Wage inequality in the United States is at an all-time high. According to a frequently cited Congressional Budget Office Study, between 1979 and 2007, the top 1% of wage earners increased their income by about 275%. And in 2012, while incomes of the wealthiest 1% rose 20%, those of the remaining 99% rose only 1%.
The most common and probably the most broadly accepted theory for why these wages rose so precipitously revolves around marginal productivity. In any market — free or otherwise — wage earners will always bargain up to, but cannot bargain beyond, their last marginal dollar, the dollar beyond which an employer will say “you are this productive, but not a dollar more productive.” Should the employer then pay the employee one dollar more, the cost of hiring that employee would be greater than the earnings she or he brings in, and that employee would fall outside or beyond his or her marginal productivity.
In his study of Capital in the Twenty-First Century, Thomas Piketty argues that the dramatic increase in wage disparity since 1970 cannot be explained by any theory of marginal productivity (1) because the differences in skill levels of the top centile and the remaining top decile of managers is inconsequential; (2) because comparably skilled and equipped managers of equally productive companies in France and Germany earned incomparably less than their US counterparts; and (3) there is no demonstrable relationship between performance and earnings such that the increase in earnings could have been justified on the basis of increased performance or productivity (Piketty, Capital, chapters 9-10).
Piketty therefore credits the wage disparity to cultural factors, not to actual shifts in marginal productivity.
And, yet, if we follow Piketty’s argument, it could lead us to conclude that prior to 1970 or roughly from 1914 through 1970, when the capital-income ratios in all the world’s leading industrial nations declined to all-time lows, wages were based on marginal productivity. And it is this claim that deserves closer scrutiny.
As early as 1870, I would argue, when the “marginalists” shifted economic modeling away from the classical land-labor-rent-money-interest paradigm and toward a new paradigm that treated all factors as simply so many margins seeking aggregate equilibrium, economists recognized that the value composition of any of these factors was relative to each and all of the other factors within markets where the short-term values of all factors were recognized to be in constant flux. The value of any commodity, therefore, let’s say corn, at any market, on any given day, would bear a stronger relationship to long-term changes in transportation costs, climactic changes, migratory patterns, changes in international taxation, and so on, than it would, say, to the amount of labour time at any given wage devoted to each unit of corn on sale at the market. As the father of neoclassical theory, Alfred Marshall, noted in 1890: “The value of a thing, though it tends to equal its normal (money) cost of production, does not coincide with it at any particular time, save by accident” (Principles, Book V, Chapter 7, page 401).
This is because the relationship that any good bears to its value is a social relationship, however, which, although also cultural, is much more general than its cultural value. To appreciate this distinction, we might consider the wage difference between a migrant laborer in the central valley of California and a skilled line worker at Toyota. Let us say that the wage differential between the two is 50 to 1. And let us say further that this differential can be accounted for, as above, on the basis of marginal productivity. But what does this mean?
Let us assume that the bunch of grapes that I purchase at Andronico’s for $3.00 returns $2.95 for transportation, distribution, rent, and profits for the employer of the migrant laborer, leaving $0.05 for the laborer; which, I think, is a very generous estimate. Now, let us suppose that for an equivalent unit of the finished Toyota, a worker at the Toyota plant could claim $25. Presumably, the worker in the central valley field enjoys just as much or greater intelligence, skill, manual dexterity, and so on, as the Toyota worker. And, yet, presumably the market for Toyotas differs somewhat from the market for grapes. Would anyone pay $25 for a bunch of grapes? Almost certainly not. And, yet, if you did, the migrant laborer would then be pulling in a salary and benefits, caeteris paribus, comparable to the Toyota line worker. Fair enough.
But, someone will doubtless note, the grape worker needs a basket, a truck, plenty of water, latrines, health facilities, and so on, while the Toyota line worker is laboring on a line worth billions of dollars whose cost must, like the migrant laborer, be covered by his or her marginal productivity. To which someone else should reply: but the grape picker is working just as hard or harder; to which someone else should reply: but there is a large gap in the cost of training, etc., etc.
Certainly one way to capture the different variables contributing to these different wage structures is to look at the factors themselves and their costs. But, except at the margins, this is not at all the way that neoclassical modeling works. The way that neoclassical modeling works invites us to consider the marginal returns on the $3.50 bunch of grapes, the $4.00 bunch of grapes, the $7.00 bunch of grapes, and so on. Could employers of migrant laborers charge $7.00 for a bunch of grapes they surely would. But at some price — presumably close to $3.00 per bunch — the employer begins to see declining marginal returns. So that the actual wage, $0.05 per bunch, is determined by the socially agreed upon demand price of the bunch of grapes, plus the socially agreed upon supply price of the employer; that is to say, the amount per bunch below which the employer says the she or he is seeking a new line of business, minus the marginal wage of the employee.
But, in each of these cases, the margins are socially determined. That is to say, they have very little to do with the actual costs of production, except at the margins. We agree upon them together, socially, collectively, through our sales and purchases.
Returning then briefly to our question of wage inequality, why do super-managers earn 500-1000% more than their employees? They earn that much, first, because these sums still fall under or within the marginal costs of their product. Second, they earn these sums because shareholders have concluded, perhaps rightly, that a sum less than these amounts will bring super-managers to market themselves elsewhere. And, third, they earn these sums because, socially and politically, they can. For we can clearly imagine social and political circumstances under which those who earn these sums would be accused, as Piketty puts it, of being caught with their hands in the tills, especially given the difference between their wages and the low end of the wage scale in their firms. Yes, this is cultural. But it is more than cultural. It is social.
Moreover, it has always been social. Even when top wages were not so out of line with average wages.
Power differentials are always social. And they are always political and cultural as well. But this means that our economic modeling, which tends to overlook the social, the cultural, and the political, must itself be taken as a social and cultural artifact, reinforcing or contesting norms and practices whose “objectivity” is constituted in practice.