Monday, February 17, 2014

Income Disparity

What if the rich deserve to be rich?

Gregory Mankiw asked the question in a New York Times column. He answered in the affirmative.

Take Robert Downey, Jr., for example. Downey starred in a movie called “The Avengers.” For his work he earned $50 million.  It’s a lot of money until you consider that the movie grossed $1.5 billion at the box office.

This does not tell us whether it would have grossed as much with another actor, but let’s grant the point. Nor does it tell us why there wasn’t a more equitable distribution of the profits.

No one much cares, Mankiw notes, that Lebron James earned $56 million in salary and endorsements last year. In his case, we know that very few if any human beings play basketball as well as he does. Thus, he is unique in ways that a movie star might not be.

Mankiw argues that we do not take offense at these outsized earnings because we can see what these people are doing. Their abilities are on public display.

He writes:

One reason seems to be that they understand how he earned it. … When people can see with their own eyes that a talented person made a great fortune fair and square, they tend not to resent it.

It is also worth emphasizing, Mankiw suggests, that entertainers are, strictly speaking, in our employ. We pay their salaries directly when we go to the movies or buy a pair of sneakers. If we resented them their earning power we can stop going to their movies or watching their ball games.

Also, he adds, the amount that you contribute to these salaries is relatively miniscule. What percentage of your movie ticket goes to the star actor: a quarter, a half dollar… it does not really impact your bottom line.

Of course, if you ask what entertainers and celebrities are contributing to the nation’s economy, their compensation feels somewhat out of joint.

Entertainment does not allocate capital or produce very many goods and services. Entertainers do not build highways or fight wars or cure illness. However much we console ourselves with the thought that entertainers are working for us, there is something strange about the fact that Robert Downey earns $50 million for pretending to be someone he is not.

Next to an entertainer, Mankiw argues, a CEO has an enormous value. It makes sense that someone who is good at it  earns a lot of money.

In Mankiw’s words:

A typical chief executive is overseeing billions of dollars of shareholder wealth as well as thousands of employees. The value of making the right decisions is tremendous. Just consider the role of Steve Jobs in the rise of Apple and its path-breaking products.

A similar case is the finance industry, where many hefty compensation packages can be found. There is no doubt that this sector plays a crucial economic role. Those who work in banking, venture capital and other financial firms are in charge of allocating the economy’s investment resources. They decide, in a decentralized and competitive way, which companies and industries will shrink and which will grow. It makes sense that a nation would allocate many of its most talented and thus highly compensated individuals to the task.

But, Mankiw continues, we do not see what CEOs do, so we tend to believe that they do not exactly earn their oversized compensation packages. This is especially true when we compare their wealth with that of the people who work for them.

He might have added that the media plays an important role in demonizing corporate executives, or, as the media calls them: colonialist, imperialist plutocratic oppressors.

The less you know about what someone does, the easier it is to slander and demonize him.

Mankiw should have noted that tech oligarchs have very good press—often because they are directly involved in the media—and thus that citizens tend not to begrudge them their phenomenal fortunes.

We often compare CEO salaries to those of a company’s janitors. Of late, the disparity has grown exponentially.

Yet, when we ask whether a star athlete or an actor deserves so much money we do not think of how much the hot dog vendor or the script girl makes. Apparently, we understand that the star athlete's talent is manifestly so much greater than that of the hot dog vendor that we understand why he earns so much more.

Perhaps we understand athletes, actors and musicians because we can all try to do what they do. We can try shooting a few hoops or playing a round of golf. We can act in the school play or auditioning for American Idol. When we do so, we gain respect for anyone who excels at such activity.

We do not, of course, have the opportunity to function as upper management for a time. The stakes are too high; the risks too many to allow just anyone to occupy such positions on a try-out basis.

Mankiw explains that we do not really know and do not understand what a CEO does. If we did understand it, we might believe that it is not so difficult.

His point is well taken. If the American public understood what went into being a CEO it would not have elected Barack Obama president.

