"Income Inequality, Writ Larger"

In a New York Times article, Daniel Gross sympathetically discusses a paper by MIT economists Peter Temin and Frank Levy on the role of institutional behavior and social attitudes in income inequality. As a preface to his comments about their work, he sets forth some of the conventional arguments for the inevitability of inequality, namely, that it results from differences in skills and productivity:

Many economists, especially those who find themselves in the Bush administration, argue that the winner-take-all trend is fueled by other, unstoppable trends. After all, globalization, information technology and free trade place a premium on skills and education. “The good news is that most of the inequality reflects an increase in returns to ‘investing in skills’ — workers completing more school, getting more training and acquiring new capabilities,” as Edward P. Lazear, the chairman of the Council of Economic Advisers, put it last year.

It takes an optimist to find good news in the fact that the top 1 percent have steadily increased their haul while the other 99 percent haven’t; after all, many more than one in every 100 Americans are investing in skills and education.

But the orthodoxy surrounding income inequality is being undermined by research that looks at institutional issues: changes in the way the corporate world measures the performance of workers, the decline of unions, and government wage and tax policy. In this view, skills, education and trade aren’t the whole story. They’re simply “factors operating within a broader institutional story,” as Frank Levy, the Rose professor of urban economics at the Massachusetts Institute of Technology, describes it.

One big change in recent decades has been a rise in performance-based pay. Through the 1970s, thanks in part to unions that negotiated wages collectively, “people with different abilities and capabilities were frequently paid the same amount for doing similar jobs,” said W. Bentley MacLeod, an economics professor at Columbia.

But as companies and compensation consultants began using information technology to determine more accurately the contributions of individual employees, employers began to discriminate among employees based on performance. In a working paper, Professor MacLeod, along with Thomas Lemieux of the University of British Columbia and Daniel Parent of McGill University, mined census data and found that the proportion of jobs with a performance-pay component rose to 40 percent in the 1990s from 30 percent in the late 1970s.

“Since companies are better able to measure precisely what an employee contributes, we’ve seen a greater range of incomes among people doing roughly the same jobs,” Professor MacLeod said.

The fact that more Americans are paid less on the basis of a job title and more on their individual output inexorably leads to greater inequality. The authors’ conclusion is that the rise of performance-based pay has accounted for 25 percent of the growth in wage inequality among male workers from 1976 to 1993.

Arguments like this are prima facie evidence for why you can’t leave something as important as economics in the hands of economists.

“…companies are better able to measure precisely what an employee contributes” is a fiction because individual contribution is a fiction. Yes, employees can be more or less productive within certain confines. But their productivity is determined much more by institutional factors and environmental conditions than by their own efforts. Quality guru (and father of modern statistics) Edward Deming was vehemently opposed to the management by objectives construct created by Peter Drucker which was one of the early efforts to create individual accountability in the corporate context. Deming the statistician was adept at illustrating how differences in performance were often random or otherwise due to factors outside the employee’s control, and efforts to base rewards on apparent productivity could make matters worse.

Now Deming was concerned mainly with manufacturing, where individual output was much more measurable than in other environments, where the circumstances facing each employee are subject to greater variability than a worker on an assembly line.

Consider sales. Selling is one of the few areas in an organization where individual output can be measured, right? Yes, but assuming that results simply reflect talent and doggedness is a mistake. Anyone who has ever been in sales knows that who has the best results reflects in large measure who has the best territory. And in established businesses, territories are assigned, not developed.

Now one can argue that big companies have an incentive to put their best salesmen on their best territories, so talent will win out anyhow. But how true is that at the margin? With large accounts, they may have reasons for preferring your company that extend beyond the salesman’s initiative, such as unique product characteristics, warranty, or political controversy and risk involved in switching accounts. Thus, whole salesmen on the top accounts must be competent, they may not necessarily be the best.

Furthermore, organizations have well-documented tendencies to pay attractive and tall people better. One would expect these prejudices to operate in sales, with prettier and taller people being preferred as salespeople and given better assignments. The drug industry and certain Wall Street firms are know for hiring attractive, athletic types for client facing positions. Thus, what is being rewarded is not talent or effort, but advantages that have nothing to do with skills. So much for the argument that pay for performance reflects merit.

