High unemployment and high inflation are the Scylla and Charybdis of Keynesian economics. It used to be that capitalist economies tacked dangerously close to one, then to the other. But with the cold winds of stagflation in the late 1970s, the straits between recession and inflation became nearly impassable, and the traditional instruments of Keynesian economic navigation were largely ineffective.

Now, the U.S. economy looks to be on a smoother course. But Massachusetts Institute of Technology economist Martin Weitzman still remembers stagflation, and fears its return when the business cycle takes its predictable turn downward. In anticipation, he's devised a method to better protect the economy from inflation and unemployment. And right now his new idea is hotly debated by fellow economists and thinkers.

He calls it the "share economy." Instead of paying workers a fixed wage, he proposes a lower base wage plus a bonus to reflect the profitability of the company at any given time. In boom times, that would mean pay would rise with profits. In bad times, all workers would suffer lower pay. The beauty of it all, says Weitzman, is that it would build into the capitalist economy a strong inclination to avoid layoffs and keep prices low. In short, an antidote to stagflation.

Weitzman's New York accent and flair for simple explanations camouflage the serious macroeconomic analysis that lies behind his proposal. He spoke about his findings and conclusions in The Share Economy (Harvard University Press) with INC. senior writer Tom Richman and journalist Tom Bethell late last year.

INC.: How did you stumble upon this new idea?

WEITZMAN: I was diddling with theory -- theories about unemployment. Unemployment is a perpetual problem for economists. For a long time, ever since Keynes, it's been a puzzle why a market economy should have unemployment in the first place. It sounds like a very simple sort of thing to which there ought to be a simple answer. But it's not, because the market for labor is different from the market for bread or potatoes or orange juice, where we don't see surpluses, where we don't see the analog of excess supply. Why is it different?

In some economic modeling I was doing, I began to see that an awful lot was hinging upon our wage mechanism -- this idea that the firm has to pay its workers, not with something denominated in what it produces or anything related to that, but in an outside unit of account. That is typically money, although it could be anything. But I didn't know what to make of this observation.

Then -- it must have been in early 1982 -- there was some talk between the UAW and General Motors. The union proposed a deal. They said something like, "Look, if GM will lower the price of its cars, then we will stick with our moderate demands. But if it raises the price of the cars, our wages have to go up correspondingly." Now that is what economists call a product-wage. In effect, the worker is being paid in terms of automobiles, because the automobile price index is being used to pay his wage.

I saw immediately that this would have a dramatic effect on GM management. If every worker, say, produced three automobiles and was paid the equivalent of two automobiles for his services, then the natural inclination would be for GM to hire more and more workers to produce more and more automobiles, even if it meant lowering the price to the consumer. And I began to think that if everyone was doing something like that, it would have very beneficial effects on the economy as a whole. It would encourage more employment, and it would keep a lid on inflation.

All of a sudden, the theories about the nature of unemployment were not just abstract math anymore. I could see that a lot of schemes -- a product-wage scheme but, even better, a profit-sharing scheme -- would have these beneficial effects.

INC.: Are there any examples where something like this has worked?

WEITZMAN: Sure there are. Japan is a place where there is a widespread bonus system. It is a huge feature in their economic landscape. Roughly one-quarter of a worker's pay is in the form of a bonus, typically handed out twice a year. And that bonus looms large in national income accounts -- it is bigger than profits, for example. Korea and Taiwan also have very strong bonus systems.

INC.: Are you saying that is the key to the Japanese economic miracle?

WEITZMAN: It is hard to pull out just exactly what role these bonus systems play, because there are a lot of things going on in those economies. But sharing is one contributing factor.

In the United States, you have isolated companies that do profit sharing, and the impression one gets in talking with such firms is that they are more employment stable -- and often more profitable. There is a book called The 100 Best Companies to Work for in America, and fully half of those companies have something they call profit sharing, as compared with about 15% of all corporations.

