On wage ratio policies

Jeremy Corbyn’s call for “some kind of high earnings cap” on high pay has its flaws. But it’s potentially a good idea.

The first flaw in it is that it’s lousy presentation, and suggests Corbyn’s team have learned little from behavioural economics. A wage ceiling allows lackeys of the rich to whine that Labour hates the well-off. We should reframe the policy. Rather than say nobody should earn (say) 20 times more than the lowest earner we should say that nobody should earn less than one-twentieth of the top earner. We should call the wage cap a wage floor.

The second problem is that a blanket wage floor is too blunt a policy. It doesn’t distinguish between different types of inequality. Some wage inequalities might be tolerable on economic grounds* if they are rewards for great service. This might be the case for entertainers, sportspeople, innovators and even, I’ll concede, some good managers. Other inequalities, though, arise from rigged markets, cronyism and exploitation. It’s these we should most want to abolish. But a simple legal wage floor hits all inequalities indiscriminately, as do higher taxes. That’s sub-optimal.

There are, though, solutions here.

One possibility, as Corbyn says, for the wage floor to apply only to government contracts. Here, the problem of deterring innovation isn’t so great: what matters is that contracts be sufficiently well-written to avoid agency problems. A wage floor would help disincentivize the rent-seeking that accompanies outsourcing.

A second possibility is to have worker and/or consumer representatives on remuneration committees for larger firms. If a manager or innovator adds great value, the dispersed wisdom of crowds should recognise this and so accept a high wage ratio. But where managers are mere rent-seekers, the committee will rein in his pay.

It’s possible that these mechanisms will actually stimulate the free market that rightists (often insincerely) claim to want. If a manager thinks he has great talents which aren’t sufficiently rewarded by a cap on wage ratios, he should set up his own business where the wage cap doesn’t apply**. In this way, a wage floor might actually incentivize entrepreneurship.

I’d add three other observations:

Corbyn is right to identify inequality as an issue. The fact that productivity has stagnated after an increase in inequality should alert us to the likelihood that inequality is indeed bad for growth.

Measures to tackle wage inequality, however, are not sufficient. Inequality of pay is a symptom of inequality of power – and this is an under-rated problem.

What we want here are policies that are stepping stones towards more socialist ones. For example, a cap in inequalities in companies getting government contracts might encourage the growth of co-ops. And greater worker representation on remuneration committees might lead to demands for more worker power in other dimensions. Blind statist policies might be a dead-end, but more flexible and empowering ones might not be.

* We should distinguish between economic and moral objections to inequality. Even if inequalities arise in a perfectly free market and have no adverse economic effects, there might still be philosophical objections to them from, for example, luck egalitarians.

** If worker/consumer-dominated remuneration boards only applied to firms employing more than 250 people they would cover only 0.4% of companies. This would provide a very big sector where bosses could earn as much as their talents would permit.

Comments

[Patrick Kirk]

25% of income tax is paid by the top 1% of earners. Corbyn's policy will simply eliminate that revenue base and he hasn't said where the missing revenue will be made up.

[paulc156]

"25% of income tax is paid by the top 1% of earners. Corbyn's policy will simply eliminate that revenue base and he hasn't said where the missing revenue will be made up."Patrick Kirk.

The reduction in aggregate tax revenues from the 1% would likely be made up by increases in tax revenue from elsewhere.
1. Significantly less money for CEO's and senior directors will allow for small but widely dfistributed increases in remuneration for middle and lower ranking staff. This measn they will pay more tax, in aggregate.
2. To the extent that savings are returned to shareholders then this too would lead to greater tax revenues from dividend taxation.
3. The net increase [after tax] in remuneration for lower ranking staff will to some extent lead to small increases in aggregate spending, since lower earners have a greater tendency to spend any additional income. This in turn leads to greater economic activity...and thus ...tax revenue.

[Anarcho]

Best to stop those at the top "rewarding" themselves in the first place -- we need stronger unions, more direct action in the workplace, repeal of the anti-union laws (and as Adam Smith recognised, state regulation of wages always means lower wages -- and if the state regulates strikes and unions, you regulate wages...). That way we workers can keep more of the wealth we create (and which is currently being monopolised by those at the top of the autocratic-hierarchies which are capitalist firms):

http://anarchism.pageabode.com/anarcho/pay-inequality-where-it-comes-what-do-about-it

Rather than look to the state, we should be looking to building our own forces, our own organisations, etc. It is the CAPITALIST state, after all...

