The Profit-Sharing Economy

Laura Tyson

JUL 31, 2015

extreme wealth

BERKELEY – Over the last 35 years, real wages in the United States failed to keep pace with productivity gains; for the typical non-farm worker, the latter grew twice as fast as the former.
Instead, an increasing share of the gains went to a tiny fraction of workers at the very top – typically high-level managers and CEOs – and to shareholders and other capital owners. In fact, while real wages fell by about 6% for the bottom 10% of the income distribution and grew by a paltry 5-6% for the median worker, they soared by more than 150% for the top 1%. How can this troubling trend be ameliorated?
One potential solution is broad-based profit-sharing programs. Together with job training and opportunities for workers to participate in problem-solving and decision-making, such programs have been shown to foster employee engagement and loyalty, reduce turnover, and boost productivity and profitability.
Profit sharing also benefits workers. Indeed, workers in companies with inclusive profit-sharing and employee-ownership programs typically receive significantly higher wages than workers in comparable companies without such arrangements. About half of Fortune’s list of the 100 best companies to work for have some kind of profit-sharing or stock-ownership program that extends beyond executives to include regular workers.
Despite the demonstrated benefits of broad-based profit-sharing programs, only about one-third of US private-sector workers participate in them, and about 20% own stock in their companies. If these programs work so well, why are they not more widespread?
First, executives for whom shared profits already account for a significant portion of income may resist programs that distribute profits to more workers, fearing that their own income would decline.
Even when such programs increase overall profitability, they could reduce the profits going to top management and shareholders.
Second, workers are concerned that profit-sharing may come at the expense of wages, with the substitution of uncertain profits for certain wages resulting in lower overall compensation. Effective profit-sharing schemes must be structured to prevent this outcome, and strong collective bargaining rights can help provide the necessary safeguards.
Third, if inclusive profit-sharing programs are to have the desired effect on productivity, they should be combined with other initiatives to empower workers. One way to achieve this is by establishing “works councils,” elected groups of employees with rights to information and consultation, including on working conditions.
Works councils and strong collective bargaining rights, both features of high-productivity workplaces, are common in developed economies. But they are lacking in the US, where federal law makes it difficult for companies to establish works councils and prohibits negotiations between employers and employees over working conditions outside of collective bargaining, even though most workers lack collective bargaining rights. Promisingly, the United Automobile Workers union recently announced that, as it continues to push for collective bargaining rights, it is also cooperating with management to form a works council in the German-owned Volkswagen plant in Tennessee.
The fourth impediment to the establishment of profit-sharing programs is that they require a fundamental shift in corporate culture. Though most companies emphasize the importance of their human capital, top executives and shareholders still tend to view labor primarily as a cost driver, rather than a revenue driver – a view embedded in traditional and costly-to-change human-resources practices.
Unlike the financial benefits of reducing labor costs, the financial benefits of profit sharing, realized gradually through greater employee engagement and reduced turnover, are difficult to measure, uncertain, and unlikely to have an immediate effect on earnings per share, a major determinant of executive compensation. It is unsurprising, therefore, that the advantages of profit-sharing are undervalued by many companies, especially those that focus on short-term success metrics.
Moreover, even when they do recognize the advantages of profit sharing, companies may lack the technical knowledge needed to design a program that suits their needs. Some states have established technical-assistance offices primarily to help small and medium-size companies overcome this gap.
The federal government should create its own technical-assistance program to build on states’ efforts and reach a larger number of companies.
From a policy perspective, much more can be done to encourage firms to create broad-based profit-sharing arrangements. Current US law allows businesses to deduct from their taxable income the wages of all employees, except the top five executives, for whom deductions are limited to $1 million of annual pay, unless the excess compensation is “performance-related.”
Spurred partly by this tax incentive, corporations have shifted top executives’ compensation toward shares, options, and other forms of profit sharing and stock ownership, largely leaving out regular workers.
Some have proposed limiting the tax deduction for performance-based pay to firms with broad-based profit-sharing programs. But, although this approach might encourage profit sharing with more workers, it would continue to provide companies with significant tax breaks for huge compensation packages for top executives.
US presidential candidate Hillary Clinton has a more targeted proposal: a 15% tax credit for profits that companies distribute to workers over two years. By providing temporary tax relief, the scheme would help companies offset the administrative costs of establishing a profit-sharing program. In order to limit costs and prevent abuse, profits totaling more than 10% on top of an employee’s wage would be excluded; the overall amount offered to individual firms would be capped; and safeguards against the substitution of profit sharing for wages, raises, and other benefits would be established.
The tax credit could also foster changes in corporate culture, by spurring board-level discussions not only of the benefits of profit sharing, but also of sharing information and decision-making authority with employees.
The stagnant incomes of the majority of US workers are undermining economic growth on the demand side (by discouraging household consumption) and on the supply side (through adverse effects on educational opportunity, human-capital development, and innovation). It is time to take action to promote stronger and more equitable growth. Clinton’s profit-sharing proposal is a promising step in the right direction.

