Myth: The rich get rich because of their merit.

Fact: Researchers have uncovered dozens of social factors that contribute to becoming rich.



Summary

The vast majority of academic studies on who becomes rich have found that intelligence and merit are only a part of the reason -- social factors play a huge role as well. Studies of Fortune 500 companies have found that American executives are seeing exploding pay, but there is no correlation between their pay and a company's profitability. In fact, companies with the greatest inequality of pay suffer worse product quality. And many studies have found that societies with the greatest equality generally enjoy the fastest rates of economic growth.



Argument

Many conservatives and libertarians defend the current levels of income inequality on the basis of merit. They claim the rich got rich because they worked harder, longer or smarter than the rest. However, researchers have conducted a vast number of empirical studies on what factors contribute to success, and in what proportion. A classic example of one of these studies is the 1972 book Inequality, by Christopher Jencks. (1) And these studies show that the meritocrat's position is not just arguably wrong, but clearly wrong.

For adults, countless factors other than personal merit contribute to success. A partial list includes:

Studies from many professions have consistently found that taller and more attractive people make more money than shorter and plainer folks. Just one of countless examples is a study of lawyers conducted by Jeff Biddle of Michigan State University and Daniel Hameresh from the University of Texas. They found that the more attractive the lawyer, the more rapid the promotions within the firm. By the end of 15 years' time, the more attractive ones were earning 13 percent more than the less attractive ones. (2)

One major factor in determining who becomes successful is inheritance. In 1989, one third of all Americans who earned more than $1 million began with an inherited fortune. (3) But even more widespread is the practice of "living inheritances" -- the advantages passed on from parents to their children while still alive. Examples include wealthy families sending their kids off to college, providing venture capital for their start-up businesses, and otherwise granting them every advantage in a competitive world.

This points up the importance of childhood factors in determining later success as well. The above chart reflects mostly adult factors, but sociologists have identified many childhood factors as well. A partial list includes: Even conservatives who believe in meritocracy inadvertently acknowledge the importance of childhood social factors. One of the hottest topics today among the richest 1 percent is finding top-quality private schools for their children. But if they truly believed that merit is everything, and that social factors do not explain or promote individual success, then they should be satisfied with sending their kids to public or even inner-city schools. Of course, the very idea would horrify them -- which provides eloquent testimony as to the importance of the environment even as appraised by wealthy conservatives.

How large a role do the various factors play? One well-known conservative estimate can be found in The Bell Curve, by Richard Herrnstein and Charles Murray. They studied data from a long-term survey of 12,000 young adults, and concluded that intelligence was a far better predictor of future success than childhood socioeconomic status (or SES). For example, a white child raised in the bottom 5 percent of SES is eight times more likely to become poor than a child from the top 5 percent. But a white child whose IQ is in the bottom 5 percent is fifteen times more likely to become poor than a child whose IQ is in the top 5 percent. (5)

However, Herrnstein and Murray's analysis has been roundly criticized, because they defined SES as only three things: parental income, occupation, and education. To get a truer picture, many sociologists have assembled a more complete SES index and reanalyzed the very survey data that Herrnstein and Murray used. A team of Berkeley sociologists led by Claude Fischer has conducted perhaps the best known effort, for the book Inequality by Design. They added family size, the presence of two parents in the home, geographical residence and other social factors to the list, and then recalculated the survey data. They found that social factors predicted future success far better than IQ did. In fact, based on their results, the authors conclude: "If we could magically give everyone identical IQs, we would still see 90 to 95 percent of the inequality we see today." (6)

The social aspect of wealth accumulation can be seen in the following statistic: between 1975 and 1992, the amount of national household wealth owned by the richest 1 percent rose from 22 to 42 percent. (7) Does this mean the richest 1 percent suddenly became twice as smart or productive? Does this mean that someone in the top 1 percent is 71 times smarter or more personally productive than anyone in the bottom 99 percent? Of course not. Social factors must be responsible for such tremendous differences, even if these are simply the dynamics of the market. What this means is that conservative talk of "merit" is misguided, and not a little ironic.

Exploding executive pay: justified by merit?

In the last 20 years, total pay and compensation of America's top executives have been exploding. Graef Crystal is undoubtedly the United States' most renowned expert on this phenomenon, and his book, In Search of Excess: The Overcompensation of American Executives, commonly serves as the starting point for all debate. (8)

The statistics Crystal reports are not in dispute. Among the 500 biggest firms in the U.S., average CEO compensation in 1975 was 41 times what an average worker earned. By 1995, that ratio had soared to 197 times. (Again, are CEOs five times smarter and harder working than they were 20 years ago? Of course not. Many are the same people.) From 1994 to 1995 alone, CEO compensation rose 16 percent, compared to 2.8 percent for workers, which did not even keep pace with inflation. Their stagnating wages cannot be blamed on corporate profits, which rose a healthy 14.8 percent for that year. (9)

In 1996, Business Week published the findings of an income survey of the top two executives at 362 of the nation's largest companies. This is what they found:

CEO pay and other trends (original figures have been converted

into constant 96 dollars) (10)



                     1990              1995             Percent change

---------------------------------------------------------------------

Average CEO pay      $2.34 million     $3.86 million     +65%

Average worker pay   $27,615           $27,448           -0.6%

Corporate profits    $212 billion      $317 billion      +50%

Worker layoffs       316,047 persons   439,882 persons   +39%

The fact that CEOs are helping themselves to record paychecks at a time when they are laying off tens of thousands of workers and freezing everyone else's wages begs a defense. And it's not just liberals who demand an answer; blue collar conservatives are just as outraged. A 1996 telephone survey of 800 voters, accompanied by six focus groups, revealed that Americans of all ages, all incomes, all races, and both political parties are seething over the way large corporations have been treating their workers in recent years. Large layoffs during times of profitability were regarded as a "serious problem" by 81%; huge CEO salaries were a "serious problem" for 79%, and stagnant wages were a "serious problem" for 76%. (11) In fact, no less a far-right candidate than Patrick Buchanan used this economic populism to score a stunning upset victory over Bob Dole in the 1996 New Hampshire Republican Primary.

Wealthy conservatives offer a few defenses. One is that executive pay is tied to the profitability of the company, in a widespread system called "pay-for-performance." This payment method involves paying executives through stock options and incentive bonuses -- hence, an executive merely gets what he deserves. Sometimes they even offer anecdotal evidence: in 1994, Disney CEO Michael Eisner cashed in on $203 million in stock options, after successfully restoring the once moribund Disney to the nation's leading entertainment business.

Few, if any, would disagree that merit should be rewarded proportionately. However, anecdotal evidence often gives a false picture of what is happening; to get a truer picture, we need to look at generalizations. The fact is that nearly all CEOs are seeing exploding pay, whether their companies are performing well or not. Some of them inevitably do. But despite their company's performance, almost all executives are raking it in as fast as they can, reducing the name "pay-for-performance" to little more than a public relations gimmick.

Crystal has conducted studies measuring the correlation between profits and executive compensation in Fortune 500 companies. "It's a table of random numbers," he told the New York Times, "like throwing darts against the wall." Specifically, he found there is "no relationship between pay-package sensitivity and longer-term shareholder return." He also found that "there is no relationship whatsoever between the size of stock option grants and future performance [of the company]." (12) Crystal adds: "There is no reason why they need to be paid this sort of money. They could use that money to lower the cost of products, give workers raises, or give shareholders more profits." He sums up his findings this way:

Even so, some have defended stratospheric CEO pay on the grounds that it attracts top talent and provides incentive to achieve, if only to remain a CEO. But Crystal argues: "It's insane to think that these 'incentives' worth millions of dollars are buying anything extra." (14) He explains that it is difficult to provide further incentive to U.S. executives for three reasons. First, they are already working as hard as possible. Second, they are already old enough to be set in their management approach. Third, they are already making the nation's largest fortunes anyway. (15)

However, greater inequality has become a clear disincentive to workers, who are working harder, producing more, yet seeing stagnating wages and greater prospects of being laid off. The following sentiment, from a United Technologies middle manager who has seen his company downsize by some 30,000 employees in the past six years, is typical: "I used to go to work enthusiastically. Now, I just go in to do what I have to do. I feel overloaded to the point of burnout. Most of my colleagues are actively looking for other jobs or are just resigned to do the minimum." (16)

Studies confirm that business performance deteriorates when pay differentials become excessive. In a study of over 100 businesses (producing everything from kitchen appliances to truck axles), researchers found that the greater the wage gap between managers and workers, the lower their product's quality. (17) Businesses with the greatest inequality were plagued with a high employee turnover rate. Study author David Levine said: "These organizations weren't able to sustain a workplace of people with shared goals." (18)

In fact, the negative effects of income inequality can be seen on a national level as well. Economists Torsten Persson and Guido Tabellini conducted a thorough statistical analysis of historical inequality and growth, and found that nations with more equal incomes generally experience faster productive growth. (19) Numerous other studies have also confirmed their findings. (20) Two historical examples immediately stand out; the first is the U.S. after World War II. Between 1947 and 1973, income inequality never rose above .376 on the Gini Index (and fell as low as .347). But after 1973, it began rising substantially, to .426 in 1994. And how did the growth rates of these two periods compare? In the more equal 1947-1973 period, the economy grew at 3.4 percent a year. But since then, growth has slowed down to 2.5 percent a year. (21)

The second example is international comparisons. The United States has by far the worst income inequality of all rich nations. No other country even comes close. And here are the growth rates for several of these nations: 


Annual percent growth in GDP per capita (22)



                1960-   1979-

Country         1979    1989

----------------------------

Japan            6.5    3.4

Italy            4.1    2.2

France           3.7    1.7

Canada           3.5    2.0

West Germany     3.2    1.6

Sweden           2.8    1.8

United Kingdom   2.3    2.0

United States    2.2    1.7

We should note that the causes of different rates of growth are still controversial even among top economists. However, these statistics tend to refute the conservative claim that faster economic growth occurs when we allow market dynamics to disproportionately reward the rich.

