It Looks Like Lots of Workers Aren’t Paid What They’re Worth

(Bloomberg Opinion) -- Are you paid what you’re worth? How about other people? This might sound like a simple question, but it’s actually incredibly complex and difficult to answer. Yet the answer may figure in the very stability of American society.

There is a theory in economics that says that workers get paid their marginal product of labor. This means that an employer pays a worker exactly the amount of money it would lose by firing that worker. The logic is intuitive — if a worker earned less than her marginal product, some other equally efficient company could make a profit by hiring her away. If she earned more, some worker with similar skills would come in and offer to do the job for less.

There are lots of ways that this theory could be wrong. It obviously assumes that markets are both extremely competitive and fluid — there’s always another company waiting to scoop up underpaid workers, and another worker waiting to replace the overpaid. In reality, employers have a lot of market power — economic research consistently finds that the fewer employers there are in an area, the less workers in that area get paid. Because it’s difficult and expensive for a worker to switch jobs, employers can afford to pay them less than their marginal product.

So it’s likely that many employees are paid less than the amount of revenue their work generates for their company. But it’s not all bad news for workers — there are some reasons companies might want to pay workers more than their marginal product contributes. For example, as Henry Ford famously discovered, giving workers higher pay can make them work more efficiently.

In reality, these and other distortions of the imaginary perfect market probably exist all at once, and each one probably affects different workers to varying degrees. But what does the data say? The question is difficult to answer, because it’s very hard to actually know how much revenue a company would lose by firing an individual. Simply comparing average wages with average productivity, as many do, won’t give you the answer — the same people who make that comparison probably also believe that chief executive officers tend to be overpaid.

There is research from the 1990s that suggest men get paid 10 to 20 percent more, relative to the value they add, than women do, suggesting gender discrimination. More recent research measuring the effect of unexpected worker deaths have found that revenue goes down by more than compensation, suggesting that workers tend to be underpaid.

So there’s reason to believe that wages tend not to line up with the economic value a worker adds to a company. But this is only one of many reasons to suspect that workers aren’t paid what their worth, because a worker’s real value goes way beyond the revenue she generates for a company.

Economic theory recognizes many reasons why the monetary value of various activities isn’t equal to its true value to society. A low-paid scientist laboring in a dusty research lab finds a way to save millions of lives, but never gets paid for the discovery. Schoolteachers’ salaries may not reflect the value of having a workforce that can read and write, and doctors don’t necessarily get paid more when they cure communicable diseases.

Meanwhile, there are plenty of ways people’s monetary value to a company can exceed the true social value of what they do. The top executive at a coal-fired power plant gets paid a lot even if people get lung diseases from the smoke his company belches into the air; the medical bills don’t come out of his paycheck, nor does any of the damage from global warming caused by releasing carbon. Bank employees can be overpaid if investors systematically make mistakes that cause them to buy those banks’ exploding financial products. Private-equity managers can be overpaid if tax breaks allow them to make money by saddling companies with unaffordable debts. The list goes on and on.

What happens if society starts believing that these distortions are large? What happens when scientists, teachers, factory workers and cashiers decide that their compensation doesn’t match their contribution? And what happens when they look at their peers in the finance or energy or defense industries, or in executive positions, and decide that those people are overpaid?

It’s hard to say what might happen, but it’s likely that the results won’t be good. Large-scale resentment could lead to a drop in morale that causes people to be less productive at their jobs. There could be social and political unrest, as everyone starts calling for their own occupation to be subsidized and for others to be taxed. That could produce political chaos as the various factions fight it out.

In other words, even though the question of whether workers are paid what they’re worth is incredibly hard to answer definitively or even with any generality, it’s important for economists and policy makers to keep asking it, and keep trying to tweak the system so that compensation is more in line with contributions. The alternative — a system that everyone increasingly believes is unfair — is not a happy one to contemplate.

To contact the editor responsible for this story: James Greiff at jgreiff@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Noah Smith is a Bloomberg Opinion columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.

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