Competition at the top: is managerial compensation really increasing economic inequality?

Bank bonuses have, since the financial crisis, been at the center of the debate on economic inequality. The public has grown tired of such generous compensation, which is seen as underserved, because of the direct role that the banking sector played in the recent—and in many places—still ongoing crisis. The scandals about Libor rate manipulation and the very recent reports on HSBC hidden Swiss accounts are exemplar about the type of behavior that people take—and rightly so—as unacceptable and as incompatible with huge bonuses.

However, finding such behavior reprehensible may turn the conversation towards a question of professional ethics and morality that are context specific and, therefore, cannot be swiftly use to make any assertions of economic inequality, as an issue that goes beyond individual or sectorial behavior.  The real question must be one that takes into account managerial compensation at large (throughout all sectors): should we see super-salaries as equally outrageous across all industries? And, more concretely, are super-salaries really a contributing factor to rising economic inequality?

Are super-salaries really a contributing factor to rising economic inequality?

The French economist Thomas Piketty takes a close look at the actual evidence in his acclaimed work, Capital in the Twenty-First Century. He explores the changes that the highest incomes from labor have had in recent decades and in particular since the 1980s. What he finds is highly insightful and provides persuasive arguments, based on hard evidence, about the true role that exuberant managerial compensations are really playing.

The figures

Piketty provides clarifying figures, from which a detailed image of the labor inequality landscape emerges. It is important to keep in mind that the following figures focus only on the income that results from people’s work, that is, their salaries and other related compensation, such as bonuses. This distinction is key, because income can also be the result of investments, savings and an array of financial instruments—and taking a close look at this second source of income provides impactful conclusions, without a doubt, but not conclusions on how labor income is contributing to economic inequality.

So,

The upper 10% of the labor income distribution (the best-paid 10%) in developed nations, says Piketty, generally receives between 25–30 percent of total labor income. This means that the best-paid 10% of the population takes home around 25% of all the income that results from salaries, bonuses, etc., within a country.

Is the richest 10%—in the US or the UK—made out of the same people that are in the best-paid 10%?

Not exactly, and this is where it gets interesting. The richest 10% is not made out of the same people as the best-paid 10%, because the richest 10% receives most of its income not from their salaries (their work in any shape or form), but from the capital they owe (from income generated mainly in the financial and real estate markets). To understand this difference in income sources and the role it plays in economic inequality Piketty divides that wealthiest 10% even further, between the richest 1% and the rest (the 9% left). What he finds out is that,

The top 1% receives a much lower proportion of their income through their salary and other forms of work-related compensation, than the rest—than the missing 9%.

In fact the higher up you go—so from the richest 1% to the richest 0,1% and then even higher up to the 0,01%—the less important income from labor becomes.

Now, you may be thinking at this point, ‘so the super-rich don’t earn their money like most people, so why is this important?’

I will tell you that it is important for three reasons:

1.    People, who make most or all of their income, through financial instruments alone (capital income alone), are people who inherited their wealth in the first place (Piketty, 2013). Hence, when we are talking about the richest 1% we are not mainly talking about moguls of innovation like Steve Jobs or Richard Branson, but actually of heirs like the Hiltons or the Kennedys, just to name a couple of exemplar cases.

2.    Capital income, in addition, has been increasing as a percentage of GDP in most developed countries, between 1975-2010, from

• 22% of GDP to 27% in the US
• 19% of GDP to 20% in Germany
• 17% of GDP to 30% in the UK

(Piketty, 2013, p. 222)

This means that capital income has become more and more important in our time, than it has been for the past seventy years, and is set to become even more important in the future. This is important because it means that wealth inheritance has likewise become in the recent decades more and more important.

40-year trend in capital income for developed countries

Source: Piketty, Capital in the Twenty-First Century, p. 222

3. The bottom 50% of wage earners is becoming poorer in comparison to the rest.

·      While they make up 50% of the labor force, they get to keep only 30% of the total income generated from labor—they take virtually nothing of the income generated from capital.

·      When we look at general wealth, the bottom 50% owes less than 5% of a country’s total wealth (US figures).

This is a very worrying trend, because it means that the bottom 50% can never expect to earn any income from capital, because their savings are insignificant—plus they have no inheritance at all—and their income from labor does not allow them to be able to buy into even the less-profitable types of financial instruments; too many in the workforce are stuck with at most a savings account, offering a rate of return that is barely above inflation, and is probably lower than inflation today.

Western societies proudly boast that ancient hierarchies, where last names mattered more than personal ability, have been long left behind: if you work hard and persist, society will compensate you in turn, was the mantra that most of us were born repeating. Believing that hard work is the underpinning of economic success motivates many to study, to want to excel at their jobs, to want to become entrepreneurs, etc., as well as to be trustful of corporations and firms at large.

