Michael Jacobs

Michael Jacobs is Director of the IPPR Commission on Economic Justice, whose final report, Prosperity and Justice: A Plan for the New Economy, was published in September.

September 28, 2018

Economists don’t have much time for the concept of power. It’s too non-quantifiable. It can’t be written in equations. It’s hard to model. But it may be the best way of understanding today’s economy.

Executive pay is a good place to start. Thirty years ago, a FTSE 100 chief executive earned on average 20 times the salary of an average worker in his company (and it always was a him). Today the figure is 129 times. (And it’s still almost always a him.) A conventional economist would want to understand this in terms of the marginal productivity of chief executives relative to the marginal productivity of workers, and of the supply and demand of top talent.

But these explanations simply don’t fit the evidence. Measured by profits or share prices, corporate performance on average has not improved by anything like the increase in executive pay, whose rise has had no relationship to the movements of stock markets. And there is no evidence at all that such pay results from a scarcity of talent – many of those who have cleaned up over the last three decades have exhibited mediocre performance (which is why they tend to stay in post such a short time) and there is no let-up in the conveyor belt of directors waiting to replace them.

Further reading
When it comes to corporate pay, who scrutinises the scrutinisers?

By Charlotte Pickles

A much more plausible explanation for the rise in top pay is the structure of corporate governance. The remuneration committees which decide pay packages are made up almost entirely of other directors. This creates a self-serving system in which one group of directors pays another exorbitant salaries, and these then act as the ‘competitive benchmark’ for the next round. In other words, it is the power of directors as a group to set their own salaries that determines their level and growth.

Classical economics had a name for this. It was ‘rent extraction’: the appropriation of value in excess of that required to reward effort. But it was one of the ideas that disappeared when the neoclassical school – focused on marginal analysis and competitive markets in equilibrium – came to dominate the discipline. Which was rather convenient for those who took the rents.

Rent extraction derived from excessive power is most clearly seen today in the financial sector. One of the most extraordinary economic facts of recent decades has been the persistently high costs of financial services. As Thomas Philippon and Guillaume Barzot have shown, the cost of financial intermediation – what the financial sector charges the rest of the economy for its services – has barely changed over the last fifty years. Yet in that same period the productivity of these services has been transformed out of all recognition by new technologies, and the sector has become much larger.

These increased competitive pressures should have led costs to fall, as companies passed on productivity gains to their customers. What has happened instead is that the financial sector has managed to appropriate these gains for itself, resulting in consistently higher profit rates for financial firms than for the economy as a whole.

Further reading
Nomi Prins: The central banking heist has put the world at risk

By Liam Halligan

This is hard to explain in conventional economic terms, but easy in terms of power. One need only look at the money spent on political lobbying by the financial sector, and the weak regulation which has been applied to it by governments, to understand why it has been able to reward itself so handsomely.

In the digital sector too, it is power that we should be focusing on. Because while the orthodox concept of monopoly seems to apply – Google has approximately 70% of the global search engine market, Amazon has a market share across some product categories in excess of 80%, Facebook has over two billion active users globally – the term is not actually helpful.

In conventional economic analysis, monopoly should lead to higher prices. But that is not what has happened in the digital field at all – on the contrary, many of their services are offered for free, and where they do charge (such as for advertising) their prices have not risen as their monopoly position has been consolidated.

Further reading
It's time to rein in the reckless monopolies

By Ann Pettifor

Yet we should still be worried, because while the business strategy of these companies is not to maximise profits, it is to dominate markets. And not just their own markets, but the markets which will determine the shape of the future economy: digital infrastructure on the one hand, and artificial intelligence on the other. As a recent IPPR report argued, it is scale that gives these companies access to the key resource of the modern economy, data, and the ability to extract from that data the maximum value.

And just as there are serious economic implications from a financial sector chasing ever larger profits – not least the lost productivity, profits and earnings of the non-financial economy – there are serious economic implications from this extreme market power. Firstly, we need technological innovation to be as widely spread as possible, in markets that are as competitive as possible, in order to maximise its value to the economy and society.

Second, this concentration of market power is also concentrating wealth. The tech titans behind these behemoths have become fantastically wealthy as a result of their dominance. This is one of the reasons for widening wealth inequality over the last decade, and likely to be a critical cause of it over the next. Jeff Bezos, for example, is now the world’s richest man. Meanwhile the workers in Amazon warehouses are paid the minimum wage and monitored on their toilet breaks.

Further reading
Could trade unions rescue capitalism?

By Joe Dromey

Which takes us to another power relationship at work in the economy. One of the puzzles of the UK economy of the last decade is how we have managed to achieve near-full-employment at the same time as average wages have stagnated. Economists have been scratching their heads: scarcity of labour should have bid up wages. But understanding the labour market in terms of power makes it entirely explicable. The reason that average wages have been held down is that workers no longer have enough bargaining power to force them upwards.

Once upon a time, wages were determined principally by collective bargaining, in which trade unions in major companies set wage levels in negotiation with employers, and these then set the benchmark for wages in the rest of the economy. Trade unions had the power to do this because the major companies had large workforces in which it was easy to organise, and easy to threaten industrial action.

Today most of this has disappeared. As manufacturing has declined, large companies with unionised workforces have become rare. Companies have fragmented their operations into smaller sub-contracting units, making collective bargaining more difficult. In turn firms have increasingly fragmented their workforces, employing a smaller core of higher paid workers and a larger periphery of ‘self-employed’ and gig workers.

Unsurprisingly, trade union membership in the private sector has fallen precipitously, and collective bargaining with it. Few workers now feel secure enough to bargain for higher wages. The balance of power, in other words, has decisively shifted in favour of management and against workers.

Further reading
Without new foundations, capitalism will collapse

By Charlotte Pickles

Analysing the economy in terms of power – in these and other fields – does not mean abandoning conventional economic analysis. But as the recent report of the IPPR Commission on Economic Justice argues, it does mean thinking about how power can be rebalanced.

Reining in executive pay will best be achieved by changing the structure of remuneration committees – including by putting workers on them, as Labour have pledged to do – and outlawing bogus ‘incentive’ schemes which tie pay to short-term share prices. Tackling rent extraction in financial markets means resisting the lobbying power of the financial sector and regulating its profits down to reduce the costs of finance to the rest of the economy.

Curbing the market power of the digital companies will require regulatory oversight similar to that of other utilities, and preventing them from further vertical and horizontal expansion. And recoupling wage growth to economic growth means giving trade unions greater access to workforces, making it easier for workers to join unions (for example through auto-enrolment, on the model of opt-out workplace pensions), and restoring collective bargaining in low-wage sectors.

With people losing faith in capitalism and polls consistently showing public support for tackling the excesses of big business, this power-focused agenda should be of interest to both Left and Right. And encouragingly, while those on the Right have historically been like economists, uncomfortable with talking about power, that is changing. For many on both sides of the political divide, it is now impossible to imagine a competitive economy, a wider distribution of wealth and a meritocratic society without thinking about how power can be rebalanced. A consensus is forming, and it might just lead to an economy that combines justice with prosperity.