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Economics: A Post-mortem Necessary
Paper IX: Is Runaway Income Inequality a Prerequisite for Economic Growth? A look at Japan and the US at the micro and macro levels by Sophia Barkat Abstract: The paper takes the top two GNP nations in the world, Japan and the US -- both capitalist but with different attitudes towards wealth distribution and working-class cultures. The goal is to show that runaway income inequality, as exemplified in the pay difference between CEOs and workers in the US, is not characteristic of capitalism in all wealthy nations. Japan, for one, boasts little income inequality and yet ranks right after the USA in GNP. Paper: Capitalism in its rawest form presupposes income inequality based on productivity. If you leave out income inequalities arising from discrimination of workers arising from race, gender, religion, national origin, productivity-based inequality in income is the only accepted form of income inequality. If you don’t pay the best workers more than what you pay less productive workers you won’t be able to retain the best workers. Someone else will steal away the best scientists and managers and sales force right under your feet. Hence, productivity-based income distribution is the only acceptable form in market systems. The question at hand, however, is not whether productive workers should be paid more, or how much more productive workers should be paid than those who are not productive – i.e. what level of income inequality is right. The question at hand is to see if economies and companies do well if income inequalities are low and if so, how this is possible and what this means to the ideology that Economic Growth requires gross income inequalities. We will compare Japan and the US across corporate cultures to see if reducing pay-scales hurt performance. But first let’s get an idea of how large the US and Japanese economies are and how they compare. The economies of US and Japan The US is a capitalist nation with the highest GNP in the world – $9.8 trillion in 2002, (see link 1) -- but gross inequality in income distribution. The problem with the inequality is this: there were exactly the same number of people earning less than $30,000 in 1994 as in 1967, while the rich were now making double, and for some people a whole lot more. (See in Fig 3, the chart for Average Incomes link 2 ) At the very extreme, this gives us an income inequality, demonstrated by sky-high CEO compensations on one side and a minimum wage of roughly $5/hour on the other. A recent Christian Science Monitor report by David R. Francis claims that on average CEO salaries are "at 282 times average worker pay." (See link 3) The report also states that in 2002, "the average compensation of 365 top CEOs fell 33 percent to $7.4 million, the same level as in 1996", signifying that much of the sky-high compensation plan came from the burgeoning Stock Market of 1996-2000. Many people in the US, though tired of the status quo, still believe that income inequality to this extent is part and parcel of capitalism, and that without it the US cannot have smoothly functioning corporations because corporations are businesses and must generate revenues and CEOs are essential for this. Hence, CEO pay checks have gone off the wall in the US, and shareholders have allowed it. On the other hand, Japan’s economy comes in second at exactly $4.9 trillion in 2002 (See link 4) CEO compensation in Japan, however, is not allowed to be the same sky-high numbers that that is demonstrated in the US because of a cultural shame towards this kind of inequality and greed. In fact, most Japanese CEOs made about five times more than the average employee. Japan also has a "stratified labor market" making most workers "core-workers" with permanent jobs and income and retirement benefits as well as "contingent workers", as opposed to the US which hires and fires workers at will and offers no job or retirement security (Didier Jacobs, 2000). Corporations as models of income inequality Most capitalist societies, such as Japan and the US, have large private sectors. People tend to work in large and small corporations alike, though gross inequalities in compensation occur mostly in the largest corporations. Hence, looking at income inequalities within large corporations based in the US and Japan is a good way to understand what if any thing sky-high CEO pays have to do with company performance. More so, with major corporation revenues now the size of national GNPs, looking at income