I hadn’t heard the Toyota-GM example before. That’s fascinating. I wonder if people realize they are paying more for exactly the same thing they could get elsewhere.

So we are at the crux of the problem I think. Competition is supposed to bring down excessively high prices. Does it manage to do so?

I think the answer is no. It is very difficult to compete with well established brands. Coke has managed to sell its colas at a premium for decades. There are cheaper generic brands. They don’t seem to make much of a dent in Coke’s market.

I agree that meeting the needs of the customer is what’s important. My problem is that I don’t think people are very good at assessing value. Customers want what they buy to be well made and to meet its intended purpose. The relative value of different well made items is difficult to determine.

What I want is to find a way to pay people fairly to produce well made products reasonably efficiently. If people need the product, they pay the cost of the materials and labor used to produce it.

There are a couple of interesting ideas in your comments. I think that in some situations it is possible to measure marginal output. Your example of the teenager mowing lawns is a good one. I still think it is tough to determine the value of the lawn cutting service though. I’m going to have to think more about exactly why I don’t think we can value things well. There will probably be more posts on value to come.

Your examples of writers and professional basketball players is interesting. Suppose the price did reflect marginal productivity and value accurately. There is still a big problem of fairness. Book writing and professional sports are scalable professions where one person can meet the needs of a huge audience. In professions like these, many people chase the big payouts. Most fail and do very poorly. What bothers me is that to find the Michael Jordon, we need masses of people to develop their skills before the talent becomes apparent. While Michael Jordon is the one who delivers the value, I don’t know if it makes sense to make him the big winner. I’ll think more about this and probably post more about it.

We’re getting a little off topic here, but what the heck.

Can you think up a job or an individual for which it IS possible to determine the value or marginal productivity? Let’s simplify it.

Let’s say a spend a year writing a book that costs me $5 to publish per copy and sells for $10 per copy (profit of $5 per book sold). If 100,000 people buy the book, presumably they each valued it at $10 or more. I would have made a profit of $500,000, which would be equivalent to my salary for the year to write the book. Would this be a “fair” salary?

How about a professional sports player? Michael Jordan was paid quite a lot. But he increased the value to people watching the NBA – lots of people who wouldn’t otherwise have watched would watch just to see him. He also increased the revenue and assets of the owners of the Chigago Bulls. I assume that the benefit he brought to the sport and to his team was shared amongst the relevant interested parties: Jordan himself, the Bulls’ owners, the other NBA teams (because he raised their profile as well), and the fans themselves because they got a product of higher value.

How about a teenager mowing lawns around his neighborhood? If he charges $10 per cut and cuts ten lawns per day, he makes $100 per day. If people think $10 is too much, they will either do it themselves, let their grass grow long, or try to negotiate a lower price. Is his $100 per day fair? Next, what if he doubles his productivity? It’s the same value to each person, but if he could cut twenty lawns per day, his salary would double.

If by getting wages right, you mean that people get paid their marginal product, I think it is clear that we routinely get them wrong. Here’s why.

First, it isn’t clear what the marginal productivity of a worker is. If it is what the loss would be in productivity if they weren’t there, there are problems. When people work in teams to achieve results, a missing member can make the team totally dysfunctional. A hockey team without a goalie isn’t much use. Trying to apportion the results of a team to individual members is tricky.

At a deeper level, I don’t think humans are very good at estimating value. We are okay with big differences; houses are more valuable than pencils. The finer details I think are mostly lost.

If wages aren’t connected to value in some fundamental sense, what are they connected to? I think the answer is nothing.

Wages are determined by a myriad of forces. Bargaining power is important. History is important.

The problem is that there is no objective right answer. If there isn’t an overall guiding principle for setting wages, sub-goals become important. I’m interested in equality. I believe the wages set by markets are unreasonably unequal.

If a company has a position available, they can offer it to the best-suited person. If that person doesn’t think the compensation, responsibilities, or environment are suitable, he or she doesn’t have to accept. If no one is willing to accept the position, the company will have to improve the offering until someone will accept it. This seems to allow market forces to act on the value of the position and the availability of people to do it.

There are a lot of jobs in which it is difficult to determine the “value” of the job, in particular public-sector jobs like teachers. However, for pure private-sector jobs in stable economies, I don’t see why unions are needed and I don’t see why the resulting salaries aren’t good approximations of the value of the job.

Eric