How standard wage theory must adapt

Standard economic theory assumes that worker salaries reflect what they add to the firm’s receipts. This picture contains some realistic points about supply and demand, along with a number of unwarranted assumptions. The simple 20th century theory—powerful because it is simple, but also wrong because it is simple—ignores other factors that, under many circumstances, are at least as important in determining wages.
Standard economic theory has at its core the idea that prices – including wages – are set by the intersection of supply and demand. Wages are described as set at the intersection where people supply their work by choosing how much (and where and how) to work; while the demand for labor is derived from the demand for the products of that labor. The theory is further simplified by the assumptions that employers select workers based only on well-based expectations of their ability to contribute to the productive effort, and that workers have good information about all the possible jobs they could have. The conclusion from this reasoning is that all workers receive their just deserts: their pay reflects precisely what they add to the firm’s receipts.

This picture contains some realistic points about supply and demand, along with a number of unwarranted assumptions. Normally neither the workers nor the employers have as much knowledge as is assumed, about either the product market or the job market. While wages are nearly always an important consideration, many workers give equal or nearly equal weight to a number of other things in their selection of a job, including such issues as location, opportunities for learning and advancement, image and status associated with the job or the particular employer, or the social value of the product. (The latter concern is a major motivator for many people who chose to go into often low-paying jobs with non-profit organizations, or in areas such as social work). While both the lack of perfect knowledge and the presence of personal preferences receive some acknowledgment in the old model, these complications are not really factored in. The old-model conclusion is that the stringent assumptions of perfect knowledge and simply-modeled goals are good enough so that, on average, the labor market works as it is described, with all workers receiving exactly what they deserve.

Other social sciences have pointed to masses of data showing labor markets having rather different outcomes. Perhaps it is safe to conclude that the old model goes about half way in predicting outcomes. The simple 20th century theory—powerful because it is simple, but also wrong because it is simple—ignores other factors that, under many circumstances, are at least as important in determining wages. These include power, externalities, history, and culture. For lack of space, here I will only comment on one of these.

Power in society is often connected with legal status. Individuals or groups who have the standing that allows them to raise, or to resist, legal challenge have significantly greater power than those who lack such standing. A good example is provided by the case of illegal immigrants in the United States. They are vulnerable to threats of exposure to immigration authorities; and if they are mistreated or underpaid they cannot take their case to law, as that would, again, expose their status to the immigration authorities.

Unions confer on their members the legal status that makes them more effective in protesting unfair treatment. John Kenneth Galbraith famously referred to unions as the salutary “countervailing power” against excessive corporate power in the United States. However since the 1970s union membership in the U.S. has declined dramatically. The reasons include the threat that companies can replace union labor by lower-cost legal or illegal immigrant labor; the threat that union demands can cause companies to source their production overseas where wages are lower and unions are not a problem (China is notable for blocking attempts to legalize unions); and the growth of corporate political and economic power with ever less countervailing power of any kind.

When workers lack bargaining power, gains in worker productivity can be diverted into profits, rather than wages. It is increasingly widely recognized that the gains in labor productivity that were achieved through the last quarter of the 20th century mostly resulted in increased corporate profits, with little going to raise workers’ wages, and a disproportionate amount going to top management.

Another set of issues under the heading of power concern gender and ethnicity. This issue may be very briefly summarized by noting that any type of work that is predominantly associated with a group that lacks political/cultural/economic power in the larger society will have lower status and lower pay.

Given this very brief overview of existing wage theory, and the realities it faces, what would a more realistic and useful theory of wages look like?

Above all, it would start with an explicit goal, replacing the implicit goal of the existing theory, which is that the wage should be equal to the worker’s marginal revenue product (i.e., the market value of the output produced by the last unit of labor in the category to which the worker belongs). The alternative goal, for the economic theory appropriate to the new economy, should be that the returns to labor should approach the human value to society of the worker’s output. After a little discussion of this goal, I will address very briefly the economics of achieving it—that is to say, how money flows in an economy organized to this end would differ from those seen in the United States today.

