Tag: Supermanagers | Vivek Kaul

Thomas Piketty, a French economist, has taken the world by storm. His book Capital in the Twenty-First Century has been the second bestselling book on Amazon.com for a while now. Originally written in French, the book was translated into English and released a few months back in the United States.
Piketty’s Capital is not like some of the recent popular books in economics like Freakonomics or The Undercover Economist. It is a book running into 577 pages (if we ignore the notes running into nearly 80 pages) and is not exactly a bedtime read.
My idea is not to summarize the book in this column. That would be doing grave injustice to the book. Nevertheless I wanted to discuss an important point that the book makes.
A major but not so well discussed reason behind the financial crisis was the increasing inequality in the United States. Piketty discusses this in great detail in Capital.
The top 10% of the American population earned a little more than 50% of the national income on the eve of the financial crisis and then again in the early 2010s. In fact, if we look at income without capital gains, the top 10% earned more than 46% of the national income in 2010, which is already significantly higher than the income level attained in 2007, before the financial crisis started. The trend continued in 2011-2012 as well. In 1976, the top 10% of households earned around 33% of the national income.
The situation becomes even more grim when we look at the top 1% of the population. The top 1% of the households accounted for only 7.9% of total American wealth in 1976. This would grow to 23.5% of the income by 2007. This was because the incomes of those in the top echelons was growing at a much faster rate. The rate of growth of income for the period for those in the top 1% was at 4.4% per year. The remaining 99% grew at 0.6% per year.
A major reason for this inequality has been the pace at which the salaries of the top management of American companies have gone up. As Piketty writes“We’ve gone from a society of rentiers to a society of managers…Top managers[who Piketty calls supermanagers] have the power to set their own remuneration…or by corporate compensation committees whose members usually earn comparable salaries…in some cases without limit and in many cases without any clear relation to their individual productivity, which in any case is very difficult to estimate in a large organization.” This phenomenon was seen mainly in the United States, writes Piketty. But it was seen to a lesser extent in Great Britain and other English speaking developed countries in both the financial as well as non financial sectors.
In fact, Piketty even calls this phenomenon of senior managers being paid very high salaries as a form of “meritocratic extremism” or the need of modern societies, in particular the American society, to reward certain individuals deemed to be as “winners”. Interestingly, research shows that these winners got paid for luck more often than not. It shows that salaries went up most rapidly when sales and profits went up due to external reasons.
The solution to this increasing inequality of income was to some extent more education. But that is something that would take serious implementation and at the same time results wouldn’t have come overnight. How does a politician who has to go back to the electorate every few years deal with this? He needs to plan and think for the long run. But at the same time he needs to ensure that his voters keep electing him. If the voters don’t keep electing him in the short run there is nothing much he can do to improve things in the long run.
This is precisely what happened in the United States. Politicians addressed the issue of inequality by making sure that easier credit was accessible to their voters. Raghuram Rajan, currently the governor of the Reserve Bank of India, explains this very well in his award winning book Fault Lines: How Hidden Fractures Still Threaten the World Economy: “Since the early 1980s, the most seductive answer has been easier credit. In some ways, it is the path of least resistance…Politicians love to have banks expand housing credit, for all credit achieves many goals at the same time. It pushes up house prices, making households feel wealthier, and allows them to finance more consumption. It creates more profits and jobs in the financial sector as well as in real estate brokerage and housing construction. And everything is safe—as safe as houses—at least for a while.”
Hence, the palliative proposed by politicians for the increasing income inequality in America was easy credit. As Michael Lewis writes in The Big Short – A True Story “How do you make poor people feel wealthy when wages are stagnant? You give them cheap loans.”
While, the government and the politicians worked towards making borrowing easier, there is another point that needs to be made here. As income levels stagnated at lower levels, a large section of the population had to resort to taking on debt and this contributed to the financial instability of the United States. As Piketty writes in Capital “One consequences of increasing inequality was virtual stagnation of the purchasing power of the lower and middle classes…which inevitably made it more likely that modest households would take on debt, especially since unscrupulous banks and financial intermediaries….eager to earn good yields on enormous savings injected into the system by the well-to-do, offered credit on increasingly generous terms.”
So, it worked both ways. The government made it easier to borrow and the people were more than willing to borrow. As author Satyajit Das puts it “Borrowing became a substitute for rising incomes.”
This wasn’t surprising given that the minimum wage in the United States when measured in terms of purchasing power reached its maximum level in 1969. At that point of time the wage stood at $1.60 an hour or $10.10 in 2013 dollars, taking into account the inflation between 1968 and 2013. At the beginning of 2013, it was at $7.25 an hour, lower than that in 1969, in purchasing power terms.
The easy money strategy that has been followed in the aftermath of the financial crisis has again worked led to increasing inequality. The American stock market has rallied by more than 150% in the last five years and this has benefited the richest Americans.
In the five year bull run, the stock market generated a paper wealth of more than $13.5 trillion. In fact, in 2013, the market value of listed stocks in the United States went up by $4 trillion. This benefited the top 10% of Americans who own 80% of the shares listed on stock exchanges.
A similar thing happened in the United Kingdom, where the Bank of England admitted in 2012 that its quantitative easing program boosted the value of stocks and bonds by 25% or about $970 billion. Almost 40% of these gains went to the richest 5% of the British households.
Interestingly, the salaries of CEOs in the United States have continued to go up, even after the financial crisis. If one considers the Fortune 500 companies, the average CEOs salary is 204 times that of their rank and file workers. This disparity has gone by 20% since 2009.
At the same time, the income of the median American household fell to $51,404 in February 2013. This was 5.6% lower than what it was in June 2009. Further, the average income of the poorest 20% of the Americans has fallen by 8% since 2009. Given this, more than 100 million Americans are receiving some form of support from the government.
In fact new research carried out by Emmanuel Saez and Thomas Piketty reveals that between 2009 and 2012, the top 1% of income earners in the United States enjoyed a real income growth of 31%. Income for the bottom 90% of the earners shrank.
The point being that the Western world does not seem to have learnt from its past mistakes. As George Akerlof and Paul Romer wrote in a research paper titled Looting: The Economic Underworld of Bankruptcy for Profit, “If we learn from experience, history need not repeat itself.”If only that were the case!

