“Over 99 percent of all the new income generated goes to the top one percent.” This is how Bernie Sanders, an independent senator from Vermont, began his assault on the issue of income inequality during a speech he delivered at the Brooking’s Institute earlier this year. He continued his tirade, providing examples designed to communicate the severity and scale of the rich-poor divide. He explained how the top 25 hedge managers made more than $24bn in 2013 and that this figure is equivalent to the full salaries of over 425,000 public school teachers, posing the question: “Is that really what our country should be about?”
Some political commentators will contend that Sanders is only using such powerful rhetoric because he knows that it resonates with voters, with many people thinking and hoping that the senator will throw his hat in the ring for the 2016 presidential race. But regardless of his intentions, the man from Vermont still puts forward some ideas worth pondering – mainly, if it is morally, socially and economically justifiable to continue to live in such an unequal world.
In the 1960s, the late Peter Drucker warned that CEO-to-worker pay should not exceed a ratio larger than 20:1, as it would increase employee resentment and lead to a decrease in overall morale among ordinary workers. The French economist, Thomas Piketty, in his book Capital in the Twenty-First Century, coined the term ‘meritocratic extremism’, which he used to describe the doctrine that extravagant pay – which now far exceeds what Drucker advised – is justified by the merit of performance.
Imagine if everyone in every office across the land was aware of what other people in his or her role were being paid
But in Will Hutton’s book, How Good We Can Be, the British political economist contends that the huge salaries afforded to CEOs, “have almost nothing to do with carefully calibrated performance and everything to do with the attempts of CEOs and boards to keep up with each other in a status race substantially influenced by social and psychological rather than economic concerns”.
Hutton’s theory is supported by a letter the American business magnate Warren Buffett sent to shareholders back in 2005 in an attempt to explain to them how the compensation process really works: “Huge severance payments, lavish perks and outsized payments for ho-hum performance often occur because comp committees have become slaves to comparative data. The drill is simple: three or so directors – not chosen by chance – are bombarded for a few hours before a board meeting with pay statistics that perpetually ratchet upwards.
“Additionally, the committee is told about new perks that other managers are receiving. In this manner, outlandish ‘goodies’ are showered upon CEOs simply because of a corporate version of the argument many have used with children: ‘But, Mom, all the other kids have one.’ When comp committees follow this ‘logic,’ yesterday’s most egregious excess becomes today’s baseline.”
The letter exemplifies that the disparity in income between the rich and poor is not determined by purely economic factors. Instead, it suggests that income inequality, and inequality more generally, has much more to do with man’s quest for status, than any economic imperative.
Interestingly, another factor pushing the pay packets of CEOs continually skyward is the constant media reports like this one about c-suite remuneration. “Rather than suppressing the executive perks”, says the behavioural psychologist Dan Ariely, “the publicity [has] CEOs in America comparing their pay with that of everyone else”.
Imagine if everyone in every office across the land was aware of what other people in his or her role were being paid. Employees would be in and out of the HR office asking for raise on a daily basis. This is effectively the impact that the media has on executive pay, with every story published about the extortionate bonus dished out to one executive or lavish perk bestowed on another all adding up to make each example of excess ‘today’s baseline’.
Closing the gap
Looking at how executive super-salaries are calculated, it seems difficult to justify the massive disparity that is CEO-to-worker pay. But even without this information, most people tend to agree that c-suite executives are paid too much, according to research carried out by Soropop Kiatpongsan and Michael Norton.
In their report, How Much (More) Should CEOs Make? A Universal Desire for More Equal Pay, it shows that ideal pay gaps between skilled and unskilled workers are significantly smaller than estimated pay gaps, and that there is a strong consensus among those surveyed regardless of their nationality, socioeconomic status, or political beliefs.
“Moreover, data from 16 countries reveals that people dramatically underestimate actual pay inequality”, write the authors of the report. “In the US – where underestimation was particularly pronounced – the actual pay ratio of CEOs to unskilled workers – 354:1 – far exceeded the estimated ratio – 30:1 – which in turn far exceeded the ideal ratio of 7:1.”
According to the data, an ordinary worker in the US would take home $1,838,975 if pay were adjusted to the ideal. This figure is obviously too high for an average worker’s salary. But if it is possible to acknowledge that this rate of pay is extortionate, even when it is the result of what citizens deem ideal (7:1), then naturally, it must be acknowledged that the actual (354:1), which sees CEOs take home $12,259,894 as equally exorbitant.
The disparity in CEO-to-worker pay in the US is clearly out of kilter with what ordinary Americans deem acceptable. But what is arguably worse is that these huge severance packages are a huge waste of company money. In his book, Economyths, the Canadian writer and mathematician David Orrell explains that while having a good CEO at the helm contributes to the success of a company, it is less critical than their salaries suggest: “The success of a company is best seen as the emergent result of factors such as the state of the market, the contributions of all employees, the internal company culture, and so on.
“A summary of the empirical evidence from the International Labour Organisation concluded that CEO compensation has ‘only very moderate, if any, effects’ […] Moreover, large country variations exist, with some countries displaying virtually no relation between performance-pay and company profits.”
