Executive Pay and Donald Trump.

IB BUSINESS & MANAGEMENT AND IB ECONOMICS.

From ‘Brexit’, to the election of Donald Trump as US president, a number of recent world events have surprised and shocked many people.

Can we link anything on the IB Economics and IB Business & Management syllabuses to these profound changes in politics, society and economics? Can business and economics explain anything about these happenings?

Of course it can!

Let’s look first at executive pay (Section 2.4 of the Business syllabus, salaries and remuneration) . As Ha-Joon Chang points out in his masterly book “23 Things They Don’t Tell You About Capitalism“, the salaries (or more accurately the compensation packages) of senior US company executives has increased dramatically over the past few decades. In Chapter 14 of his book, “US Managers Are Overpriced”, Chang produces some astonishing statistics to back up his claim in the title of the chapter. He says that in the 1960’s the ratio of CEO compensation to average worker compensation used to be in the region of 30-40 to 1; in the 1990’s this ratio rose to about 100 to 1, and in the 2000’s to an astonishing 300-400 to 1 (P150).

How do economists explain such a huge rise in executive pay in US corporations? Demand and supply of course!  (Section 1 of the syllabus, Microeconomics) The reason why executive salaries have risen so high, they say, is that the demand for such skilled and able managers far exceeds their supply . Companies have to pay these managers such high salaries because,  if they don’t, they would be poached by their competitors. Moreover, these high salaries just reflect the ‘ contribution’ (read productivity) that these executives give to the companies that employ them.

Chang comprehensively debunks this argument. He points out that it is mainly neo-classical, or free market economists (Section 2 of the syllabus, Macroeconomics), who believe this. US Executives would have to be ten times more productive than equivalent personnel just a generation ago and this is extremely unlikely (P151).

Moreover, why have average US worker wages remained stagnant? Is this because their productivity has remained unchanged over the past two or three decades? Again highly unlikely, says Chang (P152).

Average hourly US wages have remained stagnant since 1972. Source: Economic Policy Institute, “Wages and Compensation Stagnating,” 2011, based on Bureau of Labor Statistics data.
Average hourly US wages have remained stagnant since 1972. Source: Economic Policy Institute, “Wages and Compensation Stagnating,” 2011, based on Bureau of Labor Statistics data.

Chang also points out that US executives, in comparison to their foreign counterparts, are excessively paid. In 2005, Swiss and German CEO’s were paid 64 and 55 percent of their US counterparts’ salaries; Swedish and Dutch CEO’s were paid 44 and 40 percent respectively, and the Japanese a measly 25 percent (P152).

So what has all this got to do with the election of Donald Trump? A lot. Trump ran on a ticket saying that he was going protect the American middle classes and the jobs of working class Americans. He fed off the justifiable anger that many middle class and poor Americans feel about the stagnation of their wages and the consequent fall in their living standards.  He used the language of ‘them and us’ –  it is us against the ‘global elite’.

Source: Congressional Budget Office, Average Federal Taxes by Income Group, “Average After-Tax Household Income,” June, 2010.
Source: Congressional Budget Office, Average Federal Taxes by Income Group, “Average After-Tax Household Income,” June, 2010.

The diagram above shows how the after-tax income of the richest one percent of the US population has increased dramatically since 1979, while the income of the poorest twenty percent (or poorest forty percent)  has hardly changed. 

Who is this ‘ global elite’? According to Chang, it is composed of super-wealthy business executives, who for years have paid themselves bigger and bigger salaries and better and better compensation packages at the expense of their own employees (and indeed of their own citizens and  own societies).

“ The power of this managerial class has been most vividly demonstrated by the aftermath of the 2008 financial crisis. When the American and the British governments  injected astronomical sums of taxpayers’ money into troubled financial institutions in the autumn of 2008, few of the managers responsible for their institution’s failure were punished. Yes, a small number of CEO’s have lost their jobs, but few of those that have remained in their jobs have taken a serious pay cut…” (P155).

Sources of the diagrams: http://keepthemiddleclassalive.com/

Brexit – A Revolt Against Globalisation.

IB Economics & IB Business.

