Saturday, January 1, 2011

Stuff We Do to Ourselves (and then Complain), Rich People, Middle Class Problems, National Debt

Happy New Year from the Unrepentant Capitalist!

I’ve been spending some of my holiday free time surfing the various news web sites reading business and economics articles. Am I a maniac or what? I also like reading the various comments people post at the end of articles. Scrolling through the comments, people seem to be very angry about the general state of the economy and the ‘dire’ condition of the middle class. The common villains seem to be outsourcing, overpaid executives, ruthless cost cutting by businesses, illegal immigrants, under taxed rich people, and debt.

Outsourcing, Cost Cutting, and Immigration

It’s ironic, but many of the ‘problems’ we complain about are things we’re doing to ourselves.

I’ve discussed this before, but outsourcing and corporate cost cutting are examples of things we’re doing to ourselves. I would add illegal immigration to the list of self-made ‘problems’.

We choose the rental car agency that offers us the lowest price, but then complain that the company has outsourced its call center to India. How do you think they were able to offer you that low price? We complain about illegal aliens, but happily buy the 2 pound tub of strawberries for $5 at the grocery store. Even in the depths of our Great Recession, no gringos showed up at the strawberry farms ready for work. If I had to do the picking, those strawberries would probably be $5 a piece. Hmm, a 2 pound tub of strawberries for $250? that sounds about right. As investors, we applaud management’s cost cutting measures and the 10% jump in the stock price. Oh, by the way, management outsourced most of the company’s AP function to Poland as a part of the cost cutting initiative. We like to blame others, but our actions as consumers and investors create the very ‘problems’ we complain about.

Our actions send a very clear message to business—we want it cheaper, faster, better, preferably all of the above. Companies will stop doing all these things as soon as the consumer stops demanding innovation, better products and services, and lower prices. One problem.  The day that happens is the day our economy stops growing. In a mature economy like ours (one with little to no population growth) productivity gains are about the only way for the economy to grow. Economic growth gives us higher pay, a better standard of living, etc, etc. Bottom line, consumers and investors are generally pushing business to do the right things.

When it comes to illegal immigration, we seem to like to complain about it, but our actions as consumers tell a very different story. We need to acknowledge that our economy demands a significant amount of cheap labor, and for the most part, American citizens won’t take those jobs. We need a guest worker program to manage the millions of workers our economy demands.

Those Nasty Rich People

Lots of people are sure our economic problems are the doings of rich people.

There seem to be two main variants to this theme—executives who are paid too much and rich people who are taxed too little.

CEOs, CFOs, COOs, and other corporate executives are paid many times more than receptionists, mailroom, and clerical personnel. In some instances, the pay difference between the corner office and the cube farm can be 200 times or more. This gap makes some people very mad.

We have to recognize that there is a market for talent. If you want top talent, you have to pay. If you want a left-handed pitcher who can win 20 games in the big leagues, there’s a market price for that. CEO’s are no different. A few years ago, Ben and Jerry’s (the Ice Cream guys) was searching for a new CEO and mandated that he or she could earn no more than 10 times the lowest level employee. Do you think they gave themselves the best chance to hire a great CEO at $160,000 a year when other opportunities were offering candidates ten times the Ben and Jerry’s salary?

Leading a large business requires lots of experience, skill, and hard work. The pressures on CEO’s are tremendous and unrelenting. Decisions made by CEO’s leading billion dollar companies impact lots and lots of people—shareholders, customers, employees, suppliers, etc, etc. Successful leaders are rare. If a loved one requires delicate brain surgery, do you want the most experienced and skilled surgeon you can find or do you want the guy who’ll work for 10 times what the janitor makes? While the skill sets required are very different, I contend that skilled surgeons are as rare as skilled senior executives. If you want a good one, you gotta pay up.

CEO compensation works when pay packages include measurable and objective pay-for-performance incentives that are governed by independent compensation committees.When the company does well, the CEO does well. It also helps when company stock makes up a fair chunk of the CEO’s net worth. This is a good way to achieve financial alignment between the CEO and the company. When these elements are missing, you get expensive company jets and other unnecessary costs to the company.

Reading through the comments people post, you also sense a lot of venom for rich people. This is most unfortunate, as I would like to be rich one day. There seems to be a widely held belief that rich people are rich because they’ve cheated somewhere along the way. Have a few rich people cheated? Yes. From what I’ve seen, the rich tend to be talented, hard working, and driven. Are there slugs out there living on inherited wealth spending their entire day playing Xbox? Yes, but this isn’t the norm.

