airlines, and may have played a role in the ESOP to be created at Tribune company. ESOPs that help keep poorly performing management in power would contradict the claim that this organizational form improves rather than contributes to poor performance.
Employee ownership is said to induce employees to work harder because they then have a financial stake in the company where they work. If that were true, owners would not need a tax advantage to create a sizable employee ownership since they would subsidize stock ownership by employees in order to improve productivity. Employees in a small closely held company with few workers may feel part of a family and work harder when they own an interest in the company. But in large companies with thousands of employees, such as Tribune company and other ESOPs like Science Applications International, ownership is not likely to be a strong motivating factor because hard working employees would then mainly benefit the many other employees and stockholders. Between 1995 and 2000 United Airlines was an ESOP with employee representatives on its board. Soon after 2000 the company entered bankruptcy with employees and management not known either for their great effort.
Careful studies that compare the productivity of employee-owned companies with those owned by general stockholders are limited in number and scope, and advocates of ESOPs often get quite emotional in reacting to criticisms of the concept. Still, there is little hard evidence indicating that ESOPs are better run than normal companies. Reputable studies of employee ownership in the United States and other countries generally indicate that both profits and productivity remained about the same after companies introduced employee ownership. This is not surprising since most ESOP-owned companies are not run by employees, and for the reasons I gave employee ownership does not usually better motivate workers of larger companies.
However, the most powerful argument against the view that employee ownership improves efficiency is that new firms would tend to take this form if it improved efficiency, and many older firms would convert to employee ownership on their own, even without tax advantages from doing so. Yet despite the competitive nature of American industry, with substantial rates of entry and exit of companies, less than 10 percent of employees in the United States work in firms that have ESOPs despite the considerable tax advantages to this organizational form. This more than all the highly imperfect comparisons between the performance of ESOPs and other companies is persuasive evidence that ESOPs would not usually be more efficient. Indeed, given the tax advantages, there would be many more ESOPs if they were equally efficient.
Various types of employee-ownership of enterprises are found in many other countries. Usually they are the result of legislation that either forces or encourages this form of ownership through regulations and tax advantages, sometimes when public enterprises are privatized. The evidence on their efficiency as determined by their spread and performance in these countries is similar to that for the United States: even with special privileges, employee ownership has not become the dominant organizational form of enterprises. This suggests again that employee-owned companies would tend to under perform more conventional ownership structures that have stockholders who either manage the enterprise, or are largely independent of both employees and managers.
The biggest and most obvious drawback of employee ownership from the perspective of the financial wellbeing of employees is that they hold their assets in one basket, the company where they work. Even without ownership of equity the wealth of experienced employees is still poorly diversified since it is largely in the form of human capital whose value depends on the success of the company that employs them. When the company does well, earnings from their human capital tend to rise more quickly, while the opposite occurs when the company does poorly. Ownership of shares in the company exacerbates the economic dependence on the company's performance since now the value of the financial assets of employees also rises and falls with the company's fortunes. The same problem arises with the many corporate pension plans that mainly hold bonds and stock that they have issued. When the company does poorly, the value of pension assets, and thus of the retirement incomes of employees, go down along with earnings, employment and profits of the company. Forcing top management to hold much of their financial assets in the stock of the companies they run through stock option and stock ownership plans reduces their financial diversification too, but that may be beneficial to the company's performance since the decisions of CEOs and others at the top do greatly impact company performance. As I indicated earlier, that is not the case for typical employees of large corporations.
The disadvantages of being poorly diversified is not simply hypothetical, but was sadly brought home to employees of companies like Enron and United that had substantial stock ownership by employees. After these companies went into bankruptcy, mainly due in Enron's case to mismanagement and corruption, many employees not only lost their jobs but employees lost much of their other wealth as well.
Posted by becker at 07:44 PM | Comments (1) | TrackBack (0)
The Economics of ESOPs--Posner's Comment
I share Becker's concerns with the favorable tax treatment of employee stock ownership plans. Such treatment would be justifiable only if such plans conferred benefits on society that could not be generated more cheaply by other means. Proponents of the law that authorized ESOPs and conferred favorable tax treatment on them argued that ESOPs would unlock a new source of capital—namely workers, who contribute capital to the corporations that employ them when they take part of their compensation in the form of participation in an ESOP. But there is no shortage of capital, so no justification for subsidizing investment in corporate stock. If anything, ESOPs can be criticized from an overall social-welfare standpoint as an antitakeover device that we do not need: workers are unlikely to vote for a takeover, as it might jeopardize their jobs.
As Becker points out, abolishing the favorable tax treatment of ESOPs would permit a market test of this form of corporate governance. (In confining my discussion to cases of governance, I focus on situations in which, as in United Air Lines before its bankruptcy, or the proposed reorganization of the Tribune Company, the ESOP owns all or a controlling amount of the common stock of the corporation.) I believe that it would usually flunk the market test. Granted, the ESOP has an advantage over the conventional worker-owned firm: the value of a firm's capital stock is the discounted present value of its expected future earnings, so that a worker who owns ESOP shares has, at least in his role as part owner, the same horizon as the corporation itself, rather than the truncated horizon of the worker in a conventional worker-controlled firm (a cooperative), who cannot benefit from anything the corporation does after he retires and who consequently has no financial stake in maximizing the corporation's present value.
But this advantage of the ESOP over the conventional worker-controlled form will usually be modest. A worker will trade off any long-term benefits to the corporation from a corporate action that would increase the value of his shares against whatever short-term benefits, in the form of a higher salary or greater fringe benefits or a lighter workload, an alternative course of action would confer on him; and usually the tradeoff will favor increased compensation for work over increased stock value.
