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Why the rich want to get richer

at 07:07 AM ET, 06/20/2011

In 1981, the economist Sherwin Rosen wrote a paper titled "The Economics of Superstars." What Rosen correctly saw was that the globalizing world would vastly enhance the incomes of the few who could move from playing on a national stage to playing on an international stage. Kobe Bryant could start selling shoes in China. Goldman Sachs could easily invest in Indonesia. Universal Studios could put their films on DVDs and sell them in India. If you were big enough to get bigger, you'd do far better than those who weren't quite big enough to expand overseas or sell their DVDs to millions.

The economics of superstars is real, and it's certainly been an accelerant for CEO pay. But it doesn't explain the phenomenon that Peter Whoriskey nicely gets at in this article --something I will call the the economics of starters.

It's clear enough why the head of a firm that was once national and is now international is making an extraordinary amount of money. But what about the CEOs whose firms have not gone global? Why are they making so much money? And, perhaps more importantly, why aren't the people working for them making more money, too?

Whoriskey's article suggests that the social norms are breaking down. His article contrasts Kenneth Douglas, a CEO in the 1970s who repeatedly refused raises because they'd be bad for employee morale, to his successor, who makes 10 times as much, belongs to four separate golf clubs and jets around on a private plane.

But perhaps we don't have to choose between social norms and economic forces. After all, society often adopts new norms in response to new economic realities. And I suspect that's what's happened here, too.

Study after study shows that people would prefer a medium-sized house in a neighborhood of small houses to a big house in a neighborhood of much bigger houses. What people really want isn't to have a big house, in other words, but to have a bigger house than their peers. Economists call products driven by this sort of status competition "positional goods." The less-technical term for this sort of behavior is "keeping up with the Joneses," and we all do it.

When you're talking about changes in CEO pay, you're not talking about changes in the money CEOs use to make ends meet. You're talking about changes in a compensation package that has long since become totally abstract. Making $50 million is nicer than making $40 million, but the things it's buying, and the things it's saying about you, are, at that point, positional: it's a display of worth, not the way you put food on the table. People sometimes ask what CEOs need with all this money. The answer is they don't need it. But they need to not be making less money than other CEOs. If they are making less, then what does that say about them?

So when the players at the tippy-top saw their incomes explode, it's not as if the executives one rung below them -- or one company over from them -- suddenly began to starve. But they did start to demand pay raises. After all, they weren't worth less than those guys! And then the guys one rung beneath them demanded pay raises to keep up with their peers. And on and on it went.

Worse, it happened at the company level, too. If you're a multinational company, or even a national company, and you pay your CEO much less than your competitors do, what does that say about your company? About the likely quality of your CEO? The market likes low labor costs on the worker level, but they also like the superstar CEOs who're driving labor costs up on the executive level. Perversely, paying your CEO a lot does, in a certain sense, raise fewer questions than paying him or her a little. It signals that you're taking corporate leadership seriously, that you're getting the best talent, that you're keeping up. So though we say it's the culture that changed, I suspect that it was superstar pay that changed it, even if it didn't only change for superstars.

That leaves the question, of course, of why worker pay hasn't risen with similar alacrity. I've tried to get at this subject a lot and mostly have been impressed by its massive, mammoth, complexity. Trade, education, deunionization, immigration, innovation, health-care costs, globalization, and every other explanation you hear all have something to do with it. But I do wonder whether there isn't a positional story here, too.

The wages of many workers have been adversely affected by changes in the global economy. Many middle-income families, in fact, have seen their wages decline in recent years. It seems at least somewhat possible that we're seeing a reverse-positional story there, wherein the workers who could be demanding a bigger share of the profits stay their hand because the relative struggle of their peers has convinced them that they don't have the bargaining power they maybe thought they had and they should be more careful about overstepping their bounds, just as the income of the top CEOs have convinced their peers that they have much more bargaining power than they realized and should be much more demanding when setting their compensation packages.

 
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