June 20, 2011

Why are corporate profits so high compared to a generation ago?

From the Washington Post:
With executive pay, rich pull away from rest of America 
It was the 1970s, and the chief executive of a leading U.S. dairy company, Kenneth J. Douglas, lived the good life. He earned the equivalent of about $1 million today. He and his family moved from a three-bedroom home to a four-bedroom home, about a half-mile away, in River Forest, Ill., an upscale Chicago suburb. He joined a country club. The company gave him a Cadillac. The money was good enough, in fact, that he sometimes turned down raises. He said making too much was bad for morale. 
Forty years later, the trappings at the top of Dean Foods, as at most U.S. big companies, are more lavish. The current chief executive, Gregg L. Engles, averages 10 times as much in compensation as Douglas did, or about $10 million in a typical year. He owns a $6 million home in an elite suburb of Dallas and 64 acres near Vail, Colo., an area he frequently visits. He belongs to as many as four golf clubs at a time — two in Texas and two in Colorado. While Douglas’s office sat on the second floor of a milk distribution center, Engles’s stylish new headquarters occupies the top nine floors of a 41-story Dallas office tower. When Engles leaves town, he takes the company’s $10 million Challenger 604 jet, which is largely dedicated to his needs, both business and personal. ... 
Other recent research, moreover, indicates that executive compensation at the nation’s largest firms has roughly quadrupled in real terms since the 1970s, even as pay for 90 percent of America has stalled. 
This trend held at Dean Foods. Over the period from the ’70s until today, while pay for Dean Foods chief executives was rising 10 times over, wages for the unionized workers actually declined slightly. The hourly wage rate for the people who process, pasteurize and package the milk at the company’s dairies declined by 9 percent in real terms, according to union contract records. It is now about $23 an hour. ... 
While no company over this period of time — from the 1970s to today — can be considered completely typical, Dean Foods offers a better comparison than most because fundamentally it hasn’t changed. 
The dairy business is still the root of the company; it was on the Fortune 500 by the late ’70s and remains there today. It grew then and more recently through acquisition.
Moreover, both chief executives — Douglas and Engles — could boast records of growing the company and profits. 
From 1970 to 1979, while Douglas was the chief executive, sales at Dean Foods tripled and profits increased tenfold, to $9.8 million, according to company records. Similarly, from 2000 to 2009, sales at what would be Dean Foods had roughly doubled, and so had profits, to $228 million. (Engles became chief executive after the company he led bought Dean Foods in 2001 and adopted its name.)

I'm guessing from all this that the CEO's compensation as a % of corporate profits went up from about 3% in the 1970s to about 4% these days. So, there's no apparent economy of scale in CEO pay. 

That change from 3 to 4% is not insignificant, but the big change since the 1970s seems to me to be the huge growth in corporate profits. 

And that seems kind of odd. I paid a lot of attention to the business world from, say, 1979 into the early to mid 1990s, but the size of corporate profits these days seems hard to reconcile with economic theory.Adam Smith 101 says that more perfect competition will lead to lower profits.

You might think that regional monopolies and oligopolies that allowed higher profits than the risk adjusted cost of capital would have been worn down over the decades by increased competition caused by the huge improvements in shipping, communications, data processing, and globalization. But I don't see much evidence for that.

I'm not surprised that Apple has very high profit margins on innovative products, but why does, say, P&G do so well these days on toothpaste and detergent?

I mean, sure, we all know that corporate executives have been winning in the struggle with workers over pay. But why hasn't increased competition between corporations competed away the profits won away from employees?

111 comments:

  1. Because there isn't actually any increased competition between corporations since the 70s.

    Corporate consolidation has decreased competition. The article you linked to explained that the dairy firm grew by acquiring other dairy firms. That is a pretty common trend.

    In certain token sectors like trucking and air travel, there has been an explosion in competition that has whittled profits, thanks to Carter-era reforms.

    In the rest of the economy? Not so much.

    As you have written about, we've become increasingly tolerant of monopolies and uncompetitive markets.

    We've moved away from New Deal-style free, regulated markets to a overly consolidated, centralized corporate welfare state.

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  2. It isn't taxes. In the 1970's the tax rate on corporate CEO salaries was 70% and on corporate profits it was 42%. Today the CEO tax is 35% and corporate profits also pay 35%. That should favor CEOs over corporate profits, but profits are still up.

    In the 1970's it was possible to import raw materials from abroad easily enough but regulations, monopolies, thieving unreliable international banks, and corrupt foreign officials made it hard to depend on foreign labor. With the rise of much less corrupt regimes in Latin America and Asia, it's just as easy to depend on foreign labor. That reduces labor's share of profits and makes it harder to small innovative companies to compete away the profits of big incumbents.

    A small innovative company lacks the international connections and economies of scale to make deals with foreign conglomerates and grease the right palms to send their business to China or Mexico. The smaller they are, the easier it is for a foreign partner to stab them in the back and there is often no functioning legal system abroad. That keeps the big American companies fat and happy.

    So far local small business overseas has yet to assert itself. Mostly the overbearing regulations in the newly less corrupt world is aimed at foreign investment and local elites without opening up opportunities for local professional and working classes to build businesses. That corporatism is being exported to the developed world because you need to play along to exploit the cheap labor.

    In Mexico, for instance, the locals are very entrepreneurial but have to operate in the gray market because officials routinely deny them business registration, charge them higher taxes than big businesses, demand bribes disproportionate to the size of the business, delay official licenses and registration documents for months or years that would be produced the same day in the USA, and charge extra taxes and fees against businesses that employ irregular workforces or people born in non-Spanish speaking communities. And that's just what I've been told about by businesses I patronize.

    If China and Latin America ever unleash local people to compete, the multi-nationals may find cheap labor is more expensive than it seems.

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  3. Steve, over the business cycle, there hasn't been an increase in corporate profits as % of GDP. See this graph, for example. Unfortunately, it stops at 2006, before the recent disaster:
    http://www.nytimes.com/imagepages/2006/08/28/business/28wages_chart.html
    You correctly pointed out that larger companies give out higher CEO compensation packages (which makes the whole CEO/worker ratios comparison between 1975 and 2010 meaningless). So, no scandal there either.
    My strong impression is that your posts on strictly economic matters are much less informative and of lower quality than your other articles.

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  4. Its the "Free market" steve, don't you get it?

    The reason we have 9 percent unemployment, a $1 Trillion dollar budget deficit, a collapsing dollar, a stagnant stock market, and a bankrupt Social Security system is because CEO pay isn't high enough!

    We need these "John Galts" - they're irreplaceable. Could you have done what market wiz Bernie Madoff did? Could you have run B-of-A or Washington Mutual?

    Back to the OP. Why are corporate profits so high? Easy, the Fortune 500 owns DC, they own the media companies, and the AFL-CIO & the liberals sold out American workers 20 years ago.

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  5. "From 1970 to 1979, while Douglas was the chief executive, sales at Dean Foods tripled and profits increased tenfold, to $9.8 million, according to company records. Similarly, from 2000 to 2009, sales at what would be Dean Foods had roughly doubled, and so had profits, to $228 million."

    Dean Foods probably didn't make a dime in real terms in the 1970's, after inflation. All that expensive equipment (and cows) had to be replaced at the higher, inflated price, meaning that profits had been overstated in the 1970s. In the 2000s, when inflation was low, those profits were real, even after inflation.

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  6. Consolidation has reduced competition, and regulation creates high barriers to entry. Businesses over a certain size are fine with regulation.

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  7. I don't know what the deal is with P&G and toothpaste, but the milk business is more Karl Marx 101 than Adam Smith 101.

    Do some digging around into "federal milk marketing orders" if you need convincing.

