What is the defining aspect of the way today’s economic pie is split? Executives and business owners are the purse holders deciding how profit is split. Shareholders are given dividends based on shares owned. Finally, workers are paid by something colloquially known as the “market wage”.
What does this mean in practice?
Executives and business owners get to decide how profit in the company is split but really how much power do they possess. On paper, business owners have no one to listen to, there’s no shareholders and at worst they run a partnership and must split decision making with a few others. Executives have board meetings, shareholder meetings, must pass through shareholder votes and must oblige to the demands of the shareholders. In reality, the executives hold more power. How do I make such a determination? By the commanding split of the pie they receive.
The most likely explanation is visibility. A business owner who pays workers 0.005% of the revenue and then pays himself the leftover, versus a corporation that does the same, is likely to see a much larger negative impact on morale. Ignore, for a moment, the difference in profit margin (ie. assume the business owner pays a percentage that matches the salary of a corporate worker, even if the corporate worker is earning a smaller percentage of the pie). It’s still very visible that the worker is getting an insignificant cut of the pie and would still more heavily damage morale.
For shareholders what is their slice of the pie? It’s fairly variable. Half of shares are owned through institutions. That means mutual funds and other such financial instruments own half of companies. But who owns those mutual funds and other investments? Typically individuals in the upper end of the middle class and above. That is, most Americans are not involved in institutional ownership at all. Moreover, of those who are shareholders, very few ever vote in shareholder meetings. This ends up softening demand for high dividend returns.
Further reducing the need to pay out dividends is stock speculation. Many purchase stocks to bet on price changes rather than long term gain. This in turn further reduces the need to pay dividends. As long as money is invested in the company, which pushes up the stock price, it will in turn attract further investment on the betting. People are not interested in earning dividends, they wish to earn money off trading stocks. So shareholders end up earning a significant but secondary amount of money through dividends. First picks still go to the executives.
For workers, they as you would expect have the least negotiation power and thus the smallest slice of the pie. They are paid by market wage or not at all. In practice, businesses will hire workers based on the market wage (the value of the market wage being an average of what businesses are offering, any individual business could be above/below said wage but they are essentially still offering a wage based on a market thus a market wage). And by not at all, I mean to say that if a business is not making sufficient profit to afford a worker at that wage then they will choose not to hire at all. Additionally, no one will offer above the market wage without special consideration (such as a very small business with personal relationships with the workers or family employees).
Essentially, what this means, is that workers will be paid as lowly as possible without severely impacting the bottom line. This is a complex interaction of businesses, worker skill supply and profit margins. Bottom line is heavily affected by worker productivity and productivity is dependent on not just skill. It is important for businesses to remember that motivated and passionate workers with high morale equates to high productivity. Worker morale depends mostly on the perception of fairness and options, so if a situation is highly unfair (being paid a very small slice of the pie despite making up a significant fraction of the workforce) then it must be balanced by a lack of options (no other businesses to flee to for a better wage offer).
This of course leads us into the heart of the discussion; market wage.
It has already been hinted throughout the discussion here that pay is based on market interactions. That’s simply a statement of facts, not an opinion on the matter. Here on out, it is now a normative discussion of how I believe the economic arrangement should be shifted toward for a stronger economy.
What is the ultimate effect of a market wage economy? A market wage necessarily implies that workers must be paid some fraction of profit produced for a corporation (and for the moment don’t subtract salary/wage costs from revenue yet because we are trying to calculate what the salary should be). This means that the majority of profit goes into the hands of what I’ll call the “business elite” (I use the term loosely since many business owners will unlikely feel very “elite”). For a capitalist economy, the question at this point is likely “so what?”.
Well, if we extend this scenario over a few decades, we have a revenue that is disproportionately moving toward a small segment of the society. But where do businesses earn money from? Society. Therefore, if workers are consistently handling less and less percentage of the yearly generated wealth, they are less able to purchase goods. That means that businesses will have to source their revenue from the elite rather than from the general public because there is less money there to be made. One should expect these trends:
- Decreasing middle class and increasing percentage of population in poverty
- Stagnant or decreasing median household income
- Increasing percentage of wealth in the hands of the elite
- Decreased profitability of businesses per dollar invested
But of course, this isn’t necessarily true because wealth doesn’t simply pass through based on salary alone. There are taxes and there is new wealth generated. Taxes damper the income of the elite and pass it toward the middle class and the poor. When new wealth is generated, a decreasing slice of a growing pie can still equate to greater wealth. Additionally, governments typically use fiat currencies these days, print money, cause inflation and use that as a tool to improve the income of the lower and middle classes (though mind you, inflation tax can also hurt the same people).
What do we currently see in the United States and Canada? Stagnant and decreasing middle class income. Increasing poverty. Is there decreasing profitability in the American business space?