inequality within multinational corporations is of crucial importance, as more and more sweatshop workers worldwide work for a dollar a day, while CEOs make eight digit salaries. Big Picture Consulting provides a list of the world’s largest revenue generating corporations for 2002 (See link 5). The data reveals that Wal-Mart Stores, the top ranking multinational corporation in the world, had a revenue of $219 billion -- larger than Turkey at $200 billion but smaller than Belgium with a GNP of $226 billion. Belgium and Turkey are the 20th and 21st largest economies in the world in 2002. US and Japan are 1st and 2nd respectively. Wal-Mart, turns out, is 1/50th the size of the US GNP and 1/5th that of China. Exxon Mobil came right after Turkey at $191.5 billion. General Motors (3rd) , British Petroleum (4th), Ford (5th), Enron (6th), DaimlerChrysler (7th), Royal Dutch/Shell Group (8th), General Electric (9th), Toyota Motor (10th), Citigroup (11th), Mitsubishi (12th), Mitsui (13th) followed. The top 150 economies of the world in 2002 included 97 multinational corporations, most based in the US and in Japan, Japanese companies accounting for 20 of the 97 companies. (See link 6) Questions arose about the kind of income inequalities possible in such companies, especially since they were the top 13 companies in the world. CEO & Director Compensations vs. Worker Wages in the US One way to understand the level of income inequality in a corporation is to look at the ratio between CEO & Director compensations versus the wage of the Lowest worker. The CEOs are the highest paid workers, and temporary retail and manufacturing workers usually make minimum wage, though full-timers may make a living-wage salary. When the lowest paid workers earn close to minimum wage rates the yearly salary of the lowest paid worker is about $10,000 only in the US. (If the workers are hired from third-world nations or from prisons in the US, as is true in the case of many multinational corporations today, the lowest-paid worker salary is around $2,000 a year or less (at $0.23/hr to $1.15/hr if working for UNICOR or Federal Prisons Inc.)) In such cases, a CEO earning a salary of $17.7 million, as in the case of Wal-Mart Stores in 2003, (See link 7) would be making about 1,770 times more than what a minimum-wage earner at Wal-Mart (working a 40hr week, 52 weeks of the year) makes in a year. This means that the CEO made in one year what about 1770 minimum-wage earning Wal-Mart employees make in one year in the US. Or that if the CEO took a pay cut of 50% to $8.9 million and redistributed the difference to the 1770 minimum-wage earners, each of these people could have seen a 50% rise in their own salaries – making it $10,000 + $5,000 or $15,000 per year – still less than a living wage salary, usually considered to be $18,000. Similarly, if the CEO decided to forfeit $16.7 million and just make a $1-million salary, or 1/17.7th of what he is receiving, and redistributed the $16.7 million to the minimum-wage earning 1,770 workers, then each worker could be given a salary of about $18,000 per year – a small increase in standard of living for the worker, though a huge sacrifice for the CEO. Hence, to give a decent salary, such exorbitant CEO compensation plans seem unaffordable. In actuality, income inequalities look like this:
(*total compensation for Ken Lay at Enron was 200 mill over 1997-2001) Except for Ford’s CEO, everyone in the top 7 US-based companies made millions of dollars in salaries and exercised options. The salaries of workers doubled when the CEO took a pay cut because we assumed that the CEOs pay-cut was going to be distributed to the workers. This was done to show how little workers at the very low-end of the ladder make, not to make the point that CEOs redistribute their million dollar salaries. Let’s now examine what the pay-scale is for the Average Joe working at lowest levels of these multinational corporations based in the US: Wal-Mart is the largest employer in the United with 1.3 million "associates". A large portion of these associates are paid hourly, at close to minimum wage – $6 to $7/hr, according to Barbara Ehrenreich, author of "Nickel and Dimed: On (Not) Getting By in America". Exxon-Mobil has led the oil industry in eliminating jobs, cutting 238,000 of the 361,000 jobs Exxon and Mobil had worldwide in 1982. Exxon-Mobil workers are unionized and probably make more than minimum wage. Robert Bryce, author of "Pipe Dreams" says that "Enron filed documents in bankruptcy court that showed total cash payments