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  8. I'm not surprised that Apple has very high profit margins on innovative products

    Apple sells innovative products? I guess the iPhone1/2 was innovative, and I'm sure there was something in the 80s, but aside from that I can't think of anything.

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  9. Six billion people, not enough resources. Marginal product of workers compared to both machines and third world workers just isn't good enough.

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  10. I'm guessing from all this that the CEO's compensation as a % of corporate profits went up from about 3% in the 1970s to about 4% these days. So, there's no apparent economy of scale in CEO pay.

    Well, I haven't looked at any numbers and perhaps I'm just showing my bias, but I'd be *awfully* surprised if the CEO compensation increase were really that small. Remember, Dean Foods is just some midsize company in a boring industry. Meanwhile, there's been a *gigantic* shift of overall national profits toward the financial/real estate sector, where CEO's get much larger shares of everything. And Silicon Valley and Media have been two of the other ultra-profitable sectors, where top pay is outsize. Also, there's been a general shift toward stock options which produces the same effect.

    Right now the top 1% of American households have more total wealth than the bottom 90-95%, which would seemed totally outlandish just a generation or two ago. So I just can't believe that top exec pay has just gone up by 30% relative to profits...

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  11. I think you're off base in assuming that executive pay is just from profits.

    First, the economy grew at a huge rate in the three decades following WWII, before your self-described window of paying attention to the business world, and salaries at the top weren't comparable. Productivity gains were shared, translating into more demand and higher labor costs, which fueled productivity increases in a virtuous cycle. Political changes since 1980 have broken the cycle, so everyone's productivity gains are now sucked up to the top.

    Second, if pay reflected profits then you would see comparable compensation for leaders at companies like Honda, but American executive pay is bloated relative to better run foreign competitors.

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  12. Executives basically pick the boards that pick their salaries, with predictable results. If shareholders instead had to approve large pay packages, and unreturned proxy votes had to be uncounted rather than counted for management, then American executive pay would reflect market rates and go down to the market rates of international competitors like Volkswagen.

    To see the rationality of the current system, imagine if incumbent politicians could count unreturned votes in their favor.

    Thus, much of American inequality isn't "natural" or "objectivist," because the last time I checked corporate governance rules weren't sprouting out of the Earth.

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  13. Wages are now a smaller percentage of expenses. Profits are correspondingly larger.

    There are many more competitors for jobs now, as anyone who deals with the job market knows.

    Competition has driven wages down.

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  14. In the 1970's P&G was overwhelmingly an American company. Today its more global and sells its Crest in places like China, where the local manufacturers don't seem to mind putting antifreeze in their lower priced toothpastes.

    That kind of competition is hardly the kind to reduce P&G's profits. Apparently price isn't everything.

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  15. Pretty simple explanation, and it's part of that "economic theory" you seem confused by.

    http://en.wikipedia.org/wiki/Creative_destruction#Schumpeterian_Creative_Destruction

    The pace of technology is fast, meaning entire markets keep emerging and being overtaken by new ones. There's little intramarket competition because the way to win share is to redefine the market. Once you're the first guy in, you have apparently above-market profits.

    Come on, man, didn't you go to business school?

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  16. "As you have written about, we've become increasingly tolerant of monopolies and uncompetitive markets."

    And he keeps getting beaten up badly in the comments about this.

    Antitrust law and policy before 1980 was irrational and stupid. To act like that's the golden era of antitrust is irrational and stupid.

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  17. Imagine how quickly the NFL would fall apart if the commissioner was hired and fired by Vegas bookmakers.
    "Roger Martin: Fixing the Game: What Capitalism Can Learn from the NFL"
    http://www.equitynews.info/2011/05/03/roger-martin-fixing-the-game-what-capitalism-can-learn-from-the-nfl/

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  18. "In fact, successful innovation is normally a source of temporary market power, eroding the profits and position of old firms, yet ultimately succumbing to the pressure of new inventions commercialised by competing entrants. Creative destruction is a powerful economic concept because it can explain many of the dynamics or kinetics of industrial change: the transition from a competitive to a monopolistic market, and back again."

    From wikipedia.

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  19. Probably because a lot of the big corps some how get enough subsidies to pay a net negative on taxes..

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  20. It's automation.

    Watch how it's made a few times and count the people or watch the things they do, people today mostly work in support of machines (which is easy so it doesn't pay well).

    Equally important to management salary are index funds (and closet indexing active funds) who don't do the job of owners by keeping management's hand out of the till (with all the returns to capital shareholders should be raking in returns, but they're not either).

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  21. The biggest executive pay packages are on Wall Street, which if you recall the TARP and Fed special lending facilities, hasn't exactly been at the mercy of the invisible hand.

    As for the big brick and mortar companies, a lot of them are more "financialized" than you might expect. GE for instance, was a big bailout recipient because GE Capital is one of the company's largest parts. Similarly during the bubble years the CEO of General Motors said that his company sold cars so that they could make loans.

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  22. My guess is that the cost of labor has plummeted since the '70s. China is essentially the world's plantation, keeping wages artificially low, keeping their own people in virtual slavery so it can dominate world trade.

    I'd be curious to see how much these companies are spending on labor, compared to what they were spending 30 years ago.

    I also suspect that the wealth gap is largely "paper" wealth, based on the inflated value of crazy financial instruments the availability of infinite cheap credit.

    A lot of it may just be plain fraud, based on phantom accounting and "assets" that should have been written off 10 years ago.

    If we ever have a currency crisis in the U.S., I think much of that wealth gap will vanish in a flutter of spreadsheets.

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  23. One major reason for the explosion in profits is the litany of regulations faced by the entrepreneur which greatly reduces upstart competition. The compliance cost is beyond estimation because small companies are often founded by a dynamic individual who must have his hand in everything both out of personality and out of fact that he is often the smartest, most committed person within the enterprise. As a result, the entrepreneur's focus becomes record keeping and compliance. This leads to disillusionment and abandonment of the venture and/or a significant or near total loss of sales or failure to realize them. As a result, there are few competent upstarts that can succeed. What is worse is that the existing behemoth corporations actively push the regulations in order to create barriers to entry. This tactic is even reviewed, if not endorsed, in b-school.

    As for the ability to challenge P&G, it should be noted that the cost to develop a better detergent is not really high. Surely, a top level chemist could do it for less than $30,000; I base this on asking a chemist that very question. The problem is knowing and complying with the regulations. I am starting a dietary supplement business and the new regulations, endorsed by the largest players, are horrifically burdensome and pointless at the same time. Moreover, the threat of criminal prosecution looms for anyone who does not comply with the rules regardless of if they know of all the nuances that exist.

    A hidden cost to the regulations is that companies such as mine might choose to develop the product, then outsource production to China and buy it under a different label and sell it as a retailer, thus absolving themselves of any regulatory compliance costs. Such a move means fewer American jobs, less profit in our float and complete loss of IP. Succinctly: only ignoramuses support significant regulation, because aware individuals know that regulations are nothing more than bureaucratic entrepreneurialism at work.

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  24. The manufacturing/administration of the corporation is increasingly being done by machines/computers and is shrinking in importance. There is a growing recognition that today companies succeed or fail according the quality of its top management alone. They make all the difference. A star manager, professor or general can change everything and therefore is worth everything.

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  25. Hyman Minsky6/20/11, 9:19 PM

    What about the role of interest rates -- being able to borrow and finance operations at near zero % today, versus close to double digits in the late 1970s?

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  26. So the obvious conclusion is, we don't have more perfect competition today.

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  27. I stumbled across an article a few months ago that explained the reason for the rise in corporate pay. The reason is an increase in the ease (at least until 2008) of creating new companies. Therefore, for an established large company to hire a top CEO, he had to pay that CEO at least what he would make if he created his own company. If the big corporations paid any less, they wouldn't have the top talent. It would all be found in the upstarts.