Markets Insight
August 3, 2015 6:19 am

Why gold has lost its shine for investors

Mohamed El-Erian

Metal has not reacted to events that would usually push up price

The observation that gold has been a disappointing investment of late should come as no surprise to anyone in the investment world. The fact that this has occurred in the context of developments that would normally push gold prices higher is notable. But the most consequential hypothesis of all is that gold may be losing its traditional role in a diversified investment portfolio.

To say that gold has underwhelmed investors the past couple of years is an understatement. It did not participate in the surge upwards in nearly all financial asset prices; and it has not provided protection in the more recent downturn in risk markets.

Throughout this period, gold has not benefited from rock-bottom interest rates that compensated for one of its major disadvantages as a financial holding — namely, that gold holders do not earn any interest or dividend payments. It has also shown an unusual lack of sensitivity to multiple geopolitical shocks, Greek-related concerns about the single European currency, and the massive injection of liquidity by central banks.

The performance of gold has been so dreary as to encourage a growing number of hedge funds to bet against the asset, notwithstanding its price decline of 8 per cent year to date (and 16 per cent over the past 12 months). Indeed, positioning reports point to large shorts.
Several reasons may be advanced to explain these historical anomalies. They suggest that while cyclical factors have played a role, the main drivers are much more structural and secular in nature.

First, investors have found more direct ways to express their views about the future, particularly in a world in which central banks have had such an important influence on asset prices — from the explosion in equity exchange traded funds globally to the deepening of interest rate and credit products.

Second, gold has become a lot less attractive to investors as a result of the lack of meaningful inflationary pressures. It has also suffered from the more general decline in interest in commodities among institutional and retail investors, due in part to slower global growth.

Third, gold faces the growing risk of lower demand from central banks, once deemed reliable core holders. Part of this is driven by the fall in holdings of international reserves by the emerging world, particularly as they try to cope with the impact of lower commodity prices.
Fourth, as historical correlations have broken down, the analytical case for investing in gold has been increasingly challenged. In particular, prices have failed to respond positively to some notable geopolitical shocks, eroding the metal’s attraction as a diversifier and risk mitigator.

Fifth, the main drivers of most asset prices — namely, liquidity injection by central banks and the deployment of some of the large corporate cash holdings via dividends, buybacks and M&A activity — have not spilled over in any meaningful way to gold; neither directly through reallocation of investor funds due to price movements, nor indirectly due to concerns that all this liquidity would fuel inflationary pressures.

Sixth, the size of the demand response induced by the lower prices — from jewellery and other physical uses of gold — is too small to offset the erosion of investor interest.

Finally, there is the price level argument. Before its recent lacklustre performance, the price of gold had surged (for example, at one stage it had risen more than $1,000 per ounce from its November 2008 level of around $700). Thus, it is the earlier price move that could be deemed unusual and excessive.

