CEO Pay: American and European Values

To what extent do inequalities in wealth accrue based on structural elements, such as tax deductions that only wealthy people can use, as distinct from factors pertaining to individuals, such as talent, sacrifice, and effort? The two clusters can build on each other, as people who have become rich primarily by exercising a talent and working hard use some of their accrued power to “reform” the system to their advantage at the expense of the poor and middle class. Such structural reforms in turn can make it easier for wealthy people to become even richer. In the context of a society in progress, structural and idiosyncratic factors doubtlessly interact—the trend being of an increasing chasm between the rich and poor. 

 

 

For example, as the graph above indicates, CEO compensation in the U.S. increased at a higher percentage rate than did corporate profits and factory worker pay every year from 1990 to 2005. In 2010, CEO compensation increased 27% while workers saw their compensation increase just 2.1 percent. Meanwhile, the poverty rate increased from 12% to 14%. CEOs in the E.U. were making comparably less. Foreign Policy in Focus reports that in 2006, for example, “the 20 highest-paid European managers made an average of $12.5 million, only one third as much as the 20 highest-earning U.S. executives. The Europeans earned less, despite leading larger firms.” I suspect that societal values have a lot to do with the difference, though changes in the make-up of American executive compensation should not be ignored.

Specifically, the ratio of pay between an American CEO and factory worker has been increasing in part to the growing proportion of executive compensation in the form of stock options. However, it is also true that Americans are relatively accepting of very high incomes (and inequality). A European is more likely to say, Enough is enough once a CEO has made far more than he or she could ever use. Politically, this is reflected in the fact that the Green Party and the Party of the Left are more powerful (and represented) in Europe than in America. Although the American two-party system acts to cut off the “extremes,” I suspect that the proportion of Americans who would agree with a European far-left party is less than in the E.U.

According to Foreign Policy in Focus, “In the United States, only 32 percent of the public [in 2007 supported] an outright pay cap on executive earnings. But average Americans [appeared] to be every bit as outraged over CEO pay excess as average Europeans. Indeed, 77 percent of Americans [said that] corporate executives "earn too much.” This disconnect, which I submit does not exist in Europe, reflects the American value on economic freedom and the association of freedom with putting up with someone else’s objectionable views or conduct.

In Europe, during and after the recession of 2008, “the idea of raising taxes on high-income earners” gained currency. New E.U. and state taxes were proposed, including a tax on financial transactions (E.U.) and a one-time levy on high-income individuals. In the state of Britain, the tax rate on the highest segment was increased from 40% to 50%, and in the state of Italy the government was considering in 2011 an additional 5% tax on annual incomes above 90,000 euros and a 10% on incomes over 150,000 euros. Considering the increasing fiscal demands being put on the E.U. Government and the pressing debt situations in many states, the recessionary risk of increasing tax on the rich may well be worthwhile. Indeed, Liliane Bettencourt and fifteen other billionaires made an open plea for a special tax on the European rich. Recognizing that they had benefitted financially from the European “structure,” they wanted to help preserve it.

As valuable as closing budget-gaps by revenue and spending reforms at the state and E.U. levels is, the matter of addressing a cycle of increasing economic inequality remains unanswered. If a given societal structure acts as a multiplier effect on a given inequality—exacerbating it, in effect—then something more than a new tax may be needed. In other words, any bias in the system that increases the inequality can be neutralized by the addition of a countervailing structure. For example, placing a strict limit, such as $1 million, on what an individual can inherit—with the rest going back to society via the state—would act to counter the “snowball effect” of “old wealth.” At least as of 2011, a person can live comfortably on $1 million; the surplus, being essentially surfeit with respect to what  person is apt to consume, would be better used as a corrective of the tendency of wealth to further accumulate among the rich. In other words, just as banks with assets over $1 trillion are too big to fail, a billionaire getting richer may not be worth the “cost” to society in terms of the increased inequality—to say nothing of the probable compromise to a republic form of government (which can often be too easily bought).