    Which explains why CEO compensation is lower in Europe and Japan. It is much harder (if not impossible) for a completely new company to become the next Apple or Microsoft.

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  28. Corporate profits are up, way up, because of sales to BRIC nations and other emerging markets. Most of the sales for Dean Foods according to the 10-Q online are domestic, and its asset base is domestic-foreign about 10-1. But for manufacturers, and other retailers, the sales gains from BRIC/Emerging markets have been tremendous. Basically no other consumer goods products companies with national level experience. Thus its a very lucrative market.

    Add to that the ability to dismiss lots of middle managers through IT/automation and you get the picture. A leaner, more efficient organization exploiting near-virgin territory.

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  29. Many quite plausible reasons have been advanced here. Here's another: Today's baby-boomer executives are self-absorbed, greedy bastards - the moderately wealthy of today do not have the sense of noblesse oblige exhibited by their parents.

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  30. Executive salaries are low in Japan, why?
    Robert Hume

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  31. Are we sure that corporate profits are really that high in an historical sense? They go in cycles and have been high before (1929!). So they do seem somewhat higher now than in the 1970s, but are they really that out of line if you go back 80 years? If this chart is good, they have been high in the past.

    http://www.aametrics.com/charts/econus_corpshare.pdf

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  32. Old time CEO had a lot of valuable perks that didn't count as income. Now they do. So, no more perks; cash instead.

    Imagine this standard would apply to the US President. His official salary is what, 400K? Now imagine that all his perks--the upkeep cost on the White House, the imputed rent on the same, the salaries of the service personnel, the use of Airforce One, etc.--counted as income and the President had to pay taxes on it. Forget $400K, suddenly no one would take this job for less than $40 million.

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  33. "You might think that regional monopolies and oligopolies that allowed higher profits than the risk adjusted cost of capital would have been worn down over the decades by increased competition caused by the huge improvements in shipping, communications, data processing, and globalization. But I don't see much evidence for that."

    Most of those improvements are embodied in new technologies that require capital investment (hence increase the demand for capital) but decrease the demand for labor; they are what drive the growth of labor productivity. Labor-saving technology shifts income away from labor towards capital unless steps are taken to offset these trends with updated wage-and-hour laws whose purpose is to artificially restrict the supply of labor. A six-hour day with time-and-a-half for overtime would be boon to working families today. The fruits of progress don't automatically get shared. Even Milton Friedman knew that.

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  34. Apple has made some innovative products. The original Ipod integrating with Itunes was pretty revolutionary -- the first seamless, easy to use integration between MP3 player and a computer. The Mac OSX machines brought good industrial design to UNIX in a friendly interface. The original LaserWriter was revolutionary -- a high quality printer with Postscript printing. The Imac has been widely copied, and the Iphone set the bar for smartphones.

    But even with Apple high prices have led to the OSX86 Project, and other stuff along those lines. IP in today's "build it in China" world is not really IP (since the Chinese will simply appropriate it anyway).

    It is the massive amounts of middle management done away by Excel spreadsheets, or Oracle Databases, that have dramatically lowered costs. In 1970 it would take an army of clerks and middle management to find out what is the best and worst selling milk product for Dean Foods in say, the top ten by revenue geographic areas in the US. Today that's trivial for a ERP system with executive drill-down. Just as trivial -- finding the most profitable customers and the least profitable ones, by total costs. That's something only really possible when costs and time and so on are all entered and aggregated by a massive database. THAT is a revolution that allows far greater efficiency.

    If you know you make 90% of your profits from say, a set of customers around 30%, that's where you concentrate all your effort. Meanwhile some customers actually cost more than they pay.

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  35. To answer your question Steve, think of one type of corporation that is making less money now than it was in the 70s: newspapers.
    What is it about newspapers that have made their revenues and profits decline while those of others increase?
    1. Technology. This has helped corporations reduce costs but hurt newspapers as it introduces new forms of competition.
    2. Labor. Newspapers can't employ cheap foreign labor, as a very high level of English proficiency is a key part of the job.

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  36. RKU are you sure that real estate is still a high paying area for executives? By the way, we are continuing to watch you with our secret spy satellites. Your every move. You are on to us ... and we of the Illuminati don't like nosy people.

    By the way, love what you've done with your living room, much more cheerful now.

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  37. Many reasons I'm sure.

    In specific cases, it can also be due to high margins, which comes down to successful marketing/branding. For example, Apple has generally enjoyed high margins on its products due to successful branding. Apple makes very good products (that inspire high customer satisfaction and loyalty), but you can pay significantly less and get something decent with basically the same functionality (i.e. there is competition). Apple's margins may be coming under pressure from Google's Android, however.

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  38. Steve S. said:
    I mean, sure, we all know that corporate executives have been winning in the struggle with workers over pay. But why hasn't increased competition between corporations competed away the profits won away from employees?

    The big change over the past generation (since end of Cold War) has been the revival of financial capitalism - somehow banks and institutional fund managers have gotten in cahoots with elite management of industrial corporations to screw everyone over.

    Russian oligarchs only worst of a bad bunch.

    Cheap capital from NE Asia has greatly facilitated this process.

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  39. The graph posted above from the NYT holds the key to the issue:

    1. Corporate profits are *not* much higher than before. They are about as high (before the crisis) as in the 50-ies. This seems like a critical piece of information, but instead we get an analysis of a single dairy company. Really?

    2. Hourly wages have declined as a share of the economy, mostly because:

    3. "Total compensation" has "picked up the slack". Sadly, this is mostly due to those rising health care costs you might have heard about.

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  40. Executives are paid a lot of money because modern American investors want to see good things in the next quarterly statement, and that's all that matters. Given this, where do investors want to see the money going?

    Not to workers, certainly. Paying workers more, whether to acquire more skillful labor or to reduce turnover and low morale, is not going to make money in the short term. Hence wages have stagnated since the 70's.

    Nor to improving machinery, equipment and buildings; this is a huge short-term money sink that will not pay off for years. And thus, behind the shiny office buildings and shiny MBA's inside them, the productive assets of American companies get older and worse every year.

    Instead you give money to a handful of smart operators who can come up with a cute little idea to juice the stock price, or raise money to buy somebody out. The result is that American business has become a spiritual phenomenon: investors give money to certain shamanic figures who proclaim an "innovation" - but not an engineering innovation; those are for Krauts and Japs. No, the workers stay in the same old buildings, working the same old machinery - anything else would cost money. If you really must build a new physical object, have the Chinese do it on the cheap.

    The innovation is instead metaphysical in nature, whether it's a social networking site or a financial instrument. It's like a fast-forward version of the Western Empire descending into the Dark Ages: buildings and roads fell to ruin, nations grew poorer, knowledge was lost - but the priests assured us that this was irrelevant; what really mattered was the invisible salvation that they offered.

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  41. i think the short answer is that there are more consumers now. how many humans were added to earth between 1970 and 2010?

    the long answer is something i talk about frequently: first worlders produce almost all the stuff, and everybody else buys it. as the "everybody else" segment of humans grow in number and average income, so does the number of potential buyers for stuff which is only being produced by operations run in first world nations. the third world nations have no general ability to copy most of these operations or to develop their own version of most operations, and present no economic competition in most industries. but more and more they need this stuff, and come calling with money in hand.

    i'm sure this isn't true in every industry but it's easily shown to overwhelmingly be the case in many industries and is definitely the case in every industry which takes a lot of brainpower. in those industries there is a minimum average brainpower level required even to copy an existing international industry and create your own domestic operation to try to take market share away from the foreign companies.

    brainpower below that, all you can do is allow the smart nations to come build factories for lower labor costs. so a third world nation's ability to participate in lots of industries is limited to allowing outside companies from first world nations to come in and set up operations and hire the locals for labor. all the money still goes back to the home nation of the company running the show.

    i will list concrete examples of this argument in a post below. i've got several.

