On CEO Pay and Plunging Unemployment

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— President Bush touched on the issue of CEO pay during his economic speech in New York yesterday. Instead of seeking to limit pay through legislation–as congressional Democrats are proposing–Bush went the bully pulpit route and scolded corporate boards for ignoring their responsibilities. "You need to pay attention to the executive compensation packages that you approve," Bush said. "You need to show the world that American businesses are a model of transparency and good corporate governance." But CEO pay hasn't exploded just because of buddy-buddy corporate boards. To a great extent, the sixfold increase in CEO pay between 1980 and 2003 can, according to the research of MIT economist Xavier Gabaix, "be fully attributed to the sixfold increase in market capitalization of large U.S. companies during that period." And the bigger the firms, the more CEOs are paid, which is one reason American CEOs are paid more than their foreign counterparts. There are just a lot more big, successful companies here. And as for the gap between executive pay and worker pay, a lot of the disparity stems from the fact that workers' incomes are dependent on wages while CEOs benefit from the stock market. As I noted in a recent story on income inequality and globalization:

The stock market has boomed far in excess of overall economic growth for the past quarter century. So, anyone who derives income from wages alone probably can't keep up with those who have big stock portfolios. Since 1981, U.S. gross domestic product has doubled to $11.4 trillion, while total stock market capitalization has increased 14-fold. The real economy–the one that pays wages–just isn't growing as fast as the financial economy.

My posting yesterday on a possible upcoming plunge in the unemployment rate drew one big criticism in particular. Skeptics of the current economic recovery, such as the popular and often penetrating Angry Bear blog, argue that although the current unemployment rate looks pretty low already–4.5 percent–it's actually overstating the strength of the job market because a smaller portion of the population is looking for work. The labor force participation rate–a measure of people working or actively looking for work–has dropped from 67.3 percent in April 2000, when the unemployment rate was 3.8 percent, to as low as 65.8 percent in March 2005, when the unemployment rate was 5.1 percent. So the critics argue that if the LFP rate had recovered to its 2000 level, there might be a million or more people added to the rolls of the officially unemployed. But consider three things:

1) The drop in the LFP is almost perfectly matched by a rise in the number of people saying they do not want a job. And most of those people are between the ages of 16 and 24 who are choosing school over work–probably a smart choice given the link between higher education and higher incomes.

2) A 2006 Federal Reserve study concluded that the current LFP rate is "not artificially masking the extent of unemployment (or at least no more than usual), so that the unemployment rate is providing a reasonably accurate picture of the state of the labor market."

3) Supply does tend to create its demand. The LFP rate rose throughout 2006, and yet the unemployment rate continued to fall. LFP increased from 66.0 percent to 66.4 percent through November even as the unemployment rate dropped from 4.9 percent to 4.5 percent. More workers are entering the workforce, and they are being absorbed.