Compensation

A couple of days ago, I was involved in an online discussion with some folks I don't know--they were friends of a friend--about a startling statistic the AFL-CIO had published that day.

The statistic was that in a little over one calendar day, the average CEO of an S&P 500 company makes as much money as the average American worker makes in an entire year--and over the course of a year, 354 times as much.

The other side of the discussion was presented by folks who were quick to defend CEO compensation on the basis that what CEOs do is worth every penny of what they receive, and then some.  Their side was long on conservative economic orthodoxy and short on information.  Eventually our mutual friend pulled the plug on the discussion before it became too rancorous, but it was fairly clear where the debate was headed.

I thought I might take the opportunity to talk a little bit about something that frustrates me greatly.  That frustration is rooted in the quasi-biblical faith that economic conservatives place in the economic choices we began to make in the early 1980s, and to paint as "socialism" (gasp!) all efforts to save our fair-market capitalist system from the anarchist plutocrats who are intent on plundering the American economy.

As I have said recently, I am opposed to orthodoxy in all of its various forms.  I am interested only in results, in what works and what doesn't work.  There are no sacred cows on my farm.

First of all, I am a capitalist, not just in philosophy but also in deed.  For the last 10 years, I have worked only for myself, in my own companies.  Not a single dollar passed through my wallet during that time that was guaranteed to me because I held a salaried position in someone else's employ.  I have had opportunities, I suppose, to work for other people, but I prefer to work for myself because of the economic freedom it gives me.  Prosperity or starvation, it's all within my responsibility.

But not everybody is well positioned to do as I do.  I have an advanced degree, licensure, and skills that are valued highly by the market.  For example, in my law practice, when I am billing hourly, my clients pay as much as $400 an hour for my services.  (Don't be fooled; most of the work I do is compensated at a much lower rate.)  When I am setting my rates, the only people who get to weigh in on that point are (1) me and (2) the client who is paying the bill.

That is, the bargain for my services is a market transaction that is almost entirely unregulated.  Of course, the Bar has some rules about fees; I can't charge a fee that is "clearly excessive," whatever that means.  But no one is looking over my shoulder to decide what I can and cannot charge.

And as a rule that is how I think the labor transaction ought to go.  If CEOs can convince corporate boards to part with $12 million for a year's work, that's fine with me, all else being equal.  The problem I see with the pay ratio of 354:1 described above isn't that CEOs make a lot of money; it's that the other piece of the ratio is undervalued.

Capitalism is often described as the economy of the free market.  That descriptor is partially accurate but incomplete.  That market most conservatives advocate for is the "laissez-faire" market, in which government regulation and taxation are minimized or eliminated entirely.  The French words mean "allow to do," meaning that pretty much anything goes. 

In actuality, capitalism is the economy of the fair market, in which rules are established to ensure equity in market behavior and referees enforce those rules by imposing penalties on those who break them.  The equity being enforced can be described in some senses as a balance between individual freedom and common interest.  The ability of the rules and referees to balance these competing interests tends to lubricate commerce.

To provide an example, consider that you are hungry and wish to purchase a can of beef stew for your dinner.*  In the United States, because we have a (reasonably) fair market, that transaction is incredibly easy to accomplish in a way that satisfies you.  You simply go to the store, select your brand, pay the cashier, and hurry home.  You can feel confident about that transaction because the manufacturer (and retailer) are subject to rules about inspections, contamination, spoilage, the quality of the ingredients, the processing practices, disclosures about the ingredients and their nutritional value, disclosures about the manufacturing date and the expiration date, and even the identity of the company that is selling the product.  You can also rest assured that if something has gone both wrong and undetected, and you are injured, there is a mechanism for you to obtain compensation for your injuries, either administratively from the company or through litigation.

* - If you don't like canned beef stew, feel free to substitute any other food that you do like.

In a laissez-faire economy, with none of those regulations and no mechanism to obtain compensation if you are injured, you would literally take your life into your own hands every time you opened a can of beef stew.  (More than usual, that is.)  That would force you to spend a great deal of additional time scrutinizing your purchases, which makes them more expensive than the market price would indicate.