Assessing the cyclical versus secular/structural balance of these seven factors, it is hard not to conclude that gold may well be experiencing an erosion in its positioning as a core holding in diversified institutional and retail investment portfolios. The more this happens, the more enticing it will be for “fast money” to short the metal as a way of inducing even greater sales by disappointed core holders.

This situation is unlikely to change soon but it need not be terminal. A shift would probably require a broader normalisation of financial markets, including a diminution in the direct and indirect role of central banks in determining asset prices and their correlations. Until that happens, the glittering metal is likely to continue to languish.

Mohamed El-Erian is chief economic adviser to Allianz and chair of President Barack Obama’s Global Development Council

Review & Outlook

The Washington War on Car Dealers

Dodd-Frank’s new consumer bureau sparks a bipartisan backlash.

Aug. 2, 2015 6:00 p.m. ET

                                      Photo: Getty Images

It’s been a tough few days for Washington’s least accountable regulator. First a unanimous federal appeals-court panel allowed a constitutional challenge to the Consumer Financial Protection Bureau. Then the House Financial Services Committee voted last week 47-10 to rein in one of the bureau’s misguided assaults on American business.

The consumer bureau has been waging a proxy war against car dealers by shaking down the banks that provide auto loans, which the dealers then offer to car buyers. The bureau’s political activists don’t like that some borrowers pay higher rates than others, and they believe racial discrimination is the reason.

But lacking hard evidence, they’ve embraced a method of guessing which customers are black and which ones are white based on their last names and addresses. Then the regulators demand settlements from banks and finance companies whenever it looks like the customers the regulators guess are white appear to be getting a better deal than the ones they guess are black.

The goal is to extract cash and get banks to agree to limit dealer discretion in offering different rates.

Under long practice, banks set the terms under which they’re willing to buy a loan. Then the dealer can decide to charge a higher rate to the customer and make additional profit, or perhaps accept no profit on the loan in order to close the sale of a car. The decision depends on what the customer is willing to pay for the car and financing—and how much the dealer wants to move the metal.

But this kind of commercial activity between consenting adults is anathema to the bureau. So in March 2013 it issued a “bulletin” that effectively codified its policy against dealer discretion.

Never mind that the plain language of Dodd-Frank explicitly prohibits the bureau from regulating car dealers.

Since this is the Obama Administration and since the bureau was staffed by Elizabeth Warren before her election to the Senate, the activists who run the place are also less concerned with legal niceties than with sticking it to business. So they skipped normal federal rule-making procedures, including allowing public comment on a draft regulation, before warning auto lenders that allowing dealers to exercise discretion presented “a significant risk” of “pricing disparities on the basis of race” and therefore potential legal violations.

All of this has proven too much even for many House Democrats. “A formal policy change should be done through the rule-making process,” says a spokeswoman for Rep. Ed Perlmutter (D., Colo.), one of 55 Democratic co-sponsors of a bill to nullify the 2013 bureau guidance.

The bill, which is now headed to the House floor, would require the bureau to allow public comment and publish its data and analysis online before issuing new rules on auto financing. It would also require the agency to study the costs of such guidance for consumers as well as for small businesses and other affected enterprises.

All of this ought to be the bare minimum for any Washington regulator, but with the rogue consumer bureau it requires a new act of Congress. Behold the practical damage of Warrenism.

The Government the Eurozone Deserves

Yannos Papantoniou

AUG 3, 2015

Greek flag and EU flag Greek Parliament

ATHENS – Will Greece’s troubles destroy Europe’s currency union, or reveal how it should be saved? The recent controversial bailout deal – likened by some to the 1919 Versailles Treaty, with Greece in the role of Germany – offers the latest twist in the eurozone’s existential saga.