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  42. this is why it did not make sense when obama talked about foreign investment in the US. true it helps the employment situation somewhat, but the greater the level of foreign investment, the more dollars are sucked out of the US and spirited away to some other country if the investment pays off. it's economic imperialism and a long term net drain.

    allowing other nations to set up operations in your own nation, which produce something that competes directly with a product produced by a domestic operation, is usually not a good idea in the long run. that means the foreign operation is already strong relative to your domestic industry. they can fail of course, but they can succeed too, and after a decade of well managed growth they start taking away market share from your domestic operations.

    due to a combination of demographics, and the modern american obsession with sending everybody to college where lots of people learn nothing useful, the long term foreign investment situation in the US may not be that attractive relative to other nations. siemens just put out a PR release stating that they were now having a lot of trouble finding americans suited to work for them in their US operations IE most of the applicants were either not smart enough or had a 4 year degree in something they couldn't apply instead of having a blue collar skill. lots of shop skills are highly valuable and in great demand.

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  43. Wes is watching RKU6/21/11, 3:22 AM

    The people most adversely affected by the economy over the last 30 years seem to be "working class" whites. As I remember, they were people who were strong union, "loud and proud" types that liked to drink beer, hated smart people and executives and loved to brag on themselves.

    They were usually jerks and bullies in school. I hate to say it, but I suspect that is the reason there is little sympathy for them. I remember a nerdy smart college white guy telling me he hated the blue collar bully boys ... he felt he had more in common with a smart Korean overseas then a "bud-man" here in the States.

    ... Those chickens ... coming home to roost for the bully boys?

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  44. the first industry is the movie industry, which will give you a basic idea of where i'm going with the argument. movies are MUCH more profitable on average now than they were in 1970 due primarily to international box office. that is to say, the number of buyers for the product just keeps going up every year almost without end. the growth is not in the US, but outside the US. an american movie production released in 30 nations now pretty regularly makes more money outside the US than inside it. it's not unusual to make half a billion dollars on a movie now because of how many ticket buyers there are in those 30 nations you rolled the movie out in.

    now one of the factors here is, how much materials cost is there per unit, when you ramp up production. in 1980 you would be rolling out "the empire strikes back" in 1000 theaters mainly in the US. but in 2010 you would be rolling out "avatar" in 3000 theaters in the US and 2000 theaters outside the US for a total of 5000 places where people can buy your product. but making copies of your product is not expensive.

    so, the more and more people around the world who are watching exported, english language, big budget movies, the more and more most movie releases become straight up profit for the movie studios. whether they manufacture 500 copies or 5000 copies of the product is not a major expense, but shipping 5000 copies instead of 500 is a colossal increase in revenue.

    the movie MAKING industry is world wide, but most foreign nations can't compete and can only make local, small budget films in their native language which can't be easily exported. so they don't benefit from the ever increasing number of eyeballs around the world looking to pay money to see movies.

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  45. now let's step this up to the software industry, which benefits from the same exact factors as the movie industry, except to an even greater degree.

    the world increasingly needs the software which mostly only medium to high brainpower operations can produce, so the number of buyers worldwide keeps growing. but less nations can produce their own software stuff than can produce their own movies. it's easier to make a movie than to make an application, although even smaller, less important first world nations and some second world nations can produce crappy versions of stuff if they need to.

    usually they don't though, this is something i noticed when i worked in the computer industry. china and india are huge nations which produce very little important software. india in particular, we are told that indians are "great at software" but i specifically looked to find major, major software that was developed primarily by indians in india, and there pretty much is none. last time i researched this stuff, even japan doesn't produce much software outside of the game industry. IBM, microsoft, oracle, google, SAP, HP, CSC, accenture, symantec are the major operations and those aren't east asian operations. nintendo is the biggest non-white guy/jewish guy software operation.

    and of course the REAL advantage of ramping up units produced in the software industry is, it costs almost nothing. how much does it cost to copy a few million lines of code onto a CD? games aren't that important money wise in the software business, although like movies, rolling out a major new game is a GLOBAL event now. in 1980, atari would put out 1 million cartridges of a major title for the 2600, primarily in the US. in 2010, when blizzard releases a new game, it's a major worldwide event that brings in 1 or 2 billion dollars.

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  46. let's step up again to physical stuff, like CPUs and hard disks and LCDs. now we're really elminating all the players except the top ones. even small first world nations can't produce CPUs or hard disks or LCDs at a scale that matters. phones and small devices maybe, RAM maybe, assembling parts into PCs and laptops sure, but they hit a wall at CPUs and hard disks.

    semiconductors are strictly the province of 4 or 5 nations and the other nations only participate in the industry by allowing those operations to set up fabs and factories for lower labor costs. they almost never develop their own CPU industry to compete with the foreigners. even japan buys CPUs from IBM for nintendo.

    here, the cost per unit to ramp up production is a factor, unlike making movies or software. this stuff has to be planned out 5 years ahead of time and new fabs cost 3 or 4 billion. but the cost-to-production ratio still does not scale up linearly. every year there are more people on earth who want to buy a cell phone or laptop or PC, all device which have a microcontroller or a CPU, and those things can only come from a few operations in a few countries. they can't come from some start up in brazil or indonesia or egypt or mexico. sales in this industry keep growing but the number of producers doesn't grow that much. the existing operations get more and more of the global pie but new competitors are rare.

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  47. finally you're up to big ass stuff like cars, trucks, and aircraft. while there are about 10 nations which can produce cars, only about 5 of them matter for taking global market share. the acquisitions and mergers situation makes the domestic car production in some nations send it's money back to germany or japan or the US (increasingly less and less).

    there are less makers of trucks, which matters more and more as stuff is distributed by truck and less by freight train (freight train is still a huge delivery system in the US). then you get to aircraft which only like 3 or 4 nations can make in any volume that matters.

    increasing your volume of production here is very expensive as every unit costs a lot in materials, so these operations are planned out 10 years ahead of time. new factories for vehicles cost less than new fabs for semiconductors but production is ramped up more slowly. the cost of materials is passed on to the customers though so it doesn't kill the operation.

    anyway, the same pattern persists in this industry. every year there are more humans on earth who want to buy and drive a car, and only a few operations which can deliver them a vehicle. several car companies now make more money selling cars in china than they have ever made selling cars in their own nation. so again like the movie industry example, global buyers become more important than domestic buyers. rick wagoner of GM was famously oblivious to this fact of his own company.

    the same "we make, you buy, you can't produce your own" situation exists in stuff like chemicals, energy, and even food production.

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  48. Cheap labor from China explains why wages are down, it doesn't explain why profits are up. If there was competition, then lower labor costs would be passed on to customers and profits would not increase.

    So the obvious answer is that companies have gotten better at quashing competition.

    Most markets in the U.S. are oligopolies in which the companies don't compete based on price.

    Toothpaste probably sells for at least 10 times the cost of manufacturing it. But there are only four companies selling toothpaste:

    Church and Dwight
    GlaxoSmithKline
    Proctor and Gamble
    Colgate-Palmolive

    So why can't you sell Steve's Toothpaste as half the price? I'm sure you will find that there are barriers to entry which will prevent your discount toothpaste business from making any money.

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  49. real wages for the middle class have gone down.. working class too. Duh

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  50. nobody's mentioned immigration and its effect on real wages/?

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  51. Today's baby-boomer executives are self-absorbed, greedy bastards - the moderately wealthy of today do not have the sense of noblesse oblige exhibited by their parents.
    i think this is quite true. the baby boom generation is the most selfish, immature and cares nothing for the long term - no sense of custodianship or stewardship. Me me me.

