Stephen Monrad

As I envision it, allowing different jobs to have different wage caps doesn’t change the fundamental idea that workers are being paid based on effort instead of output. The increased wage caps for some jobs just makes it easier to deal with the fact that some jobs are more appealing than others.

I also don’t envision the difference in wage caps to be that significant. I’d want the highest paid people in the economy to only be paid 2 or perhaps 3 times the standard wage. More than that can’t really be justified in terms of providing incentives.

Rock stars and basketball players would only get 2 or 3 times as much as ordinary people, not orders of magnitude higher pay.

People don’t get frustrated with low pay, they get frustrated with pay that is low relative to pay other people they know get. The question isn’t “Am I getting fairly compensated for the work I do?” The question is “Am I getting paid fairly compared to what others are getting paid?”

I was working for the government and was furious when other people doing similar work to me managed to get a promotion before I did. I thought that I was actually doing better work than some of the people who got the promotion. The funny thing is that I was angry even though the promotion wasn’t that big. It only amounted to a couple of thousand dollars a year. It wouldn’t make a material difference to my life.

I was angry because I didn’t think it was fair.

It is okay to pay people different amounts so long as there is a good story to explain the differences. It doesn’t have to be a great story, it just has to be plausible. It’s okay to pay higher wages to people with more skill, seniority, responsibility, or talent. There are plausible stories for why these people deserve higher pay. What won’t fly is to pay your friends more than your acquaintances or people with blue eyes more than people with brown eyes.

I’m not saying that paying different wages to different people is a good idea. It only makes sense in terms of other ends, such as providing incentives. If different pay levels are going to be used, though, I think it is more important that there is a good story to explain the differences than to get the magnitude of the differences exactly right.

My new approach of setting different wage caps for different job classes creates room for incentives which is good. However, it also creates a big problem: how should the wage caps be set?

I still think it is too difficult to try to measure the value of what people produce. The caps need to be linked to something else.

Another problem is that there are too many combinations and permutations of job responsibilities to try to classify all jobs individually. Simple rules would need to be used.

If we focus on the problem of incentives, the problem might be more manageable. Let’s assume that all jobs get the same standard pay range as the default. Equal pay for all fails when people refuse to do work for one reason or another. The way to determine which jobs need bigger incentives and thus higher pay caps is to look for jobs that are difficult to fill.

Instead of setting higher caps on a job-by-job basis, the factors that make it hard to fill jobs should be identified. Common sense and a little data analysis should yield results. Right off the top of my head, I expect higher pay caps would be needed to attract people to jobs that:

• involve shift work,
• are dangerous,
• require training where the cost is borne by the employee,
• are located in isolated communities,
• are unpleasant (smelly, hot, cramped),
• involve added responsibility (I’m less sure about this one), or
• require long work hours.

One solution would be to develop a long list of factors like this, find ways to measure the degree of the problem, and then assign a wage cap increase that jobs with the characteristic get. If a job has multiple negative factors, the cap increases could simply be added together.

How big should the cap increases be? That’s ultimately an empirical question. If the caps aren’t high enough, the problems attracting workers will remain. If the cap for a job is too high, there will be fierce competition to get the job. Either way, there will be clear signals that something is wrong.

Fortunately, I think our lack of rationality actually works in our favor in this case. People aren’t looking to be precisely compensated for the extra burdens of difficult or unpleasant jobs. I believe that the important thing is that there is a pay benefit for doing unpleasant work. The magnitude of the benefit isn’t all that relevant.

While idealistically I still support the idea of equal pay for all, it may not be achievable in the real world. I’d be happy if there was a decent minimum wage that paid enough to keep people out of poverty.

If the goal is to control inflation, there is no particular reason to pay everyone the same wage. All that is needed is to prevent a general creeping increase in wages across the economy.

The only way to prevent increases in wages when the economy is close to full employment is to regulate them. Someone, somewhere needs to write down maximum allowable salaries for different jobs. If every job has the same maximum, inflation will eventually push everyone up to the maximum and we would be back to the equal pay for all scenario.

The person responsible for setting wages, then, will need to set different maximum wages for different jobs. There could be many different reasons for setting higher maximums for some jobs. Right now, I’m just going to assume that the maximums are set somehow and are enforceable.

What I envision is an economy with a decent minimum wage that all workers must receive. Each job or job class has a maximum wage that is at least somewhat higher than the minimum wage. The difference creates room for the use of pay incentives.

The result would be a system where temporary bouts of inflation and deflation could occur when wages move up and down between the minimum wage and the maximums established for each job class. This type of inflation couldn’t get out of control. Prices would therefore not have to be kept in check by strong competition.

What I imagine would happen is that wages would tend to hover near their maximums when the economy is close to full employment. If a disruptive shock to the economy causes it to falter temporarily, wages could fall as the ripples of the shock spread through the economy. With proper interventions by government, the downturn would be only temporary, full employment would be restored, and wages would again rise close to their maximums.

I’ve spent a lot of time blogging about value and pricing without reaching any clear conclusions. Right now I want to drop back and remember why I am so concerned about prices in the first place.

The problem with letting prices be set by market forces is that they tend to rise when the economy is close to full employment. This much is clear and uncontroversial. What I want is to find a way to control prices directly so that the economy can be run at or very close to capacity without causing inflation.

My solution was to focus on pricing the inputs labor, raw materials, and capital in a sensible way. I would then build the prices for goods and services based on the labor, raw materials and capital used to produce them.