Return to Overview

Endnotes:

 1. Christopher Jencks et al., Inequality: A Reassessment of the Effect of Family and Schooling in America (New York: Basic Books, 1972).

2. Maryann Struman, "For successful lawyers, it's all in the looks, new study indicates," The Detroit News, September 29, 1995.

3. Calculation by Michael Hout from biographies of "Forbes 400" in Forbes, October 23, 1994. Cited in Claude Fischer et al., Inequality by Design, (Princeton: Princeton University Press, 1996) p. 94.

4. Linda Datcher Loury, letter to the editor, Commentary, August 1995, vol. 100, no. 2.

5. Richard Herrnstein and Charles Murray, The Bell Curve (New York: Simon & Schuster, 1994), p. 127.

6. Fischer et al., pp. 70-101, 14.

7. Edward Wolff "How the pie is sliced: America's Growing Concentration of Wealth," The American Prospect 22, Summer 1995, pp. 58-64.

8. Graef Crystal, In Search of Excess: The Overcompensation of American Executives (New York: W.W. Norton, 1991).

9. Study by Graef Crystal for U.S. News & World Report, reported in "The State of Greed" by Harrison Rainie, Margaret Loftus and Mark Madden, U.S. News & World Report.

10. John Byrne, "How high can CEO pay go?" Business Week, April 22, 1996. Dollar amounts have been converted into constant 96 dollars by Steve Kangas. The original figures, in current dollars, were reported thus:

CEO pay and other trends:



     CEO PAY                  WORKER PAY

     +92%                      +16%



1990 = $1.95 million          1990 = $22,976

1995 = $3.75 million          1995 = $26,652



 CORPORATE PROFITS            WORKER LAYOFFS

     +75%                      +39%



1990 = $176 billion           1990 = 316,047

1995 = $308 billion           1995 = 439,882

11. Three focus groups were conducted with Caucasian, non-college-educated, working class men and women in Hartford, Conn., San Jose, Calif., and Oak Brook, Ill.; two with Caucasian, middle class, college-educated men and women in Iselin, N.J. and in San Jose, Cal.; and one among African-American working class men and women of mixed education levels in Oak Brook, Ill. A "focus group" is a conversation between trained listeners and the members of the group, who respond to questions posed by the listener. The conversation is videotaped and then analyzed and evaluated. The results have been published as: EDK Associates, CORPORATE IRRESPONSIBILITY: THERE OUGHT TO BE SOME LAWS (New York: EDK Associates [235 West 48th St., NY, NY 10036; phone: (212) 582-4504; fax: (212) 265-9348.], July 29, 1996). Copies are available from: The Preamble Center for Public Policy, 1737 21st Street, N.W., Washington, DC 20009; telephone (202) 265-3263; fax: (202) 265-3647. Free, but if possible a $5.00 donation to cover costs would be appreciated.

12. Crystal, Graef, "CEOs and Incentives: The Myth of Pay-for Performance," Los Angeles Times, January 8, 1995.

13. Quoted in Byrne.

14. Quoted in Rainie.

15. Graef Crystal, "CEOs and Incentives: The Myth of Pay-for-Performance," Los Angeles Times, January 8, 1995.

16. Quoted in Byrne.

17. Douglas Cowherd and David Levine, "Product Quality and Pay Equity," Administrative Science Quarterly 37 (June 1992), pp. 302-30.

18. Quoted in Byrne.

19. Torsten Persson and Guido Tabellini, "Is Inequality Harmful for Growth?" American Economic Review 84, June 1994, pp. 600-21.

20. Roberto Chang, "Income Inequality and Economic Growth," Economic Review (Federal Reserve Bank of Atlanta) 79, July/August 1994, pp. 1-10; George Clarke, "More evidence on Income Distribution and Growth," Journal of Developmental Economics 47, 1995, pp. 403-27; Peter Lindert, "The Rise of Social Spending," Explorations in Economic History 31, 1994, pp. 1-37; Lars Osberg, Economic Inequality in the United States (Armonk, N.Y.: M.E. Sharpe, 1984); Edward Wolff, p. 64.

21. Gini Index: U.S. Bureau of the Census, Current Population Reports, Series P60. GDP growth: Bureau of Economic Analysis, National Income and Product Accounts.

22. Gary Burtless, "Public Spending on the Poor: Historical Trends and Economic Limits," p. 81 in Sheldon Danziger, Gary Sandefur and Daniel Weinberg (eds.), Confronting Poverty: Prescriptions for Change (New York: Harvard University Press, 1994), citing Howard Oxley and John Martin, "Controlling Government Spending and Deficits: Trends in the 1980s and Prospects for the 1990s," OECD Economic Studies 17 (Autumn, 1991), and unpublished data from the U.S. Department of Labor and Bureau of Labor Statistics.