Note: Not all data has been sourced from Thomas Piketty’s Capital in the Twenty-First Century. Some numbers have been sourced from Raghuram Rajan’s Fault Lines.

The article originally appeared in the June 2014 edition of the Wealth Insight magazine

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

Thomas Piketty is a professor at the Paris School of Economics. Over the last few months he has become the most talked about economist globally with the release of the English edition of his book Capital in the Twenty-First Century (The Belknap Press of the Harvard University Press). The original was written in French.
Capital has been the second best-selling book on Amazon.com for a while now. This is a rarity for a book which is not exactly a bed time read and runs into 577 pages (without including the nearly 80 pages of notes). But that is not a surprise given the important issues the book tries to address. In this book Piketty deals in great detail about the “distribution of wealth”.
As he writes “The distribution of wealth is one of today’ most widely discussed and controversial issues. But what do we really know about its evolution over the long term? Do the dynamics of private capital accumulation inevitably lead to the concentration of wealth in fewer hands, as Karl Marx believed in the nineteenth century? Or do the balancing forces of growth, competition, and technological progress lead in later stages of development to reduced inequality and greater harmony among the classes…?”
In this interview he speaks to Vivek Kaul. Kaul is the author of the Easy Money trilogy which deals with the evolution of money and the financial system and how that led to the current financial crisis. The second book in the trilogy Easy Money—Evolution of the Global Financial System to the Great Bubble Burst releases in June 2014.