In a word, living in a society that rewards smart, hard working people, is, for the most part, something that defines our identities and our sense of freedom, and a social virtue that provides the kind of political stability and freedom that is but a myth in too many countries around the globe. It is the increasing difficulty to reach this desirable outcome in the West that makes Piketty’s findings especially worrisome: are we set to return to the old-times, where inheritance determined our place in society? Will our kids be talking about dowries again?

Written by Daniel Vargas Gómez

If you like this article read more about economic inequality and Piketty’s ideas on The factish: The Thomas Piketty series.

“Creative people are born not made” and other copouts that keep you from being remarkable

From all the myths on creativity this is, no doubt, one of the most pervasive. Its success in becoming part of our collective imagination is due to a single, yet terribly influential belief that gives an almost mystical role to talent—‘raw talent’. My point is that creativity is neither in the brain nor in the body--also not in  society. In a word, it is not a thing, it is a process.

Spotting the ways in which this deeply held belief in 'raw talent' negatively affects our behavior is actually not diffcult.

Think, for example, about the response that most people give, when asked whether or not they would say that they are creative individuals:

‘No… I have never been the creative type… I never was into any of that artsy stuff’.

But, what do we mean when we say things like 'artsy' or even 'talent'?

Creativity we seem to think is some mysteriously cool stuff that allows people to do even more cool stuff.

Such belief, one quickly realizes, makes of creativity a sort of hovering abstract attribute which would somehow materialize in different activities—sometimes painting, sometimes playing an instrument, and sometimes dancing ballet. For the believer in the powers of 'creative stuff' practice is inconsequential or secondary: Picasso was born a Master painter. Creativity, from this point of view, is supposed to be an energy of sorts that lives in some realm that is prior to the activity itself—perhaps within an individual’s soul, mind, or spirit.

You may at this point be thinking: ‘Ok, maybe the idea lacks sophistication, but is it really such a bad thing? Not everyone is a sociologist or a philosopher you know…’. 

I agree with you, the real question is how this affects people’s ability to be creative, right?

Well, this is where the real damage lies and it comes to light when we pay attention to the effects it has on both, the so called ‘creatives’ and the other ‘square’ or uncreative individuals. Most of the believers fall on the latter category. For them they simply acquire a sense of defeat about creativity, which, fact, works as a powerful resistance against creative work. These are the same people that will tell you, when given the opportunity to be creative: ‘I’m not the person for the task’, ‘I can’t do that’, ‘I am not one of the office’s creative people…’ ‘Maybe he [while pointing to someone with frizzy hair] can help you’.

It is this attitude of insecurity or contempt for creative work what is the real hindrance, no matter what the work or the type of organization at stake. This is not to say that the role of those aspects of our lives we don’t really choose for (education, parents, geography, and luck) is negligible, but rather that thinking and working creatively is most of all a practice or a habit, which comes about through repetition.

Repetition is what allows for mastery to be acquired: an artist, who can draw wonderfully realistic portraits in minutes, is able to do so because of the hundreds if not thousands of portraits she has made in the past. Like with any activity—from driving a car to playing tennis—it is hours of dedication and repetition what truly account for what we normally refer to as talent—the 10,000 hour rule for Gladwell’s Outliers. When it comes to creativity, furthermore, talent is indeed essential but it is not sufficient on its own—not all artists are innovators, and not all are pushing the lines of their disciplines. In the cases of people like Picasso, Matisse, Hopper or Warhol, just to name a few, their true truly experimental and innovative phases came only after they had acquired mastery over the techniques necessary to render a flawless painting (or a flawless design in the case of Warhol). Talent, we must realize, is but the starting point behind creative work; talent is what comes to light after the ten thousands hours. It is what allows for experimentation to be less of a leap of faith and more of an experiment in the scientific sense, hence, more of a discovery that may at first raise more questions than answers, but which in any case allows for progress to be accounted for, to be visible.

This same engrained belief is also responsible in convincing us (namely managers) that creative work is a black-box, which implies that it is a process that cannot be accounted for or properly understood. Instead of recognizing the hard work that is needed to acquire a talent, because it makes us feel insecure about our own sense of dedication and perseverance, we put a black-box in its place. Given that we cannot simply replicate the results of someone who has mastered a technique, we decide—out of frustration—that creativity is a sort of uncontrollable fluke, which cannot be learned or taught, and which cannot be made into a central part of an organization’s way of doing things. If your manager or your CFO tells you that in order to encourage creativity the company must sacrifice on productivity and efficiency, then you can be sure that they are the type of believers I have been talking about.

So, next time you hear yourself repeating the myth, remember that you can be creative, and that by doing so you are not giving up on structure, accountability or reflection.

Written by Daniel Vargas Gómez

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