Why My Boss Is All Wrong When He Says Companies Should Pay Workers More

Following a report of what it would cost McDonalds’ to double its workers’ pay, my boss, Henry Blodget, has been on a tear this week about how “greedy” corporate managers are underpaying their employees in pursuit of short-term profits.

It’s nice to be the employee of someone who thinks this. But he’s wrong.

Henry’s posts make two separate but intertwined arguments.

(1) Businesses have become too focused on pursuing “short-term” profits; the suggestion here is that businesses are underpaying workers in a way that is actually destructive of shareholder value in the long term.

(2) Businesses should pay low-wage workers more simply because it’s the right thing to do, regardless of the impact on shareholder value.

I’m going to take these two ideas separately, because I disagree with each for different reasons.

And at the end, I’m going to make some comments about what we should do about wage stagnation (since I agree with Henry this is a big problem) other than tell companies they ought to ignore market forces and pay more.

1. Are companies destroying shareholder value by underpaying workers?

Here are the charts that have Henry so angry. Since the start of the recession, corporate profits have grown to their highest share of the economy ever, at the expense of wages.

Corporate profits as a per cent of GDP
labour share of income

This happened for a reason. It’s not like corporate managers woke up one morning in 2008 and decided to be short-sighted and greedy. The weak economy drove unemployment up, and the slack labour market has made it easy to hold workers’ pay down. They always wanted to pay less, and now they can.

Normally, you would expect an economic recovery and high profits to drive a new round of business investment, which would create jobs and cause the labour market to tighten and wages to rise. But that’s not happening because the outlook for economic growth is poor; even though profits are high now, investors see few good opportunities to expand businesses.

In that environment, is collecting profits now instead of growing your business “short-sighted”? Or is it just a proper evaluation of market conditions?

Henry points to Amazon as an example of a company that has invested heavily in growing its business and generated few profits while still enjoying a soaring stock price. And good for Amazon. Of course, we’ve heard “we’ll scale now and worry about profits later” from a lot of Internet companies and it hasn’t always ended well.

But whatever the merits of Amazon’s strategy as a way of generating value for Amazon shareholders, it’s not relevant to a company in a mature industry, like McDonald’s, which can’t plausibly claim to be in a “growth” phase where profits will come later.

Then there is the added problem that it’s not even clear that raising wages would count as an “investment” for McDonald’s. For some firms in some sectors, paying employees an above-market wage to reduce turnover and build human capital can be a good strategy. It’s unlikely that would be the case when your workforce is mostly low-skilled and your industry is built to operate with high turnover.

So, I don’t think we can knock McDonald’s management for being short-sighted or destroying long-term value. But should they be paying more anyway? That’s the next question.

2. Do businesses have a moral obligation to pay workers a higher wage than the market demands?

Let me note, I do think it is morally correct to transfer wealth from people who have a lot of it to people who do not. McDonald’s shareholders are generally wealthy and its employees are generally not, and it would be good to have forces that move wealth from the former to the latter.

But what creates any specific obligation between the employee and the employer? Payment of an above-market wage is an altruistic transfer. Why is the owner’s obligation to make such a transfer to his employee any stronger than his obligation to make one to some other person with less wealth?

The existence of such a moral obligation would actually create perverse incentives. Let’s say I’m a rich person with money to invest. I can invest in a company with employees, which creates an obligation to share some of my investment returns with those employees; or I can invest in something like bonds or mineral rights or land, where no such obligation gets created because there are no employees, and I may morally keep all the returns for myself.

Nor is the enforcement of such a moral norm likely to be an effective way to advance the interest of workers. Most companies are not like Amazon, with a dominant market position and equity investors comfortable with the idea that they will not see profits anytime soon. If McDonald’s decides to pay more than it must, it can be outcompeted by competitors who will feel no such obligation.

The idea that firms have special moral obligations to promote their workers’ economic security had led to a really big policy error in the United States: using employers as the primary vehicle for health insurance and a major vehicle for retirement saving. It would be more economically efficient and better for workers if we treated those moral obligations as resting less with firms and more with the state.

Finally, given high unemployment and businesses’ lack of enthusiasm to expand and grow, I’m very wary about layering more obligations (even mere moral ones) on people who do decide to hire.

So, what should we do about wage stagnation?

The lack of a moral obligation for employers to pay more actually strengthens the argument for policy interventions to enrich low-wage workers. If companies can’t be expected to act, the government must.

The first step is economy-wide policies to promote full employment and wage growth. The Federal Reserve should take its dual mandate seriously and implement policies that promote full employment, such as a nominal GDP target. Fiscal policy should also be more reactive to economic downturns. 

The government should also directly intervene to raise the incomes of people with low incomes. A minimum-wage increase is one way to do this, and within the range of observed minimum wages within the U.S. (under $10) it’s not likely to raise unemployment much. More progressive fiscal policy, such as by expanding the Earned Income Tax Credit, is another option.

The federal government should continue to implement a universal health care entitlement and strengthen its retirement security offerings so that such benefits are not limited to those Americans whose employers happen to provide them.

And given the shift toward higher incomes at the top and higher returns to capital relative to labour, the federal government should rely more on taxes on high earners and more on taxes on capital to pay for these things.

A broad policy approach like this would do more to enrich poor Americans (including not just those who are working low-wage jobs but those who can’t find any at all) and would better reflect the fact that moral obligations to redistribute wealth aren’t limited to employer-employee relationships.

Disclosure: Jeff Bezos is an investor in Business Insider through his personal investment company Bezos Expeditions.

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