People on third base claiming they hit a triple, or marginal product theory at work…not!

July 3rd, 2015 at 12:01 pm

One of the less defensible assumptions of microeconomics is that people get paid their “marginal product,” i.e., their wage equals the value of the output they produce. Thus, according to the theory, if the last worker hired is being paid an hourly wage less than the value of the firm’s output per hour, if would make sense to hire additional workers and vice versa, to the point where the value of the last unit of output equals the wage.

Now, it would be unduly persnickety to insist that this formulation holds exactly, and there’s certainly solid evidence that wages correlate positively with education, so the theory isn’t completely batty.

But it is way too easy to find egregious exceptions, as in this article for this AMs WaPo about the earnings and income of Jeb Bush and his family.┬áTo be clear, this is a non-partisan rant, as it’s extremely easy to find e.g.’s of people of all political stripes being paid in ways that have little to do with their marginal product.

But the article does an excellent job of taking you through the interaction of how Bush cashed in on his public service, brought his family along for the ride (as in added them to the payroll), gamed the tax code (by writing off generous pensions and compensation packages), with little evidence of “marginal product.” EG, there’s the part about advising Lehman which…um….arguably didn’t turn out so well.

Now, the boneheaded response to all this is that by assumption, he (and somehow his wife and kid) were being paid their marginal product, because if they weren’t, then they wouldn’t have been…paid their marginal product, that is (that’s supposed to be word salad, just to be clear).

But, in fact, that’s often what we hear, and beyond, “really?…seriously??” it’s hard to disprove unmeasurable assumptions (we can “back out” productivity outcomes in the case of the Lehman collapse, but that’s rare).

Some notable research, such as the work on financial markets by economist Thomas Philipon, finds that the sharp rise of compensation in that sector has not been match by productivity gains, while it quite nicely tracks financial market deregulation, clear evidence of rent-seeking versus marginal product.

No question, skills and your ability to contribute to firm output often plays some role in pay setting. But here’s what else matters, and increasingly so as you go up the pay scale, and even more increasingly so in our era of heightened inequality: power, connections, your race, your gender, and vast amounts of money in politics and policy.

What’s more, those who benefit from the arrangement just described love to cite the “rules” of economics and markets, like marginal product, to fend off the justifiable disbelief with which such self-aggrandizing BS should be met.

In other words, cutting through the theory, there are a lot of people out there who were born on third arguing that they hit a triple. Do not believe them. Most of them never even swung a bat.

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10 comments in reply to "People on third base claiming they hit a triple, or marginal product theory at work…not!"

  1. Tammy says:

    Happy Independence Day! Have a wonderful weekend with family and friends. Thanks for all you do for our country, Jared Bernstein.


  2. Martin Norred says:

    “Most of them never even swung a bat.” And would be deeply offended if asked to! (Mostly because that would expose their extensive deficiencies!)


  3. dwb says:

    Well, productivity is extremely hard to measure.

    What if he is being paid his marginal product? That is the truly sadder story: Connections are extremely valuable when it comes to lobbying and consulting. Sometimes when it comes to government contracts and the like, the rules are so arcane, you have to hire someone who knows the rules and the people reviewing the proposals, so you know how to write them. The same principal unfortunately applies to tax laws and many other things.

    Of course, if we try to simplify the rules and make them transparent, too many organizations from government employee unions to consultants have a vested interest in the status quo.

    It is hard to measure marginal product in the service industry. But, people do not hand over hard earned money for nothing. So, you should consider the alternative that maybe lobbyists and consultants actually are getting paid for what they produce.


    • Dausuul says:

      Way to dodge the point. Please explain how, for example, Carly Fiorina was being paid her marginal product at HP. (She should have been giving *them* money.)


      • dwb says:

        Saying “people/CEOs are not paid their marginal product” is not the same as saying “people/CEOs are paid their marginal product, I just don’t like the product.”

        Most people who claim CEOs are not paid their marginal product just don’t like the product. If you think you have a better way to run a company, nothing is stopping you.


  4. Philip George says:

    No one would dispute that in a market where apples are sold there is something called a consumer surplus, i.e. in the aggregate consumers need to pay less for apples than they are actually willing to pay. Why then is it difficult to believe that in the market for labour too there is a consumer surplus except that in this case the consumers happen to be capitalists?


  5. dilbert dogbert says:

    Decades ago my late wife, a CPA, told me of the wide range pay for same type positions in the small businesses that were her clients. I expect large companies have less of a range for low level positions but at or near the top marginal product is a hoot.


  6. Smith says:

    There is a lot more to wage determination of high income earners and how they deviate from efficiency or market determined rates than the factors cited above,
    “power, connections, your race, your gender, and vast amounts of money in politics and policy”
    None of those factors account for a mechanism perhaps implied in the description, which is the previously existing inequality which is a prerequisite to allow the evolution of greater inequality. Power is also so all encompassing as to have limited value in analysis. There are factors like education and the cost of education missing from the short list. Tax policy is also not secondary even though it acts as a brake vs enabler, or did in the leveling 1940s 1950s era. Social acceptance, acquiescence of the pay structure, and the reasons for this, is not the same as power. Not just power, but the concentration of power is also a factor. Power in changes to law, labor law, rights, and just new practices to skirt around exploitation prohibitions, like internships, and outsourcing, etc. The things needed for the rich to reward themselves excessively are 1) the money has to be available, not taxed away or given to workers for productivity gains, 2) they have to have the structure to extract the money. Hedge fund compensation is not just about the carried interest loophole, but the whole concept of a hedge fund as a way to get super rich. That’s just one example.

    Also there are self-made men and women, not born rich, not born on third base, who are rewarded beyond any rational marginal product. Their power and example are perhaps more important than even the second and later generations.


  7. purple says:

    Bush’s marginal product is his connections and pull.


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