It is true that to be entitled to the tax benefits of the ESOP form, the workers' shares must be placed in trust, and the trustee must vote them to maximize share value; he cannot trade a lower share value for higher employee compensation of the worker owners. (And so he cannot oppose a takeover that would maximize share value, even if it would do so by laying off many of the workers.) If the favorable tax treatment of ESOPs were abolished, there would be no requirement of placing ESOP shares in trust. But that would still be an attractive choice for the ESOP in order to reduce the misalignment of incentives in conventional worker-controlled firms.
But overcoming the problem of incentive incompatibility would not create an affirmative reason for a worker to own shares in the corporation that he happens to work for rather than in some other corporation, a mutual fund, etc. Becker rightly rejects the notion that having an ownership interest closely aligns a worker's incentives with those of the corporation. Unless the corporation is very small, which obviously is not the case with United Air Lines or the Tribune Company, the efforts of an individual worker will not have a significant effect on the market price of the corporation's shares and hence on the worker's wealth. Of course, some workers may not realize this (they may exaggerate the contribution that their working harder would make to the firm's bottom line); or they may, by virtue of being "owners," become altruistic toward "their" company; but such workers would be likely to buy shares in the company voluntarily (or take part of their compensation in the form of shares), without all the workers having to do so.
The ESOP has one genuine advantage over the conventional corporate form, an advantage that played a role in the decision to convert the ownership of United Air Lines to an ESOP. It can smooth labor relations by increasing the cost to workers of striking or otherwise pressuring the corporation to incur greater labor costs. Even though, as I have suggested, workers' work-compensation gains will usually exceed the losses in share value that will result from the corporation's greater labor costs, their demands will be moderated by the cost to them in lower share value. This depends however on the shares being held in trust, so that the workers' interest as workers is not reflected in how the shares are voted; otherwise workers may use control of management to increase rather than moderate their demands for employee compensation. But as I have said, the trust format could be retained even if it were no longer required.
Against the possible (tax-independent) advantages of the ESOP form stands the powerful disadvantage of underdiversification. The shares in their employer's ESOP are likely to be the principal financial asset of the workers. If they are risk averse, they will be bearing uncompensated risk by holding an underdiversified portfolio. The consequences were dramatically demonstrated by the United Air Lines bankruptcy. The trustee was sued for not having sold United stock before the collapse, but because the purpose of an ESOP is to hold stock in one company, namely the employer of the participants in the ESOP, an ESOP trustee does not have the usual trustee's duty of diversification; what exactly his duty is to protect the participants against excessive risk is unclear.
A further complication is presented by employee turnover. An employee who quits and goes to work for some other employer cannot remain a participant in his former employer's ESOP. His shares must be redeemed—but at what price? If the ESOP owns all the common stock in the employer, the fixing of a redemption value will be awkward. If it is too low, this will reduce the value of the shares to other employees who anticipate quitting at some future time; if too high, it will reduce the value of the shares by diminishing the corporation's assets, out of which the price to redeem departing employees' shares is paid. Still another complication is reconciling the competing interests of different classes of ESOP shareholder, such as active and retired employees.
To summarize, were it not for the favorable tax treatment of ESOPs, one would not expect the device to be common except in small corporations (and perhaps not even there, since the partnership and the closely held corporation provide attractive alternative governance forms) and in some firms that have particularly troubled labor relations.
Posted by Richard Posner at 07:26 PM | Comments (10) | TrackBack (0)
April 01, 2007
Is the Tort System Costing the United States $865 Billion a Year?--Posner
A study published last month, and favorably summarized in an op-ed in the Wall Street Journal, estimates that the American tort law system costs the nation $865 billion a year. The study, entitled Jackpot Justice: The Cost of America's Tort System, was written by Lawrence J. McQuillan and other members of the staff of the Pacific Research Institute, which published the study. (The study can be downloaded at www.pacificresearch.org.) How did the authors arrive at that figure, and is it meaningful?
They begin by estimating that the nominal (that is, dollar expenditures as distinct from social costs) annual cost of the tort system, consisting mainly of attorneys' fees and other costs of administering the system plus the amount of money paid to tort claimants in judgments and settlements, is $279 billion, of which $128 billion is the amount paid out to claimants. The estimate comes from a report (U.S. Tort Costs: 2003 Update) by Tillinghast-Towers Perrin, a consulting firm for the insurance industry, with the report's estimate updated to 2006. It is impossible to determine from Tillinghast-Towers Perrin’s report what the sources for most of its data are, and so the figures I have quoted must be taken with a grain of salt; indeed, so far as I can tell, they may be completely unreliable. They are almost certainly exaggerated, given the financial connection between the firm and the insurance industry.
The authors of Jackpot Justice know the difference between a cost, which in economic terms is a reduction in the amount of valuable resources, and a transfer of wealth from one person to another that doesn't reduce the total amount of resources but merely redistributes them. The $128 billion figure is a transfer, not a cost. But as the authors point out, the opportunity to obtain a wealth transfer can generate a cost--a cost incurred to obtain the transfer (incurring costs to obtain a wealth transfer, when socially unproductive, economists call "rent-seeking"). They assume, without analysis or evidence, that the entire $128 billion is translated into a cost.
They further assume that 28 percent of the $128 billion transfer represents a deadweight cost, that is, a loss of value. They base this assumption on a study which found that increasing the corporate tax rate by $1 generates 28 cents in deadweight costs. The basis of that finding was that a tax, like a monopoly markup, causes the taxpayer, like a consumer, to substitute for the taxed item or activity something that may cost society more to provide but looks cheaper because it's untaxed, or taxed at a lower rate. The authors of Jackpot Justice do not explain why a tort transfer would have the same effect. Of course the threat of tort liability might well alter the behavior of potential injurers--indeed, it is intended to do so--but it might alter that behavior in the direction of greater efficiency, by making potential injurers internalize accident costs. That is the objective of tort law, though imperfectly achieved. Without tort liability, firms would have weak incentives to invest in safety measures to benefit potential victims of the firms’ activities, unless the victims were either their employees or their customers.