In short, income and even accumulated wealth can reasonably be considered as applying generally to one’s life (and those of one’s kids and grandchildren) and more particularly to being used (i.e., spent). If one’s wealth vastly exceeds what can be spent on things one can consume, this might be an indication that the concentration has gotten out of hand, at the expense of society itself. In other words, if you have a bank account with a balance of $15 billion, do you really need $5 billion more?  Will you ever use it? There is an opportunity cost—part of which being contributing back to society and reducing the economic inequality. Even so, this way of thinking reflects a value on solidarity that is much more European than American, at least in terms of being valued. In other words, the typical American would be more likely to object to any limitation on economic freedom, even if the playing field is tilted in the direction of the wealthy being able to take disproportionate advantage of that freedom, irrespective of whether the additional wealth is usable.  

Sources:

David Gauthier-Villars, “Wealthy French Push for Extra Tax,” Wall Street Journal, August 24, 2011. 

Matt Krantz and Barbara Hansen, “CEO Pay Sours While Workers’ Pay Stalls,” USA Today, April 4, 2011. 

Sarah Anderson, “Executive Pay Debate Raging in Europe and the United States,” Foreign Policy in Focus, August 28, 2007. 

Banking on Buffett’s Bank

Beyond wondering what could Ken Lewis have been thinking when he ok’d Bank of America’s purchase of Countrywide, it might be worth pondering why the Dodd-Frank Financial Reform Law of 2010 did not mandate splitting up banks such as Bank of America, which with over $1 trillion in assets are too big to fail. In other words, is simply increasing their reserve requirements tantamount to gambling with the financial system in a reckless manner? Should the elected representatives of the people and the states in the U.S. House and U.S. Senate, respectively, have displayed more fortitude in resisting the banking lobbyists even when that industry was known to have been culpable in the 2008 credit crisis?

The risk still remaining in August 2011 was evident when Bank of America’s stock price went down to $6. According to the New York Times, “the speed of the descent and the surge in the cost of insuring the company’s debt awakened memories of the financial crisis, when companies like Bear Stearns and Lehman Brothers found themselves short of capital.” To be sure, BOA’s capital held at $218 billion at the end of June 2011 by one key measure, though some investors did not trust the bank’s numbers. Of course, when there is a run on a bank, a capital figure is almost irrelevant, as are claims that additional capital are not necessary. Fortunately, Warren Buffett ignored such an asseveration from Brian Moynihan, the bank’s $9 billion loss over the previous 18 months, and the bank’s increased reserves ($18 billion from $4billion in January 2010) for investors of soured CDOs. Not wasting time scheduling a meeting with Moynihan, Buffett went to the board and soon had a deal wherein the investor would put down $5 billion in exchange for preferred stock paying a guaranteed 6% annual dividend and warrants good for ten years for 700 million shares. Like Buffett’s $5 billion deal with Goldman Sachs, which netted the investor over $1 billion as of mid-2011, the BOA deal looks like a money-maker for him. In exchange, the bank gets a huge vote of confidence, which regardless of any capital needs, was of great value to the bank (as the other deal had been to Goldman even though that bank had not yet needed $5 billion in additional capital).

Tossing around $5 billion to Goldman (and $3 billion to GE, which had been relying on the repo market) and $5 billion more three years later—in both cases to buttress a bank too big to fail—ought to make clear to the rest of us that merely allowing the $1 trillion club of banks to continue to exist is itself of such systemic risk that high stakes gambling is necessary to avoid catastrophe. My point is that through our elected representatives, the American electorate has a choice; we need not accept the presupposition that economic liberty requires that even banks whose very existence represents systemic risk have a right to continue to operate as going concerns. To put it differently, Warren Buffett was 80 years old when he put together the BOA deal.

Isn’t there something precarious about an empire the size of the U.S. relying on an old man to keep a major bank from imploding due to the financial fallout stemming from a stupid decision to acquire a mortgage servicer on steroids? Had anyone from BOA bothered to do what Larry McDonald did while he was at Lehman—Dick Fuld’s Lehman for Christ’s Sake!—namely, simply going a restaurant near Countrywide’s headquarters in California to chat at lunchtime with a few of the many brainless salesmen wearing gold watches and driving new sports cars bought from the double commissions on the known-to-be junk mortgages—BOA’s managers and board would (hopefully) never have agreed to ingest the leprosy, let alone play with it and touch it. Strangely, Ken Lewis had a reputation at the time as an expert on M&A; after all, that is how he had expanded BOA. Nevertheless, Lewis on Countrywide seems a lot to me like Lee at Gettysburg (what could possibly been in the confederate general’s head as he disregarded Longstreet’s objections to Pickett’s charge?—Lee might as well have used a firing squad on the division and saved the Union army the trouble). I think we are too enamored with authority that comes with position, whether in corporations, government or religion.

