Vox Populi

This is not going to be a socialist diatribe against the wealthy bourgeoisie. I would like to make a few confessions of faith right out the door. I do believe that income inequality must exist, that there must be a group of professionals at the top of thee pay structure who make significantly more money than the people below them. But I also believe that their larger share of income must be due to and in proportion to their elevated skill sets and capabilities. I believe in the free market and in the efficiencies it brings. But I also believe that free shouldn’t mean laissez faire and that the state must intervene in the market to curb its excesses. Afterall, the invisible hand of the economy often does not belong to an entity with the kindness and justice of a benevolent god but to an entity with the greed and manipulation of the devil.

Since the 1980s, across the world, executive pay has skyrocketed. This exponential increase in the pay for the top executives of the economy while explained by the conservative politics ushered in the world by Reagan and Thatcher, are not explained by any proportionate increase in the profitability of the firms that these executives lead. Simply put, the increasing of the pay of the top management by leaps and bounds makes political sense but not much economic sense. Are business leaders today more proficient than the leaders of the past? Are our economies growing faster than they ever did in the past? Are employees happier with their jobs than ever in the past?

It is difficult to answer any of these questions in the positive for almost any nation in the world today. Even if we were to attribute the negative answers to these questions to the negative bias of the human psyche, common place cynicism, the data doesn’t lie. The rise in executive pay has consistently and exponentially outpaced the rise in the GDPs around the world. Case in point being the “Deloitte India Executive Remuneration Survey” over the past few years. Per the report, the average CEO compensation has seen a double-digit growth since the pandemic. This even while India experiences its worse growth slowdown since the 1970s. A look at the financial statements of most firms will also make it clear that while the aggregate revenue numbers might definitely be on the rise generally speaking, the profitability of firms across different industries still remain comparable to the 20th century.

Afterall, the invisible hand of the economy often does not belong to an entity with the kindness and justice of a benevolent god but to an entity with the greed and manipulation of the devil.

Then what justifies the pay for the business leaders surging so high up when the performance of our businesses remains comparable to the past where their compensation wasn’t so disproportionately high? I am no economist, but to borrow a favourite expression of economists, “it’s complicated”. There are many reasons driving this growth. The prominent of these would be higher education and technological competencies now demanded of the business leaders. While this is a good point to make, one must remember that the educational and technological requirements have increased for employees at all levels and often proportionately. Most entry level jobs today require an undergraduate degree and more and more require a postgraduate. Why then should the increase in pay of executives be so disproportionately high when compared to the rest of the organisational pyramid? The other reason justifying this growth might be the bloating up of the financial sector in the economy which now captures more and more share of the GDP and pays out huge commissions and bonuses to its executives, driving the trend of high executive pay in the rest of the economy. Even this justification is perilous as most economists now warn us that a disproportionately large finance sector is dangerous for the economy. It is easy to understand why. Finance by its nature is meant to facilitate other productive activity in the economy. We basically raise investments to procure equipment and labour to either manufacture a product or to provide a service. A bloated financial sector while the manufacturing sector shrinks means an economy where finance is its own end. Where finance is used not to finance productive projects but to simply speculate the future prices of assets to make money. An economy like this with such high levels of speculations is prone to bubbles and consequently to crashes and economic disasters.

Even if these explanations fail to convince the detractors, high income inequality is inherently bad for the economy any way. How then must we remedy it? The answer gets especially tricky if you are a fellow believer of the tenets I confess to in the beginning of this writing. That income inequalities born out inequality of skills, experience, and capabilities are desirable. And two, that the market should be allowed to function with as much freedom as ethically possible.

Before I explain the solution I propose, I believe it will help to understand just how bad the situation is. The graph below tracks the evolution of the national income shares of the top 10%, middle 40%, and the bottom 50% income earners in India.

The graph clearly demonstrates that the income inequality has been constantly on the rise with the top 10% taking a larger and larger share of the national income when compared to the bottom 50% of the population. As I have said earlier, this rise in inequality hasn’t been born out of a sudden renaissance among the richest people in India wherein they have suddenly become more intellectual and capable than the rest of the country. Nor has this skewing of income flows in their favour resulted in high economic growth. As Reagan and Thatcher would have found out if they had lived long enough to see it, trickledown economics does not work. The naïve belief that the rich getting richer will result in them making more investment and consequently the money trickling down to bottom levels of the society has been debunked pretty thoroughly.

