Wednesday, June 8, 2016

What Is The Primary Cause Of US Income Inequality?

Economists tend to look at the labor market to understand job and income growth.  One common explanation for the decline in middle class incomes is to claim the market is rewarding the well educated, especially those with technical skills.  The rise in executive compensation is explained in a similar fashion.  Executives have scarce skills and the high demand for those skills rewards executives with a premium that is determined by an assumed market for CEO's.

This article shifts the attention away from a labor market explanation based upon the advance of technology and the scarcity of technical and executive skills to changes that have occurred in our large corporations.  The basic argument is that they used to retain and invest their earnings to improve their competitiveness.  They are now downsize and distribute organizations.  That is, they cut costs primarily by downsizing their permanent labor force in order to increase profits.  In turn, they distribute their profits to shareholders by increasing dividends and buy repurchasing their own stock. The metric that governs CEO asset allocation is earnings per share (EPS).  For example, IBM's EPS in 2011 was $13.44.  Its CEO announced that its goal for 2015 was $20.00.  It attempted to reach that goal via an extensive downsizing operation, and by spending $70 billion on dividends and stock buybacks.  In other words, IBM redistributed 70% of its net earnings to shareholders in an effort to reach a singular target of EPS.  Despite that effort,  it was only able to hit $14.72 EPS target.  Slow growth in its traditional markets prevented IBM's efforts to manage its EPS growth through downsizing and distribution of profits to shareholders.  HP distributed 120% of its net income to dividends and stock buybacks between 2004 and 2011.  It also reduced its labor force from 349,000 in 2011 to 302,000 in 2014 to cut labor costs.  Cisco distributed 108% of its net income to dividends and buybacks 2002-2014.  All of this is being done to manage EPS in order to satisfy a common goal.  That is, to increase shareholder value.  Accordingly,  CEO and top executive compensation is primarily based upon the award of stock options and dividends.  They are among the largest shareholders of the corporations that the serve.  The management for shareholder value has also been good for the financial industry.  It has grown along with the effort by CEO's to manage EPS through the agency of financial institutions.

The income growth of the top .01% includes a large share of top corporate managers as well as managers in the financial industry.  Many of the victims from corporate downsizing have been college educated middle managers. The stagnant incomes of the middle class cannot be explained by the loss of unskilled jobs to low wage countries.  Stagnant income growth for the middle class and increasing job insecurity is built into the downsize and distribute model that drives corporate behavior.

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