In summary, relying on one rich old man to prevent the financial system from imploding from the demise of a bloated, misguided bank like BOA does not sound very prudent to me. We might as well make every American city into Las Vegas and paint the towns red. Forgive me but I have to ask, Do we really know what we’re doing, folks? Minding the store might mean slapping some hands (or worse) when our elected representatives get to playing too much with the self-absorbed banking lobby.

Sources:

Nelson D. Schwartz, “Buffett to Invest $5 Billion in Shaky Bank of America,” New York Times, August 26, 2011. 

Ben Protess and Susanne Craig, “Buffett’s Bank of America Stake Viewed as a Seal of Approval,” New York Times, August 26, 2011.

Royalty: Natural or Exaggerated?

On April 29, 2011, the world watched in utter fascination as a crown prince in one of the E.U. states married a wealthy commoner in London's Westminster Church--the same edifice in which Queen Elizabeth had married in 1947.  The prince is of course William, and his bride is Kate (or Catherine to the purists), who in one hour's time went from being the daughter of two wealthy commoners to royalty.  It is as though she leap-frogged from “the many” past “the few” to join “the one”--the firm. My question is whether these distinctions, involving birth as well as wealth, are natural in terms of human nature or exaggeraged artifices borne of excessive privilege and power.

The seemingly-eternal tripartite division was on display during the wedding, as throngs watched large screens in large parks and crowded pubs while a relative few, which had been invited to attend the ceremony in person, took their seats inside the church after which the royal family arrived with great attention to each individual member. Of course, “the one” literally refers to the person of the monarch, Queen Elizabeth II, who uniquely stood deliberately silent as the congregation sang “God Save the Queen.” One might ask whether having a living human be the subject of a national anthem evinces a category mistake wherein a person is taken for the nation as a whole (i.e., an abstraction). Does aristocracy go so far as to end up as standing for a nation itself?

Thomas Jefferson and John Adams both referred to a natural aristocracy of virtue and talent. Such differences do indeed exist between people, and thus are generally agreed to be quite natural. Indeed, most people view it fitting that distinguishing people by their character or effort is a perfectly valid basis for rewards. The two American founders also wrote of an artificial aristocracy based on birth and wealth. While nobility and royalty are typically associated with the latter, a monarch may also serve as a check on the sort of artificial wealth that grabs more than it is entitled to on the basis of character and effort. In other words, a king or queen, being in the job for life, can in theory protect titles from simply being bought. This potential benefit of royalty implies a downside to the aristocracy in the American republics wherein what counts is the size of one’s bank account rather than whether one has been raised well and is talented.

In virtually any of the American states, for example, a boorish used-car businessman or subprime mortgage salesman who has become newly rich by providing lemons could join a country club and thus be reckoned as part of his city’s aristocracy. Similarly, wealthy CEOs like Lew Glucksman and Dick Fuld of Lehman Brothers could be members of the most exclusive country club in New York and yet lack “gentlemanly traits.” Such qualities cannot be purchased like some commodity traded by investment banks; instead, a gentleman is fashioned from birth. Such natural aristocracy is beyond the reach of the vast wealth of the sort like the envious Glucksman and the childish Fuld even if they could buy themselves into exclusive country clubs. In a European state such as Britain, however, the monarch could theoretically forestall a grasping capitalist from buying a title. Hence, even a rich CEO in Europe can remain a commoner regardless of his or her wealth, which in an American state would clearly differentiate him or her from the masses in terms of exclusivity and privilege.  This is not to say, however, that European aristocracy and royalty are without their downsides.

