Mike Konczal, one of the most important new voices to have emerged during the financial crisis, offers an extended riff on 13 Bankers that ranges across many different subjects. I was particularly intrigued by his thoughts on how the internal logic of the financial sector has shaped the broader economy.
Think of the work experience of a Wall Street analyst. (Here the ethnography work of Karen Ho, particularly her book Liquidated, is useful.) It’s a form of labor with a strictly quantitatively graded measurement system, “rank-and-yank” style of rapid promotions, and massive turnover and layoffs. This rampant job insecurity is made coherent through strict market identification, with a special emphasis on working for power, prestige and most of all, cash. It’s a job where being “smart” and “working hard” are the primary values that override any other concerns. It is fiercely hierarchical, centered around a pernicious form of meritocratic elitism. The “superstar” contract generates inequality, uncertainty and anxiety but also ruthless internal competition and an adversarial relationship with clients and co-workers.
And it is a labor experience that is being propagated into the real economy. Ho’s point is that this employment habitus structures how these analysts both study, but also then create, expectations of the corporate and real economy. So as the financial sector advises the real economy through a network of consultancy and analysts, it projects its own labor experiences onto its subjects. This experience of labor colonization brings a superstar work ethic to places it did not formerly exist, and emphasizes cash as the primary goal of work instead of the myriad of dense virtues that come with a job well done.
This raises a number of important and difficult questions. In Categorically Unequal, Princeton sociologist Douglas Massey argues that the employment verification system in the IRCA changed the low-wage labor market by encouraging the emergence of employment intermediaries — basically, new organizations emerged to take on the legal liabilities that traditional employers would rather not take on. According to Massey, this put pressure on the wages of less-skilled workers, though I doubt he’d argue that this was the main source of pressure.
In a similar vein, Mike is suggested that tournament-style compensation has spread from the financial sector through the broader economy. While I’m sure that there is some truth to this, my guess is that there are many other factors involved. In 2007, Thomas Lemieux, W. Bentley MacLeod, and Daniel Parent wrote a paper “Performance Pay and Wage Inequality,” subsequently published in 2009 in the QJE. Here is the abstract:
We document that an increasing fraction of jobs in the U.S. labor market explicitly pay workers for their performance using bonuses, commissions, or piece-rates. We find that compensation in performance-pay jobs is more closely tied to both observed (by the econometrician) and unobserved productive characteristics of workers. Moreover, the growing incidence of performance-pay can explain 24 percent of the growth in the variance of male wages between the late 1970s and the early 1990s, and accounts for nearly all of the top-end growth in wage dispersion(above the 80th percentile).
My guess is that the financial sector accounts for much of this growth in wage dispersion at the top-end. But note that bonuses, commissions, and piece-rates are used throughout the economy, and indeed had been fairly common in the service sector long before the financialization of the U.S. economy took off. The reason these forms of compensation proved successful is that, in the so-called “war for talent,” they proved a powerful inducement for highly-productive and potentially footloose workers to stay on the team.
As advanced economies have shifted from manufacturing, and in particular forms of manufacturing that involve repetitive tasks, to highly complex services, it hardly seems surprising that we’d see more room for performance pay. The productivity gap between one employee and another matters more. Moreover, the rise of bonuses had another happy consequence. In his 1984 book The Share Economy, Harvard economist Marvin Weitzman called for heavier reliance on bonuses (gain-sharing or contingent compensation schemes) on the grounds that it might smooth out the boom-bust cycle: bonuses would allow firms to lower costs without shedding workers.
So yes, performance pay increases inequality, almost by definition. But has it had zero positive impact on productivity? That seems highly unlikely. It could be that the collective embrace of compensation systems based on ruthless internal competition is simply a form of collective madness, one that an innovative firm can’t break from despite the vast rewards it would reap on the other end. Another possibility is that it works reasonably well.
I should note, however, that I do think corporate governance deserves some scrutiny. One of my colleagues at Economics 21 recently wrote a splendid blog post on how the shift from the partnership model shaped the behavior of the big investment banks.
A few decades ago, all of the major investment banks – like most law and consulting firms still are today – were limited liability partnerships. When the partners’ own capital was at risk, they exercised strict control over the risk, compensation, and underwriting at their firms. Just as home borrowers traditionally placed a down payment to ensure that they had “skin in the game”; similar requirements from the owners of banks encouraged prudential corporate governance.
All of this changed as investment banks gradually went public over the last few decades. The boards of directors that assumed managerial control over investment banks performed abysmally in their role. Few members had the time or background to understand the complex financial trades companies like Lehman Brothers or Bear Stearns were making, and they frequently deferred to the wishes of the CEO. Profits, after all, were soaring – at one point the financial sector contributed over 40% of corporate earnings. Shareholders were too small and diffuse to exercise meaningful control; and those who were concerned about risk were content to short company stock. The financial collapse of most investment banks in 2008 can be seen as a crisis in internal corporate governance at least at the level of Enron or Worldcom.
I’m definitely not an expert on these matters, but this strikes me as a more persuasive story than the notion that pay-for-performance is a pernicious delusion rather than a genuine productivity-enhancing measure, for all the emotional distress it undoubtedly causes.