On the other hand, a substantial number of corporate CEOs do not have such a great track record. Michael Tomasky offers a strident argument against them:

Every year for the last 20 years, the Institute for Policy Studies has looked at the compensation packages of the top 25 highest-paid CEOs as defined by the Wall Street Journal. That’s 500 spots. Of those, 112 were held by Wall Street CEOs who drove their companies to bankruptcy or bailout. Another 39 were held by CEOs who ended up being terminated. A final 38 were taken by executives who ended up paying fines or settlements arising from fraud charges. That’s 189 out of 500, or 38 percent. Basically, two of every five of America’s highest paid CEOs behaved in a way that, if they were regular workers, would have gotten them fired, disgraced, possibly prosecuted—maybe even jailed.

Tomasky would have done better to recognize that the corporate CEOs who failed on the job did suffer grievous penalties. Even after noting that bad CEOs were fired, fined or disgraced, he goes on to say that they should have been fired, penalized or disgraced.

Of course, if the job of CEO is that difficult, those people who do it well and honestly must deserve their compensation.

We live in a celebrity-driven culture and we sometimes believe that being an executive is just like acting like an executive in a movie. Thus we vote for the candidate who looks the part, not the candidate who is most qualified.

Based on no real evidence, Americans still consider John F. Kennedy to have been a great president.

Of course, there’s also the character issue. Anyone who had Robert Downey Jr.’s history of drug abuse and incarceration would never be considered for the job of corporate CEO.

Besides, celebrity does not look like work and does not seem to involve human connections. Entertainers and athletes excel at activities that we consider as leisure. We do not often see them as working.

Celebrities did not need to spend years cultivating contacts, building a network of relationships, clawing their way up through the ranks.

Moreover, celebrities do not need to set an example. When they need to keep themselves in the public eye, they can do it by being dissolute.

Celebrities are not “on” all the time. They are not ultimately responsible for the good of a corporation or for the national economy. Their responsibility begins and ends with their own performance.Even if an actor puts in a bad performance, the ultimately responsibility belongs to the producers. It’s one thing to strike out with the bases loaded in the World Series or to throw an interception in the Super Bowl, but it is quite another for an executive to destroy his company by taking on too much debt, hiring a bunch of thieves or trying to sell a product that the public does not want.

When something goes wrong with the economy, it makes very little sense to blame baseball players. They are not and will never be in charge.

If the financial system craters or freezes, we tend to hold those who are in charge of it accountable. The fact, in the 2008 crisis, that the titans of American finance did not seem to pay a sufficient price for what happened, strikes people as unfair and unjust.

This does not mean that many of them did not pay dearly for their dereliction. Think Dick Fuld. Yet, many people believe that more of them should have been held accountable when the system failed.

Outsized CEO salaries bring outsized responsibility. When the masters of the universe did not pay a sufficient price, the public believed that they have rigged the game and thus are not deserving of their pay.

We tend not to hold bureaucrats and government functionaries responsible for crises in the private economy because we do not see their heavy hands at work. Besides, most of them do not earn outsized salaries.

The exceptions are the heads of Fannie Mae and Freddie Mac. They made fortunes in the mortgage market, but were never held accountable for the crisis. Even today, no one much cares about their failures. 

They had friends in high places. And besides, the media narrative condemned the Bush administration and Wall Street CEOs.

Surely, the CEOs of financial institutions bear some responsibility. Yet, they were in many cases the only people who knew enough to try to right the system. And besides, others bore some considerable responsibility, too. The problem had, at least in part, been engineered by Congress, the Clinton and Bush presidencies and bank regulators. With the exception of the Bush administration-- in which Mankiw served, incidentally-- the other responsible government officials walked away from the crisis.


Memphis said...

You guys are applying logic and reason to an argument that is intentionally deceptive and divisive, relying on a lack of understanding by those who hear it and later vote. The 'inequality' argument politicians use is a lie. But they don't care, and they don't care if you can disprove it, just so long as their weak-minded supporters don't understand your arguments and keep using their feelings to make decisions with.

Anonymous said...

Yes, there are disparities in income. Always have been, always will be. Get on with it. The world is not perfect. Life is not fair. We have so many programs in place to redistribute income. We need MORE??? Really?