Whatever you may think of Hillary Clinton, her profit sharing proposal introduced last week was a very smart piece of politics. It addresses two concerns that are really on the minds of voters, especially Democrats, and it threads a tiny needle of public values.
The first is that people who aren’t at the top of the income distribution haven’t done very well in the years since 2001: Real wages are either flat or down, depending on what measures you look at; job insecurity remains high; hours of work are up; and so forth.
The second is the growing awareness that while wages have stagnated, profits are up, and a much bigger proportion of the national pie is going to owners and investors now. A related issue is that since the 1981 recession, employers have asked employees (especially unionized employees) to make sacrifices in down periods to help business, yet there didn’t seem to be any upside for employees when things improved.
Profit sharing addresses these concerns while navigating around a political hot button. A policy that would explicitly redistribute money from the rich to the poor would likely elicit howls of “class warfare” from Republicans, and the idea of loading another burden on employers doesn’t play that well with many Democrats, either. But a program that shares the gains that employees and employers produce together, and that gives them both an incentive to produce more—well, that sounds fair.
The idea that employers should share profits with employees as a way to secure the cooperation of workers and create incentives for them to work hard probably goes back to ancient civilizations, but the US incarnation seems to have begun with Frederick Taylor’s “scientific management” approach of the 1920s, which led to time-and-motion-studies and the modern factory system. Taylor argued that employers should share profits with workers to get them to follow orders more or less like a robot. Employers like most everything about Taylor’s model except the profit sharing part, which didn’t really take off.
However, something similar temporarily caught on in the 1950s, in the form of an arrangement that came from Joseph Scanlon, a machinist who later became an MIT instructor. Scanlon’s sensible idea was that workplace performance would improve dramatically if employers and employees cooperated with each other. The program he developed, known afterwards as Scanlon Plans, had employers share profits with workers—but, crucially, they also shared information about the business operations, including finances, through a series of employee/management committees that worked on ways to improve productivity. Scanlon plans were quite popular through the 1970s but faded quickly after that. (I discuss other historical shifts in the employer-employee relationship in my new book.)
So what does that history tell us about Clinton’s plan? It demonstrates some of the limits of profit sharing as a means of addressing the slow growth of employee compensation—and also where the opportunities lie.
The first limit is that profit-sharing per se doesn’t seem to improve employee and business performance. Most employees figure out quickly that their individual contributions barely affect company profits, so working harder to try to improve your profit payout doesn’t make sense. Profit sharing seems to matter only when it is combined with increased employee participation in decision making and an approach to management that persuades them that “we’re in this together.” The requirement that employers share more information and engage employees in decision making appears to be what stunted Scanlon plans in the 1980s, and may be a big hurdle for profit sharing plans now as well.
The second limit is the fact that a great many companies already have profit sharing plans. That is especially so if we count retirement plans that include profit sharing. A tax break will induce more companies to use profit sharing plans, but just how many more is not at all clear. How much of the tax break might go to companies that already had profit sharing plans? Certainly some of it will, in which case, nothing changes for employees, and those employers get a windfall from the tax credit.
The third and most important limit is that these plans may not actually increase employee compensation because they may come at the expense of other forms of pay. If a profit sharing plan on average raises pay by 10% per year, for example, some employers will try to get away with paying salaries that are 10% lower. As a result, even in cases where profit sharing plans do give employees an upside when a business turns out to be very successful, they come with an intangible cost in the form of risk because they make pay more variable over time. That might be fine if profit sharing is just an add-on to the pay employees would have received. But on balance it’s a bad thing if it becomes a substitute for predictable wages.
The big plus of the Hillary Clinton proposal is that it might create some interesting conversations in board rooms as to why companies don’t already have profit sharing plans, and what would be required to make them succeed—namely, more sharing of information and decision making. That could happen even if the profit sharing proposal never becomes law, and would be a good thing all around.
Peter Cappelli is the George W. Taylor Professor of Management at the Wharton School of the University of Pennsylvania and director of Wharton’s Center for Human Resources. He is also the author of numerous books, including his most recent, Will College Pay Off?: A Guide to the Most Important Financial Decision You’ll Ever Make.