Inequality, CEO Compensation and Thomas Piketty

Posted on May 27, 2014 by

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What do the three phrases in the title of this blog have in common?  This is not a trick question, although some may be tricked by the rhetoric that has come from these.  OK, you have had enough time to think about it.  The answer is:  Inequality is the “new” social justice term, median CEO compensation has reached $10 million per year, far above the lowest paid worker in a given firm, and Thomas Piketty has captivated liberals with his new book in which he (in about 700 pages) sees income inequality as unsustainable, especially the inequality between the highest paid CEOs and the average worker.  And now, why is it important to discuss these three together?  Let’s dig a little bit more.

Equality is all over the news recently, and I have even written about it here in this blog.  What do people usually mean when they complain about income inequality?  They usually mean that the wages or compensation between top and bottom of the organization of a firm are too far apart, creating unfairness.  Say the CEO makes 200 times the wage of the workers at the bottom.  That is defined as inequality–and it is unequal–and by definition unfair.  So when someone says wages are unequal they usually mean they are unfairly unequal.  If you press them, they will almost always be unable to define what is a fair wage or compensation gap.  I suppose for some anything but absolute equality would be unfair.  Most don’t go quite that far, but that leaves them mired in ambiguity.

I bring up CEO compensation because one of today’s (May 27, by Ken Sweet) AP stories is entitled “Median CEO Pay Crosses $10 Million in 2013.”  The article wasn’t critical of the 8.8% average increase, just reporting the fact of it.  But it turns out that perhaps Thomas Piketty, the newly discovered economic sensation from France, might just have quite a bit to say about both inequality in general and about CEO compensation as well.  Perhaps we may find he dwells entirely too much on CEO compensation.

On the relationship of Piketty’s new book, Capital in the Twenty-First Century (Harvard/Belknap, 2014), and the wage gap, I direct the reader to an excellent article by Brink Lindsey in reason.com on May 23, 2014.  The title, “What Thomas Piketty Gets Wrong About Capitalism,” gets to the heart of the issue, and the author succinctly informs us where Piketty has gone wrong:

l”,,,et’s assume Piketty’s numbers are right. And if they are, then all the Sturm und Drang over rising U.S. income inequality boils down to a complaint about trends at the very tippy top of the income scale—those 150,000 or so top earners who, in any given year, comprise the top 0.1 percent. (Of course there is considerable turnover in that group from year to year, and thus the specific members of the club change over time.)

Who are these people? Piketty relies on the analysis in a 2012 working paper by Jon Bakija of Williams College, Adam Cole of the U.S. Treasury Department, and Bradley Heim of Indiana University. According to their work, roughly 60 percent of the top 0.1 percent are executives, managers, and financial professionals (41 percent in non-finance, 19 percent in finance). Lawyers, doctors, and real estate developers make up another 15 percent or so, while media and sports stars constitute under 4 percent. Piketty surveys these data and concludes that “the new US inequality has much more to do with the advent of ‘supermanagers’ than with that of ‘superstars.'” (Lindsey, May 23, 2014).

Lindsey further writes:

“Here then is the crux of the matter, according to Piketty: “This spectacular increase in inequality largely reflects an unprecedented explosion of very elevated incomes from labor, a veritable separation of the top managers of large firms from the rest of the population.” And indeed, executive compensation has skyrocketed in recent decades: according to one measure, average compensation for CEOs has risen (in inflation-adjusted constant dollars) from about $1.1 million in 1970 to $10.9 million in 2011 (down from a peak of $18.2 million in 2000). Although the escalation in CEO pay is probably the most dramatic, other senior corporate executives have also experienced whopping increases in remuneration.” (Lindsey, may 23, 2014)

So there it is.  Piketty has focused on how the top of the top have “broken from the pack” in terms of income.  The top of the top is mostly the CEOs.  From this fact–and all it is is a fact–Piketty speculates that if the trend continues significant social and political unrest will arise.  The solution?  Some sort of 80% tax on certain income or compensation levels, levied globally, in order to bring back a measure of equality.  Piketty goes on to explain why these compensation levels may have grown so fast.  His favorite explanation is simply that CEOs are self-interested and therefore seek higher income (and are able to get it).  Perhaps I should give Piketty a little credit here.  I agree that CEOs can be self-interested, but would go even farther to say all humans can be self-interested.  So is he saying CEOs are inherently greedy, while the rest of us poor stiffs are just altruistic all the time?  It would certainly look that way to me. And he would be wrong.

But is is also interesting to note that the compensation of all those at the top of the top has increased, including lawyers, doctors movie stars and sports figures.  Is Piketty going to argue that these people are somehow more noble?  And if he says they are just as self-interested, then isn’t he attacking individuals whom very few of us would dare to criticize, for example, sports stars who have come from abject poverty to become incredibly well-off due to their talent, or doctors who are so skilled that their efforts save literally hundreds if not thousand each year.  That’s one slippery slope.

But there are other big problems.  What level of compensation is too high?  Is there some formula we can apply to determine when the ratio of highest to lowest compensated is too great?  Is the gap too wide when it reaches, say, 200 to 1, or 100 to 1, or 50 to 1?  Who decides?  What do we do to equalize?  How would a radical equalization solution affect not just CEOs but average workers?  Do we really believe it would have no unintended consequences?  Finally, what difference does a large income gap make?  Piketty’s data have been challenged by other economists, whose work indicates that all incomes have generally risen.  If one includes measures of well-being besides wages or related compensation–automobiles, smart phones, TVs, bathrooms, number of rooms in a house, kitchen conveniences, food of various prices and types, clothing choices and prices, etc., etc.–then even a wage gap may not be nearly as or at all significant.  In short, all this hoopla may not really matter, especially in the United States.

Before I close, think with me about your own economic well-being compared to your parents, grandparents and great grandparents.  If you are one of the envious 99%, ask your self whether you really are suffering?  I know my grandparents didn’t have indoor plumbing until the 1930s.  They didn’t have a car until then, and only one until they died.  They had only window air conditioning units after the mid-1950s, because almost no houses had central air until the 1960s.  Food choices were few, not particularly healthy in many cases, and often more expensive in relation to income than today.  Clothing was simple and very few families had more than two or three different outfits–and many styles were very expensive in relation to income.  Some goods and services were unheard or undreamed of that today we take for granted and pay little for.  The first computer took up the space of a large room, but had a fraction of the computing power of today’s laptops.  Today we have those powerful computers and on top of that we pay relatively little to get one and mere cents per day for internet service.  And what do I need to say about telephones (yes that is the full word, for those who never knew)?  We are well-fed, well-clothed and well-protected in general, and our standard of living is “light years” beyond the wealthiest ruler of past millenia.  Now tell me, what is so important about a wage gap in itself?  Thomas Piketty seems to be barking up the wrong tree, but he will have many avid followers.

I will be reporting more on Thomas PIkettys’s new book in weeks to come.  Full disclosure: I am now about 200 pages into it.  My initial reactions:  It is both dry and interesting, but no great revelations thus far.  His historical data is illuminating and potentially helpful.  His thesis has come out indirectly on a couple of occasions, but at least he isn’t Karl Marx–not yet anyway.

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