And the parting on the left is now the parting on the right

I appreciate Marx and Engels more and more over time (although I assure you I am not on the verge of becoming a Marxist!): while they weren't happy with the then current social system, they were scathing about utopians who had not even bothered to understand classical economics and yet were proposing fairy-tale fixes for what ailed the world.

I would like to resurrect Engels in particular to unleash his sarcasm on Matthew Hutson of Slate, who seems to think market prices should be arrived at by measuring some objective fact about two things offered on the market, and then making sure their price ratio reflects that measured ratio:

"But a quick look at the data shows the limitations of raw smarts and stick-to-itiveness as an explanation for inequality. The income distribution in the United States provides a good example. In 2012 the top 0.01 percent of households earned an average of $10.25 million, while the mean household income for the country overall was $51,000. Are top earners 200 times as smart as the rest of the field? Doubtful. Do they have the capacity to work 200 times more hours in the week? Even more doubtful."

Oy! If you are .00001% smarter than me, but that additional .00001% allows you to improve a production process in a way that saves millions of dollars, you very well may be worth 200 times more on the market than me. Michael Jordan's shooting was not "200 times" as good as mine, but I was worth nothing to a professional basketball team, while Jordan was worth millions.

Even in the "imaginary construction of the pure market economy," even if we add to it the imaginary construction of the "evenly rotating economy," factors of production are not paid based on how many "times" more of something they have than some other factor: they are paid according to their marginal value product. On the margin, someone a wee bit smarter than me might be worth a heck of a lot more than me.

Certainly, we are in a less-than-ideal world: the point is, even a "perfect" market would not function anything like Hutson thinks it should. Can't someone get Krugman or DeLong to write Slate and tell them to get economic columnists who know something about economics?

8 comments:

  1. Okay, this is something that I have struggled with for awhile. I think that guy's column is stupid, but it just does not make sense to me how labor derived income (wages) could be very, very different. (say, more than two orders of magnitude.) Every such massive discrepancy of return would seem to invite competition and entrepreneurship - - basically a reorganization of the production structure to alleviate the discrepancy. A persistent, stable massive wage difference would seem to imply a market restriction. And every such practical example I see people give seems to come with just that - - professional athletes from sports cartels, CEOs and such from various centralizing tendencies that that artificially reduce the number of firms competing for top business talent, inventors from patents, etc. Which is fine - - I can accept that a 'true free market' is just some hypothetical thing, so this stuff exists and it's not really such an enormous deal. But I just can't see how a marginal difference of utility/value product can account for a massive price discrepancy without some intermediating force that restricts the availability of competing positions. I can certainly see how it happens with restrictions in place, though.

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    1. Yes, Scott, I'm not clear on what puzzles you here.

      Let's say you have a company with 100,000 employees each making $100,000 per year. (Just making the math simple!) I come to and say "What if I can make each employee 1% more efficient? Will you split the increased revenue with me?"

      If I can do what I say, I stand to make $50 million. Why does this seem inexplicable?

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  2. Hi Scott,

    Isn't it the case that there are a limited number of CEO slots across Fortune 500 companies? Why is this different from the sports team scenario?

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  3. Gene --

    There is nothing inexplicable -- the stratospheric income depends upon market restrictions. From your example I see two market restrictions -- 1) there is only one company, and 2) there is only one idea (yours). Which is why it works out the way you say (though I don't think in reality it would work out that way.)

    If there were not only one such company, (say ten or a hundred,) the idea would be worth vastly more than $50 million. The owner could buy your idea from you, borrow at the market rate, buy up capital and 'retool' it (per your instructions) and make above the market rate on his investment by eating into his competitors' market share. (But this strategy would not work if he could not restrict access to your idea. If he could not, the idea is worth nothing to either of you. Once the idea becomes known, the entire field will 'retool,' each in attempt to remain competitive, and the savings passed on to the consumer in the form of lower prices.)

    More realistically, I would imagine that once you approached the owner, he would hire a consultant or two, say me (a half-wit version of you). I would say, "Well, I can't save you 1%. Gene is marginally smarter than I am. But I can save you maybe 0.9% to 0.95%. And, I'll tell you what, I'll sell you the idea for only $1 million." The owner will happily take my offer, (and I'll be happy because $1M>>$0) and keep the remainder of the value for himself, probably investing it at the market rate of interest. You can grouse all you want, but the reality is that your only alternative is to approach another company. If there is no other company, or you can't persuade some capitalist to give you the capital to build a competitive business, too bad for you. And if he's paying 100K employees $100,000, I'm assuming that's a huge investment to make to maybe get a tiny fraction above the market rate. Too risky (there's your restriction). My activity as your competitor brings your income back down out of the stratosphere. Your genius has been commoditized -- you get only market wages. Only with restrictions do you get 'what you're worth.'

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  4. (cont'd.)

