Paul Krugman’s Monday op-ed piece, “Another Economic Disconnect,” attracted the normal amount of attention in the blogsphere (which is to say quite a bit) with less enthusiasm than usual. And I must say I understand why. This piece was a little flat, and managed to miss some key issues.
Disclosure: I am a fan of Krugman’s, and am also sympathetic to his problem of needing to be clever twice a week, in a tightly constrained number of words, and appeal to a mass audience without garnering the ridicule of Serious Economists.
Part of the reason for the lack of enthusiasm was that Krugman is a bit late to his topic, which is that high corporate profits have not been accompanied by increased pay to workers. To be a bit more econo-geeky about it, this recovery has been starkly different from past ones in the share of GDP growth going to profits versus labor. In every previous recovery, the preponderance of GDP growth (on average, over 60%) has gone to wages (a combination of wage increases and increased hiring). The lowest proportion heretofore was 55%. Our current recovery? 29%. This is a huge disparity, one that merits comment.
This isn’t news; our colleague Susan Webber discussed it at some length in “The Incredible Shrinking Corporation,” in the November/December 2005 issue of the Conference Board’s magazine. And as this trend has continued, it has gotten more widespread notice.
So why has the pattern changed so dramatically with this recovery? Krugman isn’t really sure, he ruminates, and the lack of confidence in his ideas no doubt contributed to the lukewarm reader response. He comes up with two theories, lack of confidence and stock buy-backs:
Nonresidential investment — that is, investment other than housing construction — has grown very slowly by historical standards. As a share of G.D.P., nonresidential investment remains far below its levels of the late 1990s, and it has been declining for the last two quarters.
Why aren’t corporations investing, and what does the lack of business investment mean for the economy?
It’s possible that sluggish business investment reflects lack of confidence in the economic outlook — a lack of confidence that’s understandable given the bursting of the housing bubble, which has already caused G.D.P. growth to slow to a crawl.
But as Floyd Norris recently reported in The Times, there is a more disturbing possibility. Instead of investing in physical capital, many companies are using profits to buy back their own stock. And cynics suggest that the purpose of these buybacks is to produce a temporary rise in stock prices that increases the value of executives’ stock options, even if it’s against the long-term interests of investors.
It’s not a far-fetched idea. Researchers at the Federal Reserve have found evidence that company decisions about stock buybacks are strongly influenced by “agency conflicts,” a genteel term for self-dealing by corporate insiders…..
[L]ow investment may be one reason productivity growth has slowed dramatically over the last three years — another development that hasn’t received as much attention as it should.
In any case, next time someone tells you that any action that might reduce corporate profits a bit — like actually enforcing health and safety regulations or making it easier for workers to organize — will reduce business investment, bear in mind that today’s record profits aren’t being invested. Instead, they’re being used to enrich executives and a few lucky stock owners.
While Krugman’s general conclusions aren’t wrong, the mechanisms are a lot more complex. In this modern world, if you are going to accuse Corporate America of bad behavior, you need to characterize it in such a way that they can see themselves (or at least their peers at the country club) in the mirror. Otherwise you are just preaching to the converted.
I see corporate chieftans as much victims as perps. The people really pulling the strings are Wall Street, specifically analysts, investment bankers, and the financial press (I used to be one of them, so I speak with some knowledge). That’s why accusing CEOs of greed isn’t a sufficient explanation. Yes, there are some who are pigs at the trough. But most won’t (can’t?) see themselves in that light, in part because they are surrounded by enablers (particularly compensation consultants) who have an incentive to push pay to even higher levels (but that’s another long discussion).
The main driver of this behavior isn’t so much greed as extreme short-termism and insecurity. Once upon a time, most companies had 5 and 10 year planning horizons. Now they are fixated on the quarter. And if your focus is very short term, the only activity that produces certain results is cutting costs. That will provide an quick uptick in profits. Anything else takes time and involves risk. I have heard stories from all fronts of companies cutting investments essential to growth, like marketing and advertising, to “make the numbers.” One telecom would not spend to advertise a second line service, its most profitable activity, even though the campaign had an 11 month payback. That wasn’t good enough. Simiarly, major companies will routinely impose firm-wide hiring freezes. That makes no sense, since some areas will clearly have high growth potential and would recoup the investment in increased staff.
So how does this cost fixation relate to wage stagnation? Easy. Costs key off of headcount. So the first line of defense is to contain or better yet reduce headcount. And the shrinking employment at large corporations gives them considerable bargaining power over those who remain. Although white collar wages haven’t suffered like manufacturing pay, everyone I know who is at a large company is doing at least 1 1/2 jobs. So their pay has effectively been cut too.
Why do companies care so much about profits? It’s because Wall Street likes predictable and increasing profits, a nice orderly artificial progression of numbers (the pressure to produce pretty figures helped create the accounting scandals of 2001-2002, plus non-criminal forms of earnings smoothing).
And why does Wall Street hold the whip hand? My view is the driver isn’t greed per se but a more poisonous combination of fear and greed. The markets and the financial press are punitive if a company falls short of its targets, and if it happens more than a couple of times, a CEO is on his way out. So CEOs are sensitized to stock price declines. It’s not about losing their stock options but about losing their jobs and being criticized in the press (and remember, CEOs get a great payday when they are pushed out). And because the risk of getting fired is real (even if the consequences aren’t all that bad), they and their minions use it to rationalize their pay. So ego may be as powerful, if not a more powerful, factor in this calculus.
One might imagine CEOs and top executives as being in a cult, or some other form of alternative reality, where things that look indefensible to mere mortals are accepted, even common, in that realm. That doesn’t justify their behavior, but it may help explain it.