With the addition of 28 percent of $128 billion ($36 billion) to $128 billion in assumed rent-seeking expenditures, the authors jack up their estimate of the annual social cost of the tort system to $164 billion. To this they add another $36 billion, on the assumption (it seems---this part of the report is none too clear) that efforts to avoid the deadweight cost will cost that amount. This appears to be double counting, based on the assumption that $36 billion is spent every year in a futile effort to avoid a $36 billion cost. It is possible, however, that some--maybe considerable--costs are being incurred to prevent that deadweight loss from rising from $36 billion to some higher level—for example, legal-counseling costs (not included in the attorneys' fees incurred in actual litigation) or costs in curtailed new-product development (see below). But there is no basis for supposing that the sum of such costs would equal $36 billion; nor do the authors make any effort to defend the figure or estimate the actual costs.
They add to their new total of $200 billion the $128 billion transfer, for a grand total of $328 billion. The addition is improper, since the transfer is not a cost. They are adding apples and oranges.
They borrow from another study an estimate that tort liability generates some 2,000 accidental deaths a year by discouraging the introduction of risk-reducing products and services. But they fail to offset against that figure (and its monetization) the number of accidental deaths that are prevented by the deterrent effect of tort liability. In the absence of liability, potential injurers would spend less on safety, at least with regard to potential victims with whom the injurers lack actual or potential contractual relations.
The authors of Jackpot Justice cite a respectable economic study by Daniel Kessler and Mark McClellan which finds that malpractice liability increases hospital costs by 5 to 9 percent; and they treat the entire amount as social waste. But as I said earlier, the aim of liability is to induce potential injurers to spend more on safety, and so the fact that they do spend more cannot be adjudged a failure to improve social welfare. Medical-malpractice law is in its administration rife with inefficiency, but it would be surprising if eliminating it entirely would be all social benefit and no social cost (nor in fact do the authors argue for eliminating it, as we’ll see).
The authors argue that products-liability law is responsible for the loss of $359 billion in new products. They base this on a study by the economists Kip Viscusi and Michael Moore which found that when the ratio of liability costs to sales revenues exceeds 5 percent, firms reduce their investment in R & D. The authors of Jackpot Justice identify product markets such as power tools, fireworks, and cigarette lighters where they believe (relying however on the questionable data in the Tillinghast-Tower Perrin reports) that this ratio is exceeded. Then, using Viscusi and Moore's estimate that 6 percent of the products of the industries that the two economists studied are new products, Jackpot Justice multiplies the output of these markets by 6 percent; with certain other adjustments, this calculation produces the estimate of $359 billion in lost sales.
This is not, however, as the authors believe, a social cost. The social cost is the consumer surplus that the sales of the new products would have produced. Suppose that a product costs $10 and is sold in a competitive market for $10, but that consumers would pay $12 for it if it were priced at $12. Then if the product is not produced, there is a loss of consumer surplus of $2. That, not the $10 in lost sales revenue, is the social cost of not producing the product.
The sum of $328 billion and $359 billion is $687 billion, which is almost $200 billion short of the authors' grand total of $865 billion. The excess malpractice costs and accidental-death costs they estimate at less than $50 billion, so there is still a big gap. I can't figure out how they fill it.
So far in the report, there is nothing about the benefits of the tort system. To estimate those benefits, the authors compare the percentage of U.S. GDP that is accounted for by our tort system with the percentage of GDP accounted for by the tort systems of other developed countries. They base all these percentages on the dubious Tillinghast-Towers Perrin report. The U.S. percentage is estimated at 2.2 percent, twice Germany's and roughly three times Japan's and the United Kingdom's. The average for the foreign countries in the comparison is 0.9 percent, so the authors of Jackpot Justice conclude that the benefits of the U.S. tort system are equal to only 0.9 percent of our GDP. The possibility that our more costly system might generate greater benefits (though not necessarily equal to the greater costs) is ignored. But a more serious weakness is the implicit assumption that a tort system generates benefits exactly equal to its costs. It might generate much greater benefits. Politics, which the authors assume lead to greater than optimal liability, might instead lead, in the countries they compare to the United States, to less than optimal liability. And even if investment in the U.S. tort system has been carried to the point at which the last dollar spent on the system generates exactly one dollar (no more) in benefits, the total costs may be far below the total benefits because average cost may be much lower than marginal cost. This is apart from the possibility that politics may have prevented our investing enough in the tort system to equate benefits and costs at the margin.
The authors' estimate of the benefits (= costs) of the average foreign tort system, when subtracted from the $865 billion "cost" of our system, results (with some further adjustments) in an estimate of an annual excess of costs over benefits of almost $600 billion. The figure, however--the authors' estimate of the net social loss created by our tort system--is, as I have tried to show, fictitious.
Posted by Richard Posner at 07:22 PM | Comments (18) | TrackBack (0)
Improving the Tort System-Becker
Posner 's criticisms of Jackpot Justice are right on the mark, as the authors of the study considerably exaggerate the cost of the tort system. Still, I agree with them that the tort system is not efficient and can be improved. I offer a few suggestions for how to do this that maintain the essentials of the American approach to using the legal system to correct harms inflicted by some actors on others, which is what a system of torts tries to do.
The old rule of caveat emptor, or buyer beware, is too rigid in a world where buyers of products, or of medical and other services, may be much less informed about possible risks than are the producers or doctors who provide them. Nevertheless, in the world of excessive and sometimes inefficient litigation that Jackpot Justice tries to measure, a bias in the tort system toward buyer responsibility is warranted. Such a bias would reduce the amount of litigation, and hence the social cost of the tort system, by discouraging lawsuits in cases where reasonably informed and careful consumers could have avoided being damaged. So a person who buys a cup of coffee that is excessively hot should nevertheless not be allowed to sue for burns caused by the coffee's spilling when driving with the cup on his lap. For common sense would indicate not to drive with hot coffee situated in a way that it may spill and cause harm. On the other hand, a tort should be possible if very hot coffee spilled and caused burns because sellers of coffee used defective plastic cups that would not be obvious to customers but could have been know to sellers.