I still think that focusing on the prices of inputs is the right place to start. There are far fewer inputs to worry about than outputs.

What I want to do at this point is to consider less egalitarian approaches to setting prices for labor, raw materials, and capital. If we want full employment, we can’t let the prices be set freely. However, there may be ways to set them where more variation can be allowed. The egalitarian approach was appealing to me. There may, however, be better pricing mechanisms for inputs that can provide better incentives.

Suppose we want to pay producers based on the value of what they produce. I think there is a fundamental problem. Nobody really knows what things are worth.

People aren’t rational. We aren’t good at putting numbers to things. We aren’t even that good at arithmetic often. I think it is unrealistic to expect people to be able to do anything more than guess at an order of magnitude value for the things they buy.

I believe that our intuition about fair prices is based mostly on recent history. If apples cost a dollar yesterday, it’s okay for them to cost a dollar today. A dollar feels fair because we are used to paying it. I believe we convince ourselves that an apple is worth a dollar when we really don’t have a clue. We are just making crude comparisons to yesterday’s prices.

Given stable prices over a long enough time period, I think we could convince ourselves that apples are “worth” anywhere from 20 cents each to $2 each.

While it might be nice to pay people based on the value of what they produce, I would want to see at least moderately objective way for establishing value first.

This post follows on my last two posts. You should start with my post on September 27th.

It seems clear that the best outcome is for everyone who needs it to get the cure. The remaining question is who should benefit. At one extreme, everyone who is cured could be forced to live at subsistence level handing any surplus income over to the inventor of the cure. The other extreme would be for patients to pay nothing.

I don’t think there is any clean answer for how to divide up the benefit. The inventor can claim that the invention is his and others have no right to it. He should be able to extract as much money as he can from selling it.

The patients could argue that it is just bad luck that they got sick. They could argue that it costs the inventor nothing to give them the cure. It is unjust to make them pay large sums unnecessarily.

The mainstream economics approach of letting the market set the price so markets clear doesn’t work in this situation. The inventor has a monopoly. Competition is not present.

There is no objective or rational answer.

The likely real-world outcome would be that the inventor would become very wealthy, but would not manage to extract the whole value of the cure. How much the inventor extracts will depend on the legal system in place and the tolerance of people to put up with a high price for the cure.

My feeling is that the price should be kept low and the inventor should only be modestly compensated. The inventor should have compassion for others and not take excessive advantage of his good luck.

This is a follow-up on yesterday’s post about a hypothetical miracle cure for cancer.

If the hypothesized cure is practically free to produce, denying sick people the cure doesn’t benefit anyone. The sick person dies. The inventor doesn’t avoid any effort. The world would be unambiguously a better place if the sick person were given the cure.

The question of how many cancer patients should be cured is trivial. They should all be cured.

The real question is how to divide up the benefit of the cure between those who are cured and the inventor.

Any fixed price is a problem because there will always be some people who need the cure but can’t afford the fixed price. The best solution would be to have a price that varies depending on people’s ability to pay. While a system like this would be difficult or impossible to administer, it is theoretically interesting.

What if cancer patients were expected to pay a fixed fraction of their future income as payment for the cure? If this was still too onerous on the poor, the fraction could increase as total income increases.  This system would ensure that the cure is affordable for everyone.

If the inventor is greedy, he could still earn billions of dollars by setting a high fraction for middle and high income patients.

A fraction of income system like this makes more sense to me than a fixed price. There is, though, still the problem of how high to set the fraction.

Suppose you have a flash of insight and discover a way to cure cancer. This idea pops into your head out of nowhere with little or no effort on your part.

To make this simple, let’s assume that your cure uses common food stuffs so you don’t have to go through a protracted drug approval process. As a hypothetical example, let’s assume that you can cure cancer by drinking a mixture of grapefruit and mango juice. To further simplify the process, let’s assume that the cure is 100 per cent effective so that there is no need for trials or fancy statistical analysis. The success of the cure is overwhelmingly obvious.

The benefit you would bring to humanity would be enormous. What should you be paid for your new cure?

I’m going to assume for now that we want to pay you based on the value of what you have produced. The effort was essentially zero so there is no need to think about it at all.

If there was somehow a way to prevent people from copying your simple cure without paying you using a patent of some sort, we could use markets to determine what your cure is worth.

The next best option for many cancer patients would be death so their willingness to pay is going to be quite high. It would be reasonable to expect to be able to charge every patient you cure several thousand dollars. Since there are millions of cancer patients, you could expect to earn many billions of dollars from your cure through the market mechanism.

Is it reasonable to set a price of, say $5,000 per cured person? The people who are cured would definitely receive $5,000 worth of benefit. For a few month’s salary in rich countries, people would avoid a slow and painful death.

There is a possibility that if people are provided with a way to live above the poverty line without working, they won’t work.  They might choose to take the path of least resistance through life sitting on their butts watching daytime TV.

If this turns out to be the case, the idea of providing a decent minimum income would be unworkable. It may not be possible to raise people above the poverty line with handouts.

Instead, ways would need to be found to make sure that everyone can find a regular job. Ultimately, it is probably better to provide people with jobs than with handouts.

This makes me think of the English proverb “Give a man a fish and you feed him for a day; teach a man to fish and you feed him for a lifetime.” What people really need is the ability to meet their own needs.

The role of the economy is to connect the things people need to actions they can take today, right now.