At this juncture, I would digress a little to explain that the income from inequality that we see on the graph has two components. Income from labour inequality and income from capital inequality. Income from labour would include wages, salaries, and bonuses while income from capital would include profits, dividends, rents, and capital gains. The income from capital tends to be stickier than the income from labour as one can imagine because capital can in large part constitute generational wealth like property passed down generations or shares inherited. I believe addressing inequality of income from capital will require more complex and holistic approaches which maybe we can visit in the future. The executive pay however is a perfect cause, symptom and example of inequality of income from labour. It is the inequality of income from labour that I propose a solution for today. And no, I do not intend to propose a tax or a cess. Taxes tend to be too blunt a tool and are difficult to administer, especially in developing economies. Nor do I propose an absolute ceiling on executive pay. Absolute thresholds might remove the flexibility that firms need.

I propose the managing of the percentiles of a company’s total wage bill. At the risk of being accused of mansplaining, I would like to refresh our memories on what percentiles are. Percentiles basically represent the percentage of all the observations in a data set that the particular observation you have selected, exceeds in value. For instance, if I say your marks are in the 90th percentile, then that means that you have scored higher marks than 90% of all the people who gave the test. It’s fairly simple to calculate once we arrange any series into a descending order. See below.

The example above also makes evident certain inherent advantages of using percentiles to study the pay structure in an organization. Once the data set of 10 employees is arranged into a descending order, it doesn’t matter what the average pay in the firm is or even the designations to which these employees belong to. Any change in compensation can simply be incorporated by rearranging the data in descending order. Irrespective of what the actual pay of the employee is, the top employee would constitute the top 10% of the income earners of the company, the next four will constitute the middle 40% and the remaining 5 would constitute the bottom 50%.

Now that we have got the concept of percentiles out of the way, let’s talk about what could be a very effective solution to income inequality. It’s a solution which will result in considerably increasing the pay of almost 99% of the workforce while neither increasing the taxes on the rich nor by asking companies to pay more on salaries than they currently do. In fact, it will in most cases result in reducing the total payroll expenses of the firm. We must rationalize the current wage distribution among the different percentiles of the wage earners. A legislation putting limits on what percentages of the total payroll expenses of a firm can go to different segments of employees on the wage distribution will go a long way in addressing the issue of rampant inequality. If we look at the graph presented earlier and try to find the most equitable split that can be achieved without creating too much of a shock, I believe the following split might be the best suited – the top 10% getting no more than 40% of the total payroll expenses , the middle 40% getting no more than 40%, and finally, the bottom 50% getting at least 20%. If we were to look back at our percentile example and mark down the shares of these three segments that I have outlined, in the total payroll expenses of the firm, it would look something like this.

It is clearly a very skewed wage distribution and is in no way an exaggeration when compared to reality.
I am in no way proposing a socialist utopia where everyone gets an equal pay. And this is in no way a personal attack on the top 10% of income earners. This is just a proposal of market correction. The current pay of our executives just does not make any economic sense. The exponential increase in their pay has not been concomitant with similar increase in the productivity or profitability in the economy. It is basically a self-reinforcing vicious cycle, wherein executives demand higher and higher pay and companies engage in a race to the bottom to meet their demands in order to attract the best talent. Even if it were true that the most talented executive is getting paid the highest among all the executives, the point is that even the lowest paid executive is grossly overpaid in proportion to their contribution to the firm, meaning everyone else above them is overpaid too. Nor is this proposal born out of the rich vs poor trope. In fact, it would be far more effective if we were to divide the employees into not three but four segments – Top 1%, the next top 9%, the middle 40%, and the bottom 50%. Why? Because the income inequality is even more stark among the top 10%, the so-called “rich class” with the top 1% pocketing as much as half of the total income going to the top 10%. The graph below about historical income shares in India illustrates the magnitude of this inequality very clearly.

Legislation making sure the top 1% getting no more than 15%, the next 9% getting no more than 25%, the middle 40% getting no more than 40%, and the bottom 50% getting no less than 20%, I believe, would help curb this imbalance.
A law based on percentile has the advantage of adaptability. As mentioned earlier, it is not dependent on the organization structure of the firm. Hence, it can be implemented across all organization no matter what titles they use in their firm. The percentile system also does not require firms to open their books to the government and provide information that they are not already providing. All employers are required to collect TDS for their employees and issue Form 16 to every employee. This information is sufficient for the firm to create a percentile distribution and for the government to ensure compliance to the limits. It also doesn’t put any absolute thresholds on the amount of pay that the firms give its employees. It also leaves plenty of room for the firm to differentiate the packages of different employees at the same level based on performance as the percentile distribution is not linked to designations or organizational levels. It is much easier to administer and very adaptable to every firm size. It does not require the firms to increase the amount they spend on salaries as it is a mere redistribution of a firm’s existing payroll expenses.