After my own book came out, I got a call from someone at a company called Steelcase, in Grand Rapids, Mich., that makes high-quality, heavy-duty office equipment. And the man who called said that about half of their workers' pay is in the form of profit sharing -- a huge amount. There are no layoffs, morale is high, and there's a queue all the time to get these jobs.

INC.: Bonuses, commissions, even profit sharing -- those forms of compensation have been around for a long time in the service and retail sectors. But explain why the share system that you propose has the effect, when times get bad, of causing employers to lower prices rather than lower output and lay off workers, which is what happens today. How does your system help stem inflation and unemployment?

WEITZMAN: All right, but we are going to have to go through a little bit of economics here. The main reason that employers adjust output rather than prices during contractionary times is that the costs that they face don't move very much. Think of General Motors again. It signs a three-year contract with the UAW. Without profit sharing, it is locked in for a long period of time to paying all its workers that wage -- or laying some of them off.

Now, under such circumstances, when the costs of production are fixed, the company has two choices when demand for its cars goes down.It can lower prices in an effort to stimulate demand and maintain output and employment. Or it can let prices rise and simply produce fewer cars with fewer workers. And for technical reasons having to do with the cost structure and demand structure of much of American industry, the profit-maximizing choice for GM is to produce fewer, more expensive, and more profitable cars.

INC.: How would a share economy change that?

WEITZMAN: Well, in the auto industry, the incremental cost per car is roughly equal to some multiple of base wages. With lower base wages, GM does not feel so inclined to lay off workers during a downturn. So the profit-maximizing response to competition or to a downturn in the economy will be to maintain output and maintain sales by cutting prices. Now, when everyone is doing that, the general price level is going to go down -- or at least there is less pressure on it to go up.

INC.: How widespread does this profit sharing have to be, how many companies have to get involved, before the whole economy begins to enjoy the benefits of more stable prices and employment?

WEITZMAN: I would say if the 500 biggest companies were to pay their workers 80% of their pay as base wages and 20% of their pay as some negotiated fraction of profits, that would have significant macroeconomic effects on the economy. I wouldn't say that this, by itself, would eliminate the business cycle, but it would go a long way in that direction. It would certainly make it easier for us to operate our economy with the standard macroeconomic tools available -- controlling the money supply, adjusting interest rates, changing government spending and taxation, things like that.

INC.: But the other millions of companies in the country, everybody besides the Fortune 500 -- how would they behave and how would their employees be affected?

WEITZMAN: The thing to do is to get a large enough core of the economy doing profit sharing. It could be the bigger companies; it could be the smaller companies. It doesn't matter. If enough employers are wanting to hire workers and are not wanting to lay them off, they create a tight labor market for everyone. Even if another firm is just a wage firm, it will feel the effects.

INC.: Is it more likely this profit-sharing idea would appeal to big business or small business?

WEITZMAN: For blue-collar workers, it may be more appealing for them to take profit shares in lieu of wages in a company that's more established, with a more stable record of earnings. In that respect, you may be more likely to see this sort of thing with a big company first.

INC.: Does it make a difference whether you share profits or revenues?

WEITZMAN: It doesn't make an analytic difference. From a practical point of view, revenues are sometimes easier to measure. Profits, depending upon the company, sometimes are arbitrary. In extractive industries, for example, how are they writing off the stuff under the ground? Revenues are something that you can get your hands on more easily.

INC.: Wouldn't profit sharing create a built-in bone of contention between management and workers? Suppose a company agrees to share a certain percentage of its profits with its workers as a replacement for some portion of the base pay. That may give the company an added incentive to hire new workers. But doesn't it also give existing workers a stake in opposing new hires to prevent a dilution of their share of the profits?

WEITZMAN: Obviously that is an issue that has to be dealt with. The first thing to notice is that if -- and this is a big if -- there is widespread profit sharing, management would not be able to find new workers unless the total pay per worker in that firm is higher than the competitive pay per worker. There would not be pockets of unemployed workers who could come aboard and drive down pay.

