How Shareholder Primacy Hurts Jobs and Wages

Lenore Palladino— 

The debate around stagnant wages and job creation seems well-settled: scholars point to globalization, or skill-biased technical change, or the decline of union density.  Others point to the ‘rise of the robots’, claiming that automation and technology are driving us towards a jobless future. But few consider that the dominance of shareholder primacy within America’s public corporations has contributed just as much to economic inequality as these more commonly-cited factors.

I define shareholder primacy as the shift within public companies from investing corporate profits within the firm or its workers to instead sending corporate profits back to shareholders, and, in some cases, holding increasing amounts of financial assets. Companies today care more about their financial metrics than they do about producing goods and services more efficiently over time. That’s why corporations are on track to spend $1.2 trillion this year simply rewarding shareholders by purchasing back their own stock and paying dividends.

For a current example of the dominance of shareholder primacy, take the response to the big tax reform legislation of 2017, which lowered the corporate tax rate to twenty-one percent. According to Trump and the GOP, the legislation was meant to incentive companies to create jobs. What have companies done so far? $171 billion dollars have been spent on share buybacks, whereas only $6 billion has gone to workers’ bonuses and small wage bumps. When the point of corporate activity is to return money to shareholders, investing in productive workers who can grow the business over time is beside the point.

Much of the public still thinks that America’s largest businesses function as they did in the post-World War II era: they earn profits, use those profits in part to enrich their top CEOs, and also invest in their workforce, innovation, and in better prices for us all. But somewhere along the way, in the Reagan administration, government regulations and reforms in corporate governance broke this productive cycle. Some companies focused on shareholder payouts, while others focused on profiting more and more off of financial activity. This shift was led by our industrial mainstays: the paradigmatic American firm, General Electric, earned 43% of its profits in its banking arm, GE Capital, as recently as 2014.

Firms made these choices in direct response to rising pressure from capital markets to move money out of the firm and into the pockets of shareholders, and in order to keep share prices steadily rising—choices sweetened by the fact that CEOs were increasingly paid in company stock.

When investing in a stable and productive workforce is not essential, worker bargaining power declines. Before the 1970s, American corporations paid out 50% of profits to shareholders, while retaining the rest for investment. Now, shareholder payouts are over 100% of reported profits, because firms borrow in order to lift payouts even higher.

Thus the changing nature of work—the rise of the fissured workplace and the gig economy—is driven not just by a generic drive for profit or the attributes of the “knowledge economy,” but a structural shift within corporations from a productive to financialized use of corporate cash. The relentless search for short-term profits expresses itself through squeezing employees’ pay, transforming employees into independent contractors to avoid paying benefits or pensions, and outsourcing work to contracting firms that compete to pay lower and lower wages. If firms don’t count on their employees to come up with the next big productivity improvement or exciting product idea, there’s no reason to invest in employee efficiency or longevity with the firm.

Demands on firms intensified with the rise of ‘activist investors,’ formerly known as corporate raiders. As institutional investors became large shareholders of major corporations, they pressured firms to push up share prices by maximizing short-term profits. Since such institutional investors could move their investments around easily, firms grew more responsive to capital markets than to their customers. For public companies, key regulatory and legislative changes allowed for a greater focus on stock prices. In 1982, Congress passed the safe-harbor provision for buybacks, which formerly would have been considered market manipulation. Further, the shift to allow CEO ‘performance pay’ to be deducted from corporate tax incentivized corporations to pay CEOs in stock. On the private firm side, the rise of private equity and the increase in leveraged buyouts has led to extractive financial strategies in which private firms cut jobs and reduce wages in order to extract maximum wealth for the holders of equity.

Though the literature is still nascent, several scholars have examined the direct negative impact of corporate financialization on income inequality. One study found that financialization, net of other factors, could account for more than half of the decline in labor’s share of income in the nonfinancial sector of the economy, and is comparable to the effect of de-unionization, globalization, and technological shifts.  Others look directly at the impact of financialization on declining corporate investment, finding that the financial profit rate is correlated with a significant decline in investment, especially for large firms. Less investment can mean less to spend on improving the skills and productivity of one’s workforce.

Corporate financialization is not the only driver of labor market challenges. It has become impossible, though, to think about how to solve problems in the labor market without taking on the primacy of shareholders. It is not simply that firms want to spend less money on workers—it’s that they actually need them less, and so the incentive to invest in a high-quality workforce is much reduced. In order to have a stable and productive workforce, and for workers to have the bargaining power they need to take home a fair wage, the incentives that drive shareholder primacy must be reformed.