Put differently, the presumption should be against buyers except in cases when an unreasonable degree of information or care would be required by buyers to avoid accidents that would cause them harm. The presumption should be against lawsuits in all other cases, including those where it is not clear whether reasonable buyers could have avoided harm. A presumption of caveat emptor would eliminate a sizable fraction of all tort cases that have been brought in recent years. More importantly, the cases eliminated would tend to have the highest social cost because these cases are likely to be litigated until the courts reach decisions that would tend to be more arbitrary and difficult to predict in advance by both plaintiffs and defendants.
To reduce the magnitude of the defensive and rent seeking spending rightly emphasized, although not accurately estimated, in Jackpot Justice, punitive damages should be restricted to no more than four times compensatory damages, except in rare circumstances, and when the damages are small so that a high ratio is necessary to stimulate any litigation by those harmed. To a first approximation, the multiple in punitive damages should be determined by the inverse of the probability that a real tort is discovered and litigated. For example, if the probability of bringing such a lawsuit is 1/3, punitive damages should be 2 times actual damages in order to bring the expected cost to producers of the torts, through the sum of compensatory and punitive damages, in line with expected damages.
Anti trust law uses the criterion of treble actual damages for antitrust violations to reflect that many violations are not discovered and prosecuted. Perhaps in product liability, medical malpractice, or other tort cases, the multiple should sometimes be larger than trebling, but only rarely or for small losses should it be higher than four times.
Jurisdiction shopping (often called "forum shopping”"by lawyers) is the practices whereby plaintiffs bring their cases to the jurisdictions that are most likely to be sympathetic to their claims among all the jurisdictions that are possible for any particular case. Such shopping has been criticized because some jurisdictions tend to be biased against defendants when they are large corporations with deep pockets, or for other reasons. A practice that leads to a bias against certain types of defendants is obviously not "fair", and it will tend to stimulate strategies by producers regarding the pricing of their products and the way they are produced that would often not be efficient.
On the other hand, to the extent that known biases also means greater certainty about outcomes, jurisdiction shopping would reduce the amount of extensive litigation. For defendants are more likely to settle early when they can predict an adverse outcome if their case were to be litigated through to a court decision. More generally, both sides may benefit from jurisdictional shopping if it leads to cases being brought in jurisdictions where outcomes are more easily predicted by both sides. One of the most costly aspects of litigation stems from outcomes that are not easily predictable, so that both defendants and plaintiffs would litigate extensively since they both may be confident that they will win. Shopping among jurisdictions tends to bring greater certainty about outcomes, even if it also leads to a bias toward plaintiffs.
Posted by becker at 06:02 PM | Comments (32) | TrackBack (0)
March 26, 2007
Private Property and Socialism: A Contradiction? BECKER
In March the National People's Congress of China passed a law to take effect in October that legalizes private property and gives it equal status to public property. As a matter of principle this is a revolutionary measure since the abolition of private property is a basic tenet of traditional socialism. However, de facto, China has long ceased to be a socialist country as the private sector has grown rapidly to produce about two-thirds of its GDP.
In 1989 I visited Poland as that country was beginning a transition from a socialist state to one based on private enterprise and private property. In a meeting with the head of the ideology department of the Communist Party, I asked whether private property is consistent with communism and socialism? His answer was that they were still debating that! The Polish Communist Party was shortly afterwards swept out of power before the ideologues could provide an official answer, but China has now given its own answer.
It is clear from the contentious debate over legalizing private property that its official recognition is a major step away from China's claim to be a socialist state. Although a law legalizing private property was proposed years ago, it was delayed until now by vocal opponents who correctly believe that widespread ownership of private property is inconsistent with socialism. Dissent this time, however, was not welcomed, and the 3000 delegates to the Congress overwhelmingly passed the law with only a few votes against. This legalization of private property, when added to the admission not long ago of entrepreneurs into the Communist Party, completes China's official recognition of the dominance of capitalism in its economy.
I will concentrate my remaining comments on likely consequences of the new law for the economic development of China. That nation has had an extraordinary development during the past 30 years, with an average annual growth rate of its GDP exceeding 7 per cent without any laws fully legalizing private property. The inference I draw is that official protection of private property is not essential in generating rapid development from low levels of income, and that China has had enough de facto protection of property to allow its private sector to grow rapidly from negligible levels to the predominant form of economic organization.
Despite limited official protection, houses, land, businesses, and corporate shares are privately bought and sold. Strong profit incentives encourage the formation of new businesses, investments in farms and companies, and improved productivity. Recent calculations indicate that the efficiency of China's economy improved at over 4 per cent per year since 1993, while the growth in capital per worker contributed an equal amount to its annual growth of 8.5 per cent in labor productivity. These are unprecedented achievements, especially when one recognizes too China's large improvements in output per worker during the 15 years prior to 1993.
I would qualify this very rosy picture in three ways. Studies indicate that long-term investments in agriculture have been discouraged by uncertainty among farmers about whether they can maintain possession of their land in the longer run. Numerous riots and other violent incidents have taken place in rural parts of China in protest against the forced expropriation of land by local governments that provide little compensation. Even the new law will not give farmers fully marketable rights over the land they now will own in principle but not fully in fact. City dwellers have also been increasingly concerned about the security of the ownership of their homes since they have faced expropriation of their land by city governments in need of land for other purposes. The new law states that compensation has to be offered for houses and land taken by governments, but is silent on how big the compensation should be,
I believe property rights that are much more secure than in the past are necessary to enable China to grow much further, and begin to join the club of higher income nations. The advanced economies that China would like to emulate protect software, patents, franchises, buyback provisions, complicated leases and property ownership clauses, and still other forms of tangible and intangible property. This protection is necessary if investment is to be encouraged in such forms of property that are increasingly important as an economy progresses.
