Lies, Damn Lies, & The New York Times, v. 876,319

7 Jan

"Statistics"

Since the beginning of the Financial Crisis, the already-suspect business section of the New York Times seems to have been more adept than ever at propagating half-truths as gospel, which despite the best efforts of financial bloggers, goes largely un-noticed by most readers.

The most recent example of this insidious brand of “journalism” comes from Editorial Board member Eduardo Porter, whose impressive resume includes stints covering business & economics in Asia and South America, and the Hispanic population in the United States after earning an “MSc in quantum fields and fundamental forces from Imperial College of Science, Technology and Medicine in London,” (whatever that means).  I mention his background not as a means of ad hominem attack, quite the contrary; unless that graduate degree is nothing like what it sounds like, I’d expect someone with a background in math and science to know better than to make amateur mistakes, e.g. conflating correlation with causation, misrepresenting data, presenting knowingly incomplete information, etc.

I’m far from perfect here, but considering my posts responding to nonsense from the NYT are by far the most viewed ones on this site, I think I just may be onto something.

In an adaptation from his forthcoming book, “The Price of Everything,” Porter seeks to explain the phenomena he refers to as “The Superstar Effect,” which seeks to explain the disproportionate increase in pay for those “at the top” of their respective fields relative to their “lesser” peers and the population as a whole.  He mentions that the pay of “elite” entertainers, executives, and athletes has skyrocketed in the past 40+ years, far outpacing average relative and absolute levels, which is not exactly news to anyone who hasn’t been living in a cave that whole time:

Nearly 30 years ago, Sherwin Rosen, an economist from the University of Chicago, proposed an elegant theory to explain the general pattern. In an article entitled “The Economics of Superstars,” he argued that technological changes would allow the best performers in a given field to serve a bigger market and thus reap a greater share of its revenue. But this would also reduce the spoils available to the less gifted in the business.

Indeed, exponentially more people got to see soccer superstar Christiano Ronaldo play in this most recent World Cup than did Pele over 40 years ago, due to satellite and tv infrastructure improvements since then.  Similarly, the largest corporations have become exponentially larger and more complicated to manage than they were decades ago, which at least partially explains the increase in pay for large-company executives relative to most of their employees.

IF one loosens slightly the role played by technological progress, Dr. Rosen’s framework also does a pretty good job explaining the evolution of executive pay. In 1977, an elite chief executive working at one of America’s top 100 companies earned about 50 times the wage of its average worker. Three decades later, the nation’s best-paid C.E.O.’s made about 1,100 times the pay of a worker on the production line.

This has separated the megarich from the merely very rich. A study of pay in the 1970s found that executives in the top 10 percent made about twice as much as those in the middle of the pack. By the early 2000s, the top suits made more than four times the pay of the executives in the middle.

At least partially contrary to popular belief, salaries of top executives are largely a function of supply and demand, specifically, the perceived shortage of “top” management talent relative to the demand for it.  Simply-put, the demand curve for executives determined by boards and shareholders to be capable of running massive, complex organizations has shifted to the right, driving up the price buyers – in this case board members and shareholders – are willing to pay for them.  Technological progress and shifting tastes/demographics/etc have driven these changes to the point where in the market for both entertainers and executives, those “at the top” of their games are pulling down tens of millions of dollars a year.

How many people would want to take the reins at massive firms like JP Morgan Chase or Exxon Mobile without the promise of making a mint for a job well-done?  Would people still be chomping at the bit to become CEO, where on any given day shareholders, suppliers, customers, regulators, activist groups, employees, politicians, and any number of other stakeholders are all demanding your attention?  I know I wouldn’t.  In my experience, those who are often the harshest critics of income disparity seldom understand that most of those who earn a lot of money (non-passive income) make considerable sacrifices to do so, whether we’re talking about the heart surgeon, the white-shoe corporate lawyer or dare I say the bank CEO.

Imagine literally having someone’s life in your hands, or being responsible for unraveling the debacle that was/is the Lehman Brothers bankruptcy, or running a firm with hundreds of thousands of employees and more moving parts than some factories.  Many of these people put in twice – if not more – of the time your average 9-5 employee does for much of their careers, and similarly, many (if not most) of these people work harder while they’re at the office than the average employee[1].

