Passing through the eye of a needle.

But I am worth a half million pound bonus

I was talking to an investment banker, Helen, last week.  She was complaining about the attacks on the high paid in the media and politicians.  Yes, she had got paid a bonus of half a million pounds but had made over eight million revenue and had also paid two hundred and sixty thousand pounds of the bonus in tax.

Helen told me she had three degrees, spoke four foreign languages and was taking additional FSA exams in her limited spare time. She worked, about; sixty hours a week, seldom took holiday and had no time for relationships.  Helen told me that she was only as good as her last deal and that she was effectively performance managed on an hourly basis as she traded her book of derivatives.

This set me to thinking about who were the high earners and why did they get paid large amounts.  I was surprised at the answers.  High pay is partly a function of a highly segregated labour market but mostly a function of the family and social environment in to which we were born.  So the solution to income inequality is not to further tax or attack the high paid; but to give our children the ability and skills to enter and be successful in the segmented labour market.

Do you know someone high paid?

The UK Government considers that if you earn a hundred and fifty thousand pounds a year or more you are in the top 1% of tax payers.  In the UK those 1% take about fourteen per cent of all income (http://cep.lse.ac.uk/conference_papers/04_11_2011/TopPayUK_slides.pdf)  and pay about 27%  of all income tax. (http://www.bbc.co.uk/news/magazine-15822595).  So who are these high earners?  Well, a list by the Guardian (http://www.guardian.co.uk/money/2010/dec/18/uks-best-paid-jobs) suggest the following jobs are high paid:

  • Heads of large organisations
  • GP’s
  • Aircraft Pilots
  • Senior Government officials
  • Dentists
  • Lawyers
  • Air Traffic Controllers
  • City Brokers

So if you know someone in one of these jobs it is quite likely that they are one of the 1%.

 

 

 

But I am talking of real money:

These people perhaps do a bit better in the earnings stakes than you and me:

Name

Estimated Earnings

David Beckham £40 million per year
Frank Lampard £14 million per year
Michael Schumaker $31 million per year
Tiger Woods $90 million per year
Stephen Spelberg $107 million per year
Jonathan Ross £6 million per year
James Patterson (writer) $84 million per year

Table one – The really high paid, source Forbes

Are the high paid different to you and me in some way?

It depends how you are looking at these groups.  What is clear is that they operate in particular segments of the labour market.  We all work in a segment of the labour market, be in the South-east, the Midlands, as a manual worker, a white collar worker, a dentist, a politician, but the high paid tend to work in a particular niche.

It is possible to argue that the labour market segments of high–paid occupations tend to have some very specific characteristics.  These are both explicit, in terms of entry requirements, continuing education and training, and (arguably more importantly) implicit requirements in terms of “knowing how things are done around here”.   These factors get you on the bottom rung of the ladder of a high paid profession.

The other reason why some people are high paid is because of something called “Tournament theory”.  A Forbes magazine article by Tim Harford summed it up quite nicely like this;

“The ugly truth is that your boss is probably overpaid–and it’s for your benefit, not his. Why? It might be because he isn’t being paid for the work he does but, rather, to inspire you. In other words, we work our socks off in underpaying jobs in the hope that one day we’ll win the rat race and become overpaid fat cats ourselves. Economists call this “tournament theory”

http://www.forbes.com/2006/05/20/executive-compensation-tournament_cx_th_06work_0523pay.html

 

How do I get in to a high paid profession?

These are the common factors high paid occupations tend to have:

  • Explicit knowledge
    • A high level of a particular skill
    • A long training period  often involving a period of internship, training or practice on very low pay
    • The passing of some form of professional or skill hurdle For example, examinations, or some form of competitive elimination that excludes a lot of people trying to enter that profession or trade.  The “X” Factor or Professional football are good examples of competitive elimination.
    • Implicit knowledge- the unwritten rules of the particular labour market segment, “the way we do things around here”.
    • You also need high levels of non-cognitive skills such as self-discipline, leadership, self-awareness and self-control.  The Institute of Fiscal Studies argues that there is clear evidence that such non-cognitive skills are highly valued in the labour market.  (http://www.ifs.org.uk/publications/5541)   They also present evidence that the higher the occupational group your parents belong to the more likely you are to have high levels of these skills.  This point is also one of the major themes of David Brooke’s excellent book “The Social Animal” (http://www.amazon.co.uk/Social-Animal-Story-Success-Happens), and the major source of inspiration for this blog

So how do you and I get these knowledge sets?  The primary answer is social networks.  The family we were brought up in.  The school and university we went to.  We have to have knowledge that these professions and jobs exist and the points of entry.

If one of our parents or members of our family work, say, as medical consultants we already have a head start in knowing both the explicit and implicit requirements of that profession.  In terms of the importance of which school we attend, we only have to look at the current UK cabinet, all ex-Etonians, with the exception of the token northerner.

