No one can deny that the Occupy Wall Street movement was a profound expression of dissatisfaction with capitalism world-wide. A year on, the legacy of that upheaval is less clear. A common summation of the massive protests is that the outcry was long on criticism but woefully short on solutions. The manifest villains were corporate greed and corrupt money-changers, the placards read, but the way forward was incoherent, muddled, or simply not known. The battle cry of the 99% seems to have had little impact on the 1%. Income inequality remains a huge problem.
In hindsight, it’s a pity the protesters were not all issued at the outset free copies Dr.s Robert Frank and Philip Cook’s seminal 1995 book The Winner -Take-All Society; Why the Few at the Top Get So Much More Than the Rest of Us. By no means right-wing ideologues, these economics professors lucidly outline the market forces that drive up to absurd levels the incomes of a small set of “winners.” As it turns out, the role of greed and corruption in income inequality is insignificant compared to the power of the choices that we, the consumers, the 99%, freely make every day. Its the behaviour of the average person that makes the 1% possible.
Frank & Cook start off by getting readers to buy into the basic goodness of a competitive labour market. If everyone was distributed exactly equal amounts of pay regardless of their occupation or performance, there would be no incentive for anyone to work hard and strive to achieve. Without the prospect of superior income, few would spend the time and effort to become doctors or take the risks to develop innovative products. Competition is necessary, but in the case of some fields or endeavour, the distribution of those rewards becomes super concentrated at the top.
The Winner-Take-All phenomenon is most commonly and easily observed in sports, entertainment, publishing and other media intensive fields, but other fields, like the CEO market and education also display super incomes. In sports, the quintessential and now tragic example of the WTA affect is cyclist Lance Armstrong. In cycling, as with so many other sports, mere minutes, seconds or fractions thereof can separate a field of hundreds or thousands. Although Armstrong was only marginally better than his opponents, he enjoyed almost all of the media attention, resulting in fabulously lucrative sponsorships. Armstrong became a household name, whereas the runner-ups are virtually unknown outside racing circles. The spectacularly disproportionate rewards he enjoyed for being number one proved to be an irresistible motivation to enhance his performance by doping.
Consumers of television and other media have only so much mind-share, and showing the winners is a magnet for high ratings. Winning the gold medal may net a fabulous fortune for a gymnast, whereas the bronze nets negligible income. The limited attention of the consumer also drives book publishing, the music industry and big budget films. There are only so many books we can read or movies we can go to or recordings we can buy. When making spending decisions for media, consumers are notoriously risk averse. When faced with a decision to buy tickets to a film starring George Clooney directed by a famous director and on the other hand a film with an unknown cast and an unknown director, in the absence of other compelling information such as glowing or negative reviews or awards, we choose the star-studded film because we have a reasonable expectation of quality from those who have proven their quality in the past.
The same risk aversion applies to choosing books and music. Proven names in media become proxies for commercial success and open bidding for these names can drive compensation into the stratosphere. Frank & Cook call this phenomenon a positional arms race, similar to dilemma faced by foes in a cold war. No nation on its own would choose to spend billions on arms, but the risk that another nation might outspend them and gain a catastrophic tactical advantage is simply too great and the decision to match spending become the default. This is why salary caps in professional sports are sometimes necessary. The temptation to outspend ones opponent is intense, even when doing so may be detrimental to profits. Teams would rather lock in a quantifiable loss than suffer a crushing defeat with unknown consequences.
Driving media and sports compensation positional arms races is the power of the consumer who chooses to watch or not watch, attend or not attend, buy or not buy. We, the 99%, the consumers, it turns out, decide that if Sydney Crosby is not on the team, we will not watch. If our superstars are taken away from us, we vote with our eyeballs and pocketbooks and head for the exits.
In the corporate world, WTA markets most famously are seen in CEO compensation. Firms locked in competition with rivals can engage in bidding wars for talent because the consequences of losing the battle can be grave. In firms with hundreds of millions or billions of dollars in revenues, the decisions of a CEO, even if they make a difference of plus or minus 3%, can translate into staggering gains or losses. Incremental loss of market share can lead to the demise of billion dollar empires (eg. RIM). In this light, if a board of directors believes the right CEO can safeguard against massive losses and even gain on its rivals, agreeing to an extremely lucrative contract can be a trivial detail when compared with the job of getting the right person.
