Economy

The Cost of Overpaying: How High CEO Salaries and Income Disparity Affect Our Wealth, Health and Happiness

Author Eduardo Porter discusses the costs of overpaying CEOs and athletes, as well as the price of happiness, work, revulsion and the future.

Hidden beneath the visible price tag of the many accepted ways of life are hidden costs that most do not consider. Sometimes they are societal costs that are harder to calculate. But without accounting for these hidden costs, policymakers and societies frequently accept the status quo. What if we did calculate the true price of everything? That is the work of journalist and author Eduardo Porter. In his new book, the Price of Everything: Solving the Mystery of Why We Pay What We Do, Porter examines the costs of overpaying CEOs and professional athletes as well as the price of happiness, work, revulsion and the future.

Maria Armoudian: What is the true cost of superstars, professional athletes and CEO's salaries? Their salaries have grown exponentially. How much have they grown and how does this affect the rest of us?

Eduardo Porter: The share of income that has gone to the most highly paid in this country has grown exponentially. In 1980 the top 1 percent of Americans, the richest 1 percent of Americans, reaped about 10 percent of the nation's income and by 2008, which is the last figure that I've seen, they were reaping about 21 percent. So their share of the nation's income has more than doubled. This means much less income for anybody else, so it clearly has an impact on all of us, not only because of the large share, but also what this does to the incentives for everybody else.

MA: Let's talk about the incentives. You wrote that capitalism relies on inequality, but when it becomes so grossly disparate, people start to drop out. Talk about that phenomenon.

EP: That's right. Experiments have shown that when the rewards are tilted so heavily to pay the very few, others will assume that there's no chance that they can be up there with the most highly paid and will therefore stop trying. The idea that inequality generates incentives is fairly sound [because when] we want to earn more, we try harder when we know that there is a higher wage at the end of our efforts. But when we think that the higher wages are all captured by the very few, this turns this engine down.

MA: You wrote about two experiments that are important to mention. Describe the one at the University of California about pay and job satisfaction, and the one showing that "winner-take-all" games produced more cheating and less effort.

EP: Yes, people tend to react badly to inequality within their own jobs and labor experience. If you know that the person next to you earns much more than you do for roughly the same sort of work, this will detract from your morale and it clearly has an effect on how people work. The second experiment was a surprising discovery showing that when games are extremely tilted to favor only the very best, it will lead people to cheat. But it sort of makes sense if people feel that they have no chance except if they cheat. But if you tilted the rewards from perfect equality -- in which everybody gets the same no matter how well they do -- to slightly incentivize better performance, in which people get a little bit more if they perform a little bit better, it works fine as an incentive. But once you've tilted this so immensely such that only the very best got most of the rewards, then it totally broke down.

MA: So it seems there's a long-term cost to gross disparity in people's incomes, which is more cheating in societies and I can see potentially more bubbles as a means to beat the systems too.

EP: Yes, we can see this in the economic history of our country. I mean, people might say, "Well look at all the economic growth that we've had even in a period in which inequality has grown tremendously, like the 1980's until now." But if you look at the 30 years before that, when inequality was not rising in the way that it is today -- and inequality at the time, measured as a share of income going to the very top, was roughly stable or even declining a little -- we grew faster at that time than we grew over the past 30 years. So this notion that inequality is necessary for growth because of the incentives it generates to super-perform and invest, is I think, wrong-headed, particularly when you get to the levels of inequality that we have today.

MA: The other related factor with inequality is the issue of happiness. You noted in the book that people are less happy when they have less than their neighbors. So it seems that this disparity also costs us happiness. It creates more unhappiness.

EP: Happiness responds both to absolute levels of income and to relative levels of income. So if you gain just a chunk of money as a surprise you become happier; if your neighbor loses a chunk of money, in a surprising way, you also become happier because there's this relative component to happiness. So this of course leads to what you just pointed out -- that extremely unequal societies [produce more unhappiness]. So even if we have fast-rising average incomes, if this rise is very unequal, at the end of the day, it may not improve our overall happiness, which is something that we've seen in the United States. The U.S. is in this peculiar situation in which our income growth has grown remarkably since World War II and yet our level of happiness as measured by surveys has not followed our income growth.