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  52. I know that the article mentions this briefly, and I don't know if the affects what is happening with the executiuve pay, but Dean Foods from the 70s isn't the same company it is today. I grew up less than a mile from the oriognal Dean Foods headquarters. Back then Dean Foods was headquartered in a non-descript industrial building that looked like it was built in the 40s. Dean supplied milk and dairy to grocery stores in Chicago and the Midwest. I always admired it because it did not go for all of the flashy corporate office buildings and seemed to be a really good company. As it became more successful, it drew the attention of larger national and international corporations and was eventually taken over by a big flashy internation conglomerate from Dallas. This company then changed its name to Dean Foods.

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  53. I know for a fact that perks are much better protected in Europe as well, company car's, access to company owned guest houses are much more compatible with the overall tax structure so this accounts for some of the cash income disparity, but I don't imagine all. Nice German sedans are a common perk for technical staff as well (guys making way less than $100,000).

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  54. It's simple and obvious Steve, the two great big 'neo-liberal' pushes of the last 3 decades namely open borders and 'trade liberalization' have done what 'said on the tin' and gutted the US labor market.
    Basically yer average Joe Blow has to race to the bottom to compete with his friendly neighborhood Mexican peon or agains Chinese earning perhaps $20 a day.Simple and obvious as that.
    Why have corporate profits held up? - Simply because it is in the interest of the big toothpaste cartels (for instance) to give each other an easy life and not race each other to the bottom for market share.There are onlt two or so toothpaste firms in the business, they know full well that any so-called 'competition' between them well in the long run only harm each other whilst benefitting no one, so in a cosy cartellish sort of way allow maximum profit equilibrium to prevail.
    And of course entry costs for any upstart are prohibitive.

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  55. @Half Sigma: "Cheap labor from China explains why wages are down, it doesn't explain why profits are up."

    This is simply an error, Half Sigma. As the ratio of capital to labor grows smaller (which is what trade with populous, poor countries like China effectively causes to happen) the rate of return to capital increases. It is sometimes called the law of variable proportions, more often the law of diminishing returns.

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  56. The problem of agency needs to be mentioned: the fact that the CEO's and their chosen Boards of Directors are in positions to act in their own interests rather than in the interests of the shareholders, who are too numerous, divided, and ill-informed to know what is really going on or to do much about it even if they did know. Mutual fund managers might be an exception but they are frequently members of the same old boys network.

    The Citizens United ruling is likely to intensify the problem. Top management will use corporate resources to further their own private political and financial interests as well as those of the companies they control. What is to stop them? The mere threat will be enough to bring most candidates into line. And once the devil is in the saddle, how do you get him off?

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  57. "Cheap labor from China explains why wages are down, it doesn't explain why profits are up."

    How is it possible that supposedly "data-oriented" bloggers consistently ignore the only real piece of evidence regarding corporate profits in this entire thread?

    http://www.nytimes.com/imagepages/2006/08/28/business/28wages_chart.html

    That corporate profits briefly reached the same levels as in the 60-ies and 70-ies just before the recent crisis is hardly good evidence of any major shift in the distribution of the surplus between capital and labor.

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  58. On amy given subject you get more info and food for thought in one comments section of iSteve than you get in years of subscribing to a news magazine.

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  59. The change began 5-6 years after the 1965 immigration act. The extra profits from lower wages trickled up and some of it was used to lobby the legislature to allow the formation of oligopolies and to regulate against new competition.

    More recently off-shoring has not only increased unemployment and put even more downward pressure on wages but also in the course of off-shoring and creating new companies in the destination country the management teams have been finessing the ownership of the new companies so they end up owning more than they originally did.

    Britain is following a similar path but starting in the 80s rather than the 70s. Germany, France and Japan not so much.

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  60. Anon 6/20/11 8:41 PM:

    Antitrust policy may not have been especially rational or fair in the past, but it seems almost inevitable that there was a tradeoff there--more aggressive antitrust policy probably did result in less market concentration, in much the same way that sending the police out to round up the usual suspects and smack around the habitual losers probably does actually decrease the crime rate.

    To my mind, the important issue w.r.t. corporate mergers isn't economics, it's concentration of power. Media mergers in particular represent incredible, scary concentrations of power over the whole society in a small number of hands. Telecom mergers seem like potentially ugly concentrations of power, but also like opportunities to really stifle the hell out of innovation, since monopolists and near-monopolists have little incentive to innovate. (Some still do, notably AT&T and IBM twenty years ago, and Google now. But I don't think that's the way to bet.)

    And larger companies become better, in general, at getting what they want from government. A huge company with a presence in every state and an army of lobbyists and control of a media empire which will, in practice, never run stories too strongly against its business interests, is in a position to get a lot of laws passed in its favor.

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  61. Anon 6/20/11 8:41 PM:

    Antitrust policy may not have been especially rational or fair in the past, but it seems almost inevitable that there was a tradeoff there--more aggressive antitrust policy probably did result in less market concentration, in much the same way that sending the police out to round up the usual suspects and smack around the habitual losers probably does actually decrease the crime rate.

    To my mind, the important issue w.r.t. corporate mergers isn't economics, it's concentration of power. Media mergers in particular represent incredible, scary concentrations of power over the whole society in a small number of hands. Telecom mergers seem like potentially ugly concentrations of power, but also like opportunities to really stifle the hell out of innovation, since monopolists and near-monopolists have little incentive to innovate. (Some still do, notably AT&T and IBM twenty years ago, and Google now. But I don't think that's the way to bet.)

    And larger companies become better, in general, at getting what they want from government. A huge company with a presence in every state and an army of lobbyists and control of a media empire which will, in practice, never run stories too strongly against its business interests, is in a position to get a lot of laws passed in its favor.

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  62. Here's an alternative model for this: Over the last several decades, corporate management has become more intelligent (less based on who your parents are, more based on what you've managed to do). At the same time, it's become much more educated (MBAs, accounting, finance, and law degrees are common at the top.) Those two changes mean that the management class, very broadly speaking, is today smarter and better equipped to negotiate more money for itself than it was 30-40 years ago. That class is similarly quite good at lobbying for and justifying its own privileges and benefits.

    So that's my guess--corporate managers are smarter and better educated, and so they're broadly better at gaming the systems they run to get more money out, to set up more heads I win tails you lose situations, etc.

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  63. Half-Sigma:

    Perhaps. I'll note though that while the toothpaste manufacturers probably don't fear my potential competition or the DoJ's willingness to bust up their oligopoly, they probably fear the heirs of Sam Walton quite a bit.

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  64. Douglas Knight6/21/11, 7:52 AM

    Does anyone have a citation for those 3% and 4% numbers? At least that's an objective question.

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  65. Steve -- You're not firing on all cylinders here. How do you get from one company to pronouncements about corporate profits generally?

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  66. Perhaps there are barriers to entry to industries that were lower than now. I am thinking particularly of regulatory barriers. How easy is it to get the various health etc permits today compared to then set up a dairy industry today. Tesla nad de Lorian are the only new car manufacturers, as opposed to foreign ones moving in, since the 1930s & neither of those are mass market.

    Branding may also play a bigger part in preventing competition. People will buy petrol from anybody but jeans only from a brand name. In theory branding should be less important because even non-branded goods tend to be of a pretty high quality today, which was not the case back then.

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  67. Church and Dwight
    GlaxoSmithKline
    Proctor and Gamble
    Colgate-Palmolive

    So why can't you sell Steve's Toothpaste as half the price? I'm sure you will find that there are barriers to entry which will prevent your discount toothpaste business from making any money.


    Your basic premise is sound, but consumer choice is still a factor - Americans are still willing to pay more for name brands, and slicker marketing.

    For instance, there's the generic variety of "equate" toothpaste at Wal-Mart that is considerably cheaper than any of these brands... but nobody is buying it.

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  68. Those curious about these matters ought to read "Toward a Truly Free Market" by John Medaille.

