Corporations Know Income Inequality Will Sink Us All. Here’s Why They Just Can’t Help It.

Wallace Hopp May 5, 2017

An 1847 illustration of "The Scorpion and the Turtle" from the Kalilah wa-Dimna—an ancient Indian fable that inspired "The Scorpion and the Frog."

Scor­pi­on met Frog on a riv­er bank and asked him for a ride to the oth­er side. How do I know you won’t sting me?” asked Frog. Because,” replied Scor­pi­on, if I do, I will drown.” Sat­is­fied, Frog set out across the water with Scor­pi­on on his back. Halfway across, Scor­pi­on stung Frog. Why did you do that?” gasped Frog as he start­ed to sink. Now we’ll both die.” I can’t help it,” replied Scor­pi­on. It’s my nature.”

This cen­turies-old para­ble, which has been retold by Orson Welles and many oth­ers and some­times refers to a tur­tle rather than a frog, is usu­al­ly meant to show how a bad nature can­not be changed — even if self-inter­est and preser­va­tion demand it.

It’s also an apt metaphor for the grow­ing scourge of income inequal­i­ty, one of the defin­ing issues of our age. 

A stan­dard expla­na­tion for why income inequal­i­ty is increas­ing, to bor­row a quote from Nobel-win­ning econ­o­mist Joseph Stiglitz, is that wealth begets pow­er and pow­er begets more wealth.” That is, because the rich and cor­po­rate CEOs use their influ­ence to pro­mote their self-inter­est, inequal­i­ty is built into the very DNA of cap­i­tal­ism. And to return to our metaphor, the rich scor­pi­ons sting the rest of us — by exac­er­bat­ing income inequal­i­ty through pay poli­cies, stock buy­backs and oth­er actions — because it’s sim­ply their nature.

But there’s plen­ty of evi­dence income inequal­i­ty under­mines the econ­o­my and, as a result, harms com­pa­nies and the wealthy too. Even­tu­al­ly, we all sink together.

A grow­ing body of research in the emerg­ing area of pos­i­tive orga­ni­za­tion­al schol­ar­ship” sug­gests a dif­fer­ent les­son from the scor­pi­on fable: every­one can ben­e­fit if they work togeth­er. That is, com­pa­nies can invest in their work­ers, help reduce income inequal­i­ty and make more mon­ey, all at the same time.

But they need a new per­spec­tive to see how.

Age of rage

The issue of income and wealth inequal­i­ty received a lot of atten­tion on the cam­paign trail, as can­di­dates argued whose poli­cies would be most effec­tive at lift­ing wages of the work­ing class. And no won­der. The per­cent­age of total income received by the top 1 per­cent of earn­ers in the U.S. has risen from under 8 per­cent in the 1970s to over 18 per­cent today. The per­cent­age of total wealth held by the rich­est 0.01 per­cent (the elite 1 per­cent of the 1 per­cent) has soared from under 3 per­cent to over 11 per­cent over this interval.

For an inter­ac­tive ver­sion of this graph­ic, click here. (Source: World Bank / The Conversation)

We haven’t seen extremes like these since the start of the Great Depres­sion. So the response, con­sist­ing of speech­es by polit­i­cal can­di­dates, arti­cles by pun­dits, research by aca­d­e­mics and angry out­bursts by the pub­lic, is hard­ly a surprise.

How inequal­i­ty hurts growth

Let us con­sid­er two impor­tant ways income inequal­i­ty under­mines the econ­o­my: (1) by dimin­ish­ing work­er moti­va­tion and (2) by reduc­ing the veloc­i­ty of money.

The demo­ti­vat­ing impact of income inequal­i­ty occurs when work­ers see the gains of pro­duc­tiv­i­ty going almost entire­ly to exec­u­tives. Since 1973, pro­duc­tiv­i­ty has increased by over 73 per­cent, while (infla­tion-adjust­ed) hourly work­er pay has risen by only about 11 per­cent and CEO com­pen­sa­tion has soared by 1,000 percent.