    Basically, the MVP is not something that is 'objectively' handed down out of heaven. It emerges out of the concrete facts of the bidding process. It is not just a matter of 'what the thing is worth to the buyer,' (demand) it is also a matter of scarcity (supply). Oxygen is also very valuable to this production process (if for no other reason than to keep the workers alive.) But because it isn't scarce, it earns zero income as a factor of production. You can only make these sweeping generalizations while certain assumptions hold. Once they stop holding, new forces start to overwhelm the picture (and different ways of looking at the problem become more useful).

    So, the ability to earn far above the normal rate of return ultimately relies on a market restriction of some sort. Yes, I know that the whole idea of property rests on the ability to restrict access to it, but as you move from owning something for which there are many buyers and sellers, to one for which there are only a few or one, new dynamics take over.

    (Note -- I feel kind of dumb regurgitating all this to you, because I know you already know it better than I do. But this idea of market restrictions I got from Thorstein Veblen, and I have neither found anyone who could refute it to my satisfaction or would support it who came from a knowledgeable perspective. In fact, almost nobody seems to want to touch it. I did, however, get an email from a friend of mine with a MS in business, who told me that this is exactly the strategy they taught him in business school -- screw your customers by restricting access, screw your suppliers by expanding access. You don't want to be operating in a 'free-market'. It is also what I tend to observe in real life. I would very much like to stop believing it, as I could go back to being a 'red in tooth and claw' Austrian instead of a rather compromised one. But while I do believe it, I can't have much sympathy for 'capitalists' who bash leftists for whining about 'inequality.' I don't agree with the leftists, but I also don't think you can say that 'the free market' produced that result, so suck it up and deal with it, crybaby. The gripe strikes me as somewhat legitimate, if not the solutions generally proposed.)

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  5. Marris --

    It is not different. My point is that they were similar -- a market restriction creates both situations.

    Generally -- you have so much consumer demand focused on, say, professional football (or widgets.) So much consumer income will be directed towards these wants. By keeping the number of teams low, the NFL diverts all of this income towards existing members. But it finds itself in competition with one another for the truly scarce factor of production -- the very best athletes. So all of the surplus income generated by the restriction flows to the players, and the owners are left earning the market rate on whatever capital they put in. So, the owners find it necessary to implement a salary cap to make sure that they get the extra income. If the number of teams were allowed to expand (or contract) freely, eventually there would be many more teams, and the owners and players would make far less (though the total income to 'professional football' would be the same). The existing owners only add teams as they think it will benefit themselves, and rely on the substantial barrier to forming a new league competitive with the NFL (as opposed to any individual NFL team) to keep the restriction in place. (I also observe that the simple fact that the number of teams is restricted totally changes the nature of the 'product'. My guess is that this is a big part of what turns sports into these all-consuming spectacles so many people obsess about. Anyway, I'm not really a sports guy, but all that's as it seems to me.)

    Same applies to 'the Fortune 500.' Each 'stage of production' is worth so much to the total production structure, with total revenues given by total consumer demand. If you've artificially restricted the number of actors in that stage, you divide that income by fewer actors (and therefore inflate their salaries). The corporations themselves wind up not making all that much more than the market rate. The surplus flows to the top talent on the boards, even when they are not really all that much better than the next guy who didn't quite get hired. With more companies, there would be lower salaries.

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  6. (I think the first part of my comment got lost in the ether --)

    Gene --

    There is nothing inexplicable -- the stratospheric income depends upon market restrictions. From your example I see two market restrictions -- 1) there is only one company, and 2) there is only one idea (yours). Which is why it works out the way you say (though I don't think in reality it would work out that way.)

    If there were not only one such company, (say ten or a hundred,) the idea would be worth vastly more than $50 million. The owner could buy your idea from you, borrow at the market rate, buy up capital and 'retool' it (per your instructions) and make above the market rate on his investment by eating into his competitors' market share. (But this strategy would not work if he could not restrict access to your idea. If he could not, the idea is worth nothing to either of you. Once the idea becomes known, the entire field will 'retool,' each in attempt to remain competitive, and the savings passed on to the consumer in the form of lower prices.)

    More realistically, I would imagine that once you approached the owner, he would hire a consultant or two, say me (a half-wit version of you). I would say, "Well, I can't save you 1%. Gene is marginally smarter than I am. But I can save you maybe 0.9% to 0.95%. And, I'll tell you what, I'll sell you the idea for only $1 million." The owner will happily take my offer, (and I'll be happy because $1M>>$0) and keep the remainder of the value for himself, probably investing it at the market rate of interest. You can grouse all you want, but the reality is that your only alternative is to approach another company. If there is no other company, or you can't persuade some capitalist to give you the capital to build a competitive business, too bad for you. And if he's paying 100K employees $100,000, I'm assuming that's a huge investment to make to maybe get a tiny fraction above the market rate. Too risky (there's your restriction). My activity as your competitor brings your income back down out of the stratosphere. Your genius has been commoditized -- you get only market wages. Only with restrictions do you get 'what you're worth.'

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    1. Scott, I wanted to let you know I find your thoughts above fascinating... I just have no time to think them through at present. I am working on two major papers and a couple of minor projects at once, and can't possibly devote the time I would need to really grapple with what you wrote above. I hope one day I can!

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