23 Things They Don't Tell You About Capitalism

Some people are paid a lot more than others. Especially in the US, companies pay their top managers what some people consider to be obscene amounts. However, this is what market forces demand. Given that the pool of talent is limited, you simply have to pay large sums of money if you are to attract the best talents. From the point of view of a giant corporation with billions of dollars of turnover, it is definitely worth paying extra millions, or even tens of millions, of dollars to get the best talent, as her ability to make better decisions than her counterparts in competitor companies can bring in extra hundreds of millions of dollars in revenue. However unjust these levels of compensation may appear, we should not engage in acts of envy and spite and try to artificially suppress them. Such attempts would be simply counterproductive.

What they don’t tell you

US managers are over-priced in more than one sense. First, they are over-priced compared to their predecessors. In relative terms (that is, as a proportion of average worker compensation), American CEOs today are paid around ten times more than their predecessors of the 1960s, despite the fact that the latter ran companies that were much more successful, in relative terms, than today’s American companies. US managers are also over-priced compared to their counterparts in other rich countries. In absolute terms, they are paid, depending on the measure we use and the country we compare with, up to twenty times more than their competitors running similarly large and successful companies. American managers are not only over-priced but also overly protected in the sense that they do not get punished for poor performance. And all this is not, unlike what many people argue, purely dictated by market forces. The managerial class in the US has gained such economic, political and ideological power that it has been able to manipulate the forces that determine its pay.

Executive pay and the politics of class envy

The average CEO compensation (salaries, bonuses, pensions and stock options) in the US is 300–400 times the average worker compensation (wages and benefits). Some people are terribly upset about this. For example, Mr Barack Obama, the US president, is frequently quoted criticizing what he sees as excessive executive pay.

Free-market economists see no problem in this pay disparity. If the CEOs are paid 300 times more than the average worker, they say, it must be because they add 300 times more value to the company. If someone does not have the productivity to justify her high pay, market forces will soon ensure that she is sacked (see Thing 3). Those who raise issues with executive pay, like Mr Obama, are populists who engage in the politics of class envy. Unless those who are less productive accept, they argue, that people need to be paid according to their productivity, capitalism cannot function properly.

One could almost believe in the above arguments, if one made a small concession – ignoring the facts.

I am not disputing that some people are more productive than others and that they need to be paid more – sometimes a lot more (although they should not be too smug about it – see Thing 3). The real question is whether the current degree of difference is justified.

Now, accurately totting up executive pay is very difficult. To begin with, the disclosure of executive pay is not very good in many countries. When we look at compensation as a whole, rather than just salaries, we need to include stock options. Stock options give the recipient the right to buy a certain number of the company’s stocks in the future, so they do not have an exact value in the present and their value needs to be estimated. Depending on the methodology used for the estimation, the valuation can vary a lot.

As mentioned earlier, bearing these caveats in mind, the ratio of CEO compensation to average worker compensation in the US used to be in the region of 30 to 40 to 1 in the 1960s and 70s. This ratio has grown at a rapid rate since the early 1980s, reaching around 100 to 1 in the early 1990s and rising to 300–400 to 1 by the 2000s.

Contrast this to the changes in what the American workers get. According to the Economic Policy Institute (EPI), the Washington-based centre-left think-tank, the average hourly wage for the US workers in 2007 dollars (that is, adjusted for inflation) rose from $18.90 in 1973 to $21.34 in 2006. That is a 13 per cent increase in thirty-three years, which is around 0.4 per cent growth per year.[1] The picture is even bleaker when we look at overall compensation (wages plus benefits) and not just wages. Even if we look at only the recovery periods (given that worker compensation falls during recessions), median worker compensation rose at the rate of 0.2 per cent per year during 1983–9, at the rate of 0.1 per cent per year between 1992 and 2000 and did not grow at all during 2002–7.[2]