Research & Ideas
Entrenching the Wealth Gap
Written by Gavin Chait
Ex-President Thabo Mbeki used to lament conspicuous consumption by the wealthy, even as governments of the world push trillions of dollars of borrowed cash at consumers so that they can conspicuously consume.
First among things that cause rage are the massive salaries paid to senior executives in both the public and private sectors. “Paying these outrageous salaries and bonuses to chief executives has become a South African fetish. There is no correlation between what CEOs earn and how their companies perform,” says Kimani Ndungu, research director at the COSATU -aligned National Economic Development and Labour Institute.
The remedy that COSATU, and other left-leaning organisations, offer is massive redistributive taxes levied on the rich.
Why do these massive salaries exist at all? After all, if business really is about the optimum pursuit of wealth, why would the owners of a company choose to pay so much to senior executives if they got nothing in return?
Businesses, and large businesses especially, are not run by one or two people. There can be thousands all working to produce the products we buy. Aligning the interests of all these diverse humans with the objectives of the company is pretty difficult. Work-related performance incentives of all stripes have been tried, and found wanting.
What, by a form of evolutionary pressure, was found to work was to get staff to compete for the best prizes. It’s a tournament familiar to sports fans. Soccer teams compete in preliminary sports rounds for minimal prizes, giving everything they can and putting their bodies at stake, in the hopes that they can win the ultimate prize.
Economists Edward Lazear and Sherwin Rose call this Tournament Theory. “The salary of the vice president acts not so much as motivation for the vice president as it does as motivation for the assistant vice presidents,” says Lazear.
If you knew that all the teams could compete as hard as they liked but the final winner would be chosen in a lucky draw, you’d probably change channels. Worse, for the spectators, the players would lose any interest in performing at their best.
If legislation or taxation removes the benefit of being a senior executive, it also removes the incentive for those not in that income bracket to work so hard for the promotion. And it is these hard-working junior executives who really drive growth and innovation.
Worrying about the pay of CEOs in comparison to unskilled, semi-employed workers is a red-herring. It misses the real question: how do we make it more exciting to be a junior employee racing to get to the top?
In a strictly meritocratic business environment, people are promoted based on their abilities, and a tournament encourages those with the best ideas and work ethics to excel. When distortions arise, such as punitive taxes on the rich, then those who aspire to be well-paid by virtue of their abilities tend to find other things to do, or other places to live.
Black Economic Empowerment has changed the nature of the tournament still further. Ability is no longer sufficient. However, we have continued with high pay for senior executives when the criteria by which we measure people for promotion has little to do with anything they can influence. A person can commit to improving their work performance, but what can they do about their race?
As the nature of “victory” in the business tournament has changed, it is unsurprising that the average unemployed township youth is alienated by it. Worse, it is also unsurprising that the abilities of South African companies to generate wealth and employment have suffered.
Tournament-related massive executive salaries only work when everyone in the tournament knows that their own abilities determine the result. When the winner is chosen by lottery, based on factors none of the other players have control over, then they all stop working as hard.
And everyone else changes channel.
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