This is a little hard to calculate. We can pull up some numbers:
In 2012, United States had 2,095.1 billion in non-residential investment.[1] Or from CIA world factbook, investment was 12.9% of 15.65 trillion, which means about 2018 billion.[2] Those numbers look pretty similar.
For 2012, France had a GDP of 2580 billion, with roughly 19.9% of it in gross fixed investments which translates to about 513 billion.
Let’s choose a few more countries: Canada, Sweden, Germany and Greece.
Canada: 1770 billion GDP, investment at 23.7% therefore 419 billion
Sweden: 520 billion GDP, investment at 18.2% therefore 94.6 billion
Germany: 3367 billion GDP, investment at 17.8% therefore 599 billion
Greece: 255 billion GDP, investment at 10.4% therefore 26.5 billion
Okay, now then, how do we figure out profitability? Well that’s the hard part. Corporations play shell games with their income so it’s very difficult to tell where they are earning their money and where their revenue is sourced.
For 2012, the United States Bureau of Economic Analysis indicated that corporate profits were 1560.6 billion. But unfortunately that probably includes income from foreign sources. So let’s look at specific companies. Google earned 54% of its revenue from outside the United States.[3] That number is similar for other corporations but the numbers/reports are hard to find.
Ultimately, it’s hard to make a statement with such limited numbers. As far as I can tell half of corporate revenue for American corporations is sourced from outside the United States. I would like to state that the super-majority of investment dollars put in by American corporations are put into America (and operating costs such as advertistments, sales relations, enterprise relations etc). And if that means only half their income is from America but they spend most of their money in America that would be circumstantial evidence pointing toward decreasing profitability on American soil.
In the time frame of a few decades if we continue to see that investment in America does not see the same return as dollars invested in Europe or Asia, we’re likely to see American corporations source greater revenue from non-Americans. But that is bad for the American economy.
Businesses earn money through individuals in society giving them their money. Total gross domestic income must equal gross domestic spending (money you save would count as “spending” in the category of investments and such). When the split of profits moves disproportionately toward the elite then it means the area where you must make your sales moves more toward the elite. Your profit margin on anyone else is decreasing afterall.
So over a span of say 50-100 years, this type of wealth imbalance implies that for businesses to cope and maintain revenue in the United States they must gear themselves toward selling to the poor (such as Walmart) or toward the rich (luxury cars, yachts, low-level services such as landscaping, house cleaning etc).
However, that tends toward becoming incredibly inefficient. By quantity of goods produced, the industries geared towards the poor will be much more prevalent but their actual profit margins will be low and thus make up less of the corporate profits as a percentage despite making up a significant fraction of corporate revenue (similar to how Blackberry has a very large market share outside North America but because those are mostly poorer markets, the profit margins are low and thus Blackberry turns a small total profit). Goods produced at the low end will have to be made as cheaply and efficiently as possible. So overall, it’s not much of a concern to a libertarian but is one to a socially conscience individual (having 90% of Americans with cheap unsafe goods isn’t ideal).
For elite industries the problem is that they are inherently inefficient. The rich are spending for status and/or opulence and only a small portion goes toward real quality increases. And since a much more significant fraction of revenue is in elite industries it implies significant deadweight. One has to remember that the only way businesses make money is through people spending on their goods/services, which means that if the elite make 90% of the income then 90% of your sales must come from the elite (as a total for all business income). And what happens if 70% of the cost of a good is not going towards real value addition? Then 63% (90% * 70%) of your economy is pure deadweight.
Today is a world of globalisation and what it means for countries like the United States or Canada is that they are not operating in a vacuum. Poor business profitability on American soil equates nearly instantly to decreased foreign investment and ultimately a decrease in long-term standard of life.
What happens if we pay people by revenue generated?
This will mean several things. Individuals working for successful corporations will directly earn more money. In the current system, the only way it holds true is if unions are capable of arguing for higher wages (but in a globalised society that is difficult with outsourcing) or workers are paid with significant equity (basically never happens outside of small start-up companies). In general, if everyone is paid based on value addition to a company (the revenue they generate and a cut of the profits), then industries need not specialise in any manner toward the rich or the poor. The people with the most money are business owners, shareholders and workers who work for the most successful businesses.
Now, this doesn’t automatically equate to better long-term economic conditions. People will still have to be choosing to buy goods/services based on value addition. They will still have to petition government to make the right decisions to create a healthy business, political and economic environment. What it does eliminate is the imposed wealth imbalance over the long-term. Businesses, over time, will not have to gear themselves toward strangely adhering to the demands of the super poor and super rich. They can simply make decisions on creating sensible products based on value addition.
