The Brookings Institution has released a report that I can only describe as “compelling.” Titled “More Builders and Fewer Traders,” it focuses like a laser on the perverse policy incentives that have contributed to dramatic levels of inequality.
In our new paper “More builders and fewer traders: a growth strategy for the American economy” we identify a handful of obscure but important shifts—in laws, regulations, and standard practices—which, taken together, have changed the incentive structure of leaders in American corporations. This set of incentives has led to short term behavior on the part of corporate leadership. These incentives are so powerful that once they became pervasive in the private sector, they began to have broad effects. No one set out to create this myopic system, which arose piecemeal over a period of decades. But taken together, these perverse new micro-incentives have created a macroeconomic problem.
The report zeros in on four trends that have contributed to what the authors call “short-termism.” One consequence of these trends is that–while cash distributed to shareholders as a share of cash flow has surged– the share devoted to capital investment has fallen to a record low.
I don’t disagree with the authors’ focus on these trends, the problems they pose for the economy, or their contribution to inequality. I do wonder, however, how much of the lack of investment in the future of American industry can be traced back to the way we finance corporations and the separation of ownership from management.
“Ownership” can mean many things, but it is difficult to square our common-sense understanding of ownership with the purchase of a few hundred shares of stock in a major corporation. Such “ownership” carries with it no meaningful control, no right to make decisions, and “risk” only to the extent that there may be a decrease in the value of one’s stock.
The reality is that American corporations borrow money two ways–through the sale of bonds, which are more secure but which carry only a stated rate of return, and the sale of stock, the proceeds of which represent a gamble on the future of the enterprise: more risk, but the chance of a superior “reward.” Let’s be honest: Neither the bondholder nor the small or medium-sized shareholder is an owner in any meaningful sense of the word.
Meanwhile, the people managing these companies are frequently not “owners,” either. They’re hired hands, often with little investment in the business. Their compensation and continued employment depend significantly upon their ability to keep short-term stock prices high, thus they have every incentive to keep workers’ wages down and their own paychecks as high as possible.
None of this fosters the capitalist virtue of pride in the product, or good corporate citizenship (except as a marketing tool), or decision-making that is in the long-term best interests of the enterprise.
When a company is truly owned by an individual or small group, when those owners see their own prospects intimately bound up with the long-term success of the venture, corporate behavior changes. Such owners are certainly focused upon earnings and the bottom line–but they understand what innovations and behaviors will be needed to protect that bottom line into the future. Concern for long-term fiscal health provides incentives to care about their reputation, their workforce, the quality of their products and the health of the communities in which they operate.
When public policies incentivize short-term gains over long-term decision-making, the focus turns from producing goods and services to playing financial games–with broad negative consequences for job creation, wages, economic stability–and ultimately, American competitiveness.
This reinforces SCOTUS’s belief that corporations are people. Some are forward-thinking, reasonable and intelligent, interested in the long-term well-being of their employees and their companies, while an increasing number are greedy and short-sighted, looking for quick returns and not concerned about the product or the long-term health of the employees or the company.
One advantage of a life long and lucky is captured in a saying that comes to my mind often. “You don’t know one culture until you know two.” I’ve been fortunate to know a couple from different places as well as one over time.
When I was young I was an observer of adult culture then and learned that one aspect of life was business. After all one needed money to fund interests and obligations and professional accomplishment added meaning as well. So adults in my life wandered off to work while we engaged in the profession of learning. All was well.
As my own career meandered a cloud came over the peace of professional accomplishment. It wandered towards obsession. Long hours, frantic competition, doing more with less, business to satisfy accounting not vice versa. And those who excelled not professionally but competitively became much wealthier. Beyond funding interests and obligations and professional accomplishment. In fact some had to go exotic just to find outlets for their wealth.
And I observed a return to slavery. Not the crack of the whip but drudgery and dreams of something missing.
Of course we had entertainment practically free in every living room. That gave kids something to experience while the adults frantically searched for missing meaning.
It didn’t strike me as better. And then I learned that it was all on loan. It was at the expense of the kids mesmerized by the flickering screens who have become obligated to pay on the loan. It was not a path but a treadmill.
Can we get off? That remains to be seen.