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  69. @ Charlie 2:36

    That was the most prescient observation I have read in a while. Thank you Sir!

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  70. "You might think that regional monopolies and oligopolies that allowed higher profits than the risk adjusted cost of capital would have been worn down over the decades by increased competition caused by the huge improvements in shipping, communications, data processing, and globalization. But I don't see much evidence for that."

    All those huge improvements favor certain economies of scale--though not all. Though all businessmen can buy stuff from China or Mexico, Walmart can buy 1,000,000 units at a time whereas a small wholesaler might buy a 1000 at a time.
    As for dairy, it means the BIG COMPANIES can penetrate and deliver to just about every community thanks to better transportation and storage. In the past, local communities would be served by local producers. Now, Dean, a national chain, can deliver milk to all 50 states.

    Otoh, traditional print media would bound to take a hit since people can go online for easy and free news.

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  71. executive pay and bonuses have increased on a yearly basis REGARDLESS of performance - what really has been going on is looting of the company assets, and lots of 'tricks' to make the company look good on paper and/or but long term america's overall competitiveness has been declining.

    Classic example was GM once selling off its solar development unit to make its 3rd quarter earnings look good. Yeah, that helped those now retired execs, but the company now?

    remember the idea i think one of the roman philosopher types had - that planting olive groves (which didn't yield olives in the grower's lifetime) was a sign of optimism and looking out for posterity. The baby boomer have been chopping down those olive groves and selling the wood.

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  72. Apart from the greed, the currency has been devaluing rapidly in the last 30 years. So increased compensation for management reflects this fact, something they of course will never acknowledge w.r.t. the average employee.

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  73. what's freaking me out is how basic commodities are in the hands of international monopolists. will this ever go away again?

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  74. All of you guys treat an article like it's just a recitation of facts.

    In actuality, the author of this article, Peter Whoriskey, has an agenda -- like the authors of all articles.

    He knows what reaction he wants to elicit. The adjectives he uses in the article ("greed") stir up the expected emotions in the comment section.

    He won't mention the fact that the upper class is increasingly non European, or that income inequality is driven by mass immigration of illiterate migrant workers.

    He won't mention the fact that this is a worldwide phenomena, in that Europeans represented 25% of people worldwide in 1900 and only 11.9% today (http://www.prb.org/Educators/TeachersGuides/HumanPopulation/PopulationGrowth.aspx).

    And he DEFINITELY won't mention the religious affiliations of many of those at the top, or those writing the articles for that matter.

    What does he do? Peter Whoriskey points the braying mob at the figure they've come to expect, one of the relatively few remaining older wealthy WASP patrician gentiles.

    Whoriskey and his ilk have vastly exacerbated IQ inequality over the past century, both globally and in this country, and then they stir up the dumber masses to attack those in the middle and the upper middle class, while their coreligionists at the true top always escape attention.

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  75. Established businesses have the force of regulation, gigantic piles of cash and other perks with which to crush competitors. It is of course never enough, and they are for example lobbying to get American patent laws changed to forever prevent anyone from competing with them at any level.

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  76. "The current chief executive, Gregg L. Engles, averages 10 times as much in compensation as Douglas did, or about $10 million in a typical year."

    I wonder how many illegals work for him and how much their Medicaid benefits, public education, food stamps, section 8 etc., for their illegitimate brats cost taxpayers. Over $10 million a year? Possibly.

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  77. Nice German sedans are a common perk for technical staff as well (guys making way less than $100,000).

    Well the taxis and many average cars in Germany are nice German sedans as well.

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  78. "lots of shop skills are highly valuable and in great demand."

    For 8.50/hour, minus Union dues, part-time only, few long-term benefits.

    I have done this kind of labor in the past. It's "in great demand" because these companies spend exorbitant amounts of money screening 500 applicants a week, hiring and training less than 5% of them, and then having like 99% turnover because of the absolutely horrible work for basically the same pay you can get selling apparel in the Mall without doing heavy lifting day in, day out in a dimly lit, cloud of particulates.

    It's in great demand because few people are willing to do the work for the pay and benefits, and they rely on super high turnover and a constant stream of working poor to always be able to temporarily fill the jobs.

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  79. So the tax on Capital is roughly 15% ["long term"], whereas the tax on Labor is very often in excess of 50%.

    And you wonder why the "rich" keep getting richer, while the - oops, baby just started crying - gotta run.

    BOTTOM LINE: The Ruling Class has recreated feudalism.


    It's worse than you imagine, considering that net assets (i.e. wealth) aren't taxed at all. Net asset (i.e. wealth) ownership is not only protected for free but it is subsidized by the "risk-free rate" offered by the government through its Treasuries.

    Since the primary function of government is the protection of non-subsistence property rights, it is sensible to charge a use fee for those rights. Note, I said "non-subsistence" property rights. The point here is that house and tools of the trade are protected from confiscation under bankruptcy law precisely because they are subsistence assets. Where government does not exist, subsistence properties are typically defended by the occupant, whose life is sustained by those assets. Government brings precisely the property rights we associate with civilization -- assets beyond home and tools of the trade.

    Given the relatively liquid nature of civilization, it makes sense to define "subsistence" in some dollar value of assets. Various ways of defining the dollar value are all approximately equal:

    * The median price of housing a person plus the median price of capitalizing a job.
    * The threshold used by the SEC for "qualified investor".
    * The level of savings insured by the FDIC.
    * Or, for the historically inclined: The market price of 20 arable acres in the Confederate south, a mule, a plow and a small house on such land.

    Until a citizen accumulates the subsistence net asset level, they should pay no tax and then pay tax only on the net assets they own above subsistence.

    Assessment should be by the owner, thereby establishing a "fair market value" for the exercise of eminent domain. Net assets only would be taxed and would be calculated by subtracting the fair market value of debts against the estate from the self-assessment of the occupant.

    Other forms of taxation could be eliminated in a revenue neutral way if net assets, in excess of subsistence levels, were taxed at the risk free interest rate (approximately the interest rate on the national debt).

    Indeed, given the centralization of asset ownership that has resulted from the subsidy of non-subsistence property, a subsidy inherent in civilization, it may be the failure to use this tax base is the ultimate cause of the repeated decay of civilizations from ancient times.

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  80. I think that the answer is that companies have learned to differentiate their products. KO has a monopoly on Coke and has convinced people that they should pay more for coke than for the generic brand.

    Also it is a very time consuming hassle to run a business and fewer people want to do it, so there is less competition from smaller operations toward the big companies. Look at restaurants and bakeries the chains are boring because their stores are all the same and yet the keep taking more of the market. I grew up in Providence RI and the bakeries and restaurants where great but nobody wants to work hard enough to run them anymore so they are closing one by one.

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  81. BTW if you want to grab a piece of that 4% that CEOs are getting you can invest in:Icahn Enterprises, L.P. (IEP). Carl Icahn buys companies and dumps the high paid CEOs replacing them with lower paid people and distributes some of the saved money to shareholders.

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  82. How much money can one person spend in a lifetime? Are they leaving this wealth to their children or throwing lavish parties, buying yachts, mansions, diamond chandeliers, etc?

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  83. Towards the end of the Post article they quote different people on the subject of executive pay raises. They say "it would be bad for morale" or "People back then thought enough is enough."
    Things are different now, we have a new elite and we have a new elite role model. This new elite does not believe in custodianship, this new elite hardly believes in the future of the country, they simply want to get it now and move on. There is no draft into the military, no identifying with the workers, we are all part of a multicultural, very diverse, global workforce and all we want to know is "Where is mine?" It is the Robert Putnam diversity syndrome written in executive salaries.

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  84. But why hasn't increased competition between corporations competed away the profits won away from employees?

    Regulatory capture, most likely.

