Thursday, January 23, 2014

The tragedy of the corporations

In 1968, economist Garrett Hardin published an article in Science magazine titled “The Tragedy of the Commons”. Although the article has been criticized for its factuality, the concept itself — also known as “the tragedy of the fishers” — has been applied in other areas. Briefly stated: One business’ best practice, when replicated throughout an industry, may become a suicide pact. That is, each business may be acting independently and “rationally” as economists define rationality (that is, according to each business’ self-interest); yet taken as a whole they’re acting in a manner contrary to the best interests of the industry … and perhaps the national economy.

One good example is the buffalo-hide boom of the 1870s: The failure of the clothing industry to put a limit on demand through high prices practically insured that the great beasts would be hunted almost to extinction, with devastating effects on the Plains Indians who had built their lives and tribes around the buffaloes’ migrations. But none of this was the suits’ intent — they were simply trying to give the customers what they wanted, that’s all.

Economics is supposed to be an empirical discipline, concerned with how people do behave rather than how people ought to behave. Part of the problem with calling self-interested behavior rational is that self-sacrificial behavior is subtly, subconsciously apostrophized as irrational; any behavior becomes “moral” so long as you can make a business case for it. The boundary between is and ought is not only frequently crossed but was probably blurred to begin with. Moreover, it creates a false position in which economic laws become not just observed (or at least theoretical) relationships but something inviolable and self-enforcing as the laws of physics; invisible, indefinable “market forces” create an economic karma which punishes the unrighteous and creates order in the house.

The narrowness of vision imposed by self-interest becomes manifest in what we could call the Standard Capitalist View of Income and Wages:

To the executive,[*] revenue comes into his business by way of consumers and leaves by way of employees; where the consumer gets his money, and what the employee does with her wages, the executive neither knows nor really cares — as far as he’s concerned, the two buckets aren’t connected. After all, he makes turbojet engines, and his employees don’t buy turbojet engines, do they?

But the real flow of revenue and wages looks more like this:

Everything that employers pay in wages, bonuses and incentives can be thought of as going into a common pool from which the businesses then draw income through purchases of goods and services. The executive’s employees may not buy turbojet engines, but they do buy airline flights, and airlines buy not only passenger jets but also replacement engines. The turbojet manufacturer buys supplies and raw materials, and the money he pays for these goods is also partially transformed into wages, some of which may or may not go towards airline tickets. Then again, the manufacturer occasionally has to send representatives off on business trips ….

In sum, once we view the flow of money as a cycle rather than simply as  a collection of streams with unknown sources and unknown destinations — once we realize that employees are consumers and consumers are employees — it becomes apparent that the individual businesses’ deliberate efforts to hold down wages become the group’s inadvertent collective effort to depress consumption. Investors are consumers too; however, consumption by investors can’t by itself uphold the cash flow cycle.

Now let’s look at some statistics: Since 1980,
  • Gross domestic product rose 104.62%.
  • Corporate after-tax profits rose 198.79%, per employee 106.85%;
  • The median income of the top 5% rose 72.53%.
  • Industrial capacity is at 79%, down 6.18%, the lowest it’s been since 1978;
  • Labor force participation fell a net of 1.88%;
  • The Consumer Price Index rose 200.75%, while
  • The median income of the bottom 80% only rose 8.12%;
  • The consumption/income ratio — spending as a proportion of income — rose 6.38%;
  •  Consumer debt per household went up 96.33%; and
  • Personal saving rate went down 59.62%.
Since 1999,
  • Gross domestic product is up 26.21%;
  • Corporate after-tax profits are up 167.25%, per employee 146.31%;
  • The median income of the top 5%: down 2.40%.
  • Industrial capacity is down 3.42%;
  • Labor force participation is down 6.55% from a March 2001 of 67.2%;
  • The Consumer Price Index is up 42.43%;
  • The median income of the bottom 80% is down 10.58%, with the bottom quintile down 15.90%;
  • Consumption/income ratio is up 4.46%;
  • Consumer debt per household is up 16.25%; and
  • Personal saving rate is down 26.32%.

In that time, the US Gini coefficient, a rough measure of income inequality, went from 0.403 to 0.477, putting us roughly among such economic powerhouses as Venezuela, Uruguay, Guyana and South Sudan. In particular, from 1978 to 2012 CEO compensation jumped roughly 875%; as a ratio when compared with average employee wages, it jumped from about 29:1 to about 278:1. In fact, CEO compensation grew faster relative to other very high wage earners than the wages of college grads grew relative to high-school graduates. As I’ve pointed out elsewhere, the majority of the noveaux riches no longer become rich through investment but through overly generous executive compensation packages.

Source: Economic Policy Institute.
Again, as I’ve stated in a previous post, this is not an argument that the top 1% are greedy, evil monsters or that no one has a right to be wealthy; in fact, I conceded quite readily that a just compensation scale differentiates according to education, training, experience and scope of responsibility. Nor does blame for the situation reside solely in executive compensation. The math practically dictates that any effort to keep profits and labor expenses proportional will result in prices climbing faster than wages, which is why I suggest greater profit-sharing and employee ownership efforts. Nor is the rise in consumer debt pure consumption; it’s also partially rising tuition and healthcare costs. Ironically, the median wage of college grads is declining even as college loan debt escalates.

Nevertheless, it turns out that B. Lester’s comment about people “pathologically hoard[ing] so much cash that they impoverish the entire nation” isn’t mere demagoguery or economic illiteracy … it’s an empirically demonstrable fact. The money has to be spent in either ordinary consumption or capital investments proportionally to its collection in order to fulfill its role in a strong economy; it can’t just be stuck in safes or wagered in “investments” that simply trade debt instruments back and forth. Unfortunately, the money’s not being spent.

Moreover, it’s clear that there’s a badly-flawed theory of value in play which overestimates the contribution of executives and undervalues the contribution of nonsupervisory labor, allowing the top ranks to pillage corporate profits while the only negotiation allowed the lowest ranks is “Do you want the job or don’t you?” Ironically, holding down wage rises is part of the executives’ job of maximizing shareholder profits.

That’s the tragedy of the corporations.

[*] From this point, it should be understood that I’m addressing large enterprises, generally consisting of more than 1,000 employees, earning more than $100 million in revenue and whose stock is traded on the NYSE.