Serendipity. Here’s accidental relevance by a professional builder of paragraphs.
http://mobile.nytimes.com/2015/07/10/opinion/paul-krugman-greeces-economy-is-a-lesson-for-republicans-in-the-us.html?referrer=
The reason I follow your blog, Sheila, is that it often contains information that adds to my understanding of how politics/government are working. Frankly, in the post today there is nothing that anyone who has been paying attention at all to the economy and corporate behavior within the loving arms of a paid for congress should not have known for years. In short–I am shocked that it is news.
More valuable would be suggesting steps by which we dismantle this greedy behemoth that sucks in tax dollars in the form of corporate welfare and spews cash and benefits to the very few at the cost of dismantling our manufacturing base along with the middle class and working poor. Warren’s re-introduction of the Glass-Steagall act would be a small beginning but much more is needed.
In time I hope that the voices of Warren, Sanders, Reich and a few others will force Clinton to move her address from Wall Street to Main Street and, when she is seemingly inevitably elected President she will actually serve the people who make up the vast majority of this USA of ours in a more sane and humane direction.
Let me close by saying that I much enjoy your posts as a rule but am disappointed that you feel you must state the blatantly obvious.
Wray, culture is tough to change. Most people aren’t even aware of how it runs our lives. We mistakenly think that we are in control of them.
We can’t change culture but it does change. It adapts when it no longer benefits the species. That’s underway as we speak and the main reason it will be Clinton and/or Sanders in a 2016 landslide.
Greece will be known in the future as the epicenter of the rebirth of democracy and capitalism and the death of predatory economic fascism.
But actual people apply human values other than maximizing profit in their decision making. Most corporations answer principally to the institutional investors who in aggregate hold the majority stake in them. Institutional investors can assume only that their customers share an interest in maximizing their return. (Furthermore, more and more investing is done in the form of index funds which mechanically buy more of any stock whose price exceeds the market’s performance. It does not matter if the price increase is obviously an unsustainable bubble.) Majority ownership by institutions means the short run maximizing of returns will nearly always be the corporation’s objective.
The reason I follow your blog, Sheila, is to fire up my old brain each morning. You always give me something to mull over for the day and hopefully find some of my own answers or solutions to the problems you present. This morning is no different. My brain has been in high gear now all morning about these changes to the economic goals of large corporations. I can see, and have seen for some time, that those same kinds of changes have taken place throughout our society with regard to the our goals about housing. Much of the house buying population no longer have the goal of buying a house to give their family a home for decades to come, much less generations to come. Thus the house does not symbolize a “home”, but rather it symbolizes an “investment”. The house’s value is not the place of collective memories, but instead the holder of the family’s bottom line. The corporations are not the only ones to have traded in their long range goals for short term profits. We all have.
Wray, I would hope that Hillary is not the Democratic Candidate for President. Sanders would clean up the Republican no brains in a debate.
Junk Bonds and Corporate Raiders at least in my Baby Boomer Life time started the trend where wealth was not made producing a product or service but consisted of moving money from the left to right pocket with Wall Street skimming their fees off the top. You could see this attitude among CEO’s and the Board of Directors where they were renting the company in sense and their Standard Operating Procedure was to cash in. If things went bad or the Company was sold there was always a Golden Parachute.
Of course the sweat shops set up in countries with dictatorships drained our manufacturing jobs. Our politicians made this easy to accomplish, add in also hiding corporate profits off shore.
A few years ago I read an article that lamented the loss of manufacturing jobs here in the USA. Not only did the employees that produced the product or service lose their jobs, but the Engineers, who designed the factory, the employees that performed maintenance, the construction companies that built the factories and the various industries that provided the raw materials for the product were swept away by out sourcing. No surprise that wages for the poor and middle class have stagnated or declined.
The 1% could care less, live for today and take what you can.
Goober, sorry Gopper , where are you?
I don’t at all disagree with the Brooking’s report or Sheila’s take on it.
There are a few points though…
1. There has been a move away from Executive compensation being pegged to short term goals. Most boards recognize the problem and have moved to long-term vesting in options.
2. Part of what’s driving the stock repurchase is the extremely low (almost 0) interest rates for bonds. Companies are issuing bonds and using that money to buy back stock.
