Losing Argument

James K. Glassman from the February 1996 issue

(Page 2 of 2)

But what about business? The authors cite statistics that compare the pay of CEOs with that of other workers. They trot out the famous "estimates" (their word) of compensation consultant Graef Crystal, who reports that while the typical head of a large American corporation earned about 35 times the pay of an average manufacturing worker in 1974, today the ratio is about 120-1.

But how much of that change comes from the fact that the corporations they run are larger, or that the productivity of the CEOs themselves has improved at a faster rate than the productivity of manufacturing workers? Does the phenomenon pervade second-tier corporations as well, or is it isolated? And, as with sports and movie stars, how much of the change merely reflects the appropriate play of market forces that were previously suppressed? Frank and Cook concede that "there has been a dramatic increase in the extent to which American firms compete with one another for the services of executive talent." For one thing, they're hiring CEOs from a broader pool, rather than promoting from within, and they're tying their compensation to stock performance, an idea that has been long overdue.

Since they have no definitive data, Frank and Cook take a kitchen-sink approach to their subject. They throw in everything they can get their hands on. For example, here is one of their explanations for how winner-take-all markets arise: "The demand for a front-rank product or service may also stem from a desire to avoid regret over possible adverse outcomes attributable to having bought less than the best." In other words, a producer may hire Robert Redford because, if the picture flops, he'll be able to avoid kicking himself for not hiring Robert Redford. He won't have to say, "Damn! If only I had hired Redford, it might have been a hit." But it seems just as likely that the producer of the flop would be glad he did not hire a pricey star: "Whew! It's a good thing I didn't hire Redford. I would have lost $40 million on that picture instead of $30 million."

At times, The Winner-Take-All Society has the feeling of an exam paper in an introductory economics course, with the students trying to impress the professor with every fact and concept they'd learned during the year. Thus, making cameo appearances are hoary notions like The Prisoner's Dilemma and The Tragedy

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of the Commons and a gratuitous attack on Reaganomics. There are touch-and-go forays into advertising, the Wall Street practice of estimating earnings, overwork, college athletic budgets, body-piercing, and celebrity journalism. While some of these little essays are entertaining, I wish Frank and Cook had devoted more space to convincing readers, through the use of actual numbers, that their winner-take-all thesis has some validity. They should have heeded the words of Lord Kelvin, chiseled in stone over the entrance to the Social Science Building at the University of Chicago: "When you cannot measure it, when you cannot express it in numbers, your knowledge is of a meager and unsatisfactory kind."

But let's be charitable and concede that winner-take-all is a sound concept. The next question is: So what? What's wrong with opera star Kathleen Battle making millions while a member of the chorus makes a few thousand? The main concern of the authors--the crux of their argument, really--is that winner-take-all markets misallocate talent and resources. Not only are such markets inequitable, they're wasteful to the economy as a whole.

Frank and Cook believe that huge winner-take-all payoffs attract "too many contestants," luring productive citizens "into socially unproductive, sometimes even destructive, tasks." In other words, seeing Kathleen Battle making so much money, a woman who might study to become a biology teacher instead devotes years to improving her voice--only to find that, as the world's 200th best soprano, she can't make a decent living. By then, it's too late for her to become a biology teacher, and society and the economy lose out.

The only evidence the authors offer as proof of this "overcrowding" thesis is the observable "human frailty" that we can see in lotteries and other forms of gambling, "namely, our tendency to overestimate our chances of winning." (Cook is the author of a book called Selling Hope: State Lotteries in America.) But gambling, for most Americans, is harmless entertainment. We take our occupational choices far more seriously. How long does it take to realize that you're not going to become a great soprano or a pro basketball star? How much talent is truly wasted? My guess is, not much--certainly not enough to have an adverse effect on the efficiency of the U.S. economy.

Also, can't the lure of a huge payoff have a good effect? As more contestants enter the race for stardom, competition increases, and those who emerge as best are better than they would have been in a less-crowded field.

The authors argue that non-winners are essentially losers. They get nothing, or next to nothing, or, at best, they get less than they would have gotten if they had gone into other careers. Again, society is said to lose. But is this true? A chief operating officer or chief financial officer who loses the race for CEO is still well-paid--and, more important, the lure of the CEO's job (and compensation) continues to inspire those lower-level executives to try harder. In fact, there's a good case to be made that, even if a $10 million salary is an overpayment to the CEO (he would be just as satisfied with, say, $5 million), it is a spur to dozens of executives lower on the ladder, who otherwise wouldn't work so hard. Thus, in the end, it is economically beneficial.

Now, let's make two concessions: that winner-take-all markets explain inequality and that such markets misallocate talent and resources. The solution Frank and Cook offer is no surprise. They want to take away a chunk of the winners' prizes through more steeply progressive taxes.

They also advocate what they call "positional arms control agreements"--contracts to curb what they see as wasteful competition for winners' prizes. One of their ideas is a national policy to "encourage people to work fewer hours." For example, "the number of official national holidays could be increased." (It's hard to see winners taking those days off. Would the authors jail them if they didn't?) "If people worked a little less," write Frank and Cook, "they would have to be paid a little less as well. But if everyone were paid less, then people would also need less to meet their obligations."

But positional arms control agreements also deter peak performance. Imagine such an agreement in a professional golf match. Four top golfers are asked to play a round in which a single winner can earn $400,000 and three losers nothing at all (like the TV Skins Game). Now imagine that the four golfers make a secret pact before the match to split the total prize money four ways, with each receiving $100,000, no matter how the actual competition turns out. Would such an agreement lead to a better performance, or a worse one? The answer, it seems, is obvious.

Having started with a compelling idea, Frank and Cook end, inevitably, with social engineering that's both oppressive and trivial. What they've forgotten is that an economy that's structured (or, better yet, unstructured) to achieve high levels of individual performance benefits practically everyone. For one thing, winner-take-all systems (or plain old unfettered capitalism) bring us, at low cost, the aesthetic pleasure of watching Mary Lou Retton and listening to Kathleen Battle. That's a pretty good payoff.