Alas, people like Porter and outlets like the NYT seldom – if ever – acknowledge these things.  To them, income inequality – and the increasing pace thereof – JUST ISN’T FAIR, reality be damned (emphasis mine)!

Yet the increasingly outsize rewards accruing to the nation’s elite clutch of superstars threaten to gum up this incentive mechanism (to acquire more human capital and become more productive). If only a very lucky few can aspire to a big reward, most workers are likely to conclude that it is not worth the effort to try. The odds aren’t on their side.

Inequality has been found to turn people off. A recent experiment conducted with workers at the University of California found that those who earned less than the typical wage for their pay unit and occupation became measurably less satisfied with their jobs, and more likely to look for another one if they found out the pay of their peers. Other experiments have found that winner-take-all games tend to elicit much less player effort — and more cheating — than those in which rewards are distributed more smoothly according to performance.

Why can only a “very lucky few” aspire to great financial success?  Everyone can aspire to it, there’s nothing stopping anyone from dreaming about being successful in any field.  There are, however, constraints that limit how many people can actually achieve it, but absent physical/mental disability there’s little if anything stopping anyone from dreaming and working hard towards their financial (and other) goals.  Only a tiny portion of MBA students are going to be Fortune 500 CEO’s, but many of those who “fall short” still end up making a very good living in other roles/fields.  If few amongst those who understand the statistically long odds consider them reason enough to “give up,” how can anyone make the claim that the rest of society simply accepts their lower stations in life as a given?

This is to say nothing of the fact that the University of California experiment cited above doesn’t appear to have anything to do with the point he’s trying to make by ignoring – at least as mentioned – any performance differences that may very-well explain pay differentials between employees in the same occupation/role.  What sounds more likely: those with below-average performance – in no small part likely the result of putting in less effort/adding less value – are simply bitter/jealous of those who they view as their peers that make more money or, that those who get paid less are simply unlucky or are actually being slighted by management?  While the latter is certainly the case sometimes, I think it’d be a gross exaggeration to presume its true even half, let alone most of the time.

Also, I’m not sure how citing the results of winner-take-all games even remotely applies to the argument the author is trying to make, especially since that sentence presupposes that “superstars” aren’t ever or even often compensated based upon performance.  Additionally, one would be extremely hard-pressed to support the claim that the “Rank & file” employees in our economy don’t get anything at all, either.  Not even relatively speaking, as evidenced by any number of measures of standard of living, for example retail sales or flat-screen TV’s, ipods, automobiles, etc, etc ad nauseum.

Finally, we get down to asking and answering one of the salient questions raised:

Ultimately, the question is this: How much inequality is necessary? It is true that the nation grew quite fast as inequality soared over the last three decades. Since 1980, the country’s gross domestic product per person has increased about 69 percent, even as the share of income accruing to the richest 1 percent of the population jumped to 36 percent from 22 percent. But the economy grew even faster — 83 percent per capita — from 1951 to 1980, when inequality declined when measured as the share of national income going to the very top of the population.

First, I’d be loathe to take these “statistics” at face value considering previous experience with the NYT, so let’s see what the numbers really say. Using BEA data, “Real” GDP (2005 Chained Dollars) increased 121% from 1980-2009 and 170% from 1951-1980, but  it appears the author used Census data for the per-capita values (not what I would have done but at least they’re not a fabrication altogether.  On a side note, would it have been so hard to cite where the data came from in the article?). Regardless, that economic growth has slowed (by these measures, for now) despite significant technological advances is not necessarily surprising as productivity suffers from diminishing returns to capital, that is, the more advanced (productive) an economy gets, each incremental dollar increase in capital has less and less of an effect on productivity.