Long term, of course, we will need to kick the bosses out and run the workplaces ourselves -- but in the short term, we can create the bodies (unions) which can do that and build the confidence that we can change things.

[Luis Enrique]

I can't help thinking that exec pay is just a multiple equilibrium problem, and a legislative shock might be what's needed to move to a better one, even if that can't be done in an 'optimal' way if you just look at whether the measure would target the 'right sort' of excessive pay and similar considerations. If we had a closed economy, I'd say there's little to fear, the quality labour supply of execs won't change if top salaries were half of what they are now, but I wouldn't put it past firms to move overseas so execs can pay themselves more, so in an open economy I am more cautious.

I am not sure I think about CEO pay in the right way. I think the main reason anybody gets paid what they do is that they get paid what's needed to recruit and retain, and that's set by outside options, so if a CEO can credibly threaten to go to company B to get paid £X then company A has to pay up. Hence if all companies reduced top pay simultaneously, we just move to a lower level.

I don't have a coherent story about production functions and marginal products.

I have not read "Executive compensation: a modern primer"

http://faculty.london.edu/aedmans/CEOJEL.pdf

but I should

[Rpkaye]

"Significantly less money for CEO's and senior directors will allow for small but widely dfistributed increases in remuneration for middle and lower ranking staff. This measn they will pay more tax, in aggregate".

If, typically, the CEO's are on a marginal tax rate double that of lower ranking staff, then redistributing income in this way would halve the tax take, not increase it.

[paulc156]

"If, typically, the CEO's are on a marginal tax rate double that of lower ranking staff, then redistributing income in this way would halve the tax take, not increase it."Rpkays.
As an approximation that's correct, but only if you exclude anything beyond first order effects. Lower earners have a much greater propensity to consume additional incomes. They effectively spend it all. Slicing the top off high earners income would have precious little effect on GDP since most of that money would have been saved. So second order effects would certainly make up some of the loss in revenues if not all. Depends on multipliers etc.

[Staberinde]

I'm not a Corbyn fan, but even a stopped clock is right twice a day.

A wage cap of 20x the lowest paid employee is a great policy. So let's address some loopholes.

First, let's make it about total reward rather than wages.

Next, let's ensure that anyone who employs freelances applies the policy to them too.

Then let's give small businesses a boost by excluding any business that employs less than 50 people and isn't a PLC or owned by another company, trust or other financial vehicle.

You run a business and you want to earn more? Find a business model that means you can afford to pay your lowest earners more.

[exBanker]

If I’m a CEO attached to my pay cheque, the obvious “solution” to this “problem” is that I outsource/spinoff any activity involving workers being paid less than 20x my comp. Every business uses companies that provide services – accountants, cleaners, perhaps external payroll services, etc. Clearly(?) the 20x rule cannot apply to the workers of any company I hire to provide a service. Or let’s say I manufacture something, with some workers in this dept being paid less than 20x. Outsource it to China. Clearly(?) the rule cannot apply to my Chinese suppliers?
Does this make low paid workers better or worse off?

[Staberinde]

Hi exBanker. Not true.

Let's say you outsource your cleaning. fine. But the cleaning company's CEO can only earn 20x what he pays his cheapest cleaner.

Let's say you hire cleaners on a temp basis. Fine: the 20x principle is applied to the pro rating.

You'll find it difficult to offshore your cleaning, but you're welcome to try.

You can, of course, offshore other things like manufacturing to places like China, but the Brexiteers who wanted to take back control of something or other probably had this sort of thing in mind. They might take a dim view of it like Trump does.

[exBanker]

Hi Staberinde,
I agree the 20x will apply to the cleaning co CEO. But it won't apply to me, who hires the cleaning co.
Imagine I currently have an internal payroll department, where a typical junior worker makes £15k. Assume these are the lowest salaries in my company. I want to keep paying myself £1m, so if the 20x rule passes I outsource the payroll function. And every other "low" paid function. It's true that the CEO of the payroll service provider cannot pay themselves more than £300k, but my current head of payroll makes £150k, so this should not stop someone providing the service or force someone to pay the lowest paid payroll employees anymore.

