THE BLOG
06/05/2014 05:04 pm ET Updated Aug 05, 2014

Corporations and Wealth Inequality

At the end of 2013, the stock market hit an all-time high. So did corporate profits as a share of gross domestic product. But wages hit an all-time low. This lopsided distribution of wealth is justified as the working of the market economy. But it is not the market that promotes increasing stock prices, high profits and low wages – it is the financial rules of the game as set by the government. Underlying much of this is the notion that the sole responsibility of corporations is to provide profits to the shareholders. This is a basic distortion of corporate responsibilities and is an underlying reason for the growing wealth inequality in this country.

Corporate Responsibilities

The Cold War vividly demonstrated the superiority of market economies, dynamic and even self-correcting. The Invisible Hand of the Market, in Adam Smith's evocative metaphor, is its inherent self-regulating behavior which insures that individuals' efforts to maximize their own gains also benefit society as a whole, even if the individuals have no benevolent intentions.

Corporations have become the core organizations in the market economy. But the invisible hand of the market early proved to be an inadequate control mechanism. As far back as the 19th century, major corporations sought to maximize their own benefits by working to corner markets. In 1890, the Sherman Anti-Trust Act limited their anti-competitive growth so that they were not simply machines to extract wealth from an exploited populace. Yet the struggle continues unabated. In a widely read 1970 article, Milton Friedman claimed "there is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits.” This legitimized a widespread belief that shareholders have every right to take care of themselves first.

But this belief is fundamentally wrong. Society facilitates the operation of corporations for the benefit of society as a whole. They provide the goods and services that society needs, jobs with wages that support the standard of living, and taxes that support government programs. Society supports corporations for all of these reasons, recognizing their activities will create considerable wealth. This wealth is for the benefit of society as a whole. Indeed, Friedman qualified his comment on profit: a corporation must stay “within the rules of the game, which is to say, engages in open and free competition without deception or fraud.

But the rules of the game are much broader. They ensure that corporate efforts support all stakeholders:

  • Society as a whole is the primary stakeholder; taxes and royalties support all the components of modern society, including courts, education, infrastructure, parks, police, and the armed forces.
  • Corporate employees are the second major stakeholder. Society sets minimum standards for treatment of employees.
  • Stockholders and bondholders are the third major category of stakeholders. They provide the capital for operations and own the net profit of corporations.

Society as a Stakeholder

In an extraordinarily complex socio-economic system, the rules of the game must also be extraordinarily complex. The Code of Federal Regulations with 170,000 pages is only one set of rules at national level, not to mention state and local ones. Theoretically, these thousands of pages of laws and regulations protect the public's interests, including environmental standards, as well as health and safety requirements and mandatory quality requirements. They also set criteria for tax and royalty payments and provide tax benefits, a major tool to guide economic development. Many corporations engage in wider social support programs because of a strong sense of general obligation to society; such efforts are commendable, but supplemental. The core corporate responsibility to society is to pay the taxes and royalties which support overall government operations.

Thousands of regulations of course mean thousands of opportunities for corporations to advance their own narrow interests. Regulations are not set by some kind of unbiased, neutral evaluation, but by politics. Shareholders have a natural interest in maximizing profit, and so an interest in minimizing social support. One result is strongly focused lobbying efforts aimed at favorable treatment in the specific provisions of some law or regulation. Even the exact wording of some obscure regulation can provide major but practically invisible benefits to some corporation(s). Such lobbying efforts are typically backed not only by considerable corporate resources but also by a broad network of largely invisible ties among legislators, lobbyists, regulators and officials. The public interest, on the other hand, is often diffuse, with no one to counter specific corporate arguments which, at any rate, are often invisible to the general public. The result is that thousands of corporations enjoy some level of dispensation from their obligations to provide social benefits.

Employees As Stakeholders

Obviously, corporate income depends on employee performance. And the state sets minimum wages, maximum work hours, and often some levels of specified benefits. Many corporations go beyond these minimal standards. A hundred years ago, Henry Ford famously paid his employees high wages so that they could buy the cars they were producing, as well as support a vibrant local community.