While this proposal will see exponential rise in the salaries of 90% of the salaried employees in the economy, it also has inherent benefits for the shareholders of a company. It will put a stop to the race to the bottom of higher and higher pay that the shareholders have to pay their executives. It will help firms reduce employee turnover and help them give competitive compensation to their employees. It also ensures efficiency in the firm. Executives have often seen no dip in their pay even in times of crisis, meaning critical resources being diverted to pay their salaries. Throughout the world, executives have had a bad habit of writing themselves big bonus cheques even as their companies are in a freefall towards bankruptcy. As companies get too big to fail, governments step in with bailouts, which again, have been historically been pocketed by the top management of the firms. The percentile income share walls will ensure that executive pay can only increase when there is sufficient increase in the revenue stream of a firm to increase the salaries of most of the firm. As any large increase in executive pay not accompanied with a proportionate increase in the pay for the lower levels of management will result in the percentile limits of income share being violated. It also gives employees of the firm more skin in the game. They know that, if the firm does well, the salaries will increase for all levels proportionately and will not just be pocketed by the higher levels. With the micro level impact of the proposal listed, let’s take a look at the macro level impact.

How would the economy react to such a shift? The legislation would inadvertently increase the pay of the lower levels of the organization the highest. A “bottoms up” approach to economics, which I believe is infinitely more effective than the “trickle-down” one. This will stimulate demand and consumption. Something most developing economies have been struggling with since the pandemic.
People might fear that this might result in brain drain of the top executives to foreign countries. I am sure we will be reminded how high in demand Indians are as top leaders of businesses in the developed world. The Pichais, Nadellas and Nooyis will be invoked. A close examination of this argument will reveal that its impact would be frankly inconsequential. There are just not enough instances of an Indian home- grown executive moving to a developed country to take over the reins of the businesses there. Most of the Indian origin leaders that we express exaggerated pride over are professionals who left for the U.S. or U.K. at the start of their careers and then never came back. Basically, almost all Indian origin business leaders in foreign countries, entered their job market at the entry level, not after spending decades in the Indian job market and then shifting to a foreign country for a better opportunity.

This proposal also has the potential of encouraging foreign firms to move more and more of their high-end processes to India as highly experienced and skilled leadership gets cheaper in India with executive pay coming down. An added advantage to the existing exchange rate.

In fact, I would argue that this proposal will reverse the brain drain by attracting foreign educated Indian talent back to India. This proposal will significantly increase middle level management pay in the economy. A perfect entry point for the Indian students studying abroad to come back to India. The increased pay would be attractive enough to entice the Indians currently working abroad with low to mid-level experience to move back to the country.
This proposal also has the potential of encouraging foreign firms to move more and more of their high-end processes to India as highly experienced and skilled leadership gets cheaper in India with executive pay coming down. An added advantage to the existing exchange rate.
The firms might react with outsourcing their entry level jobs to third parties in order to increase the lowest salary on their books so that they can retain a higher pay for their top management. Firstly, I believe this too wouldn’t take place at a drastic level as firms tend to prefer to capture talent at the earliest possible stage to train them up in their practices. The fact that their clients might also be vary of them outsourcing their data to a third party will also dampen the prevalence of this practice. Secondly, even in industries which do allow the firms to outsource their entry level jobs easily, outsourcing by big firms to smaller firms would be a net positive by helping create more startups to fulfil those needs and hence, help in wealth and job creation.

It is crucial that the percentile walls are imposed on all firms of all sizes to prevent abuse of the system by contractualizing of labour wherein firms just convert their full-time employees into part-time employees or independent contractors so as to not include them in their pay structure.

All in all, while this measure might create a shock and see drastic decrease in executive pay in the country, I believe it’s a necessary intervention. A long due correction. It would be healthy for us all to remember that the markets have a really bad track record of correcting their deficiencies. No monopoly or cartel in history has ever dismantled itself peacefully without external intervention and no bubble in the market has ever corrected itself without a crash. Hence, it is for the sake of maintaining the parity between capabilities and compensation that state must intervene to curb the excesses of market. The success of capitalism rests on the ability of the economy to reward the deserving.

The success of capitalism rests on the ability of the economy to reward the deserving.