That brings me to another point. Imagine you have profit sharing and part of the pay is based on profits per worker. Now, on any month-to-month or quarter-to-quarter basis, what is far more important and noticeable to any individual worker is the total amount of profit, not some minor adjustment in the number of workers. Workers might want to restrict the number of new hires, but I think they're more likely to keep a closer eye on profits and how well management manages. They are going to get together and say, "Why did these dopes put out the wrong model this year? Don't they know. . .?" or, "Why aren't our salesmen pushing harder?" They are going to get interested in the company in a way that they haven't been before.

INC.: That may be a good thing or a bad thing, depending on where you sit.

WEITZMAN: Generally, that's a good thing.

INC.: Well, for example, what effect, if any, would profit sharing have on the introduction of labor-saving capital equipment?

WEITZMAN: I think it would encourage it. If capital equipment is going to make the operation more profitable, that is going to increase the company's profits. The worker will want the new equipment, whereas before he was indifferent toward it, or maybe even hostile.

INC.: Yeah, but suppose I am working in a GM factory welding on rearview mirrors. The boss says, "Tomorrow we bring in the rearview mirror-welding robot. Sorry, Tom, but there is nothing for you to do here."

WEITZMAN: Let's say GM pays Tom a fixed wage of $15 an hour. When Tom is laid off, a robot is brought in that costs the company the equivalent of $10 per hour. That's a saving of $5 per hour that goes right into GM profits. That's how it would work today.

But, if Tom instead were being paid a lower base wage plus a compensating share of profits, the calculation made by GM would be different. As in Japan, the key criterion would be the base wage, not how much the worker is paid overall. If Tom's base wage is lower than his value at an alternative GM task, the company would want to keep him and retrain him if necessary.

INC.: What happens in a buggy-whip industry -- steel, for example, which is declining?

WEITZMAN: Nothing -- not share economy, not profit sharing, nor any other gimmick except for wholesale protectionism -- is going to save those industries. The issue is not how to save these declining industries, but how to make a system that transfers workers out of those industries and areas and into new industries and new areas with a minimum of disruption and harm.

INC.: Steel mills are closing and towns are dying. If we had the share system in place today, how would that be different? Or would it be different?

WEITZMAN: Here is how it is different. Look at Massachusetts. It's got an unemployment rate of about 4% or so compared with the national average of 7%. This is a pretty tight labor market. I think it could be tighter still. I think we could come down to 3%, or maybe even 2% in my fantasizing about this. But, just take the 4% now. Industries shutting down here do not pose a social problem in the same way they do elsewhere. Why? Because there are plenty of other jobs out there. Now, it is true that a particular worker may have to take some pay cut in moving to a new job. He may have to move physically from one part of the state to another. He may miss some of his buddies. Those are losses, and I wouldn't want to pooh-pooh them for a minute. But the point is this: when you've got a really tight labor market, employers are going to come looking for you. They will send buses to find you. They will advertise. Having very tight labor markets solves an awful lot of problems. Declining industries decline, and so what? New ones come up and take their place.

INC.: So here you have a new economic scheme that would permit industries to disappear or decline, that would allow workers' wages to decline when recession or competition cuts into profits. It would, under certain circumstances, encourage introduction of new technologies. Sounds like something that might have been written by the National Right to Work Committee as a backdoor way of breaking big industrial unions. Is this just antiunionism in disguise?

WEITZMAN: Unions are now just 18% of the work force and are declining by 1% a year. They are major actors, but they ain't what they used to be. Their criticism of something like this is more muted than it might have been some years ago, because they are having to come to grips with new ways of looking at things, as they have in the auto industry with wage concessions, or in the airlines with the two-tiered system.

Typically, unions don't want to discuss these things, but I don't think it is antiunion. It is asking unions to be more like the Japanese model. I have studied what goes on there, and I don't think their unions are a bunch of sissies. They stand up for workers' rights. They look to be tough and modern. They are just, to my mind, more reasonable when it comes to paying attention to how well the company is doing. They do not disregard that aspect. In fact, it is explicitly taken into account in the form of profit sharing.

