May 26, 2014

Thomas Piketty is no Marxist, he’s a Jacobin!

Yvan Allaire | Financial Post

Piketty totally misses the real driver of this huge increase in compensation of U.S. executives: stock options.

Thomas Piketty is a French economist and the omnipresent author of Capital in the 21st Century. Since the publication of the English version of his book, Piketty has become the coqueluche of the American left.

Although branded as a neo-Marxist by right-wing pundits, Piketty is actually a Jacobin, an heir of the French Revolution to which he refers in several instances and always favourably. Led by Robespierre, the Jacobins in the Reign of Terror passed radical legislation, hunting down and executing their opponents.

The gist of Piketty’s book, though, consists of a description of the pattern of income and wealth inequality over many decades and across several countries.

The Financial Times ignited a virulent controversy when it questioned some of his statistics. There were bound to be some inaccuracies and debatable “corrections” in such a massive undertaking. Though the issue will certainly do some damage, the “errors” are minor and do not change the overall picture the book describes.

However, Piketty’s policy prescriptions to solve the problem of inequality have become the controversial and questionable part of his book. Even people who share a discomfort with the present level of income and wealth inequality should recoil at his proposed remedies: 80% marginal tax on income and a global tax on wealth.

It should be noted that Piketty himself has now soft-pedaled on the book’s radical prescriptions, claiming they were merely put forth to stimulate discussion and debate.

But the book suffers from its broad-brush depiction of complex phenomena, and as a result is often superficial and misses out on important insights. In other words, Piketty bites off more than he can chew.

Take his “analysis” of the vastly increased inequality of income and wealth in “Anglo-Saxon” countries (U.S., U.K., Canada, and Australia) as compared to European countries. Piketty attributes a large part of the blame to the huge increases in “salary” paid to executives of listed companies.

This phenomenon, claims Piketty, flows from the fact that executives essentially set their own “salary.” Therefore, given the change in “social norms and acceptability” since Reagan and Thatcher, U.S. and U.K executives can pay themselves stupendous amounts without any social push-back.

In fact, the salary and bonus of U.S. executives in constant dollars do not increase much from the 1950s to the 2000s.

Piketty totally misses the real driver of this huge increase in compensation of U.S. executives and its contribution to wealth inequality: stock options and share-related compensation. In fact the term “stock options” does not even appear in the index of the book.

Stock-related compensation for executives began on a small scale sometimes in the 1970s, grew in the 1980s to 26% of total compensation for the 50 largest American companies; during the 1990s, grew to 47% and to 60% during the period 2000-2005. In 2010, stock-related compensation made up 62% of the total compensation of S&P 500 CEOs and 55% of total compensation for the CEOs of TSX 60 companies.

Up to the 1990s, this form of compensation was virtually absent in Europe (except for the U.K.). Even by 2008, the compensation package of European executives was made up of only 19% in stock options and stock-related incentives.

Then, connect the compensation of U.S. executives, which is made up of this large chunk of stock options and stock-related compensation, to the performance of the U.S. stock market. For instance, the value of the S&P 500 index was multiplied by 10 during that 30-year period.

So, prior to 1980 there was no correlation between total compensation of U.S. executives and the stock market. But beginning in the 1980s there is, not surprisingly, an almost perfect correlation between total compensation of U.S. executives and the stock market.

Given that the life of stock options is usually 10 years, given the general, though not universal, practice of granting stock and stock options every year, it is obvious why the compensation and wealth of American executives exploded during this period of 30 years. But Piketty seems unaware of these dynamic influences on wealth and income.

Piketty also misses out on another very powerful driver of unequal wealth distribution and concentration of riches in the top 1% and top 0.1% of Americans: the peculiar evolution of the American (and U.K. and Canadian) finance industry.

Below the radar, unseen by the public, a large number of specialized, privately-owned outfits carry on financial transactions, trading, speculating, and creating immense wealth for their partners and managers.

One such group, about which the veil of ignorance is lifted ever briefly once a year, is made up of so-called hedge funds.

The magazine Alpha manages to collect and report the cash income of the 25 most successful hedge fund managers each year. In 2014, it reported that these 25 guys earned $21.15-billion, with income ranging from $300-million to $3.5-billion. That, by the way, means that these 25 “managers” earned 3.5 times the total compensation of all CEOs of the S&P 500 companies, those very people who are subjected to virulent criticism for their extravagant paycheque.

Those who believe that wealth and income inequality must be reduced, that, at its current U.S. level, it becomes a socially explosive phenomenon, must come up with realistic and effective policies.

Certainly not the prescriptions of Professor Piketty!