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/

Limited Liability – Good or Bad for Society? (Part 1)

IB Business & Management.

I.B. Business syllabus links – 1.2 – Types of organisation (plc´s), 1.2 – Limited Liability, 1.4 – Stakeholders, 1.3 – Profit maximization, 1.3 – Business ethics, 1.3 – business strategy, 1.6 – Growth & evolution

On the IB Business course we learn that businesses maximizing their profits is generally a good thing, that the concepts of limited liability and company legal structures such as the public limited company (plc)  are positive, useful things for society, and that a good business manager should consider the long term interests of all the stakeholders in the business. However, is the concept of limited liability really good for society, are plc’s and the way they are run nowadays positive for society, and do business managers really take into consideration the long term interests of all the stakeholders in the business?

Some business analysts think not. Ha-Joon Chang, in his popular book ” 23 Things They Don’t Tell You About Capitalism*”, argues that these things have in many ways been bad for society, that the way plc’s have been run over the last few decades has generated more social harm than good and that, in reality, the interests of just two groups of stakeholders – company shareholders and senior executives – have taken precedence above all others.

When capitalism and business as we know it now was in it’s infancy, owning and running a business was much more risky than it is today. If your business went bankrupt and you ended up owing lots of money to creditors you could have lost all of your personal possessions and have been thrown into a debtors prison. Nowadays we have this concept of limited liability whereby you only lose the original amount of money you invested in the business and your personal possessions are protected.

What a lot of people don’t realize, however, is just how controversial the joint stock company (the limited liability company as we now know it) was when it was first invented. Adam Smith, one of the founding fathers of economics and modern capitalism disapproved saying ” The directors of [joint stock companies] … being the managers rather of other people’s money than their own, it cannot well be expected that they would watch over it with the same anxious vigilance with which the partners in a private copartnery [ i.e. partnership with unlimited liability] frequently watch over their own. “ (P 13, Chang book). His disapproval of limited liability reflected the current wisdom of the time; people felt that managers of limited liability companies would take greater risks because they were managing companies funded in most part by other people’s money rather than their own. Indeed, when the joint stock company was first invented, only very speculative, risky ventures in the national interest took the form of joint stock companies, such as the Dutch East India Company set up by Holland in 1602.

As countries industrialized, however, and there was more and more of a need for investments in large, expensive investment projects such as railways, steel and chemical plants, limited liability companies became more and more popular.  Indeed, this is the main argument for the social usefulness of plc´s as institutional structures – they enable finance to be raised for big, risky investment projects which otherwise would probably not be funded.  Nowadays, they are taken for granted as being essential to the modern business world.

* = This is an excellent book which all IB Business and IB Economics students should read. See image below. I will be using it quite a lot in the next few posts I make. You can buy it on Amazon by clicking the link above.

Ha-Joon Chang´s book cover.
Ha-Joon Chang´s book cover.

Part 2 of this post will follow soon.