Profit sharing might even give unions a new lease on life. Suppose you had widespread profit sharing. You would need somebody out there telling workers what it means, someone they could turn to and say, "Hey, is this right, the way they are calculating these profit shares?" You'd need unions to hammer out the negotiations about what share of the profits of a particular company workers will get. But all of this is certainly threatening to the current union leadership, which sees its role rather narrowly -- too narrowly, in my opinion.

INC.: How so?

WEITZMAN: They care about the current members. That is who they represent. They do not represent the unemployed. They want a deal that gives them fixed wages, independent of what happens to the company, so that the average tenured worker will go on getting paid the same whether the company does fantastically well or collapses. And I think them days are over. That kind of thinking is bad for the economy, bad for the company, and bad for the union in the long run.

INC.: Have you had any serious inquiries from anyone in organized labor?

WEITZMAN: I have had feelers. The AFL-CIO has a committee -- I forget its exact name -- to listen to new ideas. Part of it is cosmetic and part of it is sincere.

INC.: Have you had interest from political people?

WEITZMAN: Senators like Bill Bradley [D.-N.J.] and Gary Hart [D.-Colo.] have expressed interest. In Canada there is also interest, a lot more serious than here. Europe is interested in this sort of thing, too, because they really are in a state of crisis. In England, for example, the center party, the Alliance comprising the Liberals and the Social Democrats, has words about profit sharing in its platform.

INC.: How about interest from business-people? Why would an entrepreneur want his or her company to get into this?

WEITZMAN: In fact, in most cases, there is not a good strong reason why they would want to do this. On average, the total compensation paid to workers in a given company would probably be the same under profit sharing as it is under a fixed-wage system. During bad times, to be sure, the risks for the entrepreneur would be hedged because of lower pay. And during good times, they're not going to be enjoying quite the same boom in profits, because they will have to share some of those with the workers. So risks and rewards would both be somewhat diminished.

The point is, though, that the real benefits would probably not accrue immediately to any one company, but to the economy as a whole. And that would wind up benefiting every business. The unemployment out there now is costly to them. It means they have to pay higher taxes to finance unemployment insurance and welfare benefits.And it means that there is less demand for that company's goods and services because people are unemployed.

Profit sharing won't mean a bigger share of the pie for any one company. But to the degree it is accepted, it will mean a bigger pie.

INC.: But if the most powerful and organized workers -- the unions -- are not enthusiastic about this, and businesspeople don't see any big improvement in their own bottom lines, how do you go about redirecting the economy? Aren't those the very folks who just happen to exercise a lot of influence in public policy making?

WEITZMAN: That's right. The tragedy of capitalism, in my book, is that while unemployment is an awful thing, it is concentrated. Most of us don't experience it. The majority of the population is not unemployed, which creates a political problem if you're trying to promote something like the share economy. How do you interest this majority, which is not under threat of unemployment, to adopt as more flexible system that creates less unemployment for all? I see two routes -- moral suasion, which I put some faith in but not a whole heck of a lot, and a tax break.

INC.: What kind of tax break?

WEITZMAN: Some sort of tax reduction on whatever part of a worker's pay is based on profit or revenue sharing. There is a precedent for it -- look at capital gains. Capital gains are taxed at a very reduced rate in the name of helping venture capital and all that sort of thing. Why not give to working-class people some analog -- treat their profit share the same way that capital gains are treated for the same sort of argument. These workers are assuming some risk, the risk that their pay will decline, and this is helping the economy. If anything, the argument for some sort of tax preference is far stronger for profit sharing than for capital gains. After all, it is not really the venture capitalist who benefits from the lower capital gains tax so much as it is the Wall Street traders, who are not doing anything but shoving paper around.

INC.: You are not talking about a compulsory system?

