Intrinsic Value Makes People Poor

Ken Wyble, who is a smart guy and is very active in libertarian politics in Colorado recently posted a link to this news story, to which I left a fairly cryptic message claiming that the implications of the story will be that public sector wages will tend to rise in the aggregate. This will probably seem counter-intuitive to many people, so I want to flesh out the idea a little more. First, a quote from the news:

AURORA – An activist group for open government in Aurora has posted all 2,600 city employees’ salaries online and the Web site is causing uproar.

“I was really surprised. There are 94 people that work for the City of Aurora that make over $100,000 a year,” Jim Frye said.

Frye is a member of the Citizens for Responsible Aurora Government, or CRAG.

He received the data after submitting a public records request.

Frye asked for the salaries in response to Aurora’s 4A ballot issue.

Now, the intuitive response to this is that this will shed light on “government excess” and cause wages to fall. Of course, this is based on a “folk” way of thinking about how wages are set in a marketplace.

As identified by Carl Menger and the “marginalists”, wages are determined by marginal productivity. However, it is easy to think of this in relation to other, similar types of jobs — however, this is an instance where the imagination is not going far enough. Wages are actually set in relation to your marginal productivity of performing any other task in the world. The reason we have become individually richer through economic growth (especially in the West) is that each person’s marginal productivity has increased for all tasks.

If you happen to travel to a developing country, you may be surprised to find that middle class families have multiple servants, some that seem to even have a single task that they perform. Indeed, Chinese New Year (in China) represents the largest human migration in the world, as people trek from the cities to the small towns of their families to celebrate. You may then return to wonder why you have to perform such menial tasks as retrieving your own beer, or fixing an electrical socket on your own. The reason is that the marginal productivity of labor in developing countries is so low that people can afford to bid against every other possibility for a laborer, and pay them more at the margin. To do this in a rich country, you would have to pay substantially more, as the value of labor in rich countries is much higher than in developing countries. Indeed, the output of a single US laborer is many times that of a laborer in the developing world. This is because of the application of high levels of capital investment.

Most of us are very lucky that wages aren’t determined by the intrinsic value of what we create — because we’d be extremely poor. It’s only because of the existence of other possibilities that we are paid anything at all! Less-productive professions (like teaching) have ridden on the coat-tails of much more productive sectors for quite some time. Indeed, law professors make about double what English professors do, even though they do the same job…but English professors make as much or more than farmers, engineers, or mid-level managers — even though their productivity is mostly based on admissions. The reason is that law professors have much better options outside of academia. However, law professors among similarly-prestigious institutions make roughly the same amount, as do English professors. The single reason that English professors are even paid as much as they are is because they ride on the coat-tails of law professors (and other professors that have similarly lucrative options, like finance). This is because the economy tends to flatten out wage differentials between employees. Even in firms that are not governed by union contract, the wage differential between the most productive and the least productive employee in a specific occupation will be likely be within a standard deviation of eachother. We tend to not realize how much better good employees are at their jobs than bad. A very egregious illustration of this fact is in sales departments (car dealerships, especially)…almost always, compensation doesn’t come near reflecting the differences in output.

Which brings us to the point. To build organizational capital, firms are careful to do two things. The first is to smooth the differential between employees doing similar types of work, and the second is the keep individual pay confidential. Wage inequalities create extreme contention between employees (much as they do in the broader economy — like the populist rhetoric against CEO’s). This severely damages organizational capital. Now why would this put upward pressure on wages? Well, wages are extremely sticky downward, so creating equality by leveling the top-tier down is not exactly an option…so wages tend to rise. For government employees (considering benefits), there is only one thing in the world that would make them feel underpaid: comparing their salary to someone else’s…and this effect is magnified the closer proximity the subject is to the comparison (because there is no room for imagination, or yelling into the ether, or whatever). The guy down the hall, who may or may not be more productive than you (but is always, as a rule of thumb, about 10-15% less productive) being paid more, when his compensation comes ultimately from the same place, is very discomforting.

— — — —

In all honesty, the general public has very little interest in what public-sector employees get paid. It is the people who are earning the salaries who care the utmost…and that generally generates demands for wage increases.


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