There are two phrases that I hear all the time in my work. One is “It can be hard to see the forest for the trees,” and the other is “How did things get to where they are today?” Both reflect the same idea: When you are in the middle of a series of events, it is impossible to get an objective perspective.
A few months ago, I read an article written by Roger Martin in the Harvard Business Review entitled, “The Rise (and Likely Fall) of the Talent Economy.” In the article, Martin looks into how the U.S. economy got to where it is today and draws these conclusions:
- The government needs to intervene and regulate the relationship between hedge funds and pension funds
- There needs to be an overhaul of the tax structure to address:
- the low personal income tax
- the high corporate tax
- that there is no national value-added tax
- Capital needs an incentive to invest in jobs
- Companies are accumulating cash
- The U.S. is in political gridlock and neither party represents labor
- We need a mix of rewards for capital, labor and talent
So what do Martin’s conclusions mean, and how did our economy get to where it is today? Until the 1960s, most companies made money by exploiting natural resources. About the same time, we saw companies emerge that required employees to show creative thinking, independent judgment and decision-making skills. This was described as the Talent Economy. In 1960 this represented 16 percent of all jobs; by 2010 it represented 33 percent. By 2013, more than half of the top 50 companies were talent-based. Places like Google, Apple and Microsoft, for example.
A couple of changes occurred around 1980. The thinking of supply-side economists like Arthur Laffer prevailed and income tax rates went from 70 percent to 28 percent in seven years. An article was published in 1976 by Michael C. Jensen and William H. Meckling that said management’s interests need to be aligned with shareholders, and the way to do that is to get them to think long-term through stock options. Stock options are a grant that is issued to a manager to buy a certain numbers of shares of the company at a future date based on the share’s actual price today.
Hedge funds also play a big role in the current state of our economy. In 1949 there was a resurgence of a practice used by ship captains 2,000 years ago. The concept was called 2 & 20. Essentially captains were paid 20 percent of the value of their cargo once it was successfully delivered along with an overall fee. Alfred Winslow Holmes, the first acknowledged hedge fund manager, applied this principle to create an industry that would later be called private equity. Partners who invested in the firm got 20 percent of the profits known as “carried interest” on top of a 2 percent asset management fee.
This created a small group of very wealthy people. Martin said that, “The top 25 hedge fund managers in 2010 raked in four times the earnings of all the CEOs in the Fortune 500 combined.” That stands in stark contrast to our country’s production and nonsupervisory workers, who represent 67 percent of the nation’s workforce and have seen real wages decline since the 1970s. The last factor to be aware of is that hedge fund managers make money by trading. This has shifted our economy from creating value to trading value. So while the intended result of offering stock options was to align shareholder and management goals and cause appreciation, the result was volatility.
Martin says that the effect of these economic changes is to leave the largest voting block out of the economic equation. And we have seen the public’s reaction in the Occupy Wall Street movement and the We Are the 99 Percent demonstrations.
So what are the solutions? I alluded to some of these in the opening. To avoid the situation that existed in 1935 – the Great Depression – our government must make the following changes:
- Regulate the relationship between hedge funds and pension funds, or stop the collection of both an asset management fee and carried interest. One or the other.
- Tax carried interest as ordinary income. This would promote tax fairness.
- Revisit and revise the tax structure. This can be done by giving capital an incentive to invest in creating more jobs.
- End political deadlock. Neither party is representing labor, and it appears that individuals are going to have to vote issues versus party. Political parties will be less important than electing people committed to compromise.
- Outside of government, top executives, private equity managers and pension funds can modify their behavior to create a better mix of rewards for capital, labor and talent.
This seems to me to be the only way to preserve the talent economy as a way of life, and to reduce the huge disparities between the “haves” and the “have nots.” It seems like the only way for businesses to see greed, volatility and profit-for-profit’s-sake as disincentives. We either create a system that offers opportunity for all, or we disenfranchise the majority of people and wait until their level of dissatisfaction becomes so intolerable that they take action.
EASI•Consult® works with Fortune 500 companies, government agencies, and mid-sized corporations to provide customized Talent Management solutions. EASI Consult’s specialties include individual assessment, online employment testing, survey research, competency modeling, leadership development, executive coaching, 360-degree feedback, online structured interviews, and EEO hiring compliance. The company is a leader in the field of providing accurate information about people through professional assessment. To learn more about EASI Consult, visit www.easiconsult.com, email [email protected].com or call 800.922.EASI.