The Pay Ratio

Why equality is good for business—and why the tech sector should be a role model for fairness, and not just innovation

At the New Yorker blog, George Packer responded to my earlier post, Learning From Los Gatos, with a few thoughtful and generous remarks. I think we are in agreement that the politics of Silicon Valley are weirder and more Democratic than the traditional libertarian mold. But on the question of inequality, I still think Packer is missing an important point, one that is worth examining in more detail. He writes:

I’m even more skeptical after reading Johnson’s argument that Silicon Valley is fighting back against inequality by creating large numbers of millionaires and distributing profits to its workforce in a relatively equitable way. This is pretty much my point: life inside Silicon Valley can be a paradise (for its winners) of opportunity and reward. Meanwhile, life outside falls further and further behind. All those highly paid engineers, with their generous stock options and unheard-of buying power, aren’t making the Valley more equal—they’re making it less so. And their success isn’t extending very far into the rest of the economy. Unless everyone becomes a software engineer—a proposal that was floated to me by several tech people, in one form or another—egalitarian stock plans are not an answer to the deepest structural problems in America.

As Packer documents in his amazing-sounding new book (which I have just started reading) American corporations have pulled in record profits over the last few years despite the ongoing troubles of the Great Recession. While this has been great news for the stock market, those profits are not trickling down into ordinary wages. The pay ratio—the ratio of the highest paid to the average employee—inside US companies has grown to stratospheric levels. Over the past forty years, the pay ratio at US corporations has increased from roughly 30:1 to 300:1. This is not the only measure of inequality in the U.S., of course, but it is probably the most salient single statistic for measuring the social “unwinding” Packer laments. If American corporations were suddenly to switch to back 30:1 pay ratios and all other datapoints—unemployment rates, consumer price indices, health care costs—remained as they are, I doubt Packer would have felt the need to write his book.

So I think it’s fair to assume that Packer would agree that we need to flatten pay ratios. Then the question becomes: how do we do it? A number of approaches involve the redistribution of wealth through taxpayer-funded programs. We could create what would effectively be a super-charged Earned Income Tax Credit, where the government redistributes wealth by supplementing wages at the lower end of the economic spectrum. Or we could double down on stimulus spending and create even more New Deal-style infrastructure projects that would directly employ workers and indirectly rise the price of industrial labor by offering competition to private sector employment. For what it’s worth, I like both options, and I would entertain even bolder forms of redistribution. (I am a fan, for instance, of Bruce Ackerman’s idea of “citizenship inheritance.”)

But there’s another lever that we have at our disposal, which is ultimately why I wrote the response to Packer’s essay in the first place. We need to reduce the core pay ratio inside US corporations: the way they share their rewards before the government gets involved. A small but growing number of firms around the country have made more egalitarian pay ratios a defining part of their corporate culture. No one at Whole Foods, for instance, can earn more than 19 times the average employee’s wage. You can create flatter, stakeholder corporations by using stock options, but if you’re worried about the performance of your stock, you can do it simply through salaries. Silicon Valley companies use both mechanisms, as it happens — which is why I felt that they had a much more complicated relationship to inequality than Packer’s original essay suggested. Google, HP, Cisco, Amazon, and Microsoft have pay ratios that together average around 25:1, a tenth the size of the typical US company. We need to reduce the pay ratios of our corporations, and here we have one industry that has voluntarily adopted ratios far lower than the US average, and that industry turns out to be one of the most dynamic and successful in the world.

This is where I am confused by Packer’s response. He writes, “Unless everyone becomes a software engineer—a proposal that was floated to me by several tech people, in one form or another—egalitarian stock plans are not an answer to the deepest structural problems in America.”

Software engineers are winning the lottery for two reasons: they have information economy skills that the world happens to value right now and they happen to work in an industry that for complicated historical reasons established some of the most egalitarian compensation structures in the history of modern capitalism.

Packer’s response makes perfect sense if you keep it to the first stroke of luck: not everyone can be an engineer, he says, so why bother learning from Silicon Valley’s success. But my point was about the second stroke of luck: many people could work for a corporation that limited pay ratios to 20:1, or created extensive employee equity. Right now, most of corporate America is refusing even to release information about its pay ratios to shareholders, much less flatten those ratios. For people like Packer (and me) who want to see inequality reduced, Silicon Valley gives us a powerful case study in the economic benefits of more equitable compensation: equality is good for business. And it’s good for business whether we’re talking about software engineers or supermarket checkout clerks.

You can make the argument for flatter pay ratios from a libertarian perspective, and indeed that’s exactly what someone like John Mackey, the iconoclastic CEO of Whole Foods, has tried to do. The libertarian argument would basically be that companies should voluntarily adopt these strategies because the overall outcome is better for everyone involved. But a liberal or peer progressive who thinks that government has a legitimate interest in the equality of outcomes in society could encourage pay ratios through state power as well, presumably through some kind of tax benefits for companies that lowered their ratios.

But wherever you stand on the political spectrum, the beauty of tackling inequality by reducing pay ratios is that the redistribution doesn’t have to go through the channel of the government at all. The government isn’t taking money out of the private sector to fund its various social safety plans. It’s simply ensuring that the money inside the private sector is distributed more evenly. That’s an argument that I think would play well in the current political landscape, with its strange mix of outrage at both big capitalism and big government. I would love, for instance, to see Obama invoke Silicon Valley not as an emblem of the American entrepreneurial drive, but as an role model of equitable pay, a way of shaming the Wal-Marts (pay ratio of 1,000:1) who act as though profitability and inequality are inextricably linked.

In a way, it ultimately comes down to something that Packer does better than just about anyone: storytelling. Stories about entrepreneurs who won the lottery and left the rest of us behind are not new. Stories about companies that decided to the share the wealth across the organization and ended up prospering — well, those stories are not quite so common. That’s why it’s essential that we tell them.