Sunday, November 26, 2006

Strategy and Tactics in the Class War

When critics of Republican economic policies of recent years speak out on subjects like the minimum wage, growing income inequality and rolling back tax cuts for the richest Americans, they are invariably met with complaints of waging class war.
Writing in the
New York Times, conservative commentator and cameo actor Ben Stein presents a sensible essay on the so-called class war, in which he cites one of the undisputed winners, Warren Buffett:
Mr. Buffett compiled a data sheet of the men and women who work in his office. He had each of them make a fraction; the numerator was how much they paid in federal income tax and in payroll taxes for Social Security and Medicare, and the denominator was their taxable income. The people in his office were mostly secretaries and clerks, though not all.
It turned out that Mr. Buffett, with immense income from dividends and capital gains, paid far, far less as a fraction of his income than the secretaries or the clerks or anyone else in his office. Further, in conversation it came up that Mr. Buffett doesn’t use any tax planning at all. He just pays as the Internal Revenue Code requires. “How can this be fair?” he asked of how little he pays relative to his employees. “How can this be right?”
Even though I agreed with him, I warned that whenever someone tried to raise the issue, he or she was accused of fomenting class warfare.
“There’s class warfare, all right,” Mr. Buffett said, “but it’s my class, the rich class, that’s making war, and we’re winning.”
One of the assumptions underlying complaints of class warfare is that the U.S. economy is a well-functioning free market that, left to its own devices and free of artificial mechanisms like the minimum wage, would fairly provide for all who want to work with reasonable compensation.
But the market for labor is not, for the most part, a pure spot market with constantly fluctuating prices; most of us don't negotiate our wages when we show up for work every day. (Day laborers, who do have their wages set by a spot market, don't fare very well.) Most of us work under a contract of some sort with a specified wage. Even those whose pay is based on sales commissions or other incentives know that their contracts are relatively fixed from year to year. Some of these wages are set through collective bargaining; some are established by the human relations departments. The exception are those entreprenuers whose fortunes rise or fall based on the performance of their businesses. But even people working for startups enjoy the benefits of employment contracts.
So most of us who work for a living experience a kind of floor under our wages. Sometimes distressed industries like airlines seek to negotiate lower wages, but it can't be done at the drop of a hat. Even industries that move their operations offshore have to break contracts with existing workers.

So the market for labor has numerous built-in mechanisms that limit the fluctuations of wages. Which is why I find it puzzling that one particular limitation to wage fluctuation--the minimum wage--is singled out as distorting the free market, particularly when wages for those at the top of the pyramid continues to climb.
It's not surprising that the legal and economic mechanisms that govern the way people are paid for their labor favor those with greater political and economic power, CEOs for instance. Complaints about runaway executive pay are hardly confined to class warriors; investors have been asking why CEO pay has been growing faster than returns to shareholders. After all, if CEO pay were determined by a free market, investor returns and CEO pay would roughly grow (or shrink) at roughly the same rate. Instead, CEO pay has continued to climb, in good years and in bad, for good companies and for failures, for the last 25 years.
Times today has a story on one of the mechanisms CEOs use to ensure that their wages continue to climb: the use of compensation consultants to establish peer group benchmarks, which creates the now-famous "Lake Wobegon effect" in which all CEOs are above average. All a board has to do is calculate the average compensation of their CEOs from a peer group of comparable companies. The key step is deciding to place your CEO deserves to ranked in the top 50 percent of the peer group (and few corporate boards would want to admit that their CEO is below average). The effect over time is a relentless ratcheting up of CEO pay. Former New York Stock Exchange CEO Richard Grasso used the system to jack his pay up to unprecedented levels:
One reason for the outcry was the makeup of the peer group that the exchange’s compensation committee used to determine Mr. Grasso’s pay. The group included highly profitable investment banks and financial institutions that were far larger and more complex than the Big Board, which, at that time, was a nonprofit organization.
Brian J. Hall, a Harvard Business School professor and an expert on management incentive systems, conducted an analysis of Mr. Grasso’s compensation and provided it to the judge overseeing the case that the New York attorney general’s office filed against Mr. Grasso.
Mr. Hall, hired by the attorney general as an expert witness, found that the companies the New York Stock Exchange board used in its peer group had median revenue of $26 billion, more than 25 times that of the exchange. Median assets of companies in the group were 125 times the Big Board’s assets, and the median number of employees in the peer-group companies was 50,000, or roughly 30 times that of the exchange.
As noted here last year, former DuPont CEO Ed Woolard, who became chair of the NYSE compensation committee in the post-Grasso era, has spoken out against the abusive practices used to place an ever-rising floor under CEO pay:
The NYSE experience with Grasso is a good case in point. The scandal was not just Grasso's pay, but the fact that his board didn't know what he was making. A board that lets a CEO take home enormous sums is often a board that isn't paying attention to other important matters of corporate governance.
Woolard debunks the myth that CEOs earn this pay by creating wealth for their shareholders. Decades of research has failed to identify a reliable correlation between CEO compensation and corporate performance.
By the way, what has become of the same forces of supply and demand conservatives cite when arguing against the minimum wage? Have we seen a sharp drop in the supply of would-be CEOs? Surely the demand hasn't expanded? We certainly haven't seen a corresponding spurt in the number of Fortune 500 companies.
There are other mechanisms, such as the tax code, that secure the economic interests of upper-income Americans, which brings us back to the question of federal deficits, which, as Ben Stein notes, were once known to cause alarm among conservatives:
But I thought that conservatives were supposed to like balanced budgets. I thought it was the conservative position to not leave heavy indebtedness to our grandchildren. I thought it was the conservative view that there should be some balance between income and outflow. When did this change?
Oh, now, now, now I recall. It changed when we figured that we could cut taxes and generate so much revenue that we would balance the budget. But isn’t that what doctors call magical thinking? Haven’t the facts proved that this theory, though charming and beguiling, was wrong?
Republican economic policy is built on magical thinking and the myth of the free market. If, as the evidence indicates, this myth is not supported by the evidence, what are we to conclude? Are these inequalities due to the invisible hand of pure market forces? Or do they reflect the interests of those who make the rules by which the market operates?


Anonymous Anonymous said...

Hi Tom! It's Shari - I just discovered your blog.
BTW, a very interesting front page NYT article today about the rich vs. superrich. It's truly astounding that so many have, and feel entitled to, so much, when others have so very little. The greed that comes through in that piece is just amazing.

11:18 AM, November 27, 2006  
Anonymous Anonymous said...

“There’s class warfare, all right,” Mr. Buffett said, “but it’s my class, the rich class, that’s making war, and we’re winning.”
They are buying their way to the finish line...winning is easy that way if unethical.

Great Post Tom!!

10:36 PM, November 27, 2006  
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12:15 AM, November 28, 2006  
Anonymous Anonymous said...

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6:08 AM, November 28, 2006  
Anonymous Anonymous said...

Tom -- The difference between union contracts and those jobs without union contracts is the idea of turnover negotiation. When one person leaves a position, the employer is able to negotiate with the new employee, which is impossible under a fixed union contract.

As far as the minimum wage is concerned, it really is a ruse to set the floor for union negotiations. Although I'm not terribly opposed to raising the minimum wage, I think it's a political wedge issue. If we really want to help poor people, we would increase the EITC. Poor people don't need 50c more per hour for their minimum wage job; they need a better-paying job.

Right on about executive comp, though.

9:04 AM, November 28, 2006  

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