On Thursday June 23rd the British people voted in a referendum to leave the European Union ( EU). The value of the Pound promptly dropped 10% and stock markets around the word fell. As a British citizen myself who is on holiday in the UK, I thought that it would be apposite to make Brexit the topic of my next blog post.  Brexit is short for a ‘ British exit’ of the EU.

So what has Brexit got to do with the IB Economics and IB Business courses? A lot. The topics of ‘ globalization’, ‘ trading blocs’ and ‘ common markets’ appears in the IB Economics syllabus ( Section 4, International Economics) and ‘globalization’ is one of the key concepts that runs throughout the IB Business course. The impact on a UK business of Brexit would also come under ‘the external environment’ in the IB Business course ( Section 1, Businesses and their External Environment).

Why did Brexit caused such a shock in markets around the world and how can we link it to the courses that we study?

Up until last Thursday the orthodox economic, business and political view was that globalization ‘is a good thing’. Globalization means the ” increasing inter-connectedness of the world, in all areas – economic, political, technological, social and cultural”. ( See blog post entitled ‘The Course Key Concepts‘ for some definitions of globalization). For businesses globalization opens up both opportunities and challenges. Opportunities include the ability to expand market share by selling in markets abroad, the ability to take advantage of economies of scale, the ability to cut costs by buying cheaper raw materials and by hiring cheaper foreign workers. There are potential challenges for businesses too – more competition from foreign competitors, the lowering of prices in markets and consequently lower profit margins, increasing threats to patents and copyright etc.

The EU, a trading bloc, is also an example globalization. In fact, it could be argued that it is an example of an attempt to accelerate the globalization process between and within a group of countries. The EU is a particular type of trading bloc, where not only goods and services are traded freely, but also the factors of production such as ‘labour ‘ and ‘capital’. Certain countries in the EU also share a single currency, the Euro, a situation known as ‘ economic and monetary union’. Those countries that belong to the Euro are highly integrated, both economically and politically. In order for countries to have the same currency, for example, they necessarily need to have the same monetary policies.

Britain never adopted the single currency, but it did adopt all the other obligations associated with being a member of the EU. So why did British voters vote for a Brexit?

Thousands of words can be written answering this question, but I will attempt to briefly outline what I think are the main reasons:-

1) One of the main obligations of being a member of the EU is adhering to the ‘free movement’ of labour rule. This means that anyone in any EU country has the right to find work in any other member country. One result for the UK of this has been a big increase in immigration from other EU member countries. For example, net EU migration into the UK in 2015 reached an all time high of 183,000, 53,000 higher than the previous year. This huge increase in the number of foreigners living in the UK has exacerbated social tensions, which, unfortunately, some right-wing and racist groups have actively attempted to exacerbate.

2) Disaffection with the current political system and current political elites, especially since the 2008 economic crisis. Many people in the UK were badly affected by the 2008 economic crisis and have suffered due to the policies the government has pursued since. Unemployment rose, people lost their properties because they were unable to pay off mortgages and others have seen the value of their properties fall. Moreover, due to ‘austerity’ measures taken by the government since, they have less access to high quality public services such as healthcare, housing and education. ( Austerity measures occur when governments reduce public spending to correct a budget deficit). In short, living standards have fallen for quite a lot of people in the UK.

3) An inability to see what the benefits of being part of the EU are. Membership of the EU benefits some people in the UK, but not all. Farmers, for example, receive a lot of subsidy money from the EU and have benefitted a lot, as have certain deprived inner-city areas, but many groups in society have not benefitted. Furthermore, any form of financial aid from Brussels is also accompanied by time consuming rules, regulations and bureaucracy, which seem to negate any benefits associated with it’s receipt.

4) Disillusion and dissatisfaction with globalization itself. Increasing competition from Chinese, Indian and US companies in the UK over the last few decades has resulted in the closure of many domestic companies. Workers have lost their jobs due to outsourcing. Those lucky enough to find another job are often forced to accept part-time contracts, or very short term contracts, with lower wages and worse terms and conditions. In short, their lives have become more precarious and unstable.

The vote by the UK to leave the EU was certainly a surprise, a surprise to the financial markets, to the established political elites in both the UK and in Europe, and to the writer of this blog. It was also a ‘ thumbs down’ to globalization by UK citizens,  a phenomenon whose benefits have passed many by.

For more information on Brexit, listen to this excellent podcast on the subject by the USA’s National Public Radio.