It is very likely if we belong to one of these families we will know both consciously and unconsciously how to behave and have a value set that is resonant with that required to be successful in a high paid role.

Having the right family or school connections also helps us jump another entry hurdle.  Having the right contacts makes obtaining internships very much easier.  These internships, perhaps in medicine, insurance, PR or politics are a key entry point to the professions for our children.

What do we need to do to deal with income inequality?

There are two answers to this question.  The first is that we do nothing.  The labour market works in so far as it ensures we have the right number of people doing the right jobs for the right pay.  After all, we would want to ensure that the medical consultant treating us was as qualified and experienced as possible; or the barrister representing us in Court was as competent as possible.

While acknowledging that the labour market is not perfect, it is a market.  The more supply there is the lower the cost falls.  That is why some professions such as medicine and law create barriers to entry and promotion, to preserve earnings of those at the top.

When I worked in investment banking it was hard to get properly qualified, motivated people with the right explicit and implicit knowledge to be successful investment bankers.  It is not an easy job and the demand is greater than the supply.  Thus earnings will remain high.  A good trader can make millions every year for her employer.  Few professions can make that claim.  Thus, there is reward for those who have the appropriate implicit and explicit knowledge.

The second reason for not doing anything about income inequality is a return to “Tournament theory”.  To reach the top of many professions take years of education, training and sacrifice.  Very few people would undertake this hard work and sacrifice unless they thought there was a pot of gold at the end of the rainbow.  The legal partnership, the medical consultant role, the Chief Executive position and so on.

If we go back to Helen, how many people would be willing to work sixty hours a week for fifty-one weeks of the year, have no time for friends, family or relationships.  To have their work performance measured by the hour in a highly transparent way without the high rewards that go with that sacrifice?

The other answer to “resolve” income inequality is one that politicians dislike.  It is because we need to start the intervention in early childhood, or even better, in terms of parenting.  The politicians do not like this answer because it can take decades for this approach to work.  But we know that all the attempts by those in political power have failed:

“Social mobility of young people ‘being held back by government policy’

Cuts to education, benefits and pensions likely to lead to deeper inequalities in the future, says leading social policy think tank”  (http://www.guardian.co.uk/society/2011/nov/01/social-mobility-held-back-government).

I again quote from David Brooks “The Social Animal”

“As Nobel Prize-winning economist James J. Heckman had found 50 per-cent of lifetime-earnings inequality is determined by factors present in the life of a person by age eighteen.  Many of these differences have to do with unconscious skills – that is, attitudes, perceptions and norms.  The gaps in them open up fast.”

These types of finding are anathema to many politicians and liberal thinkers.  It indicates that there is one way to bring up our children that gives them a much better chance of doing well, at least economically, in the great race of life.

What does not work?

Increasing taxation on the high paid will not resolve issues of inequality.  As Manual Castells http://en.wikipedia.org/wiki/Manuel_Castells has argued in his great work on society and networks “The Information Age: Economy, Society and Culture”, place makes very little difference to flows of capital.  The flows of capital will simply transfer to where transactions costs are lowest (accepting a common level of property rights and a robust legal system).  In any case the argument above indicates that the foundations for income inequality are laid in childhood. Income inequality is not resolved by way of a taxation system, no matter how progressive.

The “politics of envy” do not work either.  Attacking and trying to belittle those who are high earners does not decrease income equality.  Also, as noted above the top 1% of earners in the UK pay 27% of all income tax.  Without that contribution, or even reducing that contribution would result in the rest of us having to pay much higher levels of income tax or face very deep cuts in social expenditure, the very thing that could make the most difference, over the long term, to income inequality.  Returning again to James J Heckman http://www.heckmanequation.org/content/resource/presenting-heckman-equation

“Life cycle skill formation is dynamic in nature.  Skill begets skill: motivation begets motivation.  If a child is not motivated and stimulated to learn and engage early on in life, the more likely it is that when the child becomes an adult, it will fail in social and economic life”

The lesson for reward and performance professionals

The above arguments are very bad news for reward and performance professionals.  There is nothing we can do to reduce income inequality.  The foundations of inequality are laid in childhood and reinforced by Tournament theory.  There is a perverse argument that we should support income inequality to ensure we have people with the right experience and knowledge, to achieve appropriate levels of performance.  That is, it could be argued, the paradox of Compensation Committees, they have to pay on an increasing upward curve, competitive levels of reward otherwise they risk losing their better performing management.

What we can do is work with our talent management colleagues, with politicians and the education sector to emphasise the importance not just of formal education, but on our children having the appropriate levels of social and non-cognitive skills such as self-control and discipline before they enter the labour market; a herculean task indeed.  Only then, when we open up the high paid segments, can our profession hope to advance the worthy cause of reducing income inequality.

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