Campaign 2012: Income stagnation & Mitt Romney’s crocodile tears

November 5th, 2012

WeilDavidThe following opinion piece was written by David Weil, professor of markets, public policy and law at Boston University’s School of Management.

When Mitt Romney discusses the stagnation of income for the American middle class, he lays the blame at the feet of President Obama. It is particularly ironic hearing the former governor citing income stagnation as evidence of the failure of the Obama administration, when, in fact, that decline reflects an economic transformation compelled by private equity companies like Bain Capital and other financial institutions over the past quarter century.

Undoubtedly, Romney is well aware that flattening of household income growth for most Americans started not only years, but decades before Obama took office. Median household income was about $49,000 in 2010, a mere 11% above where it was in 1980 in real terms. Real wages for the median worker grew by only 6% over the same period, with workers at the lower rungs of the wage distribution actually experiencing declines.

Economists cite globalization, technology change and their impact on skilled and unskilled workers as major factors behind stagnating incomes. They also cite changes in compensation policies that saw the ratio of average pay of business executives relative to average production workers balloon from 37 in 1979 to 277 just before the Great Recession. But they don’t explain the actual mechanisms by which those trends have come to pass.

With the flow of huge amounts of capital into financial markets in the 1980s and the emergence of private equity as a player in corporate decision-making, public and private companies came under increasing pressure to define the “value proposition” (i.e., improve profits) for investors. Focusing on “core competencies” — activities that define a business in the minds of customers and create market value for investors — became the mantra. For many businesses, core competencies are things like company brand, service delivery, and product innovation (think “customer experiences” in Marriott hotels or the design of cool products by Apple).

The flip side was a drive to shed activities that did not contribute directly to core competencies. Rather than pay employees inside the company, cast off those tasks to businesses outside of corporate walls. Early examples included payroll, human resource, and information technology functions. But soon after came janitorial, landscaping, and security services.

But it didn’t end there.  Large companies who once hired a wide array of workers dumped the employment (and coincidental health, benefit costs and liability for things like safety) of workers engaged in “core” activities:  hotel companies developed their brands but franchised out the properties that carried their name.  Those franchised hotel owners farmed out running the business to management companies, who, in turn increasingly hired labor brokers and subcontractors to hire cleaning staff, landscapers, and sometimes even the people at the front desk.  Though the work still involved the same tasks, stresses, and skill requirements, contracted workers were paid much less and seldom received health care or other benefits.

Companies in other sectors have developed similarly.  Retailers now draw on third-party logistics firms to operate their distribution centers (the core of modern retailing).  Logistics companies, in turn, often use temporary staffing companies to do the work.  Major telecommunication carriers service their vast system of cell towers, central to supporting millions of smartphone users, with multiple levels of subcontractors.

These changes all came alongside better known outsourcing and offshoring efforts, similarly compelled by private equity and capital markets and likewise depressing pay and benefits for those affected by it.

The upshot of this vast change is a shift not only in who does the work, but how and how well people are compensated.  Divorcing employment from the lead corporations has transformed the way that wages are set.  Evidence shows that a janitor or security worker paid as a direct employee to a major company are paid substantially more than those paid as contractors.  So too for the many people now operating outside of the firms for which they provide essential services.  When General Motors paid a janitor in the 1970s, it took into account its compensation of assembly workers.  Now, that janitor works for an outside contractor or franchisee of a service company.  The relevant comparison for GM is the price of the janitorial service relative to another potential supplier.  No wonder pay for the worker doing the actual cleaning has fallen.

If employees have paid the price of this “downsourcing,” who has benefited?  Shareholders and investors, for sure.  In some cases it also has benefited consumers in the form of lower prices, although this varies a great deal across sectors.  But it represents the means by which the often cold sounding forces of “globalization,” “technology,” and “social norms” play out, resulting in stagnation of wages for workers in low- and middle-skilled jobs.

Which brings us back to Mitt Romney.  This all has had little if anything to do with Obama administration policy.  What it flows from is the demanding nature of capital markets and investors, as implemented by the Bain Capitals of the world.  Romney’s concern over stagnating household income comes a little too late and a bit too conveniently, given his own role in unleashing the forces that continue to erode the earnings of so many middle-class voters.

Contact Weil at 617-353-4615; davweil@bu.edu

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