That Kate Middleton, a millionaire’s daughter, would be lumped together with the other “commoners” only to become royal in marriage ignores the rather obvious economic distinction between rich and poor. That is to say, because of Kate's parents’ wealth, there was something artificial in Kate being referred to as a commoner before her wedding. Moreover, royalty itself might be a highly artificial construct in so far as royals come to believe they do not share humanness with other people.

The director Ken Loach points to the irrationality in the behavior of “commoners” when they ignore the artificiality that is in the expectations of royals. Good people “have knelt before the Queen at some point in their lives. . . . the woman you’re kneeling before represents all that is wrong with this country—inherited wealth, inherited privilege, the apex of the class system. Let’s have a bit more dignity than to crawl before that woman, please.” In other words, subjects as well as monarchs are adults and they should all act the part. There is something undignified for people such as the Middletons who created a business from scratch regressing to childlike behavior in front of a person simply because that person is regarded as the symbol of the state. Furthermore, there is something insulting in the royals referring to the Middletons as commoners because the appelation does not recognize the family's achievement in business.

Perhaps Europeans have the potential benefit in royals acting as a check on ugly usurpers grabbing off too much societally, yet at the cost of artificiality in the royal-aristocrat-commoner distinction wherein the common human denominator in all three is ignored or relegated. Ironically, I suspect that the royals themselves may be among the casualties in the severing of a recognition that we are all human beings. In addition to holding themselves to standards of behavior that may be at odds with human nature itself, royals may tend to forget that commoners are just as human as are nobles and royals. For example, we all die, and none of us knows what, if anything, is in store for us after death. So while there are real and artificial distinctions, there is also the shared basis in all of us being human. Accordingly, my instinct should I come in contact with a royal would be to relate to him or her simply as another person, whose need for genuine human contact is just as real as mine.

Source on Ken Loach: “Between Commodity and Communication: Has Film Fulfilled Its Potential?” International Socialist Review, 76 (March-April 2011), 28-44, p. 44.

See my related essay, "On the "Wedding of the Century': History Made or Manufactured?"

East Asia and Latin America: Economy & State

In the fall of 2011, the economic troubles in the developed countries were starting to hit fast-growing developing economies like China, Brazil and Indonesia. The governments of the developing countries were “girding themselves,” according to the Wall Street Journal, “to offset any economic and financial damage.” China’s government, for example, increased the investment of its sovereign wealth fund in Chinese banks. In September, China’s exports to the E.U. grew at 10 percent, compared with 22% in August. China’s increase in imports was also weaker, which did not bode well for emerging markets in Latin America and elsewhere that supply commodities for China’s construction industry.  Yet IMF projections depicted an interesting distinction between the projected increase of real GNP in Latin America and the developing Asian economies. The projections for 2011 were 4.7% and 7.9 percent, respectively. For 2012, the projections were 4.0% and 7.7 percent, again respectively. What can explain this pattern wherein Asian newly industrialized economies (NICs) were expected to fare better?

Economists might point to the regions having different mixes of industries as behind the difference in projected growth—some industries more affected by the global downturn than others. Economists might also point out that domestic markets are more mature, and thus resistant to external shock, in the Asian NICs. Political economists would likely bring up the strong/weak state variable, hence bringing in the element of government to explain the difference in the projected economic growth rates.

In their democratic incarnations, Latin American governments have been less resistant to popular pressure for increased government spending on consumption. This has come at the expense of government investment such as infrastructure projects attractive to foreign direct investment. In other words, the governments of the Asian NICs have had a stronger state in the sense that the governments have been better able to resist the demand by people for increased entitlement spending at the expense of investment oriented to industrializing. Such investment can include education/training and transportation networks. Managers at a corporation looking for a country in which to locate a factory, for instance, are apt to size up the local and regional transportation infrastructure with an eye to being able to bring in supplies in a timely manner and send off products—both to the domestic market and other markets. Also, the government of a poor country hoping to develop economically via attracting foreign direct investment invests in training facilities and attempts to reduce corruption, as foreign companies appreciate locally-trained labor and not having to pay bribes to government officials in return for being able to conduct business. Officials of strong states are less capricious, and thus less corrupt.

