John Locke’s (1632-1704) original idea was that you earn the right of property ownership through what today would be called “sweat equity.” Taking property or materials from the natural world and imbuing your labor into them established your property ownership. Capital ownership was earned through sweat equity.
However, the link between sweat equity and capital ownership broke down when larger projects required more resources than individual workers could obtain through their sweat equity. In England the nobility provided the resources when investments were larger than individuals or even groups of workers could manage. Workers were not given any ownership in such capital equipment. Subsequently, capital became concentrated in the hands of the capitalists with little trickling down to the workers.
Hard work pays off, but not for the workers doing that work. The workers’ hard work pays off for the shareholders who do nothing but watch the money pile up in their stock portfolio. We like to think of America as the land of opportunity with a level playing field for all who are willing to work hard. But the United States does poorly when compared with other developed countries in measures of upward mobility. We are listed near the bottom around country number twenty-six in such comparisons. Too often the key to financial success is just inheriting a lot of money and investing it in the stock market.
When the workers work hard, stock ownership pays off with big increases in shareholder dividends and valuations enhanced through share buybacks. In theory all that money could be used to produce lots of products. But the workers can’t afford to buy those products because of the inadequate money flow to employees relative to shareholders. Most middle-class Americans end up with lots of debt. This diversion of money from Main Street to Wall Street is a reverse money flow, where money flows out of the real economy and back into the financial markets and ends up suppressing productivity and economic growth.
Conservatives like to talk about the importance of incentives. But where is the incentive for a wealthy person to work hard when the value of their stock portfolio keeps rising without any effort on their part? The return to capital is much higher than the return to labor and has to a great extent become a substitute or alternative to rewarding rank-and-file employees for their work. Today, the largest share of the profits in most large corporations goes to the top management and the shareholders, with little left over for most of the company’s workers. In the 1950s and 1960s CEOs earned about 20 times the pay of the median worker. Today, in the United States, CEOs earn over 200 times the pay of the median worker, while in Europe the CEOs have kept their pay at 20 times that of their median workers.
Investing in Adobe or Apple in the 1990s and just checking the box that says: “reinvest dividends,” provided shareholders with an over five thousand percent return, when some of that money could have gone to employees to reward their hard work. Sure, investors deserve a reasonable return, but the extreme emphasis on maximizing shareholder value has gone to an extreme at the expense of reducing our economy’s efficiency and productivity. It is true that someone retiring with a retirement portfolio of only $100,000 is taking a big risk when investing in internet startups and stocks. But most retirees with that little money avoid taking risks with their limited funds.
Most of the money invested in internet startups and individual stocks is from millionaires and billionaires who can afford to lose $100,000 here and there with no effect on their day-to-day lives. After all, how many pairs of shoes can a person wear, how many cars can a person drive, and how many fancy meals can a person eat at expensive restaurants each day? Even buying vacation homes can become a burden after a point. In reality, the wealthiest Americans already have so much money that taking risks with excessive funds is not something that requires great rewards. Most don’t know what else to do with all that money anyway. If there were no places to invest money, a wealthy person would need to pay a bank to hold on to their money for them.
There is no shortage of money to invest in good ideas, but a shortage of creative entrepreneurs with the ability and willingness to work hard to bring good ideas to the marketplace and to inspire their employees to work hard in carrying through on effectively implementing the plans and programs needed for success. Investors, who have inherited a lot of money and don’t know what to do with it other than investing in broadly based index funds or, alternatively, gambling on individual stocks without much understanding of their potential, don’t need to be highly rewarded for spending their days at the country club playing golf. Our emphasis on rewarding shareholders, instead of actual entrepreneurs and their employees, undermines incentives in a distorted version of free enterprise.
To be fair there are some firms that are entirely employee owned such as Burns & McDonnell Engineering[1] in Kansas City, Sammons Enterprises in Dallas, Swinerton Builders in San Francisco, and Chemonics International Inc. in Washington, DC. There are also many companies that allow for partial employee ownership through various stock option plans and similar arrangements. Government should create ways for all Americans to have some stock ownership that would grow over time and supplement Social Security and other sources of retirement income. In Germany workers are represented directly on corporate boards and incentives are designed to inspire workers to work hard and thoughtfully for their companies.
When the workers cannot afford to buy back the value of the goods and services they are producing and the wealthy dominate the financial markets, the relationship between the stock market and the real economy breaks down. The stock market thrives while the real economy struggles. I do nothing, and my stocks generate more and more money. The workers work hard, while their earnings stagnate. This was not always the case. After World War II the wages of workers kept pace with worker productivity until around 1974 when real wages flattened out even as worker productivity continued to rise. After 1974 the profits from increased productivity were diverted to the shareholders.
