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Is Income Inequality a 'Moral' Problem?

April 19, 2016

Free-Market Economics and the Minimum Wage

 

Last week I blogged about the morality of raising the minimum wage. I came down on the side of the need to increase the current minimum wage of $7.25 (many states are higher). The minimum wage in 1990 was $3.80. That means it has taken fifteen years to double. The average increase is about 24 cents per year over that time period.

 

I also recognize small businesses may be hurt the most. On the other hand, raising the minimum wage will take more people off government welfare programs and lower our annual deficit and start to cut into the national debt. Consumer spending better stimulates the economy; not government programs.

 

Economic Effects

 

 

According to a 2014 study by the Economic Policy Institute (EPI), the 1980s, 1990s, and 2000s were prosperous times for top U.S. executives, especially relative to other wage earners and even relative to other very high wage earners (those earning more than 99.9 percent of all wage earners). Income growth since 2007 has also been very unbalanced as profits have reached record highs and, correspondingly, the stock market has boomed while the wages of most workers (and their families’ incomes) have declined over the recovery.

 

It is useful to track CEO compensation to assess how well this group is doing in the recovery, especially since this is an early indication of how well other top earners and high-income households are faring. The EPI study presents CEO compensation trends through 2013 and finds:

  • Average CEO compensation was $15.2 million in 2013, using a comprehensive measure of CEO pay that covers CEOs of the top 350 U.S. firms and includes the value of stock options exercised in a given year, up 2.8 percent since 2012 and 21.7 percent since 2010.

  • From 1978 to 2013, CEO compensation, inflation-adjusted, increased 937 percent, a rise more than double stock market growth and substantially greater than the painfully slow 10.2 percent growth in a typical worker’s compensation over the same period.

  • The CEO-to-worker compensation ratio was 20-to-1 in 1965 and 29.9-to-1 in 1978, grew to 122.6-to-1 in 1995, peaked at 383.4-to-1 in 2000, and was 295.9-to-1 in 2013, far higher than it was in the 1960s, 1970s, 1980s, or 1990s.

The Role of Capitalism

 

A reader of my blog wrote in that “Businesses do not exist to provide jobs. Businesses (“greedy” or otherwise) exist to create a product or service and make a profit… so that they can live again to create more products and services. Jobs are a result. And yes, businesses, like any individual, do have moral responsibilities… and the ones that don’t operate responsibly will eventually be taken out by those that do. It happens quite nicely if left alone to let it play out.”

 

This is the standard laissez-faire argument that is the foundation of modern capitalism. However, I think there is more to the moral obligations of business than that.  

 

Adam Smith famously said that under a free enterprise system, individuals would pursue their own self-interests. Anticipating his critics, Smith contended, however, that selfish individuals, with the help of an "invisible hand'' (i.e. competition), would be contributing to the welfare of all. In other words, in order to build and maintain a flourishing and profitable company, a businessman's products would have to be needed, well made, and competitively priced. If not, he would be unable to compete successfully with others also pursuing their self-interests. Moreover, he would be creating jobs and helping to expand the general economy.

 

Ethical Issues and Free-Market Economics

 

My take is that our free market economic system depends on the exercise of ethical behavior by corporate officials to provide for the public good. Absent decision making based on ethical values such as honesty, responsibility, and fair treatment of others, the system cannot be trusted to allocate resources in the best interests of society. The root cause of such problems is the pursuit of self-interests to the exclusion of all others.

 

Case in point #1 was the scandal over fraudulent financial reports in the early 2000s at companies such as Enron, WorldCom, Tyco and Health South that shredded billions of dollars of shareholder wealth; caused the loss of thousands of jobs; and, while this was happening, top management pay packages at these companies were in the multi-millions.  

 

Case in point #2 is the financial crisis that started in 2007 and resulted in large part from unethical conduct including making home mortgage loans when financial institutions knew (or should have known) that borrowers were not qualified – a fact that was ignored (or overlooked) so that these institutions could earn large fees from closing and other transaction costs.

 

It is important to remember that Adam Smith connected ethics to economics. Smith came to his philosophy of economic behavior described in The Wealth of Nations through his view of moral behavior espoused in his first book, The Theory of Moral Sentiments. Smith posited that rational self-interest informed by moral judgments based on fairness and justice would lead to promoting the best interests of society guided by the invisible hand of the marketplace.

 

Can the Problem of Income Inequality Be Solved?

 

So, what is the bottom line? I fear we are headed for a social crisis in this country. I believe the outcry in America that has manifested itself in public support for Donald Trump and Bernie Sanders is an outgrowth of the growing divide between rich and poor and the ever-shrinking middle class.

 

However, I prefer not to have the government involved in these issues because it generally makes matters worse. It is an over-bloated and ineffective system to allocate resources more fairly. It has to come from the business community, and it needs to be dealt with sooner rather than later because we are trying to avoid a national crisis and one that could lead America further down the proverbial ethical slippery slope.

 

Blog posted by Steven Mintz on April 19, 2016. Dr. Mintz is a professor in the Orfalea College of Business at Cal Poly San Luis Obispo. He also blogs at www.workplaceethicsadvice.com.

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