A modified version of this post will be published as part of the article, Eleven Things They Don’t Tell You About Law & Economics:  An Informal Introduction to Political Economy and Law, forthcoming in Volume XXXVII of Law and Inequality:  A Journal of Theory and Practice (Law & Ineq.) of the University of Minnesota.

Lenore Palladino is Senior Economist and Policy Counsel with the Roosevelt Institute, a Lecturer in Economics at Smith College, and Of Counsel with the Law Firm of Jason Wiener, p.c.

Friday Roundup

Happy Friday!

This week, the public continued to grapple with the revelation that Facebook disclosed more than 50 million users’ account information to the right-wing political consultancy Cambridge Analytica. LPE contributor Frank Pasquale has previously described how we should understand the big internet platforms as exercising a form of “functional sovereignty,” a description seemed as apt than this week as ever, when people realized how little government regulation restricted Facebook’s use of their private information. Here are three recent pieces that have caught our attention with an LPE take on the issue:

  • Beware the Big Five – the U.S. military and intelligence sector’s venture capital funding has fostered the tech sector’s consolidation and permitted the growth of private empires on the back of publicly funded R&D.
  • Facebook Isn’t Just Violating Our Privacy – Facebook is insistent on seeing its failures as harming individuals, never society as a whole, but we must insist on using collective questions to challenge Silicon Valley’s libertarian perspective.
  • The New Military-Industrial Complex of Big Data Psy-Ops – Silicon Valley’s behavioral science research has been critical to the military and intelligence apparatus.

 

Elsewhere on the web:

 

Nick Werle is a student at Yale Law School.

From Form to Reform in Law and Finance: Tammy Lothian

Robert Hockett –

As with most topics having to do with our primary modes of production and distribution – “microeconomics,” “macroeconomics,” “industrial economics,” “labor economics,” … – so with “financial economics” there is a well-entrenched orthodoxy that seems to enjoy pride of place in the academy and on the hustings. Indeed, one often hears “the financial markets” described as that site of economic activity which most closely approximates, in respect of its principal players, constitutive features, and felicitous outcomes, the received Smithian wisdom on decentralized market economies and their virtues.

Financial market participants lack market power, we are told, and the trading mechanism quickly impounds privately held value-pertinent information into publicly observable securities prices. Hence the financial markets can generally be relied upon smoothly to channel investment capital toward its “most valued uses” on a real-time basis. Continuous buying and selling produce informational efficiency, that’s to say, while informational efficiency produces allocative efficiency. Et voila, we are all of us left better off, producing more of what’s most valued and less of what’s least valued than could otherwise be reasonably expected. All thanks to our financial system – like our healthcare system, “the envy of the world.”

If there is any realm, then, in which public intervention should be “light touch” and minimal, orthodoxy tells us that it is the realm of finance. Sure, many a self-styled progressive economist will concede, there are market failures aplenty in some spheres that warrant public intervention. There is “the labor market,” for example, where monopsony power on the part of employers must be counterbalanced by state-sanctioned monopoly power on the part of employees. Or there is “the environment,” in connection with which pollution externalities are an ever-present source of inefficiency that must be made to be re-internalized. But the financial markets are one place where nature is best left to take its beneficent, Scottish Enlightenment course.

It is almost as if the vaunted “Fundamental Theorems” of welfare economics were conceived and derived with the financial markets as their “intended interpretation.”  And maybe they were: note the work done by futures markets, for example, in Hicks’s foundational Value and Capital – work of which Hicks’s intellectual descendants Ken Arrow, Gérard Debreu, and others made similar, and seminal, use later. Surely, then, the financial markets are our most market-like markets – they are markets at their just and efficient best, they are markets par excellence.

Now to anyone who has been paying attention to “real world” economic or even political developments over the past decade or so, the foregoing remarks must ring facetious. Isn’t “Wall Street” the seedbed of all that went wrong in the American and global economies during the lead-up to 2008 and its aftermath? Isn’t Wall Street itself what was accordingly “occupied” once it grew clear that neither Congress nor President Obama were going to do much beyond Dodd-Frank to put things right? And didn’t bank-bashing figure prominently, even if cynically, in certain “AstroTurfed,” pseudo-populist rightwing political movements in 2010 and 2016?

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The Mythical Community Bank

Mehrsa Baradaran — 

It’s not particularly surprising that ten years after the financial crisis, the Senate is poised to pass a deregulatory banking bill. In the world of banking regulation, memories are remarkably short. In fact, armies of lobbyists have been slowly chipping away at Dodd- Frank since its passage. But there is something sinister in the way Democrat and Republican supporters of this bill characterize what they are doing: supporting community banks so that they can serve their communities. They conjure images of George Bailey banks across the country, just waiting to be free of onerous and expensive government regulation in order to help disadvantaged and undeserved communities.

