Are workers paid their marginal product? Should they be?
By Scott Sumner
This post will probably annoy almost everyone, as I will argue that both the left and the right misunderstand the issue of wages and productivity. Here’s Alphaville at the FT:
It’s well established that since the 1980s, as workers become more productive, wage growth hasn’t kept pace. The marginal productivity theory of wages suggests that it would. As an observation, this is uncontroversial. The Commerce Department’s Bureau of Labor Statistics produced a completely readable 14-pager about it last year. The current CEA is definitely thinking about wage growth; it reported in September that wages are growing, if you measure them correctly.
The second sentence in misleading, as the increased productivity he refers to is a higher average product, not a higher marginal product (MP). That doesn’t mean the theory that workers are paid their MPs is exactly correct, I suspect it’s only an approximation of reality. But you’d need other data to disprove this theory.
It’s also worth noting that the increased share of national income going to capital since the 1980s is due to the increased return on residential housing, a capital good. The people who own their own homes earn a return on that investment, in the form of housing services, that is higher than in the 1980s—even as a share of GDP. Matthew Rognlie provides some evidence:
It you are worried about the “typical worker”, you should focus on the fact that average wages have risen faster than median wages, due to greater inequality. Thus the pay at the very top has increased much faster than at the median wage level. That’s the actual concern.
On the other hand, I believe that some on the right are too willing to wave away concerns about wages by suggesting that the wages = MP of labor theory somehow proves that the existing wage distribution is fair. It may or may not be fair, but I don’t believe that the wages equal MP of labor theory has any bearing on this question. For instance, merely by changing the laws on intellectual property rights you will impact the distribution of wage income. But the appropriate IP laws are a complex issue, about which even free market economists do not agree. There is no obvious straightforward way to think about the marginal product of labor; it depends on many institutional factors.
Some people probably visualize something like the following thought experiment. In 1820, a hardy pioneer and his family move out to a remote valley in Montana, where they build a cabin, plant crops and hunt for animals. There are no other families nearby. Doesn’t that family earn their marginal product? Yes, but that’s not why our intuition tells us that their compensation seems fair. Rather the perceived fairness comes from the fact that they also earn their total product. They earn 100% of their valley’s GDP (minus depreciation of the cabin.)
Back in the real world, workers do not earn 100% of GDP minus depreciation. Furthermore, the marginal product of a worker who cooperates with many other workers and many other machines doesn’t necessarily match our intuition as to what the term “productivity” means. There’s nothing in marginal product theory to prevent a scenario where one man owns all the capital, and earns 99% of national income, and the other 1% is divided between 150 million workers on the basis of the MP of each worker. That’s obviously not likely to occur, but it’s not ruled out by the theory. And that’s very different from the intuition behind the Montana pioneer.
I believe that utilitarianism provides a better way to think about wages and productivity, at least for economists. A sound public policy will involve a set of labor market regulations, and income redistribution, than maximizes the well being of society as a whole. Concepts like “fairness” and marginal productivity of labor are not particularly helpful.
The counterargument is that this approach is too “dry” for the average person, who has very strong intuitions about fairness. Even worse, the average person has cognitive illusions about economics, which lead them to grossly underestimate the power of incentives. So if we take a dry utilitarian approach, the public will be led to support minimum wage laws, rent controls, soak the rich taxes, tariffs on imports, and all sorts of other destructive public policies, because it looks like these boost (domestic) aggregate utility. To fight this bias, we need to create a public mythology of the hardy pioneer earning his marginal product, and then extend that myth to the point where almost all workers are earning their “just deserts”. This mythology would also give owners of housing units a “right” to charge whatever rent to people who voluntarily choose to use their property. Consumers have a “right” to buy goods from anywhere in the world. Immigrants have a right to live where they wish.
Thus the deontological approach to economic rights and fairness can be defended as a sort of correction to the cognitive biases in the average person’s economic thinking, which leads even right-wingers to be inappropriately fond of government intervention. Even many of American conservatives favor socialist programs such as Medicare and trade barriers, and oppose immigration.
But I’m an economist, not a politician, so I’ll keep fighting battles using the utilitarian ethical framework. I’ll trust my readers at Econlog to not suffer from these common cognitive biases. In my view, utilitarianism (properly understood) leads to a world that is 95% libertarian, and 5% policies such as carbon taxes and low wage subsidies.