One of the results of eliminating forced wealth imbalance is the ability for society to wean away from what I’ll call “deadweight” goods/services. The more the cost of the product pays for value addition the better. Generally speaking, the concept is that standard of living (the money per person per year to spend on goods/services) should equate to a better life. The argument against consumerism in this case is that if you’re mostly spending for consumerist goals (for instance replacing your iPhone every six months) then you’re losing the opportunity cost of that money to have purchased additional goods that you might have otherwise enjoyed and made your life materially richer. For instance, instead of buying a new smartphone every six months to get the latest and greatest, you buy one every four to five years. The money you save you instead spend on higher quality groceries and you enjoy better health as a result (health being a major factor for happiness). So anti-consumerism isn’t necessarily anti-materialism, just more about being efficient about your materialism (which probably sounds a bit ironic).
Another hope of profit-based pay is that it increases worker morale. For one thing, it is definitely seen as more “fair”. If a division of a corporation with five hundred workers is generating a billion dollars but they’re paid 25k to 30k a year, no one will feel it makes sense that out of the 2 million dollars per person, only 1.25% is left to pay for their salary. And of course since income goes up with increased productivity it is definitely an incentive for working harder. When a business demands you to be motivated, passionate and put in time on weeknights and weekends, you directly receive a cut of your work so why not? Previously, businesses argue for workers to put in this time yet pay them market wage; where is the incentive to work harder?
There are other hopeful tangential benefits. In 2012, the US GDP per capita was roughly 49 800. That is for every single man, woman and child in America. Obviously only a quarter of Americans actually work because the rest are children or need to take care of the home. The average economic household in America was 2.58 people.[4] So that means the average economic household (through evil communism) would earn $128 484 USD per year. What is the actual median household income in America? It is about $50 502 per year.[5] Compare that with the slightly higher Canadian household income of $69 860 CAD (the exchange rate puts that at roughly the same number in USD).[6] I would hope to increase median household incomes closer to the $128k mark because really it’s a result of American worker productivity to achieve those gains why should they not benefit from it?
And right now incomes are below the “happiness increase” cut-off. Beyond $75 000 annual income it doesn’t buy you happiness anymore.[7] Seeing as how neither US or Canada has reached that level, then there is incentive to continue pushing up median income. Generally, we’d like to have everyone above 75k/year which implies a median income far higher than 75k (or a median income near 75k with low standard deviation).
Of course, how do you calculate revenue-based income? Well there is the issue that yearly profit for a corporation is not static or increasing at a known rate. The easiest way would be to base pay on “expected” profit over a multi-year period (with costs not including wages/salaries) and to pay a certain fraction of that amount while banking the rest. When times are tough in a bear-ish market cycle, then you pull money out of the bank to shore up salaries until later when times are good again.
As well, what about differences in skill level? Skill sector? Well probably you can arrange pay similar to cooperative organisations where pay is a “share”. Thus a worker earns 1 share and the manager would earn 6 shares and the owner earns perhaps 9 shares. However the arrangement one would imagine it does not mimic today’s corporate world where the CEO earns 320x-400x the average worker (and about 750-800x the lowest worker). It would be hard to imagine workers agreeing to such a low share.
Paying vastly disproportionate amount of income for those who do not produce that much more value addition for a corporation is also deadweight from the perspective of the organisation itself. It is rewarding the absence of work with more pay and punishing the hardworking with less pay. This creates incentives to do less work and would likely hurt productivity.
When we look at the real world in practice, people are readily willing to accept those disproportionate wages because of the lack of ability to negotiate. With few businesses to offer jobs, large businesses have no incentive to pass on their high profit margins in the form of high salaries to workers. It is incredibly profitable for corporations in the short-term to offer market wages. However, the long term effects would damage productivity. The United States would see itself fall behind in every social index and it has already done in the last few decades (education and health now usually rank near-bottom in OECD statistics these days). Further, despite number of hours worked the actual real output will fall behind other nations. I feel it is important to stress that the United States is only doing well if it outcompetes other nations on the same indices, otherwise it is simply fooling itself.
Interestingly, the multi-year payment scheme means corporations need to think about retaining talent and bring back the pre-1980s corporate mentality that the business you work for tries to take care of you and return to a world of company loyalty. Right now we live in a strange world where businesses demand high company loyalty but perform none of the retention practices (notice for instance the number of business articles encouraging people to skip post-secondary education to immediately start contributing to the business world, be passionate, be motivated, work weekends, work nights... but where’s the pay? Concerned about pay? Then you shouldn’t be hired!).
Profit based pay will produce a more efficient economy and a more equitable one to live in.
[1] http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1#reqid=9&step=3&isuri=1&903=5
[2] https://www.cia.gov/library/publications/the-world-factbook/
[3] http://investor.google.com/earnings/2012/Q4_google_earnings.html
[4] http://www.census.gov/prod/cen2010/briefs/c2010br-14.pdf
[5] http://www.census.gov/prod/2012pubs/acsbr11-02.pdf
[6] http://www.statcan.gc.ca/tables-tableaux/sum-som/l01/cst01/famil108a-eng.htm
[7] http://www.pnas.org/content/107/38/16489
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