MA: When you compare the U.S. to other countries, through the World Values Survey, it shows that Denmark is the happiest country in the world, the least happy is Zimbabwe. How do you account for the U.S. in contrast with Denmark and Zimbabwe?

EP: Let me contrast the U.S. with Denmark. Zimbabwe is easy because Zimbabwe is extremely poor and a dysfunctional economy and [an oppressive] regime, and so I'm not surprised that Zimbabweans are unhappy. But Denmark is a much more homogeneous society; it is much more equal; income is distributed much more uniformly. There is not this enormous disparity in income as it is in the U.S.. That's one of the reasons why Denmark, which has lower income per capita than the U.S., is actually happier. And another reason I'd suggest is also because of what you have to trade to achieve higher income. Higher income does make us happy, but what we put into getting this higher income, which is essentially time, can make us less happy and more unhappy.

So consider the United States, we've grown very wealthy by working more and more. Of the industrial countries, we are the one where working hours have grown the most compared to anybody else in the OECD. Twenty years ago, Japan worked more than we did in terms of hours on average and now, they work less than us. This tends to make us unhappy. If you ask people what makes them happy, well you'll find things like talking to other people -- socializing, being with their families and things like that. But then when you look at what they actually do with their time, they spend very little time doing these things that make them happy and a lot of time doing things that they really don't like at all, like commuting to work.

MA: Do you think that is driven, in part, by the social status that comes with income, rather than merely the desire for more income itself?

EP: I'm sure that plays a role. Income doesn't drive happiness on its own. Money doesn't make us happy, but money allows us better health care, it allows us more leisure opportunities; it's associated with a longer life expectancy, and it's associated with higher education levels. So money improves our choices and objectively improves our lives. There's a great experiment in Mexico where in one town, the government came in and paved the floors in all these homes that had dirt floors, and it cost about $150 per home. One of the results of this experiment was that the happiness, the satisfaction of the life of women, the mothers living in the homes, increased remarkably. Why's that? Well, because their kids weren't getting intestinal diseases all the time, so the health of the family was much better, and this was purchased with $150 per home.

MA: While we're on the subject of happiness, you wrote that happier people are more likely to be married, have more friends, have more sex, and are less likely to divorce. But then you added that right-wingers are happier than left-wingers. Why?

EP: That's a fantastic finding, isn't it? The hypothesis, which to me is entirely plausible, is the fact that they feel less guilty about the inequality in which we live. If you believe that the distribution of resources is fair because it was achieved through your individual effort in a free market and so on, you are less likely to have qualms about why you are in the position that you are, why you are more prosperous than your neighbor, than if you have doubts about the fairness of the distribution of rewards in society.

MA: You also looked at Germany and compared the difference between East and West Germans.

EP: The move from unification of Germany did actually lead to a substantial increase in happiness in the East, and I would argue that this had to do with new political liberties that they did not have before, living in democratic West Germany. But it also had to do with the increase in their economic opportunities and the increase in the income of the East Germans, which were much poorer than the West Germans.

MA: What are the limitations of connecting happiness and money?

EP: For one, we don't really know what happiness is, and the way we measure it is kind of tentative; it's not like measuring a pound or a foot. It's something that you ask people to tell you, and so their subjective level of well-being will be affected by all sorts of things, like whether they woke up happy today, whether there's sun outside and whether their expectations in life are good or bad. Social scientists tend to split them in two: They split out what they call affects, the immediate joy that one can experience from an immediate action one gets in the gut and the more evaluative happiness, which you'd call life satisfaction. This is when you sit down and think of where you are in your life and where you're going and decide whether you like that or not. But still when there are all sorts of contaminations. There was this great experiment in which people who found a dime said they were much happier than people who hadn't found a dime. That's one limitation.

The other one is that there are many other things that lead to happiness. So if we just essentially craft policy only with purpose of maximizing our incomes, we are not going to be paying attention to a bunch of costs that we will be incurring, that will also detract from our well-being. So the example that I gave earlier of the investment of time and devoting so much time to work has reduced people's happiness because it creates stress and so forth and yet we don't measure that if we're considering that the ultimate goal is to increase our wealth, our income. We won't take into account these things that we are paying for a higher income.