Asian NICs were able to industrialize in the last two decades of the twentieth century more so than Latin American countries in part because of a strong state—meaning more resistant to spending tax revenue away on immediate consumption at the expense of infrastructure investment. This “state” variable was salient in the scholarship of international political economy when the Asian tigers were pulling away from the Latin American economies in the 1980s.

Lest it be presumed that a strong state is necessarily better simply because it can be useful in industrializing a “LDC” (low developed country) into a NIC through foreign direct investment, it is also possible that a government that is more resistant to popular pressure can also be more resistant to democracy. If republics are susceptible to profligacy in spending on consumption while dictatorships can resist such pressure and attract foreign direct investment, then a sad tradeoff could exist between liberty and wealth. Of course, as many dictatorships have shown, the wealth garnered from licensing commodity extraction (e.g., oil drilling) can be quite concentrated domestically. The tradeoff may not reach the people.

Perhaps ideally, the state is weak, or pliant, at election time, when governmental sovereignty bows to popular sovereignty. As the government turns to governing, the state hardens up in resisting the passions of the masses for immediate gratification. The resistance entailed in governing can be oriented to a people’s best interests rather than to oppressing the masses. The IMF projections may indicate that the Asian NICs came out of the twentieth century better constituted than the Latin American countries in this regard.

Source:

Alex Frangos and Patrick McGroarty, “Troubles of West Take Toll on Emerging Economies,” The Wall Street Journal, October 14, 2011. 

Federalism & Business: States in India Deregulating for Economic Growth

The gross domestic product in India for the year ended March 31, 2011 was estimated to have grown at a robust 8.6%. Gordon Chang at Forbes argued that besides Delhi’s own fiscal and monetary stimuli, competition between the states of India for business was a formidable factor. Federalism, it turns out, can be good for business—yet at what cost? Chang omits this element, writing only that “As the states try to outdo each other, India’s investment climate improves.”

Chang cites Abheek Bhattacharya, who pointed to Tamil Nadu for its protection of property rights and Gujarat for its minimal regulations. Both states have been growing at double-digit rates. However, if the lack of regulations means that the economic growth has been at the expense of the environment and health of the citizenry, perhaps the weakness of the federal government is not such a boon to India. Federalism proffers the potential of a check and balance between the federal government and the state governments such that a “race to the bottom” element among the latter can be checked by a baseline of regulations issued by the federal government. To be sure, the latter is not without its own risks.

Whereas a race to the bottom risks the destruction of the country for short-term economic development, federal regulations risk a consolidation of power at the center. Federalism functions optimally if it is in balance. Chang undercuts such balance in suggesting that the “intense rivalry could even end up moving New Delhi in the right direction.” While such change would risk consolidation at the expense of federalism, Chang again cites Bhattacharya.

Although Bhattacharya had said on the John Batchelor Show that the states are essentially laboratories for nation-wide change, he had not meant that New Delhi would take over; rather, the more “laggard” states would simply realize that they need to “catch up” to the other states by loosening restrictions on growth. While evincing a “race to the bottom” in some respects, such convergence would not risk consolidation, as would New Delhi being moved “in the right direction.” Indeed, were the other states to join Tamil Nadu and Gujarat, any federal involvement should be antipodal to the deregulation at the state level to check any downsides. However, such a check and balance could risk eventual consolidation under the guise of protecting the environment and the Indian citizens.

In short, dangers exist in both runaway state and federal power. Just as economic growth and minimizing externalities needs to be balanced, so too must federalism for it to operate optimally as a system of public governance proffering governmental checks and balances. In a general sense, any system characterized by a maximizing variable that can break through the systemic constraints is doomed to implode. Accordingly, attention should be directed, at least in part, to the system itself so it may continue to be viable.

Sources:

Gordon Chang, “India’s Accidental Economic Formula,” Forbes, May 15, 2011.

Abheek Bhattacharya, “India Looks to the States,” The Wall Street Journal.

Automatic Standing: The American States in Federalism Cases

Unlike that of the E.U., the U.S. system of public governance is structurally biased toward  political consolidation at the expense of federalism. In fact, the bias extends to jurisprudence. This is evident in a ruling by the U.S. Court of Appeals for the Fourth Circuit on September 8, 2011 against Virginia on the 2010 federal health-insurance reform law.

