Trickle Down vs Slurping Up

  1. The stock market
  2. The purpose of a corporation has changed
  3. Trickling and Slurping
  4. Our new slurping economy

The economy is now optimized for owners, not workers, and has been for decades

For a long time, here in America, we were all pretty much in the same financial boat. If companies did well, that meant we were all doing well. However, over time the incentives and very purpose of corporations shifted, and today the interests of people who own stocks and companies are disconnected from the interests of people who work for them.

The stock market

People still tend to confuse the performance of the market with the performance of the US economy, which is now a mistake. The market gives a sense of how much money owners of companies are making (or are likely to make in the near future) and that prediction is based on two factors: how much they can produce and sell (revenue and value produced) and how much they can keep out of the pockets of their suppliers and employees (costs). Top line and bottom line, if you will.

When stocks go up overall and “the market” is up, this can still mean what it once did: the economy is humming and everyone is likely to benefit. In those cases, the market can still work as a proxy for the economy. However, a bull market may also mean that companies are finding new and “better” ways to cut their bottom line — ways to squeeze dollars out of suppliers and employees, curtail charity, or exploit the environment — all of which reflect how the pie is being divided up, so stocks can rise without the overall economy doing well.

Consider this drop in stock value when a minimum wage hike was announced in the UK in 2015:

Companies lose value when wages increase. Src NLA newsroom.

Because the “National Living Wage” (NLA) hike was sudden, the impacts were sudden. Firms paying that minimum wage were immediately devalued. Some of the drop could be because higher wages are materially worse for business — but the more immediate impact is that a few pounds sterling in the pockets of the workers is a few less in the pockets of owners, and the stock price represents value to owners, so the stock price reflects owner interest, not overall economic benefit. (More technically, stock prices are tied to the present value of the indefinite income stream expected to be produced by the company, divided by the number of shares outstanding.)

The point to the diagram is that companies who were actually going to pay more wages were immediately devalued. About a 1.2% drop in three hours. After sleeping on it, investors stuck with that collective prediction the next day.

The purpose of a corporation has changed

For many years, a corporation had many purposes including “social responsibility of the business.” Some purposes included: producing goods, improving communities, providing work and a life for employees. And of course, returning money to investors (shareholders).

It was broad, if a bit vague.

Then the game shifted. The express, legal and enforceable purpose of a corporation became exclusively to maximize returns to shareholders. Milton Friedman (the Nobel Prize winning economist) wrote:

There is one and only one social responsibility of business … to increase its profits. — Capitalism and Freedom, 1962

which became known as “the Friedman Doctrine.” He even went so far as to argue against corporations donating to charity. This doctrine was broadly adopted, and is probably the basis for the “Greed is good, greed is right, greed works” speech Gordon Gekko makes in the movie Wall Street.

Philosophy aside, or perhaps following that philosophy, our laws and regulations have now enshrined this. The case eBay v Newmark found that companies have a fiduciary responsibility to shareholders, and are legally obligated to maximize shareholder value rather than consider other goals.

Second, Congress passed a new regulation in 1993 known as section 162(m) that incentivized public companies to provide stock-based compensation to executives. The innocent sounding idea was that if a company does well (at least in the short term) then the CEO and other execs should also do well.

Unfortunately, this glided over the question of what “doing well” means, and implicitly defines doing well as maximizing returns to stockholders, and it turns out that this often occurs at the expense of communities, employees, and the environment. Section 162(m) was revised in 2017 but is still linked to the situation we see today.

At the end of the day, most executives have been heavily incentivized to squeeze as much money as possible out of employees, disregard the communities in which they function, and exploit the environment if that is profitable. In addition, the “greed is good” Friedman Doctrine gives ethical and philosophical cover for execs who act in accordance with these incentives. Modern corporations are furiously optimized to extract wealth from all other stakeholders and “slurp” it up the chain to shareholders alone.

Trickling and Slurping

The old model was based on “trickle down,” a theory that has been soundly debunked using decades of data. In that theory, if corporations made more money, surely everyone else would too. A rising tide lifts all boats. There is some truth to it: companies can and do make more by producing more, innovating, and disrupting. Productivity is constantly rising, and value still drives profits.

But since about the 1970s, things have not trickled down very much. Wealth is increasingly being “slurped up” as those at the top are paid more, aligned with shareholders through mechanisms above, and our society collectively fetishizes shareholder value. Let’s be clear: “shareholder value” includes optimizing a macro transfer of wealth from non-owners to owners, which is exactly what we see today.

Below is a worker productivity chart overlaid with a line showing stagnant wages diverging from productivity after 1973.

The lower green line shows stagnant wages despite productivity. Credit VoxEU.

This illustrates that wealth is not being created exclusively, or perhaps even mostly, through wholesome value creation and innovation.

Our new slurping economy

That’s about it. In recent decades, the structure, philosophy, legal obligations and incentives underpinning our economy have all shifted from value creation and societal health toward wealth concentration at the expense of all else. The concentration is not merely tolerated, but demanded, enforced and optimized. The results, predictably, are income inequality, wage stagnation, and shockingly rich owners who have best mastered the art of slurping money “up” from workers, communities and consumers to execs and shareholders.

To their credit, many masters of this game, such as Jeff Bezos, Mark Zuckerberg, Elon Musk, David Rockerfeller, Ted Turner have pledged to donate most of their wealth. It is not solely their fault that they are lavishly paid for the slurping; it is ours. We incentivize them and legally bind them to serve shareholders, who in turn compensate them for evermore fully-optimized slurping.

Policy and awareness are shifting, but to make any real change, we must first understand the mechanisms at work.