Abstract
My education in economics, labor history and workforce management makes me concerned about the increasing concentration of wealth, the continued inadequate job creation, the increase in part-time and temporary jobs and the many underemployed workers. That reality is of course not limited to the United States. Unquestionably, it will be an issue in elections both in the United States and globally.
It is increasingly clear that in the current economic climate the next generation of workers—Millennials—will find it difficult, if not impossible, to live better than their parents. I have no idea when that goal was first expressed, but it is been central to the American ethos for decades.
Now the recent book Capital in the Twenty-First Century by French economist Thomas Piketty has triggered increased media attention to the situation. It is a heavy book both in the number of pages, over 600, and in terms of the subject. It is not bedtime reading as his argument is disturbing. Economist Paul Krugman calls it “the most important economics book of the year—and maybe of the decade.”
My purpose in this editorial is to highlight key points for specialists in compensation management. I believe everyone who works in compensation should be aware of his conclusions.
A thread that runs through the book is how equality/inequality changed through the last century. His primary measure of inequality is the percentage of national total income going to the top decile—that is the top 10% of earners. While the United States is discussed in more depth than other countries, he tracks the trends in several countries, and the patterns are strikingly similar.
He acknowledges that the diffusion of knowledge and technology over the past couple of decades has been a force for convergence among countries. As growing numbers of individuals in less developed countries are able to develop needed skills, the lower rates of pay have prompted global employers to move operations to those countries. Over time that raises pay levels in developing countries and with the reduced demand for the same skills in the United States and in other developed countries there is less pressure to increase pay levels. That is simple supply and demand.
For a time that hurt U.S. workers in industries that can operate or manufacture in overseas facilities. Reports from the last decade showed that millions of jobs in financial-services companies were transferred to offshore facilities. That was true for almost any occupation where work is done on a computer or by telephone. In the 2000s, the giant multinational companies shrank their U.S. workforces by 2.9 million, while upping their overseas employment rosters by 2.4 million. Now with the pay differentials reduced, there are reports that companies are moving jobs back to the United States.
A central point is the willingness of countries to invest in training for new high-demand skills. If governments are unwilling to invest, a generation of workers may not have the skills. That argument has been voiced recently by companies having trouble recruiting people with requisite skills. If that is allowed to continue it could prompt companies to once again relocate jobs.
But any convergence between countries is overshadowed by the rapid increase in income inequality starting around 1980. Inequality was high until World War II, with the top 10% controlling 40% to as high as 49% of the national income, peaking in 1928/9. Their share of the income fell to 35% when the world went to war and remained at that level until 1980. Since 1980 their share has risen steadily, except for a couple of years after 9/11, and is now back at the levels of the 1920s.
Although Piketty does not discuss it, since 1980 there has been a significant shift in the occupational structure of the U.S. workforce and a decline of unionization. The prominent economist Joseph Stiglitz contends, “Strong unions have helped to reduce inequality, whereas weaker unions have made it easier for CEOs, sometimes working with market forces that they have helped shape, to increase it.” The strongest unions now are in the public sector where there is a convergence of lower level pay levels with the highest salaries, with the latter held down by political pressure.
Piketty’s analyses have been criticized on two points. First, measures of income in the United States should take into consideration government transfer payments, primarily Social Security, which now are 17% of the total but were 1% in 1929. His analyses also fail to accurately consider the changes in tax laws. But those omissions would alter only the period to period comparisons. They do not materially change an assessment of the current gap.
Piketty’s analyses show that the dramatic increase since 1980 was enjoyed by the top 1% (those earning more than $352,000 in 2010 dollars). Prior to the recent recession (2007), that small group controlled almost 25% of the national income. With the market decline they fell below 20% but they are now back close to 20%. Immediately before the Great Depression the top 10% controlled almost 25%. The top 2% to 5% group controls 15%, roughly the same as the years before the depression. The similarity is striking and worrisome.
He attributes the financial crisis in 2008 to the “virtual stagnation of the purchasing power of the lower and middle classes.” That made it “more likely that modest households would take on debt, especially since unscrupulous banks and financial intermediaries, freed from regulation . . . offered debt on increasingly generous terms.”
