How Government Can Stop Pay Inequality

Three pieces of news commanded column inches this past week or so. The first was an analysis from the TUC based on OECD data showing that the UK was at the bottom of the heap – matched only by Greece – in the decline in real wages since the pre-crisis peak. In both countries wages declined by around 10.4% over the period. The second was a report by the High Pay Centre that showed that in the last year alone, CEO pay for FTSE 100 companies rose by 10% to an average of £5.5 million. The third was a letter from 16 trade associations to the business secretary Greg Clark urging the government to slow down the plans for a rise in the living wage.

So which is it? Are businesses doing so well that CEO pay-for-performance merits continued huge increases? Or is the economy so shaky – and rendered even shakier by the Brexit vote – and businesses so precarious that pay restraint remains essential to continued survival? One can’t have it both ways.

Those on the left will have an easy explanation for all this. CEOs are the evil robber barons of the modern age, leading a rich and lavish lifestyle on the backs of workers subjected to near slave-like working conditions. Those on the right will have different but just as simple explanations. It’s all about market forces: businesses compete for CEOs in the global marketplace and have to pay the going rate to secure talent while the market for labour remains competitive. They will add that CEO pay is essentially irrelevant in the context of the total cost base of a business while the total wage bill is not. Paying for good leadership while keeping your cost base down in order to survive in tough economic times therefore makes perfect sense.

We’ve heard all of that before. And it’s all tosh.

The reality is that workers’ pay and CEO pay are determined on totally different bases. Since the 1980s, most senior management compenation has, in one way or another, been tied to stock price performance. Stock markets have been doing well, driven by low interest rates and by repeated bouts of quantitative easing both of which have created an asset bubble. Workers’ pay, on the other hand, is driven by two totally different factors: supply and demand in the marketplace, and company operational performance and future outlook. Our economies are still wobbly, worker supply is still plentiful at the lower end of the scale (and is further supplemented by immigrant workers), and we continue to face significant economic uncertainty. Companies therefore have no desire to splash out on irreversible wage increases. The divergent trend in compensation is yet another manifestation of what we have known for some time – and that we made clear in our recent report:

“Equity markets are becoming increasingly dissociated from underlying economic activity. They are driven rather by trading activity within the equity market itself – what some choose to call financial speculation.”

But, what’s sauce for the goose should be sauce for the gander. If CEO remuneration is judged in the context of stock price performance then so should worker compensation. If, on the other hand, success is judged by operational performance and future outlook, that should apply to CEO as well as worker compensation. There is no possible justification for having the wages for some linked to one metric of performance and the compensation of others linked to an alternative metric with the two bearing only a passing relationship to each other.

There is one easy way in which government could intervene. It should legislate to require that all remuneration in any one company should be based on the same metrics of performance. Which metric to choose could be left to individual companies to decide. Or it could not. Personally, I would favour moving away from any form of compensation tied to stock price performance. The relatively recent introduction of this form of remuneration has led to the worst excesses of senior management behaviour that we have seen at many corporations. Long-term steady growth is traded off for any kind of financial engineering that drives stock price performance.  Which is why so many companies have used the low interest rate environment to borrow to fund stock buy backs rather than to invest in the future of their businesses. In a financialised economy, even managing for long-term decline becomes lucrative since it inevitably results in merger or takeover with consequent large payoffs for senior management.

This is no way to build a healthy economy. And it is certainly no way to address the growing inequality that is undermining the very foundations of our societies.

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Radix is the radical centre think tank. We welcome all contributions which promote system change, challenge established notions and re-imagine our societies. The views expressed here are those of the individual contributor and not necessarily shared by Radix.

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