It will never be possible, or even desirable, to achieve this goal precisely. To start with, it is impossible to make exact calculations of human value. Efforts to move toward this goal would need to be made in rather general terms, which would require a great debate about each society’s values. The most practical centerpiece of a move in the direction of the goal of aligning work income with human values is probably related to the concept of basic income.

In my companion paper, “Basic Income for a New Economy,” I propose a system that, to begin with, depends on the size and composition of any household. One portion of the proposed “BICS” (Basic Income / Core Support) system would compensate “Core” [[The term “core” is one that I proposed in about 1998, when working with Edgar Cahn on conceptual tools for Time Banking systems. (I also at that time coined the phrase, “unused capacities and unmet needs.”) “The Core economy” (or “the core sphere”) has since come into wide use, including in the textbooks I have authored (Goodwin et al, 2014 a, b and c), where the core sphere is defined as the place where people generally raise children, prepare meals, maintain homes, organize leisure time, and care for mildly (or sometimes chronically) ill individuals.]] workers for their work in five areas: food preparation, household maintenance, and managing household finances, as well as for the hours of care required for children of each age, and for elderly or ill household members who require assistance from others. The “Basic Income” portion of a BICS system calculates the purchased inputs necessary (given household size and composition) to provide food, clothing, and housing, with associated furnishings and utilities. As conceived at present, the total BICS amount would be no larger than the larger of its two elements. Importantly, the Core Support element would be identified as such, to ensure that all household members are aware of this work, now so often invisible to those who are not doing it; and efforts would be made to ensure that this portion goes to those individuals who actually do this work. [[The system, as spelled out in the paper, does not assume that it is only women who do this work, but lays out default assumptions that potentially involve all household members between the ages of 12 and 82. This is an invitation to households to discuss who is actually doing the work, and who should therefore receive and handle the income.]]

How would such a program relate to the human value of work? To give one example, caring for a child should be valued more highly than is indicated by the wages of baby-sitters and day-care personnel. I would suggest, however, that society through government should not undertake to differentiate between really excellent child-care and that which is much less good (except for setting standards for e.g. day-care facilities). This, indeed, can be partially left to the market; if each family received an amount that society deemed reasonable in relation to the ages of their children, then parents could choose to keep that income for themselves, or to turn it over to others, who would compete for these jobs on the basis of competence and caring.

For another example, consider the extraordinarily highly paid managers of money who contribute little or nothing to the real economy, but skim off large salaries by moving money around. Society could decide to exact very high taxes from people working in the financial sector – not so high as to make it impossible to earn a livelihood in that sector, but making it impossible to get very rich that way. Ideally the local banker in Portland, Maine, who accompanies a prospective borrower to view the business she wishes to enlarge, would not earn less than the Wall Street banker who bundles mortgages into packages that cannot be well understood by investors who, themselves, have no relationship with the activity.

If changes need to be made so that child care is better compensated, and money-managers are less well compensated, what would we say about artists? I would suggest that the social discussion would go along these lines. Some art is needed, and extremely valuable – but there are also many people who would be happy to spend their time producing art that very few others would value, while doing nothing else that produces humanly valuable results. High compensation for all would-be artists would be difficult for any society to afford. Selection of “the best” artists by government officials, or even by the heads of museums, does not (considering elite fashions of art today – I am showing my prejudice here) seem likely to result in selection that is either especially fair or especially conducive to the production of humanly valuable art. Therefore my own suggestion would be that artists receive a “basic income” such as BICS just like the rest of the population, and income above that amount would depend on their producing works that people do want to buy (counting on the market to manage this), or on working at other jobs, as artists do now.

This discussion has moved quickly from theory to implementation. The foregoing examples are intended to illustrate the goal described above, of better aligning the returns to work with the human value to society of the worker’s output. These examples appear to give government a very large role, in levying taxes and supplying subsidies. While one of the cases discussed (that of financial management) suggests a money flow toward government, in the form of taxes, the other cases (of child-care and the production of art) imply significant subsidies from government to individuals or (possibly) families. If governments are not to pile up impossibly high debts, there will need to be some equalization of the flows to and from government. Working this out is a huge project, which will not be attempted in this paper.

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