The deal has caused a split in Syriza, Greece’s leftist governing party; opened a rift between Germany’s Chancellor Angela Merkel and her uncompromisingly tough finance minister, Wolfgang Schäuble; and spurred an effort by France to reassert itself within the Franco-German axis that has always been the “motor” of European integration.
Meanwhile, many of North America’s Keynesian economists, such as Nobel laureates Paul Krugman and Joseph Stiglitz, sympathize with Greece’s anti-austerity stance. Other economists, mainly in Europe, argue that Germany must assume a political role befitting its economic preeminence and must accept sovereignty-sharing (and burden-sharing) arrangements to ensure the monetary union’s cohesion and sustainability. Humiliating a small country and rendering it a virtual protectorate does not serve Europe’s long-term interest.
Yet this is what is at stake. Greece signed the deal after facing an explicit invitation from Schäuble to leave the eurozone – supposedly temporarily – and adopt a new currency.
Germany’s stance marked the first open challenge by a leading European power to the notion that the monetary union is irrevocable. As the French, instinctively sympathetic to the anti-austerity argument and conscious of their increasingly junior role in the Franco-German partnership, were quick to notice, the German stance also signaled a potential shift from a “European Germany” to a “German Europe.”
It hardly helped that the negotiations between Greece and its creditors produced a growing mistrust in the competence and intentions of Syriza. Devious and erratic negotiating tactics, coupled with secret schemes to prepare – as part of a “Plan B” – for an exit from the euro, undermined the government’s trustworthiness, leading even Paul Krugman to admit: “I may have overestimated the competence of the Greek government.”
Yet, however complicated the blame game, some lessons can be drawn to guide future policy. When fiscal misbehavior by Greece, a country representing no more than 2% of the eurozone’s GDP, poses serious dangers for the survival of the currency union, something is clearly amiss.
But does the remedy lie in tougher measures – such as heavier penalties or even eviction – to enforce the eurozone’s rules, or do the rules need to be adjusted to accommodate members’ varying circumstances?
So far, enforcement has failed, owing to flaws in the eurozone’s foundations. First, fiscal and external-account balances are to be kept in check in order to ensure financial stability and sustain the common currency. Second, removing imbalances is the responsibility of national governments within the context of a rescue regime arranged by supranational authorities – the European Commission and the European Central Bank – in cooperation with the European Council, which in turn represents national governments.
The Greek saga shows that this system cannot control destabilizing imbalances quickly enough to ward off major crises. Imbalances are not solely the result of irresponsible policies. They may reflect deeper weaknesses in economic structures, such as a lack of competitiveness or institutional shortcomings. If Germany insists on national responsibility, it may find that enforcing the rules will have to be ever harsher, eventually leading to such social and political upheaval that the entire euro-edifice collapses.
The alternative is to embrace a “transfer union” that ensures a better balance between solidarity and responsibility. The United States embodies such a solution, ensuring an integrated pattern of development throughout the country. The eurozone must strengthen its fiscal structures enough to respond to overall economic conditions while taking into account the differing circumstances of each member country. These stronger structures should permit limited resource transfers among eurozone countries, either to carry out countercyclical policy or to supplement investment spending, particularly in economic and social infrastructure.
But this must inevitably involve the creation of a separate eurozone budget, transferring competences from national to supranational authorities. Common taxation and Eurobonds should form part of the new fiscal structure, and the European Stability Mechanism should include a debt redemption fund large enough to resolve sovereign-debt crises. At the same time, the banking union, established by the EU in the wake of the 2007-2008 global financial crisis, should be strengthened by enlarging the capital base of the Single Resolution Fund and establishing a common deposit guarantee scheme.
All of this presupposes that the powers of the EU’s supranational institutions, the European Parliament and the European Commission, will be significantly augmented. The Commission should become a proper government, with a popularly elected president. A European finance ministry should be created, and its head should preside over the Eurogroup (which convenes the finance ministers of eurozone member states). A special Assembly of the European Parliament, comprising the eurozone members, should have powers – on the model of a national parliament – to legislate and control the executive.
These proposals will provoke plenty of criticism – and not just from Euroskeptics. But a move toward fiscal and political integration is the price that Europe – beginning with the eurozone – must pay to maintain its unity and global relevance. The alternative is inconsistent (if not arbitrary) enforcement of the current rules, inducing divisiveness among member states and eventual fragmentation.