People on Third Base Claiming They Hit a Triple, or Marginal Product Theory at Work…Not!

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. To 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.


This has been reposted from Jared Bernstein's blog.