Excerpts:

You write that “It is an illusion to think that something about the nature of the modern growth or the laws of the market economy ensures the inequality of wealth will decrease and harmonious stability will be achieved”. Why is that incorrect? Has capitalism failed the world? Capitalism and market forces are very good at producing new wealth. The problem is simply that they know no limit nor morality. They can sometime lead to a distribution of wealth that is so extremely concentrated that it threatens the working of democratic institutions. We need adequate policies, particularly in the educational and fiscal areas, to ensure that all groups in society benefit from globalisation and economic openness. We want capitalism to be the slave of democracy and the common good, not the opposite.
A major part of your book deals with how capitalism leads to inequality…
History tells us that there are powerful forces going in both directions — the reduction or the amplification of inequality. Which one will prevail depends on the institutions and policies that we will collectively adopt. Historically, the main equalizing force — both between and within countries — has been the diffusion of knowledge and skills. However, this virtuous process cannot work properly without inclusive educational institutions and continuous investment in skills. This is a major challenge for all countries in the century underway.
What is the central contradiction in capitalism? How does that lead to inequality?
In the very long run, one powerful force pushing in the direction of rising inequality is the tendency of the rate of return to capital rto exceed the rate of output growth g. That is, when rexceeds g, as it did in the 19th century and seems quite likely to do again in the 21st, initial wealth inequalities tend to amplify and to converge towards extreme levels. The top few percents of the wealth hierarchy tend to appropriate a very large share of national wealth, at the expense of the middle and lower classes. This is what happened in the past, and this could well happen again in the future. According to Forbes global billionaire rankings, top wealth holders have been rising more than three times faster than the size of the world economy between 1987 and 2013.
That clearly is a reason to worry. Why are you confident that in the years to come economic growth rate will be lower than the return on capital. What implications will that have on capitalism and the inequality that it breeds?
Nobody can be sure about the future values of the rate of return and the economy’s growth rate. I am just saying that with the decline of population growth in most parts of the world, total GDP (gross domestic product) growth rates are likely to fall. Also, as emerging economies catch up with developed economies, productivity growth rates are likely to resemble what we have always observed at the world technological frontier since the Industrial revolution, i.e. between 1 and 2% per year. With zero or negative population growth, this suggests that total GDP growth rates will fall much below 4-5%, which has been the typical value for the average rate of return to capital in the very long run.
So what is the point that you are trying to make?
My main point is not to make predictions, which by nature are highly uncertain. My main point is that we should have more democratic transparency about how the different income and wealth groups are doing, so that we can adjust our policies and tax rates to whatever we observe. As long as top groups grow at approximately the same speed as the rest of society, there is no problem with inequality per se. But if the top rises three times faster than the size of the economy, you need to worry about it.
Your book is being compared to Karl Marx’s Capital. How different is your work from his?
One obvious difference is that I believe in private property and markets. Not only are they necessary to achieve economic efficiency and development — they are also a condition of our personal freedom. The other difference is that my book is primarily about the history of income and wealth distribution. It contains a lot of historical evidence. With the help of Tony Atkinson, Emmanuel Saez, Abhijit Banerjee, Facundo Alvaredo, Gilles Postel-Vinay, Jean-Laurent Rosenthal, Gabriel Zucman and many other scholars, we have been able to collect a unique set of data covering three centuries and over 20 countries. This is by far the most extensive database available in regard to the historical evolution of income and wealth. This book proposes an interpretative synthesis based upon this collective data collection project.
Any other differences?
Finally, Marx’s main conclusion was about the falling rate of profit. My reading of the historical evidence is that there is no such tendency. The rate of return to capital can be permanently and substantially higher than the growth rate. This tends to lead to very high level of wealth inequality, which may raise democratic and political problems. But this does not raise economic problems per se.
One of the most interesting points in your book is about the rise of the supermanager in the US and large parts of the developed world and the huge salaries that these individuals earn. You term this as meritocratic extremism. How did this phenomenon also contribute to the financial crisis?
According to supermanagers, their supersalaries are justified by their performance. The problem is that you don’t see it the statistics. In the US, between two thirds and three quarters of primary income growth since 1980 has been absorbed by the top 10% income earners, and most of it by the top 1% income earners. If the economy’s growth rate had been very high, rising inequality would not have been such a big deal. But with a per capita GDP growth rate around 1.5%, if most of it goes to the top, then this is not a good deal for the middle class. This has clearly contributed to rising household debt and financial fragility.

(Vivek Kaul can be reached at [email protected])

The interview originally appeared in The Corporate Dossier, The Economic Times on May 23, 2014

Of financial inequality and the financial crisis

Capitalism and the common good