In fact, there is evidence that bonuses and supposed incentive based pay do not reflect productivity. Consider the most closely studied bonus-receiving population, CEOs. Most studies find no correlation between pay and performance and some have even found a negative correlation (the few that have were conducted by search firms, meaning the very group that profits from developing these pay pacakges and had to go through some gymnastics to produce the desired findings).

Moreover, performance appraisal systems, which are the foundation for bonuses and other merit based pay, are hopelessly and intrinsically flawed. Carnegie Mellon professors Patrick D. Larkey and Jonathan P. Caulkins’ 1992 paper “All Above Average and Other Unintended Consequences of Performance Evaluation Systems,” discuss how, despite 100 years of effort, performance appraisal systems fail to achieve their intended results due to romanticized notions about how organizations work and difficulties in making comparative rankings of workers engaged in different tasks. For example, the article discussed the many ways a boss’s motivations and quirks could lead to misleading ratings.

Caulkins and Larkey’s analysis showed that the idea that organizations are or can be meritocracies is a myth. Yet people have a powerful need to believe that society and the institutions they belong to are fair. These factors explain not only why increasing income inequality rankles, but why so many strive to attribute it to market forces or skill differences.

Yet even if you ignored the organizational factors discussed above, the NBER study attributed only about 25% of the increase in inequality to performance-related pay. That begs the question of what caused the other 75%.

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  1. Dave Iverson

    Yes: That “…companies are better able to measure precisely what an employee contributes” is a fiction . . . .

    [W. Edwards] Deming was vehemently opposed to the management by objectives construct created by Peter Drucker which was one of the early efforts to create individual accountability in the corporate context.”

    Remember too that Drucker said the MBO was useful ONLY as long as one knew the objectives. Ninety percent of the time we don’t, said Drucker, who wasn’t himself happy with what disciples made of his work.

    Too bad almost no one here in the US pays attention to Deming, and that most misread the words of Drucker.

    Too bad people pay little attention to Peter Senge, Margaret Wheatley, Henry Mintzberg, Karl Weick, Art Kleiner, Bill Isaacs and a host of others who champion systems theory, dialog, learning organizations, and more.

  2. Dr. Raju M. Mathew


    Dr. Raju M. Mathew

    Following the American lead, almost all governments, including China, India, Kuwait, the UAE, have either introduced or on the process of introducing stimulus packages to make an easy recovery from the global economic crisis, that they prefer to call as ‘Recession’. But they are forced to admit that it is more severe than the Great Depression of 1929. Then it must be the Great Depression II of 2009. A series of global summits are under way.

    Basic Assumptions

    However, almost all packages are based on the following assumptions:

    1. The present crisis is a recession to disappear within one year or at the maximum two years, as it is only a short term phenomenon.
    2. It is basically a problem of credit crunch.
    3. The market is flooded with unsold industrial and consumer products.
    4. Speedy recovery could be made by injecting more funds either by debt or deficit.
    5. By ensuring easy credit and supporting banks and one or two major industries, the crisis could be averted and recovery could be made.

    Over Simplification

    The present Global Economic Crisis has been over simplified or presented as a mere financial meltdown or recession and it could be dealt by making available more funds to the consumers so as to create new demand for all the unsold items and thereby revive the market and ultimately bring back the boom. The required fund could be raised by either deficit financing or public debt, besides borrowing from other sources that could form the basis of further credit.

    Wrong Diagnosis

    But the very assumptions of all these recovery packages are conceived without the backing of any sound theory and strategy or even history. Both the experts and rulers ignore the truth that the basic problem is not of the credit but of income and earning of the people to create a sustained demand and ensure reasonable saving and investment. If the newly created funds are flooded to the market, of course, most of the unsold items will be sold out and after that people may not have any more money or credit with them to make further purchases. That leads to another great catastrophe to appear more rigorously.

    Boom: Real or Illusion?

    It is high time to re-examine the very truth and basis of the so called boom that the global economy had undergone with the unbelievable availability of free credit for all. Almost all banks had offered unlimited credit, ten or twenty times over their liquidity or reasonable limit, that too without bothering the repayment capacities of the borrowers. For amassing very huge amounts as bonus, the bank men had prepared inflated or fabricated statements about their assets, liquidity and profit without any basis by cleverly manipulating the e-banking, e-credit and e-commerce. On the strength of the easily available credit cards and e-money, consumers had rushed into the market, without bothering much about their real income and repayment capacity. That had made an illusionary boom, without the backing of real earning and actual purchasing power.