Aversion to risk and heightened regulation of larger firms may also contribute to runaway CEO and top brass pay. Following the decline of the technology bubble in 2000 and the catastrophic failures of Enron, WorldCom and other Fortune 500 flameouts, strict new corporate governance regulations came into place in the USA and elsewhere that greatly increased the liability of board directors for corporate failures. Under this regime, more than ever, boards have to get it right when hiring top executives. Any reading of the want ads reveals the frequency of the words experienced, proven, track record and success. As firms get larger, the relative field of experienced and proven candidates grows thin. Nervous boards are not going to take a flyer on a maverick up-and-comer, even if such candidate has manifestly superior talent. The conservative route is to hire known quantities, and such persons are often already employed at rival firms. Compensation packages need to be larded with immense incentives for the executive to remain with the firm to ward off the inevitable bidding war that will ensue if their candidate is successful.
Securities regulation is not designed to protect the titans of industry, but rather the 99%, the shareholders, the mutual fund holders, and rank and file citizens. Paradoxically, this duty to shareholders expected places boards in the position of having to make the lowest risk decision, which favours entering a bidding war, which can include golden parachutes and other lavish baubles. Ironically, the responsible actions of boards have led to their own vilification.
Frank and Cook argue that Winner-Take-All markets are inefficient and welfare eroding market failures that should be curbed by higher taxation at the top. Their primary reason for this recommendation is not that taxing the top with balance the budget, but rather that fewer entrants will be attracted to those occupations where the chance of returns is extremely remote. The fabulous success of a handful of actors leads to hundreds of thousands entering the field, 99% of which will never make a living from the craft. Similarly, a microscopic segment atop the music industry pyramid rake in virtually all of the wealth, while the rest have day jobs and perform for less than their own expenses (plus a single free beer typically).
While the taxation anti-incentive idea has merit, it is unlikely to be a cure for disproportionate participation in WTA markets. The Beatles famously fled Britain when taxation levels became overwhelming. The world is full of tax havens like Switzerland waiting with open arms for the worlds stars. There is a reason why Canadas Shania Twain lives in Switzerland, where specific towns can cut tailored deals with the uber-wealthy to make their particular town their domicile.
From my perspective, the only solution to curbing the excesses of the 1% is for consumers to consciously amend their behavior, in which regard I have a few suggestions. In music, for example, do not download illegally, as multiplying downloads only serves as a proxy whereby the winners can strengthen their stranglehold on their dominant position. Sky-high concert tickets for the 1% are extracting more and more of the rents missed through piracy. Instead of illegally downloading the music of the 1%, pay for the recordings of lesser known artists. Attend their performances, pay the cover charge and buy their CDs.
In the world of film, stop supporting sequels. As Frank and Cook explain, the sequel is a means to milk the top brand status of a successful film as the audience is already locked in. However, to ensure audience share, sequels typically must provide exactly the same content as the original, but only in greater quantity. Transformers II must have more action, violence and explosions, even if such elements add nothing to the plot or the development of the characters and take away from the artistic merit of the film. Audiences are addicted to sequels.
In the corporate world, to counteract excessive compensation, become a shareholder, read the annual reports that are sent to you and vote your shares at the AGM or other meetings. As someone who has been involved in public companies for a long time, I am always blown away by how few shareholders ever bother to vote their stock. By law, executive compensation is disclosed in public documents. If you are displeased, write to the directors as ask them to hire talent from within the firm instead of engaging in bidding wars. On the other hand, you may be surprise that as a shareholder you will find yourself supporting the mega-bucks CEO package when the shares are up 30% over last year.
In summary, excessive income inequality adds to social unrest because undermines our sense of a fair and just society. The anger of the Occupy movement is evidence of our desire for fairness. However, the 99% need to accept that the it is not the fault of the 1% that they have what they have, as it is the very choices of the 99% that make it possible for the 1% to exist. With notable exceptions, most of the 1% have not cheated, lied or harmed others to achieve their fame and fortune. We vilify bankers on Wall Street, but the exact same market forces that drive their pay packages also lavish riches on our beloved celebrities who we would switch places with in a heartbeat if given the chance.
As a society, we need to guard against the hypocrisy that can sometimes overtake us when we are swept up by angry mobs in search of a scapegoat. Malfeasance and white collar crime is a plague on society, no doubt, but forces that make a small group extremely rich cannot be boiled down to pure greed. As consumers, we demand the best bang for our buck, and when some folks figure out how to meet those demands, they make a ton of money. So next time we gotta have something, pause and think of the alternatives. We have the power to choose to buy from the little guy.
But actually, FYI, no, I’m not giving up Starbucks.