Who can blame peo­ple for being reluc­tant to work hard­er when they know the pro­ceeds will go to some­one else? Exten­sive behav­ioral research has shown that peo­ple will forego per­son­al gain to pre­vent out­comes they per­ceive as unfair. In work set­tings, this leads to demo­ti­vat­ed work­ers work­ing below their poten­tial, even when it leads to small­er rais­es or bonus­es. The result is reduced pro­duc­tiv­i­ty, low­er qual­i­ty and less cre­ativ­i­ty, all of which under­mine cor­po­rate prof­it and eco­nom­ic growth.

Anoth­er way inequal­i­ty affects the econ­o­my is by reduc­ing the veloc­i­ty of mon­ey by shift­ing cash to peo­ple who spend it more slow­ly. Work­ing-class peo­ple who are stretch­ing to make ends meet spend their income quick­ly — usu­al­ly pret­ty much all of it— while wealthy peo­ple whose resources exceed their imme­di­ate needs tend to save sub­stan­tial por­tions of their income.

Con­se­quent­ly, when­ev­er a com­pa­ny takes a dol­lar out of the hands of a work­er and puts it into the hands of an exec­u­tive or investor, the num­ber of times that dol­lar will be spent in the econ­o­my is reduced. The result is less busi­ness for cap­i­tal­ists and less employ­ment for workers.

These two obser­va­tions imply that poli­cies that decrease income inequal­i­ty also bol­ster the econ­o­my. Since this ben­e­fits both rich and poor, such poli­cies offer oppor­tu­ni­ties for the rich, and the busi­ness­es they con­trol, to be part of the solu­tion rather than part of the prob­lem of income inequality.

Hen­ry Ford’s famous $5‑a-day

The most straight­for­ward oppor­tu­ni­ties are work­force invest­ments to increase moti­va­tion and pro­duc­tiv­i­ty of workers.

This is what Hen­ry Ford did a cen­tu­ry ago with his famous US$5 a day wage—at a time when typ­i­cal man­u­fac­tur­ing wages were about $2.25 a day — which he called one of the finest cost-cut­ting moves we ever made.” In the present day, busi­ness­es rang­ing from tiny clean­ing com­pa­ny Man­aged by Q to giant retail­er Cost­co are using high wages as part of what Zeynep Ton of MIT calls a good jobs strat­e­gy” to dri­ve pro­duc­tiv­i­ty, qual­i­ty and profits.

The day after the Ford Motor Com­pa­ny announced its employ­ees would make $5 a day, 10,000 peo­ple showed up to the plant in High­land Park, Mich. to apply for jobs. (Images: The Hen­ry Ford Col­lec­tion)

But iso­lat­ed actions by indi­vid­ual com­pa­nies are too small to have a sig­nif­i­cant impact on the veloc­i­ty of mon­ey across the econ­o­my. To real­ize the full eco­nom­ic ben­e­fit of some income inequal­i­ty-reduc­ing poli­cies, busi­ness­es need to imple­ment them collectively.

This hap­pened to a degree with Ford’s high-wage pol­i­cy. Despite the leg­end that he raised wages to enable his work­ers to buy his cars, Ford’s orig­i­nal goal was to improve reten­tion and pro­duc­tiv­i­ty. How­ev­er, when oth­er employ­ers fol­lowed suit, their col­lec­tive wage increas­es pro­duced a work­ing class that could buy more cars and more of every­thing else.

Stock buy­backs make income inequal­i­ty worse

A con­tem­po­rary exam­ple of a sit­u­a­tion that calls for col­lec­tive action is the increas­ing­ly com­mon prac­tice of stock buy­backs.

These are used by pub­lic com­pa­nies to boost their stock prices by reduc­ing the total num­ber of shares, which in turn increas­es earn­ings per share. How­ev­er, because this enhances stock-based exec­u­tive com­pen­sa­tion with­out ben­e­fit­ing work­ers, stock buy­backs ampli­fy income inequal­i­ty.

An alter­na­tive for boost­ing stock price with­out aggra­vat­ing income inequal­i­ty is invest­ing in work­er com­pen­sa­tion as part of a pro­duc­tiv­i­ty enhance­ment strat­e­gy. But, since pro­duc­tiv­i­ty invest­ments take time to pro­duce results, it is like­ly that the buy­back strat­e­gy will gen­er­ate a greater increase in stock price, and exec­u­tive com­pen­sa­tion, at least in the short term. So, from a pure self-inter­est per­spec­tive, man­age­ment has incen­tive to adopt the buy­back strat­e­gy rather than the work­force invest­ment strategy.