    Simple Economic Truth

    No economy can survive long with mere credit based purchases without the backing of the real income and earning besides adequate saving and investments. Income and earning are very much related to resource allocation efficiency, over all productivity and competitiveness. Profitability depends upon demand and cost of production as savings depend upon thrift, earning and cost of living. Without a reasonable savings, no investment could be made.

    It is equally important for a healthy economy to keep its cost of production and cost of living at the bottom. Further, there must be inter-sector balance with regard to growth and earning between various sectors, as all the sectors are equally important for the healthy survival of the global economy. The very reason for the present global crisis that has grown to the extent of the Great Depression II is the deliberate denial or rejection of the basic economic truth committed by all the economic and business players, including governments and international agencies.

    The Hidden Threats

    The stimulus packages so far announced are based on wrong or improper assumptions without taking into account the simple economic truth. Credit and banking have no existence or future if the whole economy is weak and sick. No stimulus package is effective or successful by rejecting the basic economic truth. The package must be aimed at improving the very foundation and health of the economy. Other wise, the packages with shorter objectives of selling out the unsold items in the market that too based on credit, will be self-defeating and bring out further crisis more rigorously, making the entire world suffer more and making future generations more debtors.

    Global Strategy

    There is no short cut to solve the crisis other than putting the economy on a sound basis by improving the income and earning of the people besides their productivity and efficiency. In other words, the actual purchasing power of the people, even without the backing of credit, must be improved tremendously along with cutting the cost of production and cost of living, so as to ensure sustainable saving and investment. Inter-sector and inter-regional imbalances must be rectified. Since the problems are global in nature, their solutions too must be global. No country or people should be left in the efforts for a speedy recovery of the global economy.

    It is high time to adopt a mature and balanced approach towards consumerism, marketing, credit, e-banking and e-commerce besides minimizing oil or energy consumption, development based on tour and travel and automobile. The world has more cars than it actually needs; we are burning more oil than our environment could afford and people are traveling more than what is needed for the wrong or mistaken logistics of their stay and work. Because of aggressive consumerism and marketing, just 8 % of the world population spend and consume as much as the rest of the world.

    The wage and salary structure, including bonuses must be restructured so as to ensure some reasonable balance between agricultural, industrial and service sectors and between industries and services. Unreasonably high salary, bonuses and profits in some sectors or firms lead to greed, extravagance and the associated crimes that would affect their own very efficiency and survival.

    UN and other intergovernmental and non-governmental agencies must come together to chalk out global strategies and policies to deal with the Great Depression II. The major religions of the world must play a pro-active role in minimizing the sufferings of the world population rather than spreading hate and revenge leading to terrorism.

    (Note: This is the fifth series of work on the present global economic crisis under ‘Great Depression II’ by the same author).

    About the Author
    Dr. Raju M. Mathew is a strategist and theoretician with strong background in Economics, Cybernetics, Education and Information Science & Technology with long years of experience in teaching and research, including directing a major research project and supervising ten doctoral works. Dr. Mathew formulated two basic theories of knowledge consumption and knowledge production that got published jointly by the FID and the USSR Academy of Sciences in 1985 in the work, ‘Theoretical Problems of Informatics’. Now these theories are known in his name and have become the field for doctoral research.
    In 2005, Prof. Mathew proposed Knowmatics and Knowledge Technology as the two Post-Information Technology disciplines for processing and handling knowledge so as to develop knowledge industries. He is the founder president of the International Forum for Knowmatics & Knowledge Technology (IFKT). Some of his works are available in the site: http://www.ifkt.net
    Dr. Mathew is on a mission of making the world aware of the impacts and intensities of the present crisis, the Great Depression II of 2009 and persuading the governments and international agencies to formulate correct strategies and policies and implement them urgently to deal with it and make an early recovery from it, so as to save the lives of millions, especially the young. Dr. Raju M. Mathew can be contacted by e-mail: rajoocyber@yahoo.com.