I say our economy needs rich people. Our economy works, in part, because we put a big, fat brass ring out there for motivated, talented, hard working people to aim for. People are not going to work ridiculous hours, take big risks, and make sacrifices for socialist wages. Of the cool stuff we have today—pc’s, seedless grapes, iPhones, the $4.99 all-you-can-eat pizza buffet—how many of these things came out of the old communist bloc? I can’t think of any.

The other common theme out there says that the rich aren’t taxed enough. Leona Helmsley's former housekeeper testified that Leona said, "We don't pay taxes. Only the little people pay taxes.” Two thoughts. First, if Leona Helmsley really said that, she was a pig. Second, the facts are the rich pay most of the income taxes in this country.

According to the IRS, the top 10% of income earners in the U.S. pay 2/3rds of the income taxes. The data also shows the tax burden has grown disproportionately on the rich. In 1980, the top 10% earned about 32% of the income, and paid 44% of the income tax bill. In 2004, the top 10% earned about 44% of the income, but paid 68% of income taxes.

From time to time, politicians will step into the fray in attempt to ‘make things right’.  There’s a famous bit of ‘soak the rich’ legislation that was enacted a few years ago with some very unintended consequences. A luxury tax was levied on new yachts costing more than $100,000. The tax had two outcomes. First, sales of used yachts jumped as the tax made comparable new yachts more expensive. Second, sales of new yachts plummeted resulting in lay-offs among workers building yachts.

So who were the winners and losers here? Rich guys wanting to sell their yachts did well. Blue collar workers who lost their yacht factory jobs didn’t do so well.

Middle Class Problems?

I’ve also discussed this topic before, but there’s so much anger out there about the ‘sad’ state of the middle class, it’s worth revisiting. In my prior posting, I took a detailed look at long term household income data compiled by the US Census covering the years 1967 to 2007. This data shows a very clear trend: in percentage terms, there are fewer lower and middle income households, and more upper income households in 2007 as compared to 40 years earlier.

In 1967 31% of families were in the lower income group, by 2007, families in the lower income group had fallen to less that 25% of the total. The percentage of middle income households also dropped over this time period. In 1967, less than 6% of households were in the upper income group, by 2007, 20% of households were. Contrary to popular belief, families (middle class included) are become more prosperous.

A closely related topic to ‘woes’ of the middle class (and also discussed in this space before) is the myth about a family needing two incomes to make ends meet today and, in the good ol' days, a family could live on one income. The reality is, a family can live on one income today very easily, they just have to live the way people did in the good 'ol days—smaller house, 1 car, no cable and big screen TV, more eating at home, etc, etc. I think we’ve become a bit spoiled and don’t realize that many of today’s modern ‘necessities’ aren’t really necessities and weren’t available at any price in the good ‘ol days. Bottom line, the middle class is fine, our problems are due to unrealistic expectations.

National Debt

Up to this point, I’ve discussed problems that aren’t nearly as bad as we think, problems we’ve done to ourselves, and problems that aren’t really problems.

Our national debt is a real problem. We spend (and have spent) much more than we take in from taxes. We’ve loaded ourselves up a bottomless pit of publicly funded obligations (Social Security, Medicare, and Medicaid) that we don’t manage very well. With our new government healthcare plan, we’re loading on more.

At a high level, the solution boils down to cutting spending and/or raising taxes. Take a look at government expenditures over time, and you won't see a track record of cutting spending. Washington's track record does include raising taxes or putting things off for someone else to deal with later. Are we under-taxing or over-spending? If one of these is out-of-whack, the forward projections clearly say it's on the spending side.

Our top priority should be developing and implementing a long term plan (10+ years maybe more) to address our national debt problem. If we can do that, lots of other economic issues will get fixed in the process. I'm not confident that our leaders are courageous enough to lead and do what's needed. Leadership sometimes means taking a difficult stand to do the right thing in the face of large opposition. To placate voters, Washington seems to want to blame someone else for the problem, but take no meaningful steps toward resolution.

If we continue to do nothing, our finances will erode to the point where we’ll have a very damaging financial crisis. Evidently, when debating the recent Greek bailout, a high ranking German official was heard to say, ‘Maybe the Greeks should sell the Parthenon.’ Let's hope in the future we don’t hear, ‘Maybe the Americans should sell Mt Rushmore.’

Bottom line, our national debt is a problem, we’re all to blame, and we're in serious need of courageous leadership to address it.

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