MA: And speaking of income, let's talk about the price of work. You traced back to the age of slavery, the end of slavery and servitude. You said that using undocumented immigrant labor is very much like using indentured servants. For example, they're hiding from police; there's no ability to stand for their rights; they're beholden to the employers. What is the price of work?

EP: The institution governing the price of work has had many changes over history. These different labor market institutions from slavery to the unfettered free market of the present are related to changes in the external environment. So we might believe that slavery was once popular and is now illegal because we are now better people that understand that slavery is a bad thing. I suggest that's not really what happened. What really happened was that it became cheaper to employ workers rather than to enslave them. That's probably what changed this institution. Say, look to the early 20th century, in what was probably a great moment for labor in the United States -- a very strong union movement and great policy advances in terms of pensions and health benefits and labor market institutions that protect the rights of laborers. That also happened in the context in which American corporations were more protected in their [isolated] markets and therefore had some sort of monopolistic or oligarchic rents. With globalization, the world has become much more competitive for American firms, where firms are able to move to source labor pretty much anywhere, it has been much harder for workers and unions to protect the rights that workers had acquired earlier.

MA: How do you explain the phenomenon of wealthy people hiring immigrant labor as housekeepers or landscapers and then donating to politicians who want to seal the border?

EP: That's an astonishing disconnect. I think this had to do with the fact that people do not think of these two things in the same space of time. When they're hiring the landscaper or the nanny, they're thinking of their own cheap [labor]. When they're contributing to their politician, they're reacting to what they think are "strange, Spanish-speaking, different people" that are walking on their streets. I also think in the past two or three years there's a sense of shock across the U.S. about immigration, and the hostility that you saw popping up has to do with the fact that immigrant workers had come closer to communities where they've never been seen before. They were drawn by the housing boom when there was a lot of construction work available. That brought immigrants closer to a bunch of Americans who'd never seen them before, so people were just reacting to newcomers, without realizing that they were here because we were hiring them.

MA: What is the cost of the Citizens United decision? You wrote in an op-ed that the cost of the vote has gone up. You cited the Center for Responsive Politics and wrote that candidates and their friends spent a little over $2.8 billion to get some 86 million votes and that the total spending will hit $4 billion.

EP: The cost of the vote has indeed gone up. I can't remember the exact number of that. What I find interesting about this is how do we spend this amount of money to gain political power and yet feel comfortable about our democracy?

MA: So is it costing us democracy?

EP: It's a direct purchase of political power that is not that unlike what we did in the 19th century for the ads in the newspapers that put a price, like $25 for a vote. It's different in form. I think the spending right now is probably less efficient. Part of it is paying to sway people who are already convinced of your position, paying for votes that you already had. But the purpose and effect of this spending is the same, which is to sway people to vote, not in their own interests, but in the interests of whoever is spending the money.

There is this great work by Princeton social scientist Larry Bartels, who supports this view. One of his findings is that one of the correlates for an incumbent party staying in power is how well the richest did during the incumbent's term. And the explanation was, if the rich did very well, they will therefore pay for all the advertisements so that this particular government stays in place. This mechanism is stronger than any other and correlates better than employment growth. So if the rich do really well, even if employment overall doesn't do that very well, the chances of an incumbent getting reelected are high. If employment does really well, but the rich don't do very well, the chances of reelection of an incumbent are lower. I found that to be pretty strong confirmation of this notion that money in this country buys political power, not that unlike the way it did 100 years ago.

MA: You wrote that we've mispriced nature and energy. What does this mispricing do to our future?

EP: Clearly, we're using too much energy. The direct impact of not incorporating the cost of the carbon that's emitted by burning fossil fuels into the fossil fuels' price means that we're just consuming too much of it. It's not unlike what happened to the bison. When bison were free on the American plains, we just hunted them until virtual extinction. So something similar is happening with fossil fuels, we're burning too much and [because of this mispricing], we're not investing sufficiently in alternative technologies. That carbon is escalating in the atmosphere; the earth is warming, and this will have enormous economic consequences down the road. We still have not come to a point where, as a society, we're willing to pay for this carbon that we're putting in the air. I think eventually we will get to a point where we realize that we have to pay for this in order to save the future but we're not there yet.

Maria Armoudian is a fellow at the Center for International Studies at USC and host of the Scholars' Circle and the Insighters, heard on KPFK & WPRR.
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