Even with laws officially protecting private property of the type just passed, full protection requires an independent judiciary that enforces these laws in a reasonable and efficient way. Anglo-Saxon countries have been the best protectors of property rights in good part because that is how their legal systems operate. China lacks such a judiciary, and so enforcement of contracts of all types through the courts has not been guaranteed. Chinese courts are an arm of the central government, and have judges who do not even claim to be independent. Courts in China are known to be often arbitrary, which means that enforcement of laws and contracts is sometimes capricious.
If effectively implemented, the new law legitimatizing private property will have important implications for the future direction of the Chinese economy. That these implications are evolutionary rather than revolutionary is indicative of how far China has come from its socialist past
Posted by becker at 12:09 AM | Comments (10) | TrackBack (0)
March 25, 2007
Private Property in China--Posner's Comment
One would have to know a great deal more about China than I do to be able to evaluate the law that the Chinese legislature has just approved ("Property Rights Law of the People's Republic of China," March 16, 2007, available in English translation at http://www.lehmanlaw.com/fileadmin/lehmanlaw_com/Laws___Regulations/Propoerty_Rights_Law_of_the_PRC__LLX__03162007_.pdf) codifying private (and also public) property rights. Law on the books often differs from law in action (the Soviet Constitution of 1936 is a famous example), and so the new law may turn out to have rather limited significance--or may not.
If property rights are understood in practical terms, then socialist and even communist countries invariably recognize and enforce some private property rights (as well as of course the property rights of public entities). For a property right is simply a right to exclude other people from the use of some thing of value. So a tenant has a property right, and even in a communist country if someone enters without your permission the apartment you've rented from the state you can get the police to eject him. Firms buy factories in China without worrying, or at least without worrying much, that other firms might hire thugs to seize or burn down the factories; the police would prevent that kind of private expropriation. Even in its heyday, socialism (as distinct from communism) connoted merely redistributive taxation and public ownership of a handful of major industries; most property was privately owned and the owners had the full panoply of legal protections of those rights. A socialist country such as the United Kingdom once was (though it was a distinctly watered-down socialism, despite the pretensions of the British Labour Party) might provide greater practical protection to rights of private property than a disordered capitalist state that had incompetent or corrupt judges and police.
The problem is less socialism versus capitalism than statism versus private ordering. The threat to private property in a statist country is that the government will expropriate it. Apparently a good deal of that goes on in China, with local Chinese governments taking farmers' land and selling or leasing it for industrial or urban development. A major aim of the new property law appears to be to curb this practice. But whether the aim will be achieved will depend on implementation "on the ground," as it were. As Oliver Wendell Holmes argued in his famous article "The Path of the Law," from the standpoint of a lawyer and his client the law is merely a prediction of what government will do to the client if he does some act. That the act may appear to violate a law is just the beginning of the predictive inquiry. If because judges and police are corrupt or incompetent or inaccessible nothing very bad will happen to the client if he does an act that may be illegal, he is likely to go ahead and do it. So maybe local governments in China will continue seizing farmers' property. In a country of more than a billion people that despite its rapid development is still poor, has a weak legal infrastructure, and is rife with corruption, it must be difficult to implement national laws at the local level. The new law may turn out to be largely aspirational.
But there is more to property law, including the new Chinese law, than limiting governmental expropriation of private property. Becker rightly emphasizes the importance of a well-functioning system of property rights to the growth of developed economies. In an underdeveloped economy, with economic activity largely local, family ties and reputational concerns may be such effective substitutes for legal enforcement of formal rights that the costs of such enforcement may exceed the benefits. Some economic activities do not require investment, such as hunting and the gathering of wild fruits, nuts, or berries, and so the function of a property-rights system of encouraging investment may be unimportant. And a country that consumes but does not produce intellectual property may be better off refusing to enforce intellectual-property rights. And finally a poor country may not be able to afford the kind of legal infrastructure required to enforce complex property rights. This can create a chicken and egg problem, if the absence of such rights keeps a nation so poor that it cannot afford the necessary machinery of enforcement.
A notable feature of the new Chinese law (which occupies 45 pages in the English translation that I cited) is its detailed provisions regarding secured lending. Enforceable security interests enable lower interest rates, facilitating borrowing and lending, essential activities in a modern economy. These and other provisions of the new law should reduce transaction costs and--to the extent enforced, a key and open question--enable China to continue its rapid economic growth.
Posted by Richard Posner at 09:39 PM | Comments (14) | TrackBack (0)
March 18, 2007
Judicial Salaries--Posner
This past January 1, in his year-end report to Congress on the federal judiciary, which he heads, Chief Justice Roberts urged Congress to raise federal judicial salaries. They have not been increased (except for cost of living increases in some years), since a very large raise in 1991--from $89,500 to $125,100 for district judges (trial judges), and from $95,000 to $132,700 for circuit (appellate) judges. The current salaries are $165,200 and $175,100, respectively.
The chief justice's report is not analytical. It points out that federal judicial salaries have fallen in real (i.e., inflation-adjusted terms since 1969), but this is misleading because judicial salaries (cost of living increases to one side) are raised infrequently--and when they are raised, they are raised by a goodly amount. 1969, the base year picked by Chief Justice Roberts, was the year of a big raise (from $33,000 to $42,500 for circuit judges), and afterwards inflation ate away at the salary in real terms; and likewise after the next big raise, in 1991. As a result, in most years since 1969, federal judges' salaries have been lower in real terms than their current salaries.