of $309.8 million to a group of 144 top Enron executives during 2001. In addition, those same executives cashed in stock options worth $311.7 million.". Enron’s 20,000 employees were paid $13,500 per person as severance pay, by the Bankruptcy Court (See link 8) which gives you an idea of what their pay-scales were like. They have also filed a lawsuit against the company for stealing their pension fund worth $1 billion. (See Wall Street Journal, Feb. 19, 2002 report by Rebecca Smith) In general, the scenario is no different for employees working at large firms. $20 million is the average salary of a CEO of a "major" corporation; 42 to 1 is the ratio of average CEO pay to average blue-collar worker pay in 1980; 531 to 1 is the ratio of average CEO pay to average blue-collar worker pay in 2002; 535% is the percentage rise in CEO pay in the 1990s. If minimum- wage had risen as fast, it would be $24.13 an hour instead of $5.15 an hour. (See link 9). Japanese Corporate Director Compensations vs. Worker Wages So far we have picked out some ugly examples from the US. Now let’s see what kind of income inequalities exist in the second wealthiest nation in the world. Unlike that of their US counterparts, Japanese CEO pays are not public information, and hence cannot readily be obtained from running checks on the ADR stock symbols of Japanese companies, as is possible in the case of American CEOs. However, extensive studies have been conducted on CEO compensation in Japan and I shall be discussing some of the findings. Romu Gyosei Kenkyu Jo (1984) showed in a study of 38 Japanese companies with more than 10 billion Yen (US $30 million) in paid-in capital, that the average salary of CEOs was only US$122,000 in 1983. In 1988, Romu Gyosei Kenkyo Jo studied 45 companies in Japan with more than 1000 employees and found the mean salary to be US $276,000. Kato and Rockel (1992) study of 599 of the largest publicly- traded companies in Japan showed a mean salary of only US $220,000 for Japanese CEOs. Indeed, CEOs of Japanese corporations "get five times more than their rank-and-file employees at most. (link 10). Perks like company cars are not usual either if one is a CEO in Japan. Yoji Hamawaki, Chairperson of the International Management Association, who always recommends CEOs from Japan to foreign firms thinks that "Management is all about organizing people. So team-work is essential," in selecting CEOs. Fumio Sato, Managing Director of Tokyo Executive Search sites that "Nowadays only the manager-player type can get people to work." When considering CEOs he recommends those who "can honestly and frankly talk about his or her own mistakes." When foreign corporations like BMW set up business in Japan, they opt for Japanese executives to lead the operations rather than outsiders because they want someone who understands the Japanese market and business culture. But it is not easy finding the right people to work for foreign firms unless such firms provide the kind of job security that Japanese firms provide (link 10). "Compared to the US and Europe there has been less job switching from domestic to foreign firms in Japan, mainly because of Japan’s unique corporate culture and labor system, marked by life-time employment and seniority-based pay...and have to do more with the attitudes of employers rather than employees." (link 10) But that's not all. Professor Takao Kato and Katsuyuki Kubo at Hitotsubashi University in a recent study further found that CEO salaries and bonuses are directly related to company performance and not just dependent on seniority in the company. This is a direct incentive for Japan's CEOs to show positive company performance. More over, CEO pays are not connected to stock market performance, as is the case of CEOs in many multinational corporations based in the US. (See link 11) Seems like a more equitable and efficient working structure exists in Japans. And yet, there is pressure from the West that Japan’s businesses aren’t as open as their US counterparts, as though "openness" is the only legitimate argument the competitors in the West have against the Japanese way of doing business. None of this is deterring Japanese business, however. According to Yanai Hiroyuki, Executive Director of the Japan Association of Corporate Directors, there is a trend to increase corporate governance disclosure in Japan to make the accounting system comparable to the US. (See link 12) So why pay CEOs in the US so much money? It seems that Japan’s stratified labor model, job security, financial-performance- related