[Staberinde]

Hi exBanker. You're abosolutely right. And I see this as the policy doing what I hope it would do. I've no problem with outsourcing low paid work. If you want to keep paying yourself £1m then you just need to create a structure and business model which ensures your lowest-paid employee is on £50,000. I'm sure some automation could help you too. But the principle I'm looking to instil is that the people running the company cannot create success for themselves without also creating success for everyone else in the business.

[Luis Enrique]

"And I see this as the policy doing what I hope it would do."

but it would have absolutely no impact on the level of inequality in society, it would just change the organizational units of production so that high paid and low paid workers aren't mixed in the same firms. What would it mean for the firms that wind up hiring all the lowest-paid workers to have learnt "running the company cannot create success for themselves without also creating success for everyone else in the business" - once cleaners have been outsourced, what mechanism is going to raise their wages?

[Brad F]

I have 2 concerns about this post, one mechanical and one conceptual

The mechanics question is how do we define income? Imagine 2 people. One earns 50,000 a year for 40 years. The other earns 25,000 a year for 40 years but gets a 1,000,000 bonus at the end of the 40th year. Who should pay more tax? The fair answer is that they should pay the same because they both earned a total of 2,000,000. One might react to this by saying the second scenario isn't very realistic. In fact it is actually quite common. For instance every successful entrepreneur who sells her business to retire faces a similar income stream. Also, workers who leave their jobs often receive severance packages and pension payouts that can be multiples of their "regular" income.

The conceptual concern I have is that the post describes socialism as being a goal. Surely it is a means to an end, not the end in it's self. A quibble perhaps. But Mr Stumbling has recently blogged about people who regard Brexit as an end instead of a means to an end. Excellent point! Please don't make the same mistake with socialism.

[nicholas]

The problem with regard to PLC's is not just the the structure of remuneration committees. A more fundamental change is needed so the role non-executive directors supervisory is not to advise on strategy, but rather to safeguard the interests primarily of shareholders, but also other stakeholders. If they wish, they can then set up a remuneration committee or otherwise set executive pay with the goal of minimising this pay commensurate with recruiting, keeping and motivating the senior executives- not simply to ensure they are rewarded in line with other similar executives. It could also make sure there are succession plans in place to replace all directors should they leave with internal candidates, to reduce the bargaining power of such executives.
Executives need to be subject to the same disciplines of everyone else in a firm - that being the company paying only as much as is in the best interests of shareholders.

[Luis Enrique]

nicolas,

but suppose you make the changes you desire, even then if you cannot recruit what you consider to be decent candidates externally unless you pay the "going rate" for CEOs, or if your internal candidates leave because they can be paid much more elsewhere, what effective is any governance reform going to be? imo it's all about changing the going rate for CEOs.

[Staberinde]

Luis, I don't think the policy will make a huge difference to overall inequality. I think it is more likely to benefit the middle. If you look at income distribution, the changes in recent years have broadly seen middle incomes redistributed towards the highest percentiles.

So I think it's a good thing to change the incentives of top managers in this way. When they can't simply pay themselves more, and when 'the market rate' can't fuel an arms race any longer, it should concentrate mind on building more robust businesses where a rising tide lifts all boats rather than just the luxury yachts. I want senior managers to think "How can we improve business performance so I can give my lowest paid staff a pay rise" rather than "How can I convince someone to pay me more for making little difference to performance?" Chris is always telling us that leaders don't add the value they used to. Let's get them taking risks again.

[Bob]

"25% of income tax is paid by the top 1% of earners. Corbyn's policy will simply eliminate that revenue base and he hasn't said where the missing revenue will be made up."

Come on. Think a bit!

If the 'top earners' leave, the money doesn't get paid to them. It gets paid to somebody else (probably lots of somebody elses) who earns an income on which they pay tax. They then spend and somebody else earns an income.

Money doesn't stop at its first use.

Similarly government spending is what *causes* taxation, not the other way around. So there are no financial limits on what government can do - ever.