Last year, Stephen Schwarzman took home $786.5 million from the Blackstone Group, a leading private-equity firm that he co-founded and has run for more than 30 years. That sum included his salary, bonus and incentive fees totaling $125 million, plus more than $650 million Blackstone paid out as dividends associated with the sizable holding of Blackstone stock he retains as a founder and longtime executive. It was a big payday, to be sure, but not out of line with previous years, when Schwarzman’s Blackstone income ranged from $425 million to $734 million. Nor is it out of line with increases in wealth earned by a number of other billionaire financiers and company founders.
The question is: Do they deserve such extraordinary sums?
Schwarzman declined an invitation to talk through that question. But it’s a fair guess that as a staunch defender of free markets, he considers his take a proper reward for his talent, hard work, ingenuity and willingness to take risk over many years. In the past, he has criticized those who blame the wealthy for stagnant middle-class incomes and rising inequality. And when the Obama administration proposed a change in tax law that would have reduced his income, an outraged (and later apologetic) Schwarzman likened it to Adolf Hitler’s invasion of Poland.
In the theoretical models favored by economists, what Schwarzman or anyone else earns in the marketplace is thought to reflect how much we add to economic output — in the language of economics, our “marginal productivity.”
“My own reading of the evidence is that most of the very wealthy get that way by making substantial economic contribution,” Harvard economist Greg Mankiw wrote in a much remarked-upon essay a few years back that was titled “Defending the One Percent.”
Indeed, if we still had an economy of independent, self-sufficient farmers and artisans, Mankiw’s mental model might be the correct one. Someone could point to a bushel of tomatoes or a hand-knit sweater and credibly make the claim, “I produced that. It is the fruit of my labor, so what I earn from it in the competitive marketplace is my property, my just desert.”
But in a modern economy, creating products and services is a team sport, with individuals constantly interacting with other individuals and firms in complex arrangements that make it much more difficult to determine each person’s contribution to overall economic output. There are differences in market power between firms, and differences of individual power within firms, both of which have a significant effect on exactly who earns what.
One of the reasons Blackstone is so successful, for example, is that as one of the biggest private-equity firms, it gets a first look at most of the best investment opportunities. Everyone who works at, or invests with, Blackstone benefits from that kind of market power. And within Blackstone, Schwarzman has the “sole discretion” in setting the bonuses for top executives, according to its annual proxy filings.
More significantly, the amount anyone earns at Blackstone, or any other firm, is influenced by the rules, laws and norms that govern business behavior and market competition.
As someone who buys and sells companies, for example, Schwarzman has benefited handsomely from a uniquely American business environment in which companies are run with the single-minded focus of maximizing returns to shareholders and investors, rather than balancing the interests of all stakeholders.
The hotel companies and amusement parks that Blackstone has owned (Hilton, La Quinta, Motel 6, Six Flags, Busch Gardens) have benefited from a federal minimum wage that hasn’t budged in more than a decade, and labor laws that now make it almost impossible for workers to vote in a union at any company that is determined to stop them.
Over the past 30 years, the weakening of antitrust enforcement and regulations meant to protect consumers and investors have boosted the profits and increased the value of Blackstone-owned companies in the waste management, cable television, telephone, funeral and nursing home industries.
As a big investor in corporate debt, Blackstone also has benefited from bankruptcy rules that favor bondholders over workers, as it did in the restructuring of telecom firm Avaya in which $360 million in unfunded pension liabilities was effectively shifted to the government’s pension guarantee agency.
The extraordinarily low interest rates engineered by the Federal Reserve in recent years have boosted valuations for the many real estate investments that Blackstone has made, including its $37.7 billion purchase of Equity Office Properties at the top of the last real estate bubble. Low interest rates also have provided Blackstone with the financial headroom to shower its investors and executives with huge one-time dividends financed with debt.
Liberalized trade treaties have made it possible for Blackstone-owned firms such as Freescale Semiconductor and TRW Auto Parts to lower costs by moving work to low-wage countries overseas. The same treaties have also made it possible for Blackstone to attract more foreign investors, like the sovereign wealth funds of China and Saudi Arabia, while opening new investment opportunities for Blackstone abroad, such as Legoland and Versace.
Scharzman and his partners have benefited handsomely from the favorable tax treatment for “carried interest,” and the ability to defer taxes on profitable investments that are exchanged for new ones. And under the new law, their taxes will be lower, and returns higher, as a result of the new lower rates for corporations and partnerships. The repeal of the estate tax will also leave wealthy families with more money to invest in Blackstone funds.
The point here is not to quarrel with these policy choices (although there is much to quarrel with) or to suggest that Blackstone has benefited more than other firms (although that is probably the case). Rather, it is to illustrate that the amount that Schwarzman or anyone else earns in any year in the marketplace is determined in no small part by rules and norms that govern market competition.
Those rules and norms were not set in place by some all-knowing “invisible hand” — they were politically and socially determined. That is why wars have been fought over them, legislative battles have been waged over them and elections have been won and lost because of them. And it is why Blackstone and other companies spend lavishly on lobbying and electing friendly politicians who are in a position to shape them.
Under different sets of rules and norms, the market might have valued Schwarzman’s economic contribution last year at a measly $393 million — half of what he did receive, but surely still enough to persuade him to contribute his excellence.
Markets, in other words, are social constructs, and the idea that they generate a distribution of income based on a purely objective measure of individual economic contribution is a fiction, nothing more than free-market ideology. When it comes to the distribution of income, there is no “pure” market. Any distribution is, by its nature, “political,” reflecting changing social norms and the distribution of political power.
To point this out is not to suggest that I know of a more objective system for determining how income should distributed. Rather, it is to suggest that if we, as a society, decide that we find the current distribution of income unacceptable — if it offends our moral intuitions that a single financier earns as much in a year as 15,000 elementary school teachers — then it violates no great moral or economic principle to alter that distribution.
One way to make the distribution of income more equal would be to change some of the rules and norms that govern market competition.
Another would be to leave the rules and norms in place and alter the distribution after the market has delivered its judgment, through more progressive taxation and government spending.
The first has been called “predistribution,” the second redistribution, and there may be good economic and political reasons for favoring one or the other. But from a moral viewpoint, there is no meaningful distinction between the two. Both reflect the ways that societies determine the distribution of income based on subjective judgments of what is fair.
Defenders of free markets have long argued that shifting income away from those whom the market judges more talented and more productive would be to deny them their “just deserts.” But as a moral concept, just deserts is inadequate and incomplete.
For in determining whether any distribution of income is just, it is not enough to inquire whether someone has earned his income by playing by the rules. We must also look at the distribution of income and ask whether the rules themselves are fair and just.
Pearlstein is a business and economics columnist for The Washington Post and the Robison Professor of Public Affairs at George Mason University. He is also the author of “Can American Capitalism Survive? Why Greed is Not Good, Opportunity is Not Equal and Fairness Won’t Make Us Poor.”