    Most of the large corporations really were on the verge during the early 90's recession/restructuring. Greenspan's cheap money policies (starting in 1993) and huge amounts of regulation (from both Clinton and the republicans as well as the democrats) essentially saved the large corporations from bankruptcy and liquidation.

    Mind you, Clinton had a Republican congress and still all of the regulatory BS got passed. This should make anyone wonder if the GOP really does believe in limited government.

    A corporate welfare state is a good characterization of what we have today.

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  85. The higher profits are from targeted marketing of identical products in different packaging to different market sectors.

    Used to be there was just milk. Now there is skim, 1%, 2%, and whole, with barely any price difference for the lost cream in jugs averaging $4 per gallon, and the cream skimmed from the skim and reduced fat milks sold for $4+ per pint. Then there are "convenience" size half-pints of milks sold for around $1.50, while a pint of milk might be sold for $1.60.

    Apply that sort of thinking across industries where ever more elaborate targeted marketing of products like shampoos, toothpastes, paints, jeans, beer, etc. is done at a variety of price points using base ingredients that are essentially identical.

    Management compensation itself should be thought of as a fee to stockholders for the production of profits on their enterprise. Thus if you take a company's sales revenue minus material/energy input costs, the money that is left over can be divided between labor (wages of all non-officer employees of the company - i.e. everyone who does not serve at the pleasure of the board of directors) and capital (retained profits, dividends, income taxes, interst payments, executive/officer/board of directors compensation).

    If labor wages are not growing with productivity of the company so that their share of revenues stays relatively constant, it means that an increasing amount of sales revenue is being paid to capital, especially in the current popular forms of high officer pay, stock buy-backs, and debt interest payments.

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  86. Every social system starts out as a meritocracy and ends up as an aristocracy. We're no different.

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  87. The 3% and 4% figures are just my rough estimates from hazy numbers in the article of the Dean Foods CEO's compensation relative to total profits in 1979 and 2009.

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  88. Camlost:

    I'm pretty sure people are buying the walmart toothpaste (it wouldn't be on the shelves otherwise). Most likely, though, one of the big manufacturers is making it under contract. Making an unadvertised, cheap store brand is s nice way to capture business without undercutting your name brand product too much.

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  89. kurt9:

    Not just regulatory capture, but ideological capture as well. Lots of the best and brightest Harvard and Yale kids have wound up on wall street, management consultancies, marketing companies, etc. A big chunk of the intellectual class, and of the ruling class, has a direct or indirect interest in seeing money and power flow toward the top of the pyramid.

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  90. It's almost like incumbents are favored when regulation raises the barriers to entry and it's more economical to buy a senator than it is to compete with the other players in your industry.

    For instance, say you're running a bank and you want to use a patented process, but you don't want to pay the patent holder (leaving aside, for a moment, whether one ought to be able to patent a process). And further suppose you unsuccessfully fight the patent holder in court. Instead of paying up you can always just pay off a Senator to make the whole thing go away.

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  91. A big chunk of the intellectual class, and of the ruling class, has a direct or indirect interest in seeing money and power flow toward the top of the pyramid.

    That's part of it. The other part is the interrelationship of boards and CEOs. Most of these guys are sitting on a half-dozen boards in addition to their CEO job, so there are only a few hundred people in control of much of the business world. They have a vested interest in not fighting too hard on CEO compensation as board members, since their own compensation will be considered in light of the average for CEOs of similar-sized corporations.

    In theory the shareholders will eventually draw the line on CEO pay. But who votes in corporate elections? It's mostly banks and big mutual funds controlled by the same sorts of people.

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  92. Cockerney Geezer6/21/11, 3:29 PM

    I saw and bookmarked this earlier:
    http://ablankspotonthemap.blogspot.com/2011/06/neoliberal-economy-in-nutshell.html

    Part 1,

    Monday, June 20, 2011
    The Neoliberal Economy in a Nutshell

    Economics in a Nutshell

    Ravi Batra ; The New Golden Age

    The Rising Wage Gap

    Four main causes of poverty in the United States
    1) The rising price of oil
    2) Low minimum wage
    3) Regressive taxation
    4) Globalization

    Wage productivity gap

    All four relate to government policy and reflect official corruption because they all impoverish the general public while making the rich richer. Furthermore, they add to the global economic imbalances and threaten to unleash global chaos in the near future.

    Official corruption threatens economic stability around the world because it raises what may be called the wage gap which simply is a measure of the difference between labor productivity and the real wage. For the sake of precision, the wage gap may be defined as worker productivity divided by the average real compensation of employees. An economy functions smoothly and efficiently only if this gap remains constant and small. It morphs into a myriad of imbalances if the gap grows as it has since 1980. An economy is efficient if it maintains full employment with out resorting to excessive debt. Excessive debt itself is linked to the rising wage gap. Anything that lowers domestic labor demand tends to raise the wage gap because when labor demand declines the real wage falls relative to worker productivity. The rising price of oil, low minimum wage, regressive taxation and globalization all tend to trim domestic demand for workers. So they all increase the wage gap over time.

    How is all this relevant to our economy? Wages are the main source of demand and productivity is the main source of supply. Overtime, business investment and new technology lead to a rise in productivity and hence supply. If real wages keep up with productivity consumer demand matches the growth in supply so that the demand supply balance is maintained in a natural way. Here the economy tends to function smoothly and efficiently. However, if real wages trail productivity growth and the wage gap rises, supply grows faster than demand. Many distortions then arise and if they are allowed to fester the end result is growing poverty and possibly economic collapse.

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  93. Cockerney Geezer6/21/11, 3:33 PM

    Part 2:

    The first distortion is that debt must rise exponentially to increased demand. Because this is then the only way to close the demand-supply gap arising from the growing wage gap. The borrowing may be incurred by consumers and the government but not by cash rich corporations. The quantum leap in budget deficits in the US economy since the early 1980’s is purely the result of this phenomenon. This is the first distortion because the demand-supply balance is maintained artificially by ever increasing debt creation and cannot be sustained forever.

    The second distortion occurs from a quantum jump in corporate profits. Once the demand-supply balance is maintained through increased debt then profits must rise sharply because with wages growing sluggishly the fruit of increased productivity accrues mainly to the owners of capital. So CEO incomes jump. The profit leap is a distortion because it cannot be maintain without mushrooming debt. The artificial rise in profits triggers an artificial jump in share prices and leads to a stock market bubble which must burst one day because it is all supported by an exponential rise in borrowing.
    The moment debt growth slows profits begin to fall and this can lead to a crash. As occurred in1929.

    One distortion feeds another. As the market crashes the government must do something to contain its aftershocks. For instance, it slashes interest rates to lure more people into borrowing. If it does not a depression may result as in the 1930’s. But if it does, there will be a housing bubble because exceptionally low interest rates generate big declines in monthly mortgage payments and thus raise the demand for homes. So the government avoids a depression but only at the cost of future stability. This is why we now face a housing bubble around the world in the aftermath of the global stock market crash of 2000.

    With the continued rise in the wage gap the rich keep getting richer at a record pace. But the stock market crash puts them in a quandary. What to do with all that money? With the share market losing its allure the rich look elsewhere. They maybe ultra rich but they want even more. So their cash ends up in exotic assets such as hedge funds, especially those that discover new avenues of speculation like investing in oil or mortgage backed securities.

    These are all distortions that have results from the rising wage gap in the United States.

    ----
    Immigration will lower wages as well.

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  94. I think you're all (or almost all) trying to explain something that no one here, including Steve, has shown to actually exist.

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  95. Wes - High Commander of the Lizard People6/21/11, 4:02 PM

    OK, no one ever seemed to deal with the claim that corporate profits may not really be out of line with history. If you go all the way back to 1929, there have been other periods of similar profitability from what I can find.