3. I don’t know that the lack of funds is driving down investment in R&D and Plant and Equipment or employee pay. Many companies are literally up to their eyeballs in cash. I think the problem is a lack of demand:
a. Companies don’t invest in capacity and R&D unless there’s a demand for it. They don’t build widgets unless someone wants to buy them.
b. Wages are determined by the labor market – not the availably of money to pay people. In other words, if I can hire the people I need for $12 an hour, I’m not going to pay $15 just because I can.
Likewise, if I need 100 employees to supply the demand for my product, I’m not going to hire 125 just because I have the money to do so. When there is a greater demand for labor (because there’s a greater demand for goods and services), wages will go up.
4. I think that they just skimmed the surface on the premise of the article (More builders less traders). There is a significant amount of economic activity that extracts money but that doesn’t actually add much value to the transaction – such as financial transactions.
Alan and Kurt. Clearly current business behavior can be rationalized. In fact that’s how we got here. The fact that it can be however does not make it more or less functional to humanity. So we have to start with goals and asperations and apply ration on how best to reach them. Right?
Fortunately we can get some help on goals from God/Mother Nature/reality/science. The big one is sustainability. Each generation should contribute to the next not burden it. Our “system” and culture clearly fails that from the standpoint of our fixed resource bank account and energy budget. We are living on debt that the future can’t afford to pay.
We are also failing on free markets of perfectly informed buyers and sellers and government of, by, and for the people.
Time to rethink wouldn’t you say?
A thought game for some:
Accounting requires both a Balance Sheet and an Income Statement. The balance sheet to track long term cumulative progress and the Income Statement to track rate of change.
There’s no reason not to apply those to the enterprise of life on earth as well as lessor enterprises.
Life as an enterprise must exist on a fixed asset base of matter here on earth. Maybe someday we’ll have other options but limited time and energy eliminates other options today.
We never consume matter but change it to suit our purposes over time from useful to waste. From the form that we inherited to forms that are no longer useful. The rate of such change is a function of our population, our economy, and the distribution of the economy among the population.
As income we receive energy from the sun every day. We have a modest savings account of energy received in the past and stored in certain matter but not yet used.
We also have a space asset divided up among more and less useful configurations of matter and energy.
We are nearly bankrupt on our balance sheet and spending our income at a record rate.
What would good accountants recommend in terms of ongoing business practices?
My point about wages being set in the labor market are important to keep in mind when also when politicians are talking about reducing taxes, etc. on businesses in order to spur employment.
The chart showing the disconnect between productivity and real wages illustrates this very clearly and is also the argument why a gradual boost in the minimum wage would not cause fewer jobs. Businesses COULD spend more on wages if given some time to adjust since productivity is much greater – but they don’t have to because the labor marked doesn’t demand it.
Labor as a portion of finished product costs has gone down over the last 40 years — especially for businesses that don’t pay health insurance. The cost of everything else that makes up that finished product has increased over time because it could due to wages stagnating and productivity vastly improving. A quick move to $15 an hour min wage would hurt some businesses until the cost of the other component costs came down (rent, for example) but a gradual move would give everything time to adjust.
https://rwer.wordpress.com/2010/11/20/graph-of-the-week-usa-productivity-and-real-hourly-wages-1964-2008/
Sorry, forgot the reference to the chart.
Our current business model is based on optimizing each business (make more money regardless of the cost to others) and relies on Thomas Paine’s 300 year old model based on the invisible hand of perfectly informed buyers and sellers in a free market to keep things straight. Lots has changed since.
Not the least is the compensation of executives determined by investors who value only dividends and earnings driving up short term stock prices.
Now dividends compete with labor costs for sales dollar income within individual corporations. So there is plenty for executives to personally gain by pushing for lower labor costs, productivity, over lower earnings and dividends.
But the higher productivity is the fewer dollars are in the total economy for consumers, as workers have to spend all that they earn while investors have more than they spend so have money to invest. The fewer consumer dollars there are the slower the economy must be.
Nothing is simple anymore yet we keep relying on oligarchs using outdated models to make critical decisions.
Time for rethinking. Who’s today’s Thomas Paine? Thomas Pikkety?
Pete, I think you mean Adam Smith..