Saturday, May 25, 2013

Markets and Wages (7)

Here are some more problems with market wages that mean a righteous wage is still relevant in the modern world. Wages and salaries are often disconnected from supply and demand.

  • In the labour market, adjustments takes place through a change in quantities rather than a change in price, as market theory suggests. Employers do not compete on price, because the long-term risks of that strategy outweigh the short-term benefits. When a profession is scarce, it is much safer to just pay what others are paying and not rock the boat. A few high performers will be paid extra, because they are critical to the business, but most staff others will still just get the going rate, or small increases.

  • Neoclassical economics claims to have proved that in a market economy, every employee will be paid what they are worth. All differences in wages and salaries reflect differences in productivity. The problem with their proof is that their economic model depends on a serious of unrealistic assumptions that have no connection to the real world. That has not stopped employers from hiding behind the idea.

  • The neoclassical market model assumes that every employer knows the marginal productivity of every employee and pays them accordingly. According to the model, an employer should keep employing additional employees until the marginal wage of the last employee equals the value of their marginal product. This is fine in theory, but the reality is that employers have no way of measuring what an individual employee has produced, so they no way for assessing what an extra employee is worth. A mix of capital and people contribute to every product, so the contribution of one person cannot be isolated. Employers cannot measure the contribution of a single employee or group of employees, so they most just fall back on paying what other businesses are paying.

  • An employer has no way to compare the productivity of one class of employees with another. There is no economic model or accounting model that can show that the productive value of an accountant is five times greater than the productive value of a good receptionist. Decisions about their relative value depend on the subjective judgment of the employer, and they can easily be wrong.

These inadequacies with the standard economic model do not make much difference in most situations. Provided the employer has acted in good faith, and the employee has freely accepted the wage or salary offered, the situation is legitimate. However, the situation is different where the wage being offered is not enough for the employee to live on. This is where the righteous wage kicks in.


Brendan said...

Hi Ron

Some good thoughts here.

A couple of reflections. I suspect it's easier for an employer to determine and individual's productivity than you suggest. Most employers measure employee productivity one way or another.

You seem to ignore the fact that employees are mobile, and well able to leave the employment of a company where they feel inadequately rewarded or appreciated. They are not held captive to bad employers.

Blessed Economist said...

No Brendan, it is much harder than you realise.

Employers like to think they can measure productivity, because it makes them feel better, but it is an illusion.

Employers and managers can assess relative productivity, by comparing different employees, but that is not sufficient for the purpose here. To pay employees according their productivity, the employer/manager must be able to assess the absolute value of their productivity, ie the contribution of the individual to the firms in dollar terms.

If an employee works on their own without any equipment on a single product, it is theoretically possible to measure the market value of what they have produced. However, that situation hardly ever occurs in a developed economy. If an employee works as part of a team, on producing a variety products, with the assistance of capital equipment, it is logically impossible to measure the value of what the individual employee has produced. The market value of the production can be measured, but there is no way to allocate it between capital equipment and labour, or to allocate the labour share between various employees.

Most employers simply do not try to measure the contribution that each individual employee makes to the business, because it is an impossible task. Therefore, they cannot be sure that they have paid the employee according to their productivity.