The fact that stock buy­backs exceed­ed $500 bil­lion in 2015 sug­gests that many busi­ness­es made pre­cise­ly this choice.

Stop sting­ing the frog

Unfor­tu­nate­ly, because buy­backs divert mon­ey away from invest­ments in pro­duc­tiv­i­ty with­out improv­ing firm per­for­mance, they ulti­mate­ly lead to less prof­it, few­er jobs, low­er wages and a small­er over­all econ­o­my. Fur­ther­more, if oth­er firms are using them to boost exec­u­tive com­pen­sa­tion, a com­pa­ny that wants to recruit and retain top man­age­r­i­al tal­ent will be seri­ous­ly tempt­ed to use buy­backs as well. 

An option for break­ing this eco­nom­i­cal­ly destruc­tive cycle, which almost nev­er gets con­sid­ered, is for firms to lob­by to take the buy­back option off the table for every­one. If, for exam­ple, stock buy­backs were restrict­ed, as they were pri­or to 1982, man­age­ment would have greater incen­tive to make gen­uine invest­ments in their busi­ness­es, includ­ing in their workforces.

In addi­tion to pro­duc­ing pro­duc­tiv­i­ty gains with­in busi­ness­es, the increase in work­er com­pen­sa­tion would result in a veloc­i­ty-of-mon­ey induced stim­u­lus to the econ­o­my as a whole. The com­bined effect over time could even be large enough to make both exec­u­tives and work­ers bet­ter off than they would be under the buy­back strategy. 

While col­lec­tive lob­by­ing for sen­si­ble reg­u­la­tions may sound like busi­ness heresy — in a world where cor­po­rate lob­by­ing usu­al­ly seeks nar­row favors or to stymie reg­u­la­tions in gen­er­al — it is a ratio­nal response to a sit­u­a­tion in which legal and prof­itable actions by indi­vid­ual com­pa­nies cre­ate neg­a­tive con­se­quences, or exter­nal­i­ties,” on the rest of the econ­o­my, and there­by wind up hurt­ing the com­pa­nies themselves. 

Metaphor­i­cal­ly, such sce­nar­ios are anal­o­gous to a large num­ber of tiny scor­pi­ons (busi­ness­es) rid­ing across the riv­er on a giant frog (econ­o­my). When a sin­gle scor­pi­on stings the frog, it derives plea­sure from doing what comes nat­u­ral­ly and bare­ly harms the mam­moth frog. But when every scor­pi­on does the same, the frog dies and so do all the scorpions. 

But humans aren’t scor­pi­ons, so we can choose to stop the self-destruc­tive sting­ing and allow every­one to cross the river.

Dis­clo­sure state­ment: Wal­lace Hopp does not work for, con­sult, own shares in or receive fund­ing from any com­pa­ny or orga­ni­za­tion that would ben­e­fit from this arti­cle, and has dis­closed no rel­e­vant affil­i­a­tions beyond the aca­d­e­m­ic appoint­ment above. How Cor­po­rate Amer­i­ca Can Curb Income Inequal­i­ty and Make More Mon­ey Too” was first pub­lished by The Con­ver­sa­tion under a Cre­ative Com­mons License. 

Mr. Arkadin, a mys­te­ri­ous tycoon played by Orson Welles in the 1955 thriller of the same name, regales his house guests with the fable of The Scor­pi­on and the Frog.” The film was also released under the title Con­fi­den­tial Report.” (Video: YouTube / Warn­er Bros.)

Wal­lace J. Hopp is the Asso­ciate Dean for Learn­ing Design, and Pra­ha­l­ad Dis­tin­guished Uni­ver­si­ty Pro­fes­sor at the Ross School of Busi­ness and Pro­fes­sor of Indus­tri­al and Oper­a­tions Engi­neer­ing in the Col­lege of Engi­neer­ing at the Uni­ver­si­ty of Michi­gan. His research focus­es on the design, con­trol and man­age­ment of oper­a­tions sys­tems, with empha­sis on man­u­fac­tur­ing and sup­ply chain sys­tems, inno­va­tion process­es, and health care sys­tems. He is an active indus­try con­sul­tant whose clients have includ­ed many For­tune 500 firms.
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