As with corporate responsibilities to society as a whole, responsibilities to employees impose fiscal burdens which reduce profit to shareholders. So again, shareholders have a vested interest to fight such requirements. Stressing profit as the sole legitimate objective of corporate operations gives a sheen of legitimacy to reducing wages while raising profits. More importantly, politics is again a major player and the same concerted lobbying efforts and networks of corporate influence which undermine rules supporting social responsibility also undermine rules supporting responsibilities to employees. One clear example is that the federal minimum wage has not risen in almost five years and stands at a low $7.25 an hour, far below the poverty level.

The situation is further complicated by outsized levels of executive compensation. Executives are part of the total employee collective and their compensation is ultimately set by the shareholders, with minimal government direction. However, it is obvious that more remuneration to executives means less income available to distribute as wages and benefits to other employees. The extent to which senior managers actually deserve their outsized compensation has been regularly challenged. But just as legislation is complicated by interlocking networks of key players, setting executive pay is complicated by interlocking networks of corporate directors, senior managers, and wealthy shareholders. Major financial or social funds often comprise a significant proportion of shareholders, focusing on short term profit and paying minimal attention to social or employee responsibilities. Shareholders who try to support such broader interests can find it very difficult to oppose settled corporate policies and simply turn to invest elsewhere. The overall result is that the share of total corporate remuneration going to rank and file employees is steadily declining.

Current Trends

The most significant current trend is the intense effort to minimize any corporate responsibility to outside stakeholders. In addition, several other trends facilitate minimal corporate attention to broader social and employee responsibilities:

  • Corporate Consolidation. This was the focus of the Sherman Anti-Trust Act over a century ago. The obvious worst recent example was when banking institutions labeled as “too big to fail” received large government funding despite the fact they were the major cause of the market problems. But consolidation is rife; a latest example is the recently approved merger of American Airlines and US Airways. Large companies can certainly increase efficiency by eliminating duplicative administrative and support systems. WalMart is a prime example: its supply and distribution system is a marvel of modern efficiency, reducing unit processing costs to levels that strongly support its low price policies. But WalMart and other large corporations not only diminish competition, they are also able to squeeze workers and suppliers, making smaller companies less profitable, as well as putting smaller competitors out of business; this can provide lower prices and better selections to the local market, but at the cost of weakening local community life.
  • Technological advances continue to increase worker productivity, but savings in labor requirements have not translated into increases in wages. Rather, reductions in aggregate wage levels have facilitated increases in executive pay.
  • Expanding tax benefits. The mammoth size of the Code of Federal Regulations and other rules is not simply due to an increase in requirements placed on corporations. It is also partly due to increased special treatments, resulting in a greatly expanded ability of corporations to avoid taxes. A major recent example was extensive discussion on how Apple Corporation had avoided billions of dollars of taxes. Apple simply responded that it had paid all the taxes it was required to, a claim no doubt generally true. But a claim that puts a spotlight on the large number of special tax provisions that corporations can use to minimize their social responsibilities. Naturally corporations will not pay more taxes than they are supposed to, but they can very effectively lobby to minimize that amount.

Summary

A widespread notion that the sole responsibility of corporations is to make money for the owners is a major factor supporting the trend of increasing wealth at the top levels of society, at the expense of every one else. It promotes policies and activities that squeeze income to both government and workers. It ignores the underlying truth that all the assets of society belong to everyone. The central economic task of government is to ensure a distribution of these assets that benefits society as a whole. Corporations are not created so that they can use goods, services, and jobs simply as levers to extract wealth for the benefit of executives and shareholders. As the main economic engine of society, the wealth they create should rightfully be distributed among the three sets of stakeholders: society, employees and owners. Laws and regulations set out the basic criteria for such sharing and need to provide results that support society as a whole. The Invisible Hand of the Market is woefully inadequate to insure socially equitable outcomes in our complex society. It is too often thwarted by the Invisible Hand of the Washington Network. In the final analysis, the electorate needs to elect politicians who will look out for the benefit of society as a whole.