Wages: Power or Productivity?

Most modern economists find the discussion of a "Just Wage" to be problematic because they believe that wages are regulated by a formula of the "natural law" the gives each "factor" of production (land, labor, and capital) its fair share of the output. This involves a basic misunderstanding of what the natural law is, but I will leave that question for a later post. The formula is called "marginal productivity," and it is supposed to fairly allocate rents, wages, and profits among all the players. It is built on the principle of marginal utility, where things are valued "at the margins," as it were. Marginal utility is a fairly reliable physical principle. Think about being thirsty. A glass of water would have a certain value to you. But a second glass would be less valuable, and a third glass would have no value at all. As it marginal unit is added, the usefulness declines and finally disappears. When marginal utility (in the form of marginal productivity) is applied to incomes in a free market, the theory states that wages, rents, and profits will not merely be fairly allocated, but will actually be "normalized" to each other; that is, the entrepreneur or rentier will not make that much more than the worker. In other words, there would not be great differences between the rich and the poor.

I will here leave aside the question of whether a purely physical principle can be generally applied to human relations; suffice it to say that the utilitarianism that is at the base of all neoclassical economics found this a useful principle, given their rather limited understanding of the human person. There are a lot of problems I could point out with the formula (and you can read my book on that question), but here I will deal with just one question: Is it productivity or power that is marginalized? Are workers under this formula rewarded for what they do, or for the power they have--or do not have? We may ask, "Does the CEO earn 500 times more than the line worker because he produces 500 times more or because he has 500 times more power? Does the seamstress in a sweatshop in Dacca make a pittance because she lacks productivity or because she lacks power? Have the wages of most workers stagnated because their productivity has stagnated or because their power has stagnated?"

If we look at the data, the pretensions of MP are hard to justify; actual events--and actual wages--better fit the idea that MP rewards power, not productivity. The productivity of average workers has stagnated in the face of dramatic productivity increases. Moreover (as John Bogle points out in his book The Battle for the Soul of Capitalism) a new class of uber-managers has sprung up with takes to itself rewards that more properly belong both to investors and workers. But if the data better answers our question with power rather than productivity, we should ask why?

In truth, wages are set in a negotiation between employer and employee. But in any negotiation, it is power that will be the decisive factor. Workers with skills that are in short supply are likely to get a premium, while workers with more easily available or replaceable skills will have little bargaining power. Further, as Adam Smith pointed out, the employers can hold out for a longer period of time, and most workers find it difficult to with-hold their labor while waiting for a better offer.

Of course, the best test of any theory is the internal test, the test that theory imposes on itself. And the test for the proper functioning of MP is normalized wages, profits, and rents. But clearly, the formula fails this test; wages and profits are NOT normalized to each other, and there are great differences in wealth and poverty, differences which are growing, not narrowing. So clearly, this formula fails its own test. Moreover, the more "free market" a market claims to be, the greater these differences become. Clearly, something is wrong with the theory. And the mistake is this: there is nothing in the mathematics that says what, precisely, is being rewarded at the margins. And all the clear evidence we have points clearly to something other than productivity; that thing is power.

When people are rewarded for their power and position rather than their productivity, the social fabric is weakened, and the economics no longer works. Societies run-up unpayable debts in a constant effort to prop-up demand. Indeed, if we stopped playing the debt game, both the government and the economy would fail. If, for example, the Chinese stopped lending a billion $/day, the Feds could not pay their considerable bills and the trade deficit could not be financed; and if we did not continue to borrow and live beyond our means, there would be an immediate failure of demand. The failure to rationally distribute incomes means a failure to have a rational economy; instead we have one mired in government intervention and debt at every level. Therefore, the question of distributions (the very question at the heart of Distributism) is, and has always been, the most important question for economics. It was naive of the neoclassical economist to believe that a mere mathematics could solve the thorny problems of human justice. The loved the formula because it was easy, while justice was hard. But thinking about justice is a lot easier than trying to fix an economy mired in injustice.