Show Hide image 1 February 2012 Explaining rising income inequality Or, how to get paid a bonus for <em>not</em> doing your job. The ongoing crisis of the major Western capitalist economies has citizens on both sides of the Atlantic asking why the incomes of the business elite keeps rising even as companies cut jobs, banks foreclose homes, and the threat of penury faces many families who thought they were solidly middle class. In the United Kingdom, the High Pay Commission in its report last November stated that "pay at the top has spiraled alarmingly to stratospheric levels in some of our biggest companies." At BP the pay of the chief executive was 16.5 times that of the average worker in 1979-80 but 63.2 times in 2009-2011. At Barclays this ratio more than quintupled from 14.5 to 75.0 over the same time period. The annual remuneration of the chief executives of both BP and Barclays in 2009-2011 was about £4.4m. The Commission concluded that this high degree of income inequality manifested "a toxic form of free market capitalism" that undermines worker motivation and ultimately innovation. This toxic form of capitalism is even more virulent in the United States. According to data for the largest corporations reported by the AFL-CIO, CEO:worker pay ratio was an excessive 42:1 in 1980, an extravagant 107:1 in 1990, an astonishing 525:1 in 2000, and an outrageous 343:1 in 2010. The average annual pay in 2010 dollars of the top 500 highest paid executives named in US corporate proxy statements has been as high as $40.9m in 2000 and averaged $16.1m in 2008-2010. Most critics argue that this growth in income inequality is unfair, plain and simple. The problem, however, goes much deeper than that. As shown by our research from projects funded by the European Commission, the Ford Foundation, and Soros' Institute for New Economic Thinking, these overpaid corporate executives are getting these huge bonanzas for NOT doing their jobs. In a world of rapid technological change and intense global competition, the main job of the top executive is to direct the company's investment strategy, allocating corporate resources to generate new products using new processes. Through these investments in innovations, executives seek to create value in the companies over which they exercise allocative control. In sharp contrast, outsized executive pay reflects their ability to extract value from their companies, often at the expense of value creation, and of taxpayers and workers who have contributed to it. If you ask these high-paid CEOs for their job description, they will undoubtedly say "maximizing shareholder value". There is a lot of ideology packed into those three words. It says that of all the economic actors who contribute labour and capital to the company, it is only shareholders to whom the market does not guarantee a return, and hence only shareholders who bear risk. If the company does well, shareholders gain; if the company does poorly, shareholders lose. In making these arguments, corporate executives are simply parroting what has been taught since the late 1980s by financial economists at leading Western business schools. The central assumption that shareholders are the only participants in the corporate economy who bear risk is, however, false. To be sure, shareholders who provide companies with the committed equity finance required to develop new products and processes put their capital at risk. In addition, however, in an innovative economy, taxpayers and workers are constantly contributing capital and labour to support the innovative strategies of companies without a guaranteed return. The government uses taxpayers' money to invest in physical and human resources that are made available to companies below cost, often with explicit subsidies, without a guaranteed return to taxpayers. The Internet, aerospace, biotech, nanotech, and cleantech are all examples of growth-inducing technologies that originated in the willingness of the government to take on the early, high-risk investments. When these technologies achieve commercial success, taxpayers are owed a return. Workers also contribute their skills and efforts to the innovation process without a guaranteed return. Large numbers of employees work long and hard, collectively and cumulatively, to develop and utilize new products and processes, incentivized by the prospects of secure, remunerative, and fulfilling careers. Yet, especially in a world in which "flexible employment" has become the norm, workers make these productive contributions without those returns guaranteed. When the companies for which they work achieve commercial success, these employees are owed a return. And what do public shareholders do? They buy and sell shares, hoping to get a return on investments in productive resources that other people - private shareholders, workers and taxpayers - have made. Yet, in both the UK and the US, corporations are currently being run to maximize the extraction of value in the name of those very economic agents who typically take the least risk. Indeed, especially through stock-based compensation, we bestow huge rewards on top executives for overseeing this process of value extraction. For the highest paid US executives over the past two decades, gains from exercising stock options have ranged from 50 per cent of their total pay when the stock market is down to 90 per cent when it is up. To give a boost to their companies' stock prices, and hence to their own pay, corporate executives do massive buybacks of their own companies' shares. For S&P 500 companies, buybacks totaled almost $3tn over the past decade, including about $450bn in 2011. In comparison with the United States, the rise in UK executive pay has been somewhat constrained by the Combined Code of Corporate Governance established in the 1990s and a much more class-conscious labour movement. In addition, US companies have historically been richer and stronger than UK companies so that in the United States there have been larger accumulations of value for US executives to extract. Nonetheless, UK executives have done quite well in imitating their US counterparts in devising ways how to make out for themselves. It is commonly argued that even if large established companies are no longer the engines of innovation that they once were, we can look to enterprising startups to invest in new products and processes. Indeed, UK policy-makers have long envied the United States for its high-tech industrial districts, epitomized by Silicon Valley and Route 128. Yet the huge fortunes made from venture-backed startups in the United States in the 1980s and 1990s would not have been possible without decades of government investment to provide startups with publicly available high-tech knowledge bases. Moreover in the biotechnology industry, which is massively supported by the National Institutes of Health, the vast majority of startups that do initial public offerings fail to generate commercial products. Those failures do not, however, deter these companies' venture capitalists, entrepreneurs, and executives from using the speculative stock markets to cash in for themselves. There is growing evidence that since the late 1990s the US venture-capital model has become one in which impatient capitalists expect a quick return, even if the extraction of this return undermines the innovation process itself. In this, the Bush tax cuts have been a major boon. Ironically, as in the early 2000s US venture-capital model was turning from value creation to value extraction, the UK Labour Party embraced the US venture-capital model, reducing from ten years to two years the duration of time that private equity has remain invested in a company to be eligible for capital gains tax rates on its profits . The growing concentration of income at the top in the United Kingdom is both unfair to workers and taxpayers, and damaging to the growth and competitiveness of the economy. The British need only look at what has happened in the United States over the past decade to see the economic stagnation, social decay, and political gridlock that results when this concentration of income at the top becomes ultra-extreme. It is time to put an end to it, now. Mariana Mazzucato is Professor of Economics and RM Phillips Chair in Science and Technology Policy, University of Sussex and William Lazonick is Professor of Economics, University of Massachusetts. By admin A year on from the Spending Review, the coalition's soothsayer has emerged to offer another gloomy economic prognosis. Asked by ITV News whether he could promise that there wouldn't be a double-dip recession, Vince Cable replied: "I can't do that.