Krugman is wrong

Paul Krugman is a brilliant man, he has a Nobel Prize in economics. I am not and I don't.

But Krugman is wrong on a very important point regarding the financial crisis. He thinks government should regulate bankers' pay (read it here).

He says the current method of compensation created an "incentive" for the abuses that brought the world's financial system nearly to its knees. Perhaps. It was certainly a factor. But there were many interacting factors, and we have to be careful about which we choose to "fix," and potential unintended consequences.

Compensation, or paychecks, is a perfect place to encourage the power of the market place, and absolutely the wrong place for government intervention.

What needs to be done is to foster consequences in the system, where firms that fail, and by definition those who lead them, are punished by the market, without threatening the entire system.

Generally this will mean making sure that bad decisions by one firm, say an AIG, don't threaten everyone's welfare. This can include limits on market share, capitalization requirements, reducing barriers to entry into a market so that competitors can flourish, etc. And, more than anything else, transparency.

It does not mean meddling directly in compensation issues. That is a guarantee of inefficiency, mediocre leadership, a lack of creativity and it crosses a line of how we want our financial system to function. Capitalism versus something else.

We don't want our government to govern companies directly, except to create a system that preserves itself and its function to society while allowing those companies to bring efficiencies, offer new products, and to fail when their decisions are faulty.

A fine distinction, perhaps, but an important one.