    If you have other data, please provide it. Because until we prove something "new" is happening, it makes little sense to discuss "why" it's happening (since maybe it's not).

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  96. The arguments being made here in favor of the status quo are incredibly lame. The bottom line is we moving in the direction of the third world. That is bad and needs to be reversed anyway you slice it.

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  97. The bottom line is we moving in the direction of the third world.

    That may be true. It's also possible the third world is moving to the US. Lots of evidence of that in my neighborhood.

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  98. Anecdote: I did interior plant maintenance (as in watering the flowers) for Blue Cross/Blue Shield of Tennessee, which is headquartered here in Chattanooga, for 25 years. This meant I had intimate contact with all the top management, in whose offices were most of the fancy plants. For the first 15 years the company was run by three executives on the 9th floor, the President and two Executive Vice-Presidents. Neither one of the two vice presidents could afford residential landscaping for their $200,000 homes, which was something else I did. They were making less than $150,000 a year tops. The President, Robert McGuff, who had worked his way up from the mail room after serving during WWII, lived in an even more modest house and was making a little more than $300,000/yr.

    Eventually Mr. McGuff retired and the Blue Cross board of directors brought in a new president from Chicago. He brought in half a dozen new execs to help him run the company and while they were all making more money than their predecessors it was nothing extravagant. They lived in $400,000 homes and I would estimate were earning roughly twice the salaries as before.

    But then that president retired and brought in a handpicked successor, a female former nurse who grew up in the area and (presumably) had a lot on the ball. She expanded the number of vice executives on the 9th floor to more than a dozen. A year ago there was a story in the local paper detailing the compensation of some of these vice presidents. A couple of them had pay packages in excess of $5 million/yr. Presumably the pres. was making even more.

    Blue Cross/Blue Shield, bear in mind, is a non-profit corporation. Robert McGuff, the first president, was a devout Catholic who once confided to me he saw himself as "the Good Centurion." His philosophy was that "the big boys" could look out for themselves; his job was to look out for "the little guys."

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  99. camlost: "Americans are still willing to pay more for name brands, and slicker marketing."

    Yes, I know. That's the barrier to entry that I mentioned. You have to spend a lot of money on advertising to get Americans interested in your product, and after spending so much on advertising the only way to make a profit is to sell it at the same high price as the other brands. This is also an example of value transference because people are paying $3 for a tube of toothpaste that only has 30 cents of ingredients in it.

    anonymous: "That corporate profits briefly reached the same levels as in the 60-ies and 70-ies just before the recent crisis is hardly good evidence of any major shift"

    I would say that (1) measured GDP increased immensely, so corporate profits obviously increased also if they are the same percent of GDP; and (2) prior to the 1980s, corporations were the most tax-effective form of business, but today a lot of businesses are partnerships, so there are a lot of profits going to partnerships that previously went to corporations, so yes, as a percentage of GDP, corporations + partnerships would now be at an all-time high.

    Luke Lea: "As the ratio of capital to labor grows smaller (which is what trade with populous, poor countries like China effectively causes to happen) the rate of return to capital increases."

    OK, I agree with you that I oversimplified, and some of what you say above is probably happening.

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  100. I just left a publicly traded company for a private company.

    Private companies aren't run by CEO's or President's anymore. They are run by the guys in charge of pension funds like CALPERS, New Jersey Pension fund, New York Pension fund, etc. and Wall Street Money Managers. These guys are ruthless and that's who they take their orders from. If you are willing to play ball with them and you are a senior executive then you will get well compensated. Everyone else is SOL.

    It's funny that I pay tons of property taxes to teachers and police here in NJ and yet there pension fund actively tries to outsource my job as a programmer to China or India. Or better yet their pension fund tells the executives at my company to lay off all the American computer programmers and replace them with H-1B's from India and China. And all I endlessly here from our $100,000+ paid a year teachers/cops with great benefits/pensions is that they don't get enough respect and aren't treated well enough. Pleeeeeasseee. Thank the Lord for Governor Christie!

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  101. "Michael Duff said...

    My guess is that the cost of labor has plummeted since the '70s. China is essentially the world's plantation, keeping wages artificially low, keeping their own people in virtual slavery so it can dominate world trade."

    They might be the world's factory but they are hardly slaves. Quit insulting China by drawing parallels with the American south, which was not exactly a factory.

    The thing is that because China manipulates its currency, these wages are actually not that low, since almost everything else is artificially cheap, to paraphrase your words.

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  102. Douglas Knight6/21/11, 9:09 PM

    Steve,

    thanks for that clarification on the 3 and 4%. These numbers aren't important for your point, but I'm curious what they are.

    Gabaix and Landier claim that from 1980 to 2003, S&P500 market cap and ceo compensation both increased 6 fold. Assuming constant P/E, this corresponds to constant percent of profits. They say that it is well known that executive pay grows like the cube root of the firm size, at any fixed point in time, but that the constant varies with time and is such that pay is proportional to the largest firm size.

    Between 1993 and 2003, I found contradictory claims. This time series the percent of profits was the same (2.5%) at the end points, but much higher (4%) in 1999. Whereas, this paper on a larger set of firms claims that the top five executives moved from 5% to 10%. I thought it also claimed that CEO pay alone increased alone, but I can't find that anymore.

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  103. Douglas Knight6/21/11, 9:16 PM

    The standard survey on executive compensation is by Kevin J Murphy in 1999 (not to be confused by Kevin M Murphy). It has a graph showing both the time series for executive compensation and for the number of papers on the subject.

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  104. Note that Dean Foods has a market cap of 2.30 B dollars and an annual net income of 91.49 million dollars for 2010. This implies ~4% ROI on the common stock which is pretty close to the risk-free interest rate (incl. inflation, etc...). In terms of economic profits, Dean Foods is already at zero.

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  105. Blue Cross/Blue Shield, bear in mind, is a non-profit corporation. Robert McGuff, the first president, was a devout Catholic who once confided to me he saw himself as "the Good Centurion." His philosophy was that "the big boys" could look out for themselves; his job was to look out for "the little guys."

    I almost wish that iSteve-ers wouldn't post stuff like this - it's like watching Turner Classic Movies - it just breaks your heart to think what this country once was.

    [Even within the living memory of many of the younger of us, from our childhoods - distant, rapidly fading memories of how Americans, as a whole, used to be so much better of a people than we are now.]

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  106. Wes wonders if profits are that high6/22/11, 6:05 PM

    OK, so we had over 100 comments on the evils of unusually high corporate profits, without ever establishing that corporate profits were unusually high by historical standards? Can anyone provide some data - data that spans most of the 20th century - that shows an historic spike?

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  107. "Wes wonders if profits are that high said...

    OK, so we had over 100 comments on the evils of unusually high corporate profits, without ever establishing that corporate profits were unusually high by historical standards? Can anyone provide some data - data that spans most of the 20th century - that shows an historic spike?"

    Although the case for higher corporate profits is not so certain, I think it fair to say that the case that executive pay is higher - even much higher - than it was in the 70s, is more certain. And if corporate profits are not higher, than higher executive pay is even more scandalous.

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  108. Douglas Knight6/23/11, 7:54 PM

    I have seen the claim that profits are back to pre-war levels. One change that may be of interest is that pre-war companies didn't have employee-executives. They were smaller and were run by their owners. So executives may well have retained a much larger percentage of profits, but not as salary.

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  109. >Blue Cross/Blue Shield, bear in mind, is a non-profit corporation. Robert McGuff, the first president, was a devout Catholic who once confided to me he saw himself as "the Good Centurion."<

    Here's some inside info. The CEO of Blue in a certain southern state isn't Catholic, and made $30+ million one year.

    I wonder if any reader here with a Blue policy ever was paid out? I worked in the bowels and never saw even one claim that wasn't denied or litigated. Just asking. (I saw 600+ claims.)

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