  3. Dr. Raju M. Mathew



    The Present Global Crisis

    The world is under a great financial and economic crisis. To almost all finance and management experts it is just a financial meltdown or a credit crisis or at the maximum a recession. But for the economists with strong backgrounds in Economic Theory, Policy and History, who are very limited in numbers, it is the Great Depression II, far more severe than the Great Depression of 1929.

    CEOs and MDs

    Economics has been denigrated into oblivion in the onslaught of the glittering courses of the Modern Business Schools and their high salaried and bonus earning graduates as CEOs and MDs or top managers, during the time of the just receded Boom, However, the present crisis brings back Economics into the forefront for drafting strategies and policies for making a speedy recovery. In the height of the crisis, as almost all the products of the Business Schools, including Harvard turned like ostrich dipping their heads in the sands. Now they are accused the prime culprits of the present crisis. Now they are treated as dirty as pick-pockets and street pimps for their greed and immorality.

    Breach of Trust and Mismanagement

    Almost all products of the B- Schools who are elevated to CEOs or MDs of big corporations in the banking, insurance and financial sectors are charged with breach of trust and mismanagement besides eating away the big bonuses and committing money laundry, presenting false and fabricated statements, for their greed and fraud .In their passion for glamour and glitter, they violated the basic principles of management due to their ignorance of the fundamentals of Political Economy, as their knowledge, more correctly information, is in capsule form without any deep understanding of theory, history and strategies.

    Political Economy

    Political Economy or Economics is as old as the origin of the human societies and also of the nations. Kaudialya, the Indian strategic thinker, in his ‘Arthasatra’ and Machiavelli, the Italian strategist, in his ‘The Prince’ had dealt with Political Economy . The Pharaohs of Egypt had applied basic economic principles in constructing dams and pyramids while employing the Israelites as slaves, besides successfully managing the economy for a very long time. Learning from the Pharaoh, Moses too had applied basic economic principles in levying taxes, waging wars and sharing the loots, including women.

    However, Economics as a branch of Science emerged with the publication of Adam Smith’s ‘Wealth of Nations’ that paved the way for the emergence of Capitalism, especially the industrialized western economies. It was J. M. Keynes, a well known British economist, with his General Theory, saved Capitalism from eternal peril during the Great Depression of 1939. F.A. Hayek became the first Nobel laureate in Economics.

    The Great Depression

    Almost all industrialized economies have been undergone with the phenomena of ‘business cycles’, characterized by high growth, stagnation and recession. Innovative entrepreneurs could make new strides in the growth of Capitalism. However, the Great Depression of 1929 had challenged the very foundation of Capitalism as supply had not created its own demand. It was J. K. Keynes who prescribed the medicine of public spending and deficit financing besides championing the cause of establishing the IMF and the World Bank, gave new foundation for Capitalism.. However, the over dosage of the Keynesian remedies, especially deficit financing and public borrowing, designed for emergencies, have become a regular practice for almost all governments. As a result, they have getting ineffective, just like the regular and over-dosed use of anti-biotic.

    New Corporate Culture

    After the Second World War, especially during the Cold War period, most of the military technologies, including internet, had been put into civilian applications that gave new impetus to industrialization, networking, globalization and trade-in-services. The Multinational Corporations (MNCs) have emerged with grater influence over almost all governments and their budgets exceeded far ahead of the governments of smaller countries. Information Technology, has become the most powerful tool in the hands of the MNCs to control and manage their operations, spreading across several countries.

    They have entered in all major services like, banking, finance, insurance, networking and communications, management and consultancy, marketing, retail trade and real estate to have a virtual control over the entire economy and to make quick profit in terms of billions and trillions. A new type of corporate culture has emerged with the motto of making quick profit, high salary and bonuses at any cost. It has created greedy and jealousy CEOs and other corporate heads and managers who thrive with fraud and corruptions besides false and manipulated accounts and statements to deceive the government and the general public.

    The Service Sector has started to dictate or dominate all the other sectors, side tracking both Agriculture and Industrial Sectors and thereby upsetting the very basis and balance of an economy. Information Technology has penetrated in all the domains of the service sector, reducing everything into bits and bytes. In the over-emphasis of Information, the worth of Knowledge and Wisdom has withered away.