Getting back to the issue of inequality, Forbes most recent list of the World’s Billionaires has over 400 of them residing in the United States, far more than in any other country.  Even if each of these Billionaires had all of their money in longer-dated U.S. Treasuries (unlikely) earning 3% per year, each would average almost $100 million in (interest) income!  Indeed, the IRS reports that the top 400 form 1040 Federal Tax filings by adjusted gross income earn tens of millions per year from capital gains, dividends, and interest income, a number which has increased steadily over the past 20 (and no-doubt 30, 40+) years.  Even the OECD report cited by the author below mentions this, “Wealth is distributed much more unequally than income: the top 1% control some 25-33% of total net worth and the top 10% hold 71%. For comparison, the top 10% have 28% of total income.” Perhaps the author should have considered this fact when he said:

The United States is the rich country with the most skewed income distribution. According to the Organization for Economic Cooperation and Development, the average earnings of the richest 10 percent of Americans are 16 times those for the 10 percent at the bottom of the pile. That compares with a multiple of 8 in Britain and 5 in Sweden.

Perhaps we should also discuss the fact that the first sentence in the US Country notes from the report actually says (emphasis mine), “The United States is the country with the highest inequality level and poverty rate across the OECD, Mexico and Turkey excepted. Since 2000, income inequality has increased rapidly, continuing a long-term trend that goes back to the 1970s.”   None of these claims, accurate or not, bother me too-much, until we get to this seemingly inevitable point in almost any business article from the NYT:

Remember the ’80s? Gordon Gekko first sashayed across the silver screen. Ivan Boeskywas jailed for insider trading. Michael Milken peddled junk bonds. In 1987, financial firms amassed a little less than a fifth of the profits of all American corporations. Wall Street bonuses totaled $2.6 billion — about $15,600 for each man and woman working there.

Yet by current standards, this era of legendary greed appears like a moment of uncommon restraint. In 2007, as the financial bubble built upon the American housing market reached its peak, financial companies accounted for a full third of the profits of the nation’s private sector. Wall Street bonuses hit a record $32.9 billion, or $177,000 a worker.

I have absolutely no idea where the author got these figures, but I’ll basically guarantee they’re based on aggregate bonus numbers and simple averages, neither of which captures the information the author implies they do.  Popular pariah Goldman Sachs has tens of thousands of employees, and while they may have a $10-20 billion + bonus pool, much of that accrues to a relatively small number of rainmakers, traders, and top executives, that is, administrative assistants aren’t making $200,000/year (or the $500,000+ media reports claimed last year), not even close.  I’m not going to attempt to refute the claim that the financial sector became far bigger than it likely should be or that compensation schemes across the sector were in no-small-part responsible for the bubble/collapse, but arguments using grossly-oversimplified logic/data just are not the way to support those claims.

The rest of the article goes on to explain how the Superstar Effect applies to fund managers/bankers/traders/brokers and how everyone from Joe & Jane investor to CalPERS to bank managers rushed to throw money at those perceived to be the biggest/best names, driving their earnings and wealth up exponentially.  The author then attributes the disproportionate increase in earnings/wealth of the financial sector to deregulation, which is curious since the book is about the Superstar Effect; that is, I’d expect the author to discuss the group-think and other psychological ideas that leads people to buy into The Effect…although on second though, this is the NYT, so I’m really not THAT surprised the article avoids placing any blame on the Individual and instead blames the greedy Banksters and the captured Government that enables them[2].

No one is forcing anyone to buy a Rinaldo jersey, a Lady Gaga album or shares in a Bill Miller-managed mutual fund from Legg Mason.  Several people may try to take advantage of previous success and popularity (real and/or perceived) to convince you to buy what they’re selling, but ultimately the choice and responsibility still lay squarely in the hands of the Individual.  Income inequality is a legitimate concern but more importantly are the issues driving its growth.  Until we take responsibility for the consequences of our actions instead of blaming others, we, society as a whole have a far greater problem than increasing income inequality[3]


[1] Of course there are exceptions here, but they are relatively few and far between.  At separate issue are those who make a fortune not from salary/bonuses but from passive income.  For what its worth, of the 400 largest 1040 IRS filings, about 50-60% of income reported to the IRS (itself some % of their total income…) is generated by capital gains.

[2] That is not to ignore the effects of deregulation which much like compensation, enabled if not downright encouraged many actions leading up to the Crisis.

[3] Note: Links to the NY Times’ website that were originally in the text quoted herein have been removed as the NYT’s internal “encyclopedia” is far from unbiased or authoritative.

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