A further reason why the lack of regulations makes markets unfair is because well designed regulations impose the consequences of a transaction on the party best able to control those consequences.  Economists often refer to these consequences as "externalities" because the burden (or benefit) of those consequences generally falls on someone who did not choose to incur or receive them.  For example, consider a hog farmer.  The farmer incurs costs associated with hog production and receives payments for what he produces.  But hogs produce a lot of manure, which doesn't smell good (and must be borne by the farmer's neighbors) and can contaminate waterways when it runs off the farm (and must be borne, ultimately, by everyone).  In the absence of regulation, the farmer is enjoying the benefit of his economic activities without incurring all of the costs associated with them.  The manure smell and runoff are "unpriced negative externalities," meaning that they (a) aren't built into the price of the transaction, (b) cause harms, and (c) are experienced by others who aren't parties to the transaction.

A well designed set of regulations will force the farmer--who is in control of his operations and is in the best position to mitigate the externalities--to incur the cost of preventing those negative externalities from occurring.  Because this raises the farmer's cost, he is likely to raise his prices (or cut his production, which will also raise prices, all else being equal, because as supply goes down, price goes up if demand is constant), which means we all pay a little more for pork.  But that's OK, because the farmer isn't the only one benefiting from the transaction.  Pork buyers benefit, too.  When we pay a higher price for pork, we're sharing proportionally in the cost of preventing that externality.  That makes the market more fair.

More importantly, however, forcing externalities into the pricing equation makes it less likely that individuals will be able, unfairly, to gain at our common expense.  One symptom of an economy that suffer from too many unpriced negative externalities is a wide disparity in incomes and income growth.

To understand what I'm talking about, consider the plight of fast food workers.  Fast food producers are under enormous pressure to keep prices low because competition is fierce.  The largest component of fast food costs is generally the labor required to produce it.  Fast food producers have responded to this challenge by standardizing the preparation process to the point at which even illiterate workers can perform it to an acceptable standard.  The most financially successful operations constantly review and refine their practices to squeeze out every last penny.  In fact, many such operations cross the line into illegal conduct by forcing workers to work unpaid or outright stealing from their employees.

In a down economy, in which jobs are hard to come by, fast food producers have market power over their workers and can rachet wages down to the minimum (or below), because workers, especially the unskilled, have little other choice.  We enable that possibility by (a) keeping the minimum wage low, and (b) subsidizing fast food companies' workers through social welfare programs.  McDonald's, for example, has an extraordinarily high rate of food stamp eligibility among its workers.  Bear in mind, by the way, that these are people who work full-time hours, who are nonetheless eligible for (and receive) food stamps.

Now, I'm a big fan of the food stamp program, and I think it ought to be vastly expanded.  But if you are working full-time hours, you should not need to get a government subsidy to put food on your table, at least in most circumstances.

The justification for the minimum wage is not necessarily that all labor is deserving of at least a particular rate of compensation.  It's that the failure to impose a minimum wage, or to impose a sufficiently high minimum wage, creates unfair market conditions that favor the people who own fast food producers and other employers of low-wage jobs.  We, the taxpayers, aren't really subsidizing the food insecurity of needy people so much as subsidizing the cost of the externalities generated by the "free market" transaction between low-wage employers and their employees, to the benefit of the employers.

Government assistance to fast-food workers costs taxpayers about $7 billion a year, according to a recent study...which is about equal to the bonus compensation paid to top fast-food executives every year.  It's hard to think of a more stark, direct example of an unpriced negative externality.

If we imposed a minimum wage that required that low-wage companies pay a living wage to their employees, the effect would be to force those companies to bear the true cost of their labor instead of foisting a portion of it off onto taxpayers.

Such a move, and others designed to right our ship, is not socialism.  There is no central planning of our economy associated with these moves.  No one is talking about having a government agency determine all salaries or regulate in fine detail what transactions are allowed and which are not.  Rather, this is regulation for the benefit of the general welfare, which is supposed to be one of the main functions of our government.

If what the conservatives advocate worked, I would be the first person in line to sign up for it.  It just doesn't work.  It's time to try something else.  Real capitalism would be a good start.