What is true, however, as also pointed out in the report, is that federal judicial salaries are now well behind those of deans and professors at leading law schools, whereas they used to be comparable. And of course they are far behind the salaries of successful practicing lawyers. That has always been true, but a novel twist is that judicial salaries are now lower than first-year associates' salaries at New York law firms, when the associates' bonuses are included.
The chief justice's report states that the federal judiciary is facing a crisis because of the salary lag. It notes that 38 federal judges have left the bench in the last six years, and that 60 percent of newly appointed judges come from the public sector rather than from private practice, whereas the figure used to be only 35 percent.
To say that the wages in some job category are "too low" doesn't make much economic sense when one is talking about a job in the private sector. An employer who has trouble finding workers of the requisite skill and experience at the wage that he's offering will raise the wage. Even if there is an unanticipated demand for workers of a particular type, there will not be a "shortage"; the limited supply of workers will be allocated to the most urgent demanders, and other employers will substitute other inputs (including workers with less skill or experience) or curtail their output.
In the public sector, however, there is no automatic mechanism for equilibrating the supply of and demand for workers, so there may be shortages in particular jobs, and the existence of a shortage would be a signal that the legislature should raise the wages for those jobs. No such signal is being emitted in the judicial sector. There is not a shortage of applicants for federal judgeships, but instead an excess of applicants, as is true in many other government jobs (look how many people are running for President). But because there are no very definite criteria for appointment to a federal judgeship, there is a possibility that the queue for the jobs is dominated by low-quality applicants. Let us consider whether there is evidence of that.
Increased turnover could be a sign of job dissatisfaction due to a low wage. But has turnover increased? The Roberts report gets to the figure 38 by lumping in retirements with resignations. Federal judges (as I'm about to note) can when they reach retirement age (between 65 and 70 depending on their years of judicial service) either remain as senior judges, working part time, or retire, in which event they can take another job. The decision to retire is less likely to be motivated by dissatisfaction with salary than the decision to resign, and it also has less impact, since the alternative is continued service as a senior judge, normally part time. Resignations remain rare. Since the beginning of 2000, only 12 judges have resigned, out of a total of some 800. In the comparable six-year period 1969 to 1974, when there were only about 60 percent as many federal judges as there are now, 10 of them resigned, a higher percentage than in the last six years. Resignations of circuit judges are especially rare; there have been only 8 since 1981.
The most serious omission in Chief Justice Roberts's report is the other compensation that judges receive besides their salaries. Most judges who want to can teach a course or a seminar at a law school and receive another $25,000 in pay (the ceiling on outside income, apart from investment income and royalties, and a very low ceiling given current law school salaries—which benefits judges, since they can teach less to reach their ceiling, as it is an ever-diminishing percentage of a professor's salary). The federal judicial pension is extremely generous--a judge can retire at age 65 with only 15 years of judicial service (or at 70 with 10 years), and receive his full salary for life; nor does he make any contribution to funding the pension. The health benefits are also good. Above all, a judgeship confers very substantial nonpecuniary benefits. The job is less taxing than practicing law, more interesting (though this is partly a matter of taste), and highly prestigious. Judges exercise considerable power, not only over the litigants in the cases before them but also in shaping the law for the future, and power is a highly valued form of compensation for many people. Judges are public figures, even if only locally, to a degree that few even very successful lawyers are. And judges are not at the beck and call of impatient and demanding clients, as even the most successful lawyers are.
I do not mean to suggest that every successful practitioner would exchange his $1 million or $2 million (or greater) annual income for a judge's salary. But enough, out of a national population of a million lawyers, are willing to do so to enable the filling of vacancies in the federal courts, especially practitioners in their fifties who have built up a nice nest egg. So I do not think that the increased draw of new judges from the public sector is a function of salary lag. Partly it is due to the fact that the federal docket, especially at the district court level, is increasingly dominated by criminal, prisoner, and employment-discrimination cases, none of which are case categories particularly congenial to lawyers who have a commercial practice. Partly it is due to the fact that many highly competent lawyers prefer to work for government, for example as career prosecutors, rather than engage in private practice, so that competition from public-sector lawyers for judgeships is greater than it once was. And partly it is that ideology figures increasingly as a factor in federal judicial appointments, and both academics and career government lawyers are likely to have emitted clearer signs of ideological orientation than commercial practitioners.
Raising salaries would not do a great deal to attract commercial lawyers to judgeships. The lawyer who doesn't want to exchange a $1 million income for a $175,000 income is unlikely to exchange it for a $225,000 income--Roberts doesn't name a figure to which he thinks judicial salaries should be raised, but he can hardly expect Congress to raise salaries by more than 30 percent, and that only intermittently, so that inflation will eat away at the salary until the next jump. And one effect of raising judicial salaries would be to make the job a bigger patronage plum for ex-Congressmen, friends of Senators, and others with political connections, so that the average quality of the applicant pool might actually fall.
The best argument for raising judicial salaries, though not an argument that reflects well on the character of judges (but after all they're only people), is that people who have a great deal of discretion in their job, yet feel underpaid, may take their revenge by underperforming. If a judge works 2000 hours a year, so that his hourly fee is less than $90, and he feels indignant at being paid so little, he may decide to work fewer hours, delegating more work to staff, or to work the same number of hours but with less concentration, or to increase his nonpecuniary compensation by bullying the lawyers who appear before him. But this argument for raising judicial salaries is unlikely to receive a warm welcome from Congress.
But there is one compensation measure that is long overdue and could be effectuated at minimum cost to the federal fisc. That would be to introduce a cost of living differential. The cost of living differs very widely among different communities in the United States. Boston’s cost of living is 40 percent above the average for the nation; the cost of living in Kanakee, Illinois, is 12 percent below the average; and these are not the extremes. Modest cost of living differentials, constituting raises limited to high cost-of-living areas, for federal judges would go some distance toward remedying any perceived problem of judicial undercompensation.