He also notes the transfer of income—“on the order of 15 points”—from the poorest 90% to the richest 10% since 1980. The richest 10% “appropriated” three quarters of the growth in the economy from 1977 to 2007. The top 1% absorbed nearly 60% of the increase in income in this period.
An important issue in his analysis is the distinction between “wage” or “labor” income and income attributable to invested capital. Wage income fell with the Depression, and until the end of World War II salaries were essentially frozen in nominal terms. From the end of the war to roughly 1970 the top 10% earned a steady 25% of total wages—all pay levels then went up at more or less the same rate.
The pattern then began to change and the top 10% steadily increased their share of wage income and now command 35%. When investment income is added, their share increases to more than 45%.
A central point of his argument is the “rise of the supermanager”—the “explosion of very high salaries.” His data show that trend dates to 1980 and is evident in the United States, Britain, Canada and Australia—although the United States is more extreme.
Significantly the trend does not show up in the data for France, Sweden, Germany and Japan. In the early years of the last century Europe had far more inequality than the United States but that has changed dramatically. The situation in those countries shows businesses can prosper even when the executives are not paid excessively.
He discusses but dismisses the standard economic argument—“the illusion of marginal productivity”—that focuses on increasing productivity as the reason for the increase in supermanager salaries. His point is that education and technology may make employees more productive but if that explained the increases, it would have had a comparable impact in every country.
To quote from the book, It is rather naïve to seek an objective basis for their [executives] high salaries in individual “productivity” . . . [The high salaries] are generally set by hierarchical superiors, and at the very highest levels salaries are set by the executives themselves or by corporate compensation committees whose members usually earn comparable salaries.
His main point is that there is no justification for the pay increases in economic theory. He argues the pay setting process is driven by social norms, and that U.S. and British firms are “became much more tolerant of extremely generous pay packages after 1970.”
As someone who for a number of years focused on executive compensation, I know there is a degree of truth in his argument. It was in 1978 that the SEC changed its reporting requirements and for the first time the total compensation of senior executives was made public. It was also in that era that the compensation of athletes and entertainers was for the first time commonly reported by the media. Since then we have become accustomed to extremely high compensation levels reported matter-of-factly. On sports talk radio, I have become sensitive to the apparent acceptance of player salaries often in excess of $5 million by people who probably earn less than $50,000. Reports of high salaries are now routinely reported.
I realized years ago that executives often see their pay as a measure of their “value” relative to their peers in competing companies—with egos making it easy to justify increases! One of my favorite consultants from the past, Graef “Bud” Crystal, for years was an advocate for paying executives well but along the way changed his opinion and titled his last book, In Search of Excess: The Overcompensation of American Executives (1991). Interestingly the cover of his book carries a statement making the same point as Piketty but two decades earlier, “In the past 20 years the pay of American workers has gone nowhere, while American CEOs have increased their own pay by more than 400%.”
But it is no doubt true that executive pay and Piketty’s argument would not be a cause for concern if the compensation of the other 90% had kept pace as it did for roughly three decades after World War II.
He offers no solution to the compensation question. However, his analysis does raise an important point—the world’s economies would be growing faster and more jobs would be created if the aggregate purchasing power had grown at the rate that prevailed through most of the 1990s. Tighter credit also contributes to the slower growth (although many companies are reported to have large cash balances).
An issue that Piketty discusses in some depth is the minimum wage. His book, of course, was written long before the current debate on raising the minimum wage. I appreciate the argument that a higher minimum would cost jobs although the evidence I have read is not compelling. In many sectors the increased wages will be passed along in increased prices. One point is certain—the workers whose pay is increased would spend virtually every penny. That would increase demand along with the prospect for added hiring. In my opinion, the argument for increasing the minimum wage is compelling.
Compensation ultimately depends on supply and demand. Hiring of course also depends on demand for goods and services but the continued slow growth and economic uncertainty apparently has made employers reluctant to add full-time employees. That is a Catch 22 problem—slow economic growth and an uncertain economy mean payrolls are unlikely to increase, and spending will be stagnant. The solution is above my pay grade.
The most important point of the book is not the compensation question, however. It is that as long as the rate of economic growth is slower than the rate of return on capital, the gap in income for the superrich will continue to grow. I am concerned about their influence on society. I am also concerned with the political ramifications if the growth in inequality continues on its recent path. His graphs show no evidence the inequality is likely to reverse soon.