“Main Street businesses and lenders tell me that they need some regulatory relief if we want jobs in rural America,” Democratic Senator Jon Tester of Montana said during a hearing to vet the bill in November. “These folks are not wearing slick suits in downtown New York or Boston. They are farmers, they are small business owners, they are first-time homebuyers.”

But what is it that these “Main Street lenders,” fighting the Henry Potters of the world, want? The bill would exclude from Federal Reserve risk oversight banks with assets between $50 to $250 billion. There is a glaringly obvious problem with this: banks with those kinds of assets are hardly small community banks. In fact, the bill is a Trojan horse, using community banks as cover to deregulate some pretty large regional banks. Many banks that fell into trouble during the last financial crisis are within the proposed size range. This simply isn’t about harmless small banks that are just trying to help the downtrodden mom and pop store or the marginalized borrower seeking a mortgage so she can live the American dream. It’s just another sop to the big banks.

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What Role for Global Finance in a Course on International Trade Law?

David Singh Grewal –

Most years, I teach an introductory course on International Trade Law. And every year since I began I’ve included a session on the international financial architecture, on the view that this architecture is intimately bound up with the functioning of the trade regime.

Euro Dollar The European Union United States

I begin the course predictably enough with a series of sessions on the history and political economy of international trade before we get into what I call the “guts of the GATT.” Here, we study the key articles of the General Agreement on Tariffs and Trade (GATT) and the main disputes that have arisen concerning their interpretation, both before and after the establishment of the World Trade Organization (WTO). Any course on international trade law would have to introduce core elements such as “most favored nation” status (Art. I), “national treatment” (Art. III), key exceptions (for example, as elaborated in Article XX), and the main “annex agreements” of the WTO (such as the TRIPS agreement, which Amy Kapczynski has discussed on this blog), as well as the various remedies and safeguards available to states facing disruptions from international trade. But toward the end of the course, I bring my friend and colleague, Robert Hockett, to discuss the international financial architecture underpinning economic globalization as a whole.

I suspect few international trade law courses address international finance as an integral part of an introduction to trade liberalization. Given the evolution of international economic law, this choice is probably unsurprising. Neither in the treaty text of the GATT (nor in the other “annex agreements” that make up the WTO) is financial architecture explicitly regulated. By contrast with international trade law, international financial law is elaborated through a different set of governing texts, institutions, and international monetary practices—prominently, the IMF Articles of Agreement, the IMF itself, and the practices that have developed among affiliated national central banks and finance ministries. Trade law scholars may be understandably wary of bringing such complex or seemingly extraneous considerations into a course that will already be full enough.

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The Crisis of Progressive Neoliberalism

Nancy Fraser –

How should we understand the crisis of the current moment? Is the election of President Trump a temporary aberration or does it reflect deeper political trends—both in the United States and elsewhere?

In a recently published essay in American Affairs, I argue that the defining features of Trump’s agenda did not come out of nowhere. What enabled his ascent was first, the rise, and then, the unraveling, of what I call progressive neoliberalism. Progressive neoliberalism tied a finance-centered political economy to a progressive politics of recognition. Grafting neoliberal economics onto mainstream liberal currents of apparently egalitarian social movements, such as feminism, anti-racism, multiculturalism, and LGBTQ rights, it forged a hegemonic bloc that dominated American politics for several decades. Beyond the United States, progressive-neoliberal formations governed many other liberal democracies through center-left parties that made similar deals with bankers and bondholders to gain or maintain power.

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Progressive neoliberalism’s main competitor was what I call reactionary neoliberalism, which tied an exclusionary politics of recognition to the same neoliberal political economy.While reactionary neoliberalism was defeated by progressive neoliberalism, it offered no alternative to the latter’s project of Goldman-Sachsifying the US economy. Absent any organized opposition on a national scale, progressive neoliberals from Bill Clinton to Barack Obama were free to promote policies that metastasized finance and gutted manufacturing.They eviscerated unions and drove down real wages, proliferated precarious service-sector jobs and promoted predatory debt to enable the purchase of cheap stuff produced elsewhere. The result was to dramatically worsen the life conditions of the bottom two-thirds of Americans, especially (but not only) in rustbelt, southern, and rural communities, even as soaring stock markets fattened not just the one percent but also the upper reaches of the professional-managerial class. In due course, many harmed by these policies came to reject not only neoliberal political economy, but also the more inclusive view of recognition they associated with it.

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