Posted by Richard Posner at 08:42 PM | Comments (24) | TrackBack (0)
How to Use Pensions to Improve Judicial Tenure-Becker
Posner shows that salaries of federal judges are low compared to those of lawyers in private practice or academia, and judges' salaries have declined substantially over time relative to earnings of practitioners and law professors. This would imply that being a judge is now less attractive than in the past, but it does not imply that judges are underpaid. For one thing, the number of lawyers has increased greatly over time relative to the number of federal judges, so only a smaller fraction of the stock of good lawyers has to be attracted to the federal bench than in the past.
Underpaid jobs by definition have difficulty attracting and holding high quality workers. Posner's evidence indicates that resignation rates of federal judges are low, not high. It would be useful to know whether the quality of judicial opinions have declined over time, for that would be a way to determine whether the quality of judges has declined. One-way to measure whether quality has declined is to determine the trend in the frequency with which higher courts overturn the opinions of district and circuit judges, but that approach would have to hold constant both the difficulty of the cases and also the quality of the judges doing the overturning.
I believe that given Posner's discussion of judges' salaries, a high priority should be given not to adjusting their salaries, but to raising their pensions to induce more of them to retire before they are too old and have served 25, 30, or more years. Supreme Court Justices now serve an average of 26 years, and retire on average at age 80. I argued in an earlier post (see Becker, March 12, 2005) that lifetime tenure for Supreme Court Justices and federal judges is undesirable precisely because few judges resign. Low rates of resignations combined with large improvements in life expectancy mean that all federal judges, not just Supreme Court Justices, tend to stay on the bench for decades. The framers of the United States Constitution could not have foreseen the very large increases in tenure of judges when they stipulated that members of the Supreme Court would have lifetime tenure.
Judges who stay for decades run the risk of becoming isolated and out of touch with newer issues. Moreover, judges who are incompetent or lose their mental facilities can stay on for many years. Term limits for judges would be a good solution to such excessive tenure of many judges, but that would require a constitutional amendment for Supreme Court Justices, and would be politically difficult to implement for other federal judges. A different approach would be to employ the carrot instead of the stick, and use financial incentives to induce more judges to retire at reasonable ages. Posner indicates that judges already have generous pensions and health benefits, but their pensions can be made still more generous.
Suppose pensions were improved so that judges could retire after age 70, and/or after a certain number of years on the bench, at an annual pension that is 150 per cent of their salaries as active judges. A circuit judge would then receive about $250,000 per year if he retired and only $175,100 if he continues. That is likely to influence the retirement decisions of many judges. If a 50 percent retirement premium were too weak an incentive, the premium could be made larger. The financial burden on the federal budget of even large increases in the pensions of judges would be minor since judicial salaries are a tiny fraction of the budget.
Another way to encourage earlier retirement of judges would be to offer them several years of income as a bonus if they retire at say age 70, or after 15-20 years or so of service. Bonuses to encourage professors to retire were introduced by many universities after a federal law in the early 1990's prevented these institutions from forcing professors to retire. Data for the University of Chicago and other universities suggest that some 30 per cent of professors who reach their sixties accept a bonus of about two years salary plus medical benefits to retire then.
For most occupations it would not be wise to have pensions that are multiples of salaries. But judges are unusual since they have de facto lifetime tenure, and many of them do continue to serve for many decades until they are in their late 70's or 80's. Very high retirement pensions for federal judges seem to be a good way to induce them to retire at reasonable ages and lengths of tenure.
Posted by becker at 08:27 PM | Comments (10) | TrackBack (0)
March 12, 2007
Should Marriage be Subsidized? Becker
David Cameron, the leader of the Conservative Party, set off a considerable debate in Great Britain on marriage when he recently claimed "Families come in all shapes and sizes and they all need support [because]…married couples stay together longer. Therefore, there is a very strong case for supporting marriage [in the tax system]. Children do better if their mother and father are both there to bring them up". The Bush administration is also very pro-marriage, and in the past has considered using the tax code to encourage marriage.
Virtually all studies show that children brought up in intact families do better at school, and have fewer drug and delinquency problems, than do children whose parents divorced or never married. However, that evidence alone does not tell us whether or not children of divorced parents would have done poorly even if their parents had stayed together, perhaps because parental fighting creates an unpleasant atmosphere. Good evidence on the effects of divorced parents on children is much more elusive, but the limited material available confirms that divorce makes children worse off. This is partly because one-parent families have less money and time to spend on children, and because these families tend to live in worse neighborhoods. Moreover, the process of witnessing parents going through a divorce may also harm children.
A little evidence also indicates that being brought up only by mothers is harder on boys than girls, probably because boys benefit more when their fathers live with them. Since single mother families are so common among blacks, this finding has been used to help explain why young African-American males do a lot worse than young African-American females in school performance, delinquency, and on many other measures. Different outcomes between boys and girls of growing up in families without fathers suggest that this rather than which parents continue to live together is what harms children.
Even if having two parents in a household is beneficial to children, it is far from clear whether marriage per se benefits children compared to having parents who live together without being married. A further question is whether all two parent households, or only households with two biological heterosexual parents, benefit children? The statement by Cameron at the beginning of my discussion says that 'families come in all sizes and shapes and they all need support'. I am persuaded that children raised by two gays or lesbians do worse than children raised by heterosexual parents, although the evidence is far too limited to be certain about this.
The tax code of the United States require joint filing by married couples. This imposes higher taxes on couples when both work than if they were single partly because two low-income earners who marry might have too much income to qualify for the earned income tax credit, and would receive less if they do qualify. The progressive tax structure also penalizes two earner married couples, especially when their earnings are similar. Hundreds of other provisions also impose a marriage penalty, although they are mainly minor ones, while many provisions give small subsidies to married couples when only one of them works.
