The Wage Link fallacy

Posted by Marc Hodak on May 15, 2008 under Executive compensation | Be the First to Comment

Should CEOs make a lot when their workers wages are rising only modestly, if at all?

Let’s say that you’re CEO of an electronics company. You have always gotten those electrical components from a domestic supplier that is a government-protected monopoly. One day, you cleverly figure out how to sidestep that monopoly by sourcing from abroad. Your company saves a lot of money, and profits go up. The shareholders would like to reward, not punish this behavior. That’s how markets work.

Now, as certain compensation critics would have it, you have injured the earnings of the domestic producer. Your pay should be proportionately lower, to reflect their reduced earnings. Make sense? I didn’t think so. But if you replace “government-protected monopoly supplier of materials” with “government-protected monopoly supplier of labor,” then you arrive at the same illogical endpoint; the wages of managers linked with the cost of inputs. That, of course, is a recipe for bleeding the firm with a managerial bias toward uncompetitively high labor costs.

Insisting on a linkage between CEO pay and the wages of their employees is what I’m calling the Wage Link fallacy. It’s based on a primciple that is central to communism: An Individual’s wages should be unconnected to their productivity. Most purveyors of the Wage Link Fallacy, besides outright communists, are unions and their fellow-traveling politicians, most recently including EU officials from yesterday’s FT.

Excessive pay awards for company executives came under fire yesterday from the European Union’s senior economic policymakers, who condemned them as “scandalous” at a time when ordinary employees are under pressure to accept modest wage deals.

Notice how pay is prejudged as “excessive” against the standard of wages of “ordinary employees.”

Those pressing the Wage Link Fallacy invariably are pushing for government to trump the verdict of the market in assigning a small portion of productivity gains to those who create them. They wish, instead, to punish the managers who create those gains, the domestic consumers who benefit from them, and the employees outside of the unions’ sphere of influence who help make them possible.

Union supporters might argue that wage pressures from productivity gains affect more than just union members. Sure, certain workers at certain times are hurt by new technologies, new business models, new imports, etc. Are such productivity-enhancing disruptions, however, a systematic problem in need of government intervention? I don’t think so, but people with a propensity toward government intervention might disagree.

The more relevant question is: Do we need government to protect the wages of non-union worker’s? That is a researchable issue, and the answer is: Probably not. In the U.S., for instance, the BLS says that overall real wages have risen modestly over the last couple of decades. We also know that union wages have risen much more slowly than non-union wages over that period. So, government intervention is apparently needed only to protect union wages, not overall “average” wages.