Unions once provided the balance to counter businesses controlling blocks of jobs with quasi-monopsony or oligopsony power. With about a third of the labor force unionized after World War II, employee pay kept up with employee productivity increases until around 1974 when employee productivity continued to rise but employee compensation flattened out and declined to some extent in real terms when adjusted for inflation. In recent years, the degree of unionization has dropped to ten percent or less. It should be no surprise that so little money ends up in employee paychecks relative to enormous amounts of money given to the ten percent richest people in the United States who own eighty-four percent of the wealth on Wall Street.
Things have only gotten worse and more extreme since then. The top one percent have accumulated enormous wealth while the average worker has gotten nowhere except deeper in debt while living paycheck to paycheck. It is only in recent decades that the emphasis on maximizing shareholder value and CEO pay, and wealth inequality in general, has become so extreme. It is no surprise that workers have rebelled against the elite so forcefully and emphatically.
To keep the economy from tanking in the face of such a distorted money flow, the federal government has itself gone deep into debt. The more distorted the money flow in favor of the wealthy, the greater has been the rise in the national debt to try to keep the economy from collapsing into a deep recession. The fundamental problem is not the government debt itself, but the distorted money flow that makes deficit spending necessary.
Another concern about government spending in general, but government debt financed spending in particular, is whether the government is “crowding out” private investment. This assumes that the economy could achieve full employment without deficit spending. For many decades, the US economy has had weak, inadequate aggregate demand relative to the excessively robust global aggregate supply. This soundly rejects the assumption that federal deficit spending is not needed to achieve full employment. In addition, we find an a priori assumption that private investment is always preferable to government investments and that future generations would be better off if there were no debt financed government investments. But this assumption is wrong when common property resource considerations allow for government debt that is judged by voters to provide a better return for future generations than private investments of equal cost. Some investments in education, infrastructure, and basic research, for example, may require government funding to be viable. Major advances in basic research that are unprofitable at the micro level for individual firms can be highly profitable for the nation and the world. Extensive examples of the benefits of government investments in basic research and technology infrastructure can be found in several books by Mariana Mazzucato.[2][3][4]
As in any investment, public or private, the costs and benefits of taking on debt should be carefully considered before making the investment. But that fact does not rule out debt-funded public investments if such investments are sufficiently beneficial to future generations. Such investments often offer a higher return to the nation than any alternative private investment projects. This is particularly true of investments which would never be made by the private sector because their common property nature generates a free rider problem which the private sector cannot overcome by private contracting because of excessive transaction costs but is recognized by the public sector as a public benefit. From this point of view, one might be just as concerned about private investment “crowding out” public investment. When all available resources are fully employed, there will always be a trade-off between public and private investment.
On the other hand, when the economy is stuck at a lower level of capacity utilization with high levels of unemployment, government investment expenditures may more accurately be thought of as “crowding in” private investment expenditures by stimulating demand and increasing the money flow throughout the economy. There are many such investments such as money for infrastructure, education and basic research at the National Science Foundation and National Institutes of Health.
In the past America has led the world in taking the initiative in providing and requiring school attendance for its children. But now other countries such as South Korea and China are making advanced education a priority and may ultimately leave the United States behind in educating their citizens. Most universities in Germany are tuition free.
Pharmaceutical companies will only invest in medicines with patents that can effectively block competition. If a medicine could cure breast cancer using easily accessible household ingredients, don’t expect a pharmaceutical company to investigate it, reveal it, or develop it. Pharmaceutical companies are motivated to charge a high price for any medicine to cure an illness that threatens people with severe disability or death. Where the need is greatest, the price will be set the highest. Only the government through the National Institutes of Health can make the investments needed for the university research needed to find cures in a cost-effective manner that can offer cures at a reasonable price.
Concentrated economic power and patent laws have enabled pharmaceutical companies to gain enormous returns on relatively minimal investments in research. Patents were originally designed to encourage innovation by allowing a company time to earn a profit on investments that take a lot of money and time. However, patents have been extended well beyond a reasonable period to recoup costs and earn a reasonable profit. Patent trolls have matters even worse. When companies fail to adequately register patents for the products and methods they have developed, patent trolls register patents for those products and methods and then sue those companies for compensation under the patent laws. The patent trolls just exploit the system and discourage innovation. We now have a patent system that suppresses rather than encourages innovative investments.
Infrastructure is clearly another area where public investment in public goods is needed because the incentive structure of private commerce does not lend itself well to building common property resources that benefit everyone without providing a clear path to matching private costs to private benefits. Historically, the benefits of the Eisenhower Interstate Highway System cannot be overstated. The enormous benefit to our economy in general and to individual companies in particular in transporting their products has demonstrated the value of solving a common property resource transportation problem that require public investment. Fortunately, the passage of the “Infrastructure Investment and Jobs Act of 2021” is a good start toward at least repairing our damaged and deteriorating roads, bridges, tunnels, ports, airports, and rail facilities.