feuervogel | 6 Oct 2011

Income inequality is bad for growth. That rising tide doesn't actually lift all boats. Sorry, conservative economists.

As the Occupy Wall Street protests swell in size and people pay closer attention to the gap between the wealthiest Americans and everyone else, one question is why this divide even matters. After all, one way to look at income inequality is that it’s no big deal. If a country is growing at a healthy clip and everyone is steadily getting richer, then it’s hardly an outrage that a few titans at the very top are doing freakishly well, right?

But a recent study from the International Monetary Fund suggests that this conventional view is misguided. Excessive income inequality, the authors find, can actually inflict a lot of harm on a country’s long-term economic prospects.

Who are the 1 percenters?

Taken literally, the top 1 percent of American households had an income of $516,633 in 2010 — a figure that includes wages, government transfers and money from capital gains, dividends and other investment income. That’s down from peak of $646,195 in 2007, before the economic crisis hit, all adjusted to 2011 dollars, according to calculations by the Tax Policy Center. By contrast, the bottom 60 percent earned $59,154 in 2010, the bottom 40 percent earned $33,870, while the bottom 20 percent earned just $16,961. As Annie Lowrey points out, that gap has grown wider over time: “The top 1 percent of households took a bigger share of overall income in 2007 than they did at any time since 1928.” (And in New York City, it’s even more skewed: the top 1 percent have an average of $3.7 million in income.)

When you look at the disparity in net worth, things look even more skewed. Wealthier Americans have assets — in home equity, stocks and other investments — that generally outstrip their cash income. Average wealth of the top 1 percent was almost $14 million in 2009, according to a 2011 report from the Economic Policy Institute. That’s down from a peak of $19.2 million in 2007.

By contrast, the poorest households were experiencing declines in net worth even before the recession hit. In 2007, the bottom 20 percent of households had a net worth of -$13,800 in 2007, which fell further to -$27,200 in 2009. Altogether, “average wealth of the bottom 80 percent was just $62,900 in 2009 — a dropoff of $40,900 from 2007,” EPI writes. That means the wealthiest 1 percent earned an average of 225 times the wealth of the average median household in 2009 — a ratio that was 125 in 1962.

Cozy relationships and peer benchmarking send CEOs' pay soaring It's not that they're actually worth 200 times their lowest-paid employee. Sorry, conservative economists.

As the board of Amgen convened at the company’s headquarters in March, chief executive Kevin W. Sharer seemed an unlikely candidate for a raise.

Shareholders at the company, one of the nation’s largest biotech firms, had lost 3 percent on their investment in 2010 and 7 percent over the past five years. The company had been forced to close or shrink plants, trimming the workforce from 20,100 to 17,400. And Sharer, a 63-year-old former Navy engineer, was already earning lots of money — about $15 million in the previous year, plus such perks as two corporate jets.

Why?

The company board agreed to pay Sharer more than most chief executives in the industry — with a compensation “value closer to the 75th percentile of the peer group,” according to a 2011 regulatory filing.

This is how it’s done in corporate America. At Amgen and at the vast majority of large U.S. companies, boards aim to pay their executives at levels equal to or above the median for executives at similar companies.

The idea behind setting executive pay this way, known as “peer benchmarking,” is to keep talented bosses from leaving.

But the practice has long been controversial because, as critics have pointed out, if every company tries to keep up with or exceed the median pay for executives, executive compensation will spiral upward, regardless of performance. Few if any corporate boards consider their executive teams to be below average, so the result has become known as the “Lake Wobegon” effect.