The government did appoint a czar of
executive compensation for these corporations, but he approved a $7 million
salary/$3.5 million bonus plan for the head of AIG, 80 percent of which is now
owned by taxpayers. Few workers, executives included, would agree to work for
less than the going rate. Executives are simply used to earning millions of
dollars, and there is little that either the czar or shareholders can do about
it unless Congress limits all executive compensation. But the chance of such
legislation passing is slim.
Why is limiting executive compensation so
difficult? Because executives have a seemingly unassailable argument -- market
forces -- that University
of Chicago professor
Steven Kaplan defended in an October debate: "Market forces govern CEO
compensation. CEOs are paid what they are worth."
Of course, market forces are cited not only
to justify outsized compensation for executives but also poverty wages for
workers. Textbooks claim that minimum-wage laws and union wages create
unemployment. Just what are these market forces, and should we let them
determine executive compensation and wages?
When British economists David Ricardo and
Adam Smith examined this question 200 years ago, they concluded that what a
person earns is determined not by what the person has produced but by that
person's bargaining power. Why? Because production is typically carried out by
teams of workers, managers and machines, and the contribution of each member
cannot be separated from that of the rest. A driver and a bus, for example,
generate $100,000 of income a year. The driver is paid $25,000. Is this because
the driver had transported 10 of the passengers without the bus while the bus
had transported 30 of the passengers without the driver? The driver's pay is so
small only because the driver is so weak at the bargaining table.
It was Smith who explained that the
bargaining power of each party is determined by the laws that the government
passes and the way that it enforces them, and that, as a rule, the government
sides with employers against employees. He was particularly concerned with
anti-unionization laws. Had he witnessed the largesse that boards of directors
are permitted to offer executives, and the government's behavior toward
executives in the current crisis, he probably would have added that the
government also sides with executives against shareholders and taxpayers.
Despite the logic of Ricardo and Smith's
explanation that it is power, not productivity, that
determines what people earn, the notion that people earn what they
"deserve" persists. It dates to the Haymarket riot of 1886 in Chicago -- in which
police and labor protesters clashed and several policemen and demonstrators
were killed -- and the labor unrest that followed. Concerned
about this unrest, John Bates Clark, a Columbia University
professor, warned in an 1899 book: "The indictment that hangs over society
is that of 'exploiting labor.' If this charge were proved, every
right-minded man should become a socialist."
It was thus with a clear political agenda
that Clark took it upon himself to prove that
the charge of exploitation of workers was dead wrong. Clark's
"proof" was to ignore the fact that production is carried out by
teams and that individual contributions cannot be measured. He simply declared
that the contribution of each individual worker and each machine could be
measured, and that the earnings of either workers and executives or machines
are simply the values of these contributions.
In this view, if the government were to
raise wages by law, employers would have no choice but to fire workers, because
no employer can pay out more than the worker puts in. And if the government
were to set limits on executive compensation, the bright and the talented would
choose to work less or limit the level of their performance.
Evidence that Clark's
theory is wrong -- that production is carried out by teams and that
astronomical compensation is not a requirement for good performance -- can be
found everywhere. In 1941, Wassily Leontief, a Nobel
Prize-winning economist, tried to alert economists to the fallacy of Clark's theory. But Leontief, like Ricardo and Smith, was
ignored. And Clark's tale that earnings are
determined by productivity alone is still being taught around the globe.
Corporate executives take a different
approach: picking the argument that suits them. When it comes to their workers'
wages, Clark's theory rules: The wage of each
worker is equal to the value of his or her product, and raising wages will
cause unemployment. When it comes to the executives' own compensation, however,
they hide behind the idea that an individual's contribution can't be measured.
So even when the corporations they run lose big and their stocks decline, they
still collect millions in pay. Executive compensation is now so large that
executives' work effort no longer has any relation to the level of their
Adam Smith got it right: The remedy for the
rule of power is the rule of law. We need new laws to check the unfair
distribution of the fruits of our labor. One such law could set a maximum ratio
at any given company between the highest executive compensation and the lowest
worker's wage. Another could set a minimum ratio for the division of income
between labor and shareholders. Still another could raise the minimum wage and
tie it to the median wage, which would make the minimum wage a consistent
Overpaid executives take more than their
fair share and leave too little for the rest of us, threatening our health --
and that of society.
ABOUT THE WRITER
Moshe Adler teaches economics at Columbia University and is the author of
"Economics for the Rest of Us: Debunking the Science That Makes Life
Dismal." He wrote this for The Los Angeles Times.(c)
2010, Los Angeles Times.
McClatchy-Tribune Information Services.
Credit: Los Angeles Times