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The Obsession with CEO Pay Won't Help the Middle Class

Last weekend the New York Times published its annual list of executive compensation, with Oracle’s Larry Ellison topping the charts at $78.4 million (and Disney's Bob Iger in a distant second, at $34.3 million). Pay packages have increased by an average of 9 percent since 2012, continuing a steady and spectacular rise even as average wages in the United States and throughout much of the developed world have stagnated.

These figures are often presented as evidence in an ongoing debate that assumes a direct link between the accumulation of wealth at the top of the income pyramid and the stagnation of income for the vast middle and bottom. The Times article quotes the current leading critic of the inequities of global capitalism, Capital in the Twenty-First Century author Thomas Piketty: "The system is pretty much out of control in many ways."

That may be true. Business school professors who study the effect of excessive executive compensation are resoundingly convinced that too much comp hurts the overall performance of companies. Fifty years ago the ratio of average CEO comp to average salaries was 24-to-1; now it is 204-to-1. Many business scholars believe tying so much of CEO comp to stock and the performance of a company's shares incentivizes CEOs to make quarterly earnings look good whether or not it benefits the company's long-term health.

But does the widening gap between the pay of those at the top of the wealth heap and the rest actually harm those who are struggling or sinking? The underlying assumption tends to be an unequivocal yes. It's one of Piketty's claims—in sync with his overall view that capital benefits capital while chronically undermining wages and labor. Studies by University of California scholar Emmanuel Saez and Gabriel Zucman have been used as Exhibit A in the case for the pernicious influence of wealth inequality. These studies have been the subject of dozens of articles in the past month alone and are part of the corpus of evidence that accumulation of wealth is harming the middle class. Nobel Prize winner and former World Bank Chief Economist Joseph Stiglitz has made similar arguments.

But as New York Times economics writer Eduardo Porter noted recently, claiming that wealth inequality is unambiguously harmful is more about ideology than evidence. He cites the struggles of Harvard scholar Christopher Jencks, a leading chronicler of the middle class, to complete a planned book on income inequality. After years of research, Jencks was convinced that the only true statement about whether and how income inequality harms society is "It's hard to tell." Progressive economist Jared Bernstein has also found that we can’t prove the assumption that inequality leads to slower growth, given available evidence. It may be true, Bernstein wrote, but we do not have enough concrete proof.

The work of Jencks and Bernstein complicates the neat narrative of robber barons and a new Gilded Age harming the middle class. Because those views lack black-and-white simplicity, however, they tend to receive less attention. Which is a shame, because they're probably closer to the truth.

The assumption of a causal link between excessive pay at the top and low growth and stagnant incomes fuels the drive to reframe the tax code toward greater redistribution. There is a strong moral case for that, especially insofar as massive gaps between the rich and the rest can be so insurmountable as to severely dent the idea of equality enshrined in the founding of the U.S. That said, even aggressive redistribution will not fundamentally solve what now ails us.

First, this is not an American phenomenon. Capital everywhere—from the corporate CEO in the U.S. to industrial titans in India to party leaders in China—is reaping the greatest rewards of global economic growth. Altering CEO pay structures would do little to alter that trajectory.

The top 100 CEOs in the survey took home a total of $1.5 billion. That's rather nice for them, but redistributing, say, $1 billion of that would do almost nothing to help the 100 million people at the bottom of the economic pyramid in the U.S. Even if you included upper management and got to, let's say, $100 billion, the extra income distributed across American society would barely improve living standards. Boards could mandate that, say, Larry Ellison of Oracle should be less wealthy so that Oracle employees could be more wealthy, but Oracle employees are already on the winning side of the global economic equation. They are not the ones who need help.

Let's say then that you created an inequality tax, as Robert Shiller of Yale has proposed. That could certainly generate some extra billions, which could then be redistributed. But even there, the super-rich would only become slightly less super-rich, while those whose incomes are stagnating or those tens of millions underemployed and caught in a web of structural unemployment would see marginal improvement at best. In short, measures to reduce inequality might be modestly helpful, but they wouldn't solve much.

No matter what redistributive measures we took, we'd still be faced with an economic system in dramatic flux based on the erosion of traditional wage industries in the developed world over the past decades. It is not inequality that has caused the middle class to lag and suffer. Inequality rather is a symptom of a system that reached the limit of what it could provide wage earners performing jobs tied to 20th-century manufacturing.

Ballooning CEO pay is in turn a product of the globalization of capital, labor, and business (as Piketty highlights) without a commensurate evolution of some sort of global government and tax regime. Almost all of the companies that employ the top-paid CEOs are increasingly multinational and answer to no single government. That is a dramatic structural shift of the past two decades, driven by an emerging global middle class.

The focus on compensation has the virtue of a neat explanation for a real challenge. CEOs are paid egregiously; many, many people barely earn enough. But no amount of tweaking executive compensation will generate a vibrant, innovative economy. No amount of redistribution will reinvigorate the American dream or preserve the European system. Only if such tweaking goes hand in hand with a new growth engine—or a rethinking of the necessity of relentless growth—could it be constructive. Obsessing over executive compensation does nothing to contribute toward the hard work of making a generational transition away from the industrial economy that was and toward the information economy that will be.

This article originally appeared in Slate (April 17, 2014)

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Zachary Karabell
Head of Global Strategies, Envestnet, Inc., Consultant to Investment Committee*

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