    Death of Economics

    Almost all B-Schools rivaled each other for creating and supplying greedy, jealous, manipulating and unscrupulous, high salaried managers and business executives in the age of corporate culture. They challenged the very foundation and wisdoms of Political Economy. In the new age of Information Technology, a new breed of economists with mathematical and statistical tools and computing techniques have dominated the scene and they have denigrated Economics with a set of formulas and equations., that have reduced economics, a minor branch of Mathematics ort Statistics. Economics has been reduced into mere data and information without the backing of any wisdom and knowledge. Thus Economics has lost its purpose and foundation besides its human face and social commitments towards the weak and the poor. As a result, Economics, basically concerned with ‘wealth of nations’, ‘social well being’ ,‘income and employment’ and ‘constitution of liberty’, resource allocation efficiency and optimality’ has become unfashionable in the age of highly fashionable ‘Business Management or Administration’.

    Do We Need Business Schools?

    The actual contribution of the Business Schools and their graduates in the healthy development of the national as well as the global economy and in the promotion of global trade is a disputed or questionable one. Of course, they have squeezed the entire economy for their own greed and added the misery of the millions, especially of the poor for promoting consumerism, aggressive marketing and credit based purchase of consumer items. They ruined the financial stability of the millions of families, turning them into debtors and wiped out thrift and saving mentality from the society. With their lavish funding, they have even corrupted all the major religions that have become more and more materialistic by promoting consumerism at the cost of spirituality and compassion. It must be highlighted that almost all major business and industrial establishments are built by the real entrepreneurs without qualifications from any of the B-Schools. Now the basic question is do we need the immoral, unethical and greed and fraud- promoting Business Schools and their short and long courses and academic programs.

    Re-Inventing Economics

    It is high time to make Economics free from the narrow boundaries of a set of mathematical formulas and equations besides the computer generated data and information. It is a crime to reduce economics within the narrow framework of data and information, ignoring Knowledge and Wisdom. Wisdom and Knowledge are our real wealth and they alone save us at the time of crisis and perils. The world needs the visions, wisdom and knowledge of the Political Economists for a fair and ethical global order and society.
    Universities must come forward to give re-emphasis to the study of Political Economy by attracting the best students and professors so as to develop a holistic view of the working of an economy, inter-dependence of its various sectors and units besides the diverse economies of the world and finally of the global economy.

    It is time to critically examine the social value and worth of the mushrooming Business Schools with their long and short term academic programs, including M.B.A and several other gilt-edged diploma courses without any strong basis in Economics. The present global crisis made the world realized that management is not mere making profit and earning high salary and bonus, by exploiting both the workers and customers and cheating the share holders and the governments.

    Managers must be made socially committed for the creation of wealth, income and employment and thereby attaining social well being both at national and global levels. They have to plan, organize and getting things done for attaining the set objectives of their firms and also the broader social goals of making a sound and healthy economy. They must be made to follow a set of well defined business ethics and fair practices. Other wise, they become criminals to brake the very foundations of families, enterprises, nations and the entire global economy.
    (* This is the sixth series of work by the author on The Great Depression II – the Present Global Crisis. All his other works can be found if a search is made in the internet under ‘Dr. Raju M. Mathew’. )

    About the Author
    Dr. Raju M. Mathew is an economist, a strategist and theoretician with strong background in Cybernetics, Education and Information Technology with long years of experience in teaching and research, including directing a major research project and supervising ten doctoral works. Dr. Mathew formulated two basic theories of knowledge consumption and knowledge production that got published in 1985 and appeared in several languages. Now these theories are known in his name and have become an area for doctoral research.
    In 2005, Prof. Mathew proposed Knowmatics and Knowledge Technology as the two Post-Information Technology disciplines for processing and handling knowledge so as to develop knowledge industries. He is the founder president of the International Forum for Knowmatics & Knowledge Technology (IFKT). Some of his works are available in the site: http://www.ifkt.net. Now he is working with the Al Ain University of Science & Technology, Abu Dhabi, UAE.
    Dr. Mathew is on a mission of making the world aware of the impacts and intensities of the present crisis, the Great Depression II of 2009 and persuading the governments and international agencies to formulate correct strategies and policies and implement them urgently to deal with it and make an early recovery from it, so as to save the lives of millions, especially the young and the poor. Dr. Raju M. Mathew can be contacted by e-mail: rajoocyber@yahoo.com.

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