A Response to Piketty’s Capital from a Surprising Corner

Without referring to Thomas Piketty, Capital in the Twenty-First Century, the Harvard Business School, of all institutions, has recently published two studies that ultimately address the increasing economic inequality that plagues the United States and most of the developed world. Michael E. Porter and Jan V. Rivkin published the finding of the survey that the Harvard Business School did of its alumni. In short sum, the study concludes that “large and midsize firms have rallied strongly from the Great Recession, and highly skilled individuals are prospering. But middle and working-class citizens are struggling, as are small business. We argue that such a divergence is unsustainable. . . .” An Economy Doing Half Its Job: Findings of Harvard Business School’s 2013-14 Survey on U.S. Competitiveness (September 2014). Roger Martin, in the October issue of the Harvard Business Review, raises similar alarms: “In a democratic capitalist country, it is not sustainable to leave the members of the largest voting bloc out of the economic equation.” The Rise (and Likely Fall) of the Talent Economy, Harv. Bus. Rev. October 2014, pp. 41, 43.

Martin traces the shift from natural resources being the most valuable assets 100 years ago to the development of talent as the “asset” of greatest value. “By 2013 more than half the top 50 companies were talent based, including three of the four biggest: Apple, Microsoft, and Google.” As talent was becoming the most significant corporate value in the 1970’s, supply-side macroeconomic economists then argued that high income taxes created disincentives so that this talent would not be optimized. Given high tax rates for high incomes, talented people would slack off and not work as hard if so much of the resulting income went for taxes. With the Reagan Revolution, supply-side economics was the basis for the radical reduction in top tax rates. “The top marginal [income tax] rate plummeted from 70% in 1981, to 50% in 1982, to 38.5% in 1987, to 28% in 1988. Thus, in a mere seven years, $1 million earners saw the amount they kept after federal taxes increase from $340,000 to $725,000, while the $3.0 million that $10 million earners had been keeping grew to $7.2 million.” With the emergence of stock-based compensation, top executives focused on “managing the expectations of market participants, not on enhancing the real performance of the company.” The talent that was validated was in the ability short term to manipulate share value and that does not necessarily lead to the growth of the enterprise in the longer run. Thus manipulating the value of corporate stock does not lead to greater economic growth.

In addition to a tax system that creates incentives for top corporate executives to feather their own nests at the expense of the interests of the other stakeholders – shareholders and workers –, the emergence of hedge funds that rake off 2% of the value of the assets and 20% of the profits every year, provides extraordinarily high incomes to their managers. “[T]he top 25 hedge fund managers in 2010 raked in four times the earnings of all the CEOs of the Fortune 500 combined. The hedge fund industry, however, does not produce economic growth. “Essentially, the business of a hedge fund is to trade. . . . But trading doesn’t directly create value for anyone other than the hedge funds. One trader’s gain is simply another trader’s loss.” The tax system subsidizes hedge funds by not treating their earnings as earned income subject to the basic income tax rates but treat much of it as capital gains subject to lower tax rates

Putting together these two phenomena supports the conclusion that the personal gain of a small group of top corporate executives and hedge fund managers is a more important social policy than economic growth overall or even of return on the investment of capital itself. “Across the economy, the return on invested capital . . . peaked in 1979 and has been on a steady decline since the mid-1970s. It is currently below 2% and still dropping, as the minders of that capital, whether corporate executives or investment managers, extract ever more for their services.”

With little actual economic growth and the capture of so much income by top corporate and hedge fund managers, “inequality has rapidly increased, with the top 1% of the income distribution taking in as much as 80% (estimates vary) of the growth in GDP over the past 30 years.” Meanwhile “[r]eal wages for the 62% of the U.S. workforce classified as production and nonsupervisory workers have declined since the mid-1970s.

Martin attributes some job losses to the attempts by top managers to manipulate the price of corporate stock to increase their personal income by eliminating jobs, “the variable they can most easily squeeze in order to signal that they are addressing performance.”

Porter and Rivkin describe structural changes in the economy that pre-date the Great Recession. “Long-run growth rates in private-sector jobs started falling from historical levels about 2000 and remain low. The meager job creation that has occurred has been overwhelmingly in local industries, not those facing international competition. . . . Real hourly wages have stalled even among college-educated Americans; only those with advanced degrees have seen gains.”

When business expands, they do not do so by hiring new employees in the United States. “[B]usiness leaders in America are reluctant to hire full-time workers. When possible, they prefer to invest in technology to perform work, outsource activities to third parties [including off shore], or hire part-time workers.” For example, a story in the New York Times described the structure of Apple: “Apple employs 43,000 people in the United States and 20,000 overseas. Many more people work for Apple’s contractors: an additional 700,000 people engineer, build and assemble iPads, iPhones and Apple’s other products. But almost none of them work in the United States. Instead, they work for foreign companies in Asia, Europe and elsewhere.” Micro-economists would say that is as it should be because it no doubt is cost effective. From a macroeconomic point of view, aggregating the behavior of many enterprises leads to the hollowing out of our middle class work force and our middle class consumer economy. What is good for the Apples of this world, is not good for America.

Martin, Porter and Rivkin all agree that the present structure of our society, including our economy, is not sustainable. They do not, however, propose remedies. Porter and Rivken ask business to volunteer to be more proactive as to education generally and to educating their workers for the jobs that are allegedly available. While volunteerism is nice and may be of some help, it still seems grossly inadequate when what needs to be done is to redirect the structure and direction of our society and economy that does little for most people or the economy generally but creates tremendous incentives for corporate executives and hedge fund managers to capture almost all of the limited economic growth that results from these policies.

Could it be true that the Harvard Business School is proposing that we counterattack the class warfare the majority have suffered because of the extraordinary power of the small group at the top of the economic ladder? Is the Harvard Business School lining up with Occupy Wall Street?

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