In countries like Japan, where the actual CEO-to-worker pay is much less (67:1) than in the US, the lower disparity appears to have no impact on how well companies in Japan operate. In fact, the smaller gap in pay may even be a benefit for the company. For example, when Japan Airlines (JAL) fell on hard times back in 2009, its then CEO, Haruka Nishimatsu, cut all of his corporate perks and slashed his income to around $90,000 (less than the average take home pay of one of the airlines pilots), so that he could avoid downsizing employees or cutting into their pay packets – a concept that many Americans would say is inconceivable back home.
Politicians and businessmen like to say that ‘we are all in this together’, but that can seem hard to believe for the ordinary worker who is underpaid and overworked, especially when all the while their bosses already extortionate severance packets rise year-on-year. Drucker warned that exceeding a 20:1 pay gap had the potential to increase employee resentment and lead to a decrease in overall morale among ordinary workers. If he was right, imagine the damage a gap of 354:1 is doing to worker morale now. But an ever-widening gap between the top and the bottom is not just harmful for morale within companies. The wage growth has declined in recent years (see Fig. 1), and more unequal pay across the board can, and is, having a profound effect on how people feel within wider society.
Dealing with inadequacy
According to a report by the World Health Organisation, “there is overwhelming evidence that inequality is a key cause of stress, and also exacerbates the stress of coping with material deprivation. The adverse impact of stress is greater in societies where greater inequality exists and where some people feel worse off than others. We will have to face up to the fact that individual and collective mental health and wellbeing will depend on reducing the gap between rich and poor.”
There are many different definitions of poverty. Absolute poverty is defined by a deprivation in basic human needs, characterised by a lack of access to safe drinking water, food, sanitation facilities, and shelter. Relative poverty, however, is defined by the level of income or resources an individual has in relation to the average in a specific society. It is concerned with the absence of the material needs to participate fully in accepted daily life.
Many, like writer Tim Worstall, have argued that the majority of Americans do not fall under the definition of absolute poverty. Instead, those who consider themselves poor tend to fall under the European definition of relative poverty, which looks at the wider issues and impact of social isolation, which arises as people get further and further from the median.
In their book The Spirit Level, Richard Wilkinson and Kate Pickett discuss how inequality is correlated to wider issues such as mental and physical health problems, drug addiction, crime rates, poor performance in school, rates of teenage pregnancy, as well as a host of others.
Jane Hetherington, a UKCP registered psychotherapist, has worked with individuals on both sides of the rich-poor divide and believes that rising rates of inequality, along with western societies’ obsession with consumerism, creates a huge stress for many people.
“Only last night I saw someone who is employed and takes home an income within the national average (£26,500), but she regarded herself as poor because her children […] want this, they want that, but she cannot afford it”, says Hetherington. “As far as she is concerned she is in relative poverty, and that puts a huge psychological pressure on parents when they are unable to meet these expectations.”
Hetherington argues that as a result of what people see on television or view online, it all adds to help create a particular lifestyle expectation that revolves heavily around possessions. This worldview, along with the widening gap between the haves and the have less is leaving many on both sides of the rich-poor divide feeling empty.
“A while back I used to have a small private practice situated in Harley Street, so I saw people at totally the opposite end of the spectrum then”, says Hetherington. “I saw investment bankers and the like, and the feelings that they expressed were all very similar to those at the bottom. There seems to be a deep dissatisfaction with life, a void that the individual appears unable to fill. In the past there was a level of spiritual fulfillment coupled with lower expectations, but now, many appear to be suffering from existential crisis.”
Perhaps then, this deep satisfaction may not be completely down to rising inequality. There are those, like the billionaire Jeff Greene, who argue that the fault lies with people’s unrealistic expectations of life. “America’s lifestyle expectations are far too high and need to be adjusted so we have less things and a smaller, better existence”, Greene said in an interview at the World Economic Forum in Davos, Switzerland. While he may have a point, his sentiments on how the middle and working class should redefine their living standards are a bit rich considering he flew into the event in a private jet.
For Greene to feel comfortable telling struggling American families to tighten their belts while he sips champagne highlights the core cause of income inequality – a crisis of morality, not economics. People are happy to draw a line in the sand for what is an acceptable level of poverty, but no such line exists to define when enough is enough. Greene is right about Americans needing to redefine their priorities, but he is forgetting to factor himself into the equation.
“It’s obviously a characteristic of human beings that we like to feel superior to others”, writes the playwright and actor, Wallace Shawn in his book Essays. “But our problem is that we’re not superior.” In the chapter titled ‘The Quest for Superiority’, Shawn ponders why it is that when dining in an expensive restaurant he and the other guests prefer waiters to refrain from engaging in conversation.
“We like the sensation of being served by others and feeling superior to them, but if we’re forced to get to know the people who serve us, we quickly see that they’re in fact just like us […] then we become uncomfortable – uncomfortable and scared, because if we can see that we’re just the same, well, they might too, and if they did, they might become terribly, terribly angry, because why should they be serving us?”
A little inequality never hurt anyone. Many economists agree that it is essential in order to create wealth and provide incentive, but there are also those who warn that too much can threaten the stability of not just the economic system, but society at large. Nobody really wants a revolution. If it were allowed to happen there would be no rich-poor divide, only chaos. It is clear that income inequality is not an economic imperative, but rather a quest for status – one that, if pursued to the extreme, has the power to divide and destroy from within.