WEITZMAN: No, no. In principle, one could have a compulsory system, but this isn't a dictatorship and that wouldn't be too popular. You could argue that compulsory profit sharing -- fixing base wages but allowing companies to make any kind of contract they want about profit sharing -- is superior to price controls. But I don't think in this country making something compulsory, whether it be price controls or profit sharing, is the way to get anything done.

INC.: Employee stock ownership plans are very popular these days. They are a form of profit sharing based on tax incentives. Why aren't they the answer?

WEITZMAN: An ESOP really is different. Typically, it's paying workers in stock in lieu of cash. But it doesn't have the sort of expansionary property I've talked about when the company is making decisions about output and employment, because it's not like lowering the base wage. The macroeconomic effects -- improving employment, holding down prices -- I don't see any of that with ESOPs. There's some vague talk about ESOPs eliminating the antagonism between workers and owners, and that's about it.

You know, what I think those ESOPs prove, unfortunately, is that if you pass a law creating a tax break, boy, will people take advantage of it!

INC.: Let's talk about timing. The economy is moving along without serious inflation or unemployment. And in Washington, they're talking about eliminating tax breaks, not creating new ones. This doesn't seem to be the time to be pushing for a tax break to promote stability in prices and employment.

WEITZMAN: Look, when people come to me from the media, they are always interested in this year, today -- a little too much so, from my point of view. Most worthwhile ideas take years to percolate. When Milton Friedman wrote Capitalism and Freedom, those ideas that he proposed were derided as absolutely insane -- a volunteer army, flexible exchange rates, negative income tax. You go down the list. They were viewed as madness, and half of them are now in force. The other half are being toyed with or considered. So, you know, that is not te job of the intellectual. You cannot get these things so that the public immediately responds. I guess this idea has to sit on the shelf for a while.The economy goes up and down. It is going to go down someday. I well remember -- because I already had these ideas then -- in the late fall of 1982 when the national unemployment rate was going toward 11%, that I was seeing plenty of comments and plenty of editorials asking, "Where are the new ideas in economics? Why do we have these same old tools? We can either bring back inflation or have unemployment. Why haven't they come up with any new theories?"

Well, I am not saying they'll jump at this, but it is one the shelf. That is the way it goes. You don't get fundamental change until there is some perception that there is a fundamental problem.

INC.: You are proposing to millions of workers to take an act of faith, to go off their fixed-wage system and to trust that the executives who run their companies are going to make the right business decisions. Isn't that asking too much?

WEITZMAN: Look, in most capitalist countries, we are running the system in a slightly crazy way -- not altogether crazy, but slightly crazy. Workers are promised these green pieces of paper, which are fixed in amount. Now, these green pieces of paper are not worth anything inherently. You can't eat them. You can't wear them. You can't roof your house with them. They are of no value. But they give an illusion of security to everyone: I am paid this much green paper come hell or high water, if I have a job. When an economy pins itself down in that way, it stabilizes just one thing -- the level of payment for whomever gets hired. But it destabilizes the really important things: employment, the level of production, the inflation level, and, therefore, the amount people can buy. It makes stabilizing all these other things much harder. And then various Keynesians and monetarists come in with their tricks to try to manipulate this unstable economy.

What I am trying to do is to get people to admit right from the beginning that capitalism is about uncertainty, that there are no guarantees, and that the question is, "Where do we let the uncertainty come out?" It comes out one way or another. And it is really much better, much healthier if everyone, or almost everyone, shares just a little bit of that uncertainty rather than letting it all fall on just an unfortunate few.

It's must better if people say, "Look, only 80% of my pay is going to be tied directly to these green pieces of paper" -- which are themselves an illusion, although a very useful illusion -- "and 20% is explicity variable." If we do that we will end up with an economy we can control so that you young people will be able to afford houses, because we do not have to send interest rates through the sky in order to control inflation. You unemployed workers are going to have jobs. You capitalists are going to have brisker markets. If we will face up to the uncertainty at the beginning, and if each of us accepts some of it, then the society will end up with less uncertainty overall.

Published on: Mar 1, 1986