Any tax penalty imposed on two earner married couples has become more important during the past several decades because these couples are much more common. An obvious solution to a marriage penalty from joint filing would be to require, or at least allow, married couples to file separately and split their incomes. Separate filing is now the norm in virtually all other member countries of the OECD.
Subsidies to marriage could be easily implemented by allowing larger per person standard deductions to married couples than to single persons, but it is not obvious that the tax code should be manipulated to try to alter these family arrangements. Arguments based on the external effects of parental divorce and other separation decisions on children are often not applicable because the vast majority of parents do love their children. These parents take account of their children's interests in deciding whether to separate, and in their other decisions. Mainly for this reason, all countries leave the care of children to parents, except in extreme cases of neglect by parents.
Moreover, since justifications for marriage subsidies based on the positive effects of marriage on young children would not apply to couples without children, or with grown children, should subsidies be given to such families? Furthermore, suppose it were shown conclusively, the available evidence is mixed, that young children are worse off when both parents work. I doubt if there would then be much support for additional taxes on two-earner families, although the logic of doing this is the same as that for providing marriage tax subsidies.
Explicit marriage subsidies (or penalties) ,or taxes on two-worker families, will not have large effects on either marriage or the number of married couples where both work unless the subsidies (or penalties) were much bigger than would be politically feasible. But even if the tax system could be used effectively in these ways, it involves too much social engineering over choices by adult men and women. Except in extreme cases of child abuse and neglect where parental choices have sizable external effects on children, government interventions in family decisions tend to cause more harm than do good.
Posted by becker at 07:51 PM | Comments (34) | TrackBack (0)
Should Marriage Be Subsidized?--Posner's Comment
I agree with Becker that marriage should not be subsidized. The primary concern motivating proposals for a marriage subsidy is that children do better if they are raised in a household in which there are two parents. (It is an open question whether it makes a big difference whether the two parents are of the same or different sexes. My guess is that only if having parents of the same sex leads the child to be ridiculed by other children are children raised in homosexual households highly likely to suffer, and the more common such households become, the less ridicule there will be.) I assume it is true that children benefit from being raised in a household with two parents, but this point argues not for subsidizing marriages, many of which are childless (or the children are grown), as Becker notes, but for penalizing divorce or (if the parents are unmarried) separation (including deliberate single-parenthood).
Penalizing divorce, presumably limited to cases in which the divorcing couple has minor children, could operate as either a tax on or a subsidy of marriage: a tax because it would increase the cost of exit, but a subsidy because by increasing the cost of exit it would provide more security to each spouse. It is unclear which effect would predominate, and therefore it is unclear whether the amount of cohabitation would rise or fall relative to marriage whether or not there was also a penalty for dissolving a cohabitation when there were minor children.
I do not think there should be either a marriage tax or a marriage penalty. We are speaking here of Pigouvian taxes—that is, taxes designed to alter behavior rather than to raise revenue for government. The principal effect of a tax on or subsidy of marriage is likely to be to induce substitution of cohabitation for marriage, in the case of the tax, or of marriage for cohabitation, in the case of the subsidy. When an activity has a close substitute, the principal effect of a tax on the activity is to induce substitution for the taxed activity, and in the case of a subsidy to induce substitution of the subsidized activity. It seems unlikely that the decision to have children as a couple or as a single parent, or to stay together with the other parent after children are born and until they become adults, is strongly affected by the precise legal form of the relationship. Given no-fault divorce and the declining stigma of nonmarital sex, the practical difference between marriage and purely contractual forms of family relationship has shrunk to a point at which tinkering with the marriage rate through taxes or subsidies seems unlikely to produce social gains. Of course, a heavy tax on cohabitation (perhaps in the form of a heavy separation tax) would drive couples to marry--but an effect of taxing both divorce and separation might be to reduce the birthrate. This is not certain, however, because each spouse would have greater assurance that the other spouse would remain part of the household, to help take care of the children either through personal services or financially; and this assurance would increase the willingness to have children.
Of course even if there were an exact contractual substitute for marriage, as in domestic partnership laws in force in some states and some foreign countries, many people would have strong religious, moral, or sentimental reasons to prefer marriage to the contractual substitute, and a few people would have strong moral or political reasons to prefer the contractual substitute. These preferences should be honored. But it is not clear why the legal, including tax and subsidy, consequences of the choice should differ.
A serious social problem is created by the practice of some poor women of having children with no expectation that the father will participate in the support or upbringing of the children, but instead with the expectation that the government will support them. The practice--in which the role of government becomes that of financial father of children born out of wedlock--nurtures criminality and perpetuates poverty. Subsidizing the production of children by persons who because they are poor single parents lack the resources to support their children properly is highly dubious social policy. Welfare reform has reduced the problem but not eliminated it. Whatever the solution, it is unlikely to be a marriage subsidy. A man who does not want to be married and support children will marry if marriage is subsidized but will divorce or abandon his wife after pocketing the subsidy. To prevent this gaming of the marriage subsidy would require costly and probably futile enforcement efforts by the government.
David Cameron, the Tory leader, whom Becker mentions, bases his pro-marriage policy on the following sentiment: "There's something special about marriage. It's not about religion. It's not about morality. It's about commitment. When you stand up there, in front of your friends and your family, in front of the world, whether it's in a church or anywhere else, what you're doing really means something. Pledging yourself to another means doing something brave and important. You are making a commitment. You are publicly saying: it's not just about me, me me anymore. It is about we--together, the two of us, through thick and thin. That really matters." But more than 40 percent of British marriages end in divorce, suggesting that the public commitment involved in a wedding ceremony doesn't have much sticking power. True, the number of cohabitations that end in separation is surely much higher, but many of them are entered into with no expectation of permanence. So far as I am aware, those cohabitations that are entered into with such an expectation are no more (or perhaps not much more) likely to end in separation than marriages are to end in divorce.
Posted by Richard Posner at 07:29 PM | Comments (7) | TrackBack (0)
