Professor William Lazonick of the University of Massachusetts Lowell has a provocative recent paper, written for the Institute for New Economic Thinking, outlining his views on how some of the adverse trends in income inequality in the U.S. are due to changes in corporate decision-making incentives. The paper is entitled “Labor in the Twenty-First Century: The Top 0.1% and the Disappearing Middle-Class”, thus implicitly referring to Thomas Piketty’s recent celebrated book, “Capital in the Twenty-First Century”.

(Lazonick previously wrote an award-winning book for the Upjohn Institute on the same themes, “Sustainable Prosperity in the New Economy”. His new paper further develops his thinking and is shorter, but the previous book presents more in-depth research evidence.)

The brief summary of Lazonick’s argument is as follows. In recent years, U.S. corporations have become overly focused on boosting their short-term stock prices. This is in part due to the structure of the compensation of corporate executives, which is increasingly weighted towards stock options. Corporations boost their stock options by such measures as using their profits to buy back their own company’s stock. As a result, corporations under-invest in R&D, physical capital, and their own workers, and have incentives to excessively lay off workers. The consequence of this process is a redistribution of income to the top 0.1% of the income distribution, which is dominated by corporate executives, and a reduction of good jobs for the American middle-class. Furthermore, this process weakens the long-run competitiveness of the U.S. economy and long-run growth.

What implications does this paper have for how public policy might boost broadly-shared prosperity for all Americans? This particular Lazonick paper does not outline specific solutions, but the obvious implication is to consider policies that would seek to reform corporate governance, corporate pay, and the stock market to encourage long-run thinking. As Lazonick argues in another paper, written for the Brookings Institution, public policy might discourage excessive reliance on stock options in corporate executive pay, and discourage companies from trying to buy back their own stock. We might consider changes in corporate governance, for example encouraging more corporations to include workers on their boards, and to have goals other than maximizing short-term stock prices, as has for example been discussed in Thomas Geoghegan’s recent book.  For example, we might give more favorable tax treatment to corporations that were reorganized under such broader corporate charters. As Bob Lerman has argued, we might consider measures that would encourage the stock market to place a greater value on a corporation’s human capital, by encouraging better measurement of the “human capital” of a corporation’s workers. As Larry Summers has argued, we might make it more difficult for activists to threaten a takeover or restructuring of companies that are in their view failing to maximize short-run shareholder value.

How does this issue relate to other policies that promote broadly-shared prosperity? For example, how does this issue relate to early childhood education programs that seek to promote broadly-shared prosperity by better development of skills for all children? I don’t think that any of these arguments mean that “labor supply” policies – policies that attempt to improve the labor market by boosting the quantity or quality of labor supply – are ineffective or unneeded. There is research that shows not only that more education helps individuals, but also showing that improving educational attainment will help overall wages, employment rates, and per capita income, for example research by Enrico Moretti on how more skills has spillover benefits for everyone in a metro area’s economy.  Existing research on how businesses respond to increased skills can be used to estimate how more skills will help those getting skills and improve income equality, for example see this recent report by Hershbein, Kearney, and Summers.

In other words, even if corporations are more reluctant than they should be to make long-term investments in their workforce and their competitiveness, corporations will still show some response to an increased skill level of the workforce. Labor supply policies still will make a difference.

However, it is the case that labor supply policies will be more effective if we also work on the labor demand side, that is we also work directly to affect the behavior of businesses.  For example, preschool programs would have even greater aggregate effects on the U.S. economy if U.S. corporations could be encouraged to be more willing to complement these preschool investments with their own investments in workers’ skills.

The converse is also the case: labor demand policies that affect business decision-making will be more effective in advancing broad prosperity if accompanied by well-designed labor supply policies such as preschool. Even if we restructure corporate incentives so that corporations are significantly more interested in investing in their workers, these investments are likely to go mainly to workers who start out with good hard skills and soft skills. Preschool and other educational reforms will help corporate governance reforms to be more successful in broadening opportunities.

Labor demand and labor supply policies go together. (I have argued this before, including at book length.) Both types of policies are needed to improve broadly-shared prosperity.