According to the Wall Street Journal, at issue was “whether the federal government can require Americans to either carry health insurance or pay a fee starting in 2014.” In a unanimous opinion, a three-judge panel at the U.S. Court of Appeals for the Fourth Circuit in Richmond Virginia “found Virginia Attorney General Ken Cuccinelli lacked legal standing to bring his challenge. That threw out a ruling [in 2010] by a lower court judge who said Mr.Cuccinelli was entitled to sue and found the law’s requirement to carry insurance went beyond Congress’s powers under the U.S. Constitution. Mr. Cuccinelli, a Republican, had argued Virginia had standing because, shortly after President Barack Obama signed the health law, the state’s previous governor had signed a law saying the state’s residents shouldn’t be required to carry health insurance. But the Fourth Circuit judges found that law alone wasn’t enough to generate standing for Virginia, and the state couldn’t show it was directly burdened by the insurance requirement. ‘If we were to adopt Virginia’s standing theory, each state could become a roving constitutional watchdog of sorts; no issue, no matter how generalized or quintessentially political, would fall beyond a state’s power to litigate in federal court,’ Judge Diana Gribbon Motz wrote. She and the other two judges were appointed by Democratic presidents.”

Analysis:

In her statement, Judge Motz fails to grasp one of the fundamental mechanisms of modern federalism—namely, that the two systems of government—that of the states and the federal government—check and balance each other. This is necessary because governmental sovereignty is divided up between the two systems in modern federalism. The division and the related enforcement mechanism of “check and balance” are means of protecting the citizens’ liberty at the expense of tyranny (i.e., unaccountable government action). For modern federalism to work effectively, any encroachment on the sovereignty of one system by the other must be repelled. Otherwise, even one successful encroachment by one system could snowball into such an imbalance of sovereignty between the two systems that the federalism itself is defeated and the union is either de facto dissolved or consolidated with the people’s liberty paying the ultimate price.

Accordingly, governments of republics that are members of a modern federal system of governance have standing constitutionally, as semi-sovereign members, to challenge possible encroachments by the general government. I contend that Virginia had standing in the appeal because a Congressional over-reach based on the interstate commerce clause (i.e., the enumerated power authorizing Congress to regulate the commerce between two or more states) would be at the expense of Virginia’s sovereign sphere. Moreover, it is in the interest of the federal system itself, and the U.S. Constitution, that members or branches of one of the two systems of government have standing to contest over-extensions by a member or branch of the other system because otherwise one system could come to eclipse the power of the other (i.e., consolidation or dissolution).

It could be argued that Virginia’s standing is pretty obvious given Virginia’s membership in the U.S. federal system and the fact that Congress’s encroachment would be at the expense of the polity members because the federal law would bind the Virginia government. The fact that the appeals court is itself a member of one of the branches of one of the parties may account for the judge’s refusal to find standing.

In terms of the constitutional law jurisprudence, being burdened should not be required of Virginia in order for the republic to have standing; merely having an interest in terms of its sovereignty should be sufficient. Such an interest is triggered by a possible encroachment by Congress beyond its enumerated powers because the Virginia government would not otherwise be confined in its legislative, executive or judicial actions. Above all, it is in the interest of the federal system itself, and thus the United States, that both systems of government within the system have standing to contest any and all possible encroachments. Perhaps if the state governments’ standing were recognized where it is possible that Congress, the president or a federal court has unduly constricted the states’ semi-sovereign situs in the federal constitutional order, the U.S. system of public governance would be closer to federalism rather than consolidation. Given the extent of the latter, it would not be a bad thing to have each state “become a roving constitutional watchdog of sorts; no issue, no matter how generalized or quintessentially political, would fall beyond a state’s power to litigate in federal court.” Perhaps then a balance of power—and of the respective sovereignties—which is necessary for a modern federal system (i.e., not confederalism, such as in an alliance), would be within reach; the check and balance between governments that exists in viable federalism could once again function (if it ever did in the American context).

Source:

Janet Adamy, “Court Upholds Health Law,” Wall Street Journal, September 9, 2011.