compensation plans and low income inequality in the workplace are why Japanese firms have higher total factor productivity than US firms. Perhaps, Japanese CEOs in general are also more experienced than their US equivalents and that is really why the Japan’s economy as a whole is doing better than the US, if one compares per capita incomes? In a 1992 study, Kato and Rockel found that in 1000 top Japanese companies (market value), 60% of the CEOs had 15 or more years of tenure at appointment to CEO rank and that the average Japanese CEO joined the company at age 29yrs and became a CEO after 27yrs on the job at age 56. In the same study for the US they showed that 50% of CEO had 15 or more years of tenure at appointment to CEO and that the average CEO also worked their way up in the company, joining at 29yrs, and becoming CEO by 49yrs. They also showed that 95% of Japanese CEOs and 97% of US CEOs hold college degrees. Clearly, Japanese and US CEOs are not that different by way of years on the job or education, though they may well be educated and experienced in different types of business ethics and markets. Hence, better CEO experience and education cannot be the real reasons that Japanese economy as a whole is doing better than the US economy, and we are not looking at underpaid Japanese CEOs but perhaps overpaid American CEOs. It is true that CEOs and directors decide what gets made, how much gets made, and how much money gets spent on advertising and selling the product, but the Board of Directors are merely pilots without a plane if there are no employees to make the plane. Whether in retail or manufacturing or financial corporations, workers are the most crucial component of a company. The CEOs of Ford or Wal-Mart Stores or Mitsubishi could have wonderful plans that would fall on deaf ears if the employees in the companies were not producing what CEOs and Sales Directors wanted to sell. Planning aside, CEOs and Directors do little on the job. And some may even debate if CEOs and Directors are good planners. Some propose that companies that recruit a "superstar" may enjoy a short-term boost to their share price, but over the medium term their performance suffers Inequality & Values So why are US CEOs paid astronomical compensations plans to reward positive performance? And are the lower CEO pay-scale an indicator that Japanese CEOs are paid too little or just right? Ultimately, this discussion boils down to a question of values. Culturally, Japan is averse to gross income inequality structures. Even though income distribution is well in check, it is something the Japanese try to study and avoid. A survey concluded recently by Fumio Ohtake and Jun Tomioka of Osaka University (Ohtake, Tomioka, 2003, ESRI) concludes that Japanese "show a strong tendency to support greater redistribution. Interaction of aging and mobility seems strong and important." In the US it is seen as a good thing if you are 400 times richer than the average employee in your company. Income inequality exists and is valued. Could this be why the Japanese try to explain their economic progress to total- factor productivity (Fukao et al., June 2003, ESRI): to downplay the role of any single individual in corporate management and thus keep CEO compensations in check? Perhaps, it is the importance that the US and western nations show to managerial productivity and not total factor productivity that has caused a skewed sense of pride and value amongst American CEOs. References: Robert Bryce, "Pipe Dreams" Barbara Ehrenreich, "Nickel and Dimed: On (Not) Getting By in America" Romu Gyosei Kenkyu Jo (1984), Rosei Jiho, No. 2718, 70-71 Romu Gyosei Kenkyu Jo (1988), Rosei Jiho, No. 2905, 2-45 Takao Kato and Mark Rockel (1992a), "Experiences, Credentials and Compensations in the Japanese and US managerial labor markets: evidence from new micro data", Journal of the Japanese and International Economies Didier Jacobs. "Low Inequality With Low Distribution? An analysis of Income Distribution in Japan, South Korea, and Taiwan compared to Britain" (See here) Yamada, Ando, Nishizaki, 1997, Economic and Social Research Institute, Government of Japan. http://www.esri.go.jp/index-e.html Fumio Ohtake, Jun Tomioka, December 2003, Economic and Social Research Institute, Government of Japan. Kyoji Fukao et al., June 2003, Economic and Social Research Institute, Government of Japan. The Systematization of Ethical Virtue - The Position of Japan's "Companies with Committees" System (See here) |
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