Economic Trends
By Gene Koretz
Pay Perks Cloud the Crystal Ball
Will the growth of variable pay schemes prove to be an asset or a liability to the economy as it negotiates the recessionary shoals that lie ahead? That's the question posed by two recent Wall Street analyses--one stressing a positive aspect of flexible compensation, the other a possible negative effect.
Flexible pay practices, which link workers' pay more closely to company performance, have become increasingly popular among U.S. employers. Based on a Federal Reserve Board survey and Goldman, Sachs & Co. estimates, the percent of companies using one or more forms (profit-sharing, annual bonuses, stock-option awards, and the like) as part of compensation rose from 65% of respondents in 1996 to some 95% by last year--with stock options to less-than-top-rank executives up from 18% to nearly half (chart).
Why the trend? Companies say they use variable pay to improve hiring in tight labor markets, reward good workers, build loyalty, and control labor costs. Economists claim flexible pay can enhance productivity, lower unemployment during downturns, and temper inflation.
The latter effect is stressed by economist Joseph Carson of Alliance Capital Management, who notes that recent economic data revisions sharply raised estimates of compensation hikes in recent years (to 6.2% in 2000, for example), suggesting that business is facing a labor-cost problem. Carson points out, however, that the labor-cost rise was driven by new data on exercised stock options, which are treated as wage and salary income in the national accounts. Moreover, it was concentrated in high-tech manufacturing, communications, and finance--the very industries granting the highest number of options.
Why were compensation hikes subdued in other industries such as health care and consumer cyclicals that also issued a lot of options? Because, says Carson, their stock prices have generally been below their option strike prices, rendering the options worthless.
Thus, notes Carson, the big jump in labor costs in recent years appears not only to be "very narrow in scope, impacting mostly companies in the New Economy" but also to reflect a surge in variable compensation that will tend to wane in the months ahead. Assuming a near-term recovery, that spells good news for profits in 2002.
Goldman Sachs economist John Youngdahl agrees that a decline in variable pay should cushion profits next year. But he worries that it could also undermine consumer spending, retarding an economic upturn.
The reason is that a big chunk of variable pay in the form of bonuses, profit sharing, and stock is typically awarded in the early part of the year. In the wake of this year's profits decline, Youngdahl estimates that cutbacks in variable pay could reduce personal income in the first quarter by $30 billion--twice the amount by which tax cuts are expected to pad take-home pay.
The danger, says Youngdahl, is that this will come as a negative shock to households, slowing consumption just as the economy is turning up. In other words, variable pay has a potential downside as well as an upside.
Old Professors Don't Fade Away
In recent decades, colleges and universities have kept a tight rein on faculty payrolls by raising student-teacher ratios and using lower-paid adjunct and part-time teachers. For newly minted PhDs with teaching aspirations, the light at the end of the tunnel has been the hope that most tenured faculty hired when the baby boomers entered college in the 1960s would by now start to retire as they begin to hit 70.
No such luck. While a projected pickup in college enrollments over the next decade offers some hope, the exodus of aging profs is likely to be slower than expected, report Orley Ashenfelter and David Card in a new National Bureau of Economic Research study.
When the Age Discrimination in Employment Act was passed in 1986, Congress granted an exemption to colleges, who argued that they needed to enforce mandatory retirement for tenured professors at age 70 to attract young faculty and promote the hiring of women and minorities. After two studies found that profs in states banning mandatory retirement weren't retiring later, however, the 70-and-out exemption for colleges was lifted by Congress in 1994.
Ashenfelter and Card analyze faculty turnover at a large group of institutions before and after compulsory retirement rules were banned. In the post-mandatory-retirement era, they report, some 40% of professors who were working at age 70 were still working at 73. That suggests that a sizable fraction of profs now entering their 60s are likely to remain employed into their mid-70s.
Where Did All the Suitors Go?
The era of massive foreign direct investment in the U.S.--a major source of dollar strength--may be drawing to a close. Economist Joseph Quinlan of Morgan Stanley Dean Witter & Co. notes that net announced merger-and-acquisition inflows (inflows minus U.S. investment outflows) was a paltry $4 billion in July, compared with $82 billion in July, 2000. Meanwhile, the backlog of net pending acquisitions by foreign investors is also down sharply (chart).
The main cause is a drop in direct investment from Europe, which on a net basis fell to just $13 billion in the first seven months of this year, from $104 billion in the same period last year. Domestic woes, global overcapacity, and poor U.S. profits compounded by a weakening dollar are tempering Europe's appetite for U.S. acquisitions.
Last year, net foreign direct investment covered 30% of America's current-account deficit. This year and next, the share will be far lower.
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Copyright 2001 , by The McGraw-Hill Companies Inc. All rights reserved.
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