Thomas Piketty, talent management consultant

A couple of weeks ago, I wrote about a talent management consultant helping companies recruit and retain employees, which is apparently a challenging problem. Thomas Piketty, in Capital in the Twenty-First Century, offers a different perspective. According to Piketty, employers can pay whatever they choose:

What is in fact the justification for minimum wages and rigid wage schedules? First, it is not always easy to measure the marginal productivity of a particular worker. In the public sector, this is obvious [why? because government workers don't exhibit any productivity?], but it is also clear in the private sector: in an organization employing dozens or even thousands of workers, it is no simple task to judge each individual worker’s contribution to overall output. To be sure, one can estimate marginal productivity, at least for jobs that can be replicated, that is, performed in the same way by any number of employees. For an assembly-line worker or McDonald’s server, management can calculate how much additional revenue an additional worker or server would generate. Such an estimate would be approximate, however, yielding a range of productivities rather than an absolute number. In view of this uncertainty, how should the wage be set? There are many reasons to think that granting management absolute power to set the wage of each employee on a monthly or (why not?) daily basis would not only introduce an element of arbitrariness and injustice but would also be inefficient for the firm.

In particular, it may be efficient for the firm to ensure that wages remain relatively stable and do not vary constantly with fluctuations in sales. The owners and managers of the firm usually earn much more and are significantly wealthier than their workers and can therefore more easily absorb short-term shocks to their income.

This justification of setting wages in advance obviously has its limits. The other classic argument in favor of minimum wages and fixed wage schedules is the problem of “specific investments.” Concretely, the particular functions and tasks that a firm needs to be performed often require workers to make specific investments in the firm, in the sense that these investments are of no (or limited) value to other firms: for instance, workers might need to learn specific work methods, organizational methods, or skills linked to the firm’s production process. If wages can be set unilaterally and changed at any moment by the firm, so that workers do not know in advance how much they will be paid, then it is highly likely that they will not invest as much in the firm as they should.

[emphasis added]

Employers apparently are not constrained by the possibility of their workers choosing to work for someone else, choosing to stay home with family and/or collecting government-provided Welfare benefits, etc. Nor do employers have to pay about the same or a little more than other employers in a region if they want to attract workers.

It occurred to me that I actually do know employers who live in this world: elite universities. Harvard University can get bright hard-working well-educated people to come work as researchers and teachers at whatever wages it offers, even $0. Presumably that is true of the institutions where Piketty has studied and taught. Thus the employer’s world that he paints is the world of Academia that he knows. People get paid so much in prestige and the social fun of interacting with other smart people that they are happy to work basically for free.

Because all employers, as least as far as Piketty can tell, are able to get people to come work for whatever wage they choose, central planning is critical, with wise government officials setting wages:

In the United States, a federal minimum wage was introduced in 1933, nearly twenty years earlier than in France.5 As in France, changes in the minimum wage played an important role in the evolution of wage inequalities in the United States. It is striking to learn that in terms of purchasing power, the minimum wage reached its maximum level nearly half a century ago, in 1969, at $1.60 an hour (or $10.10 in 2013 dollars, taking account of inflation between 1968 and 2013), at a time when the unemployment rate was below 4 percent. From 1980 to 1990, under the presidents Ronald Reagan and George H. W. Bush, the federal minimum wage remained stuck at $3.35, which led to a significant decrease in purchasing power when inflation is factored in. It then rose to $5.25 under Bill Clinton in the 1990s and was frozen at that level under George W. Bush before being increased several times by Barack Obama after 2008. At the beginning of 2013 it stood at $7.25 an hour, or barely 6 euros, which is a third below the French minimum wage, the opposite of the situation that obtained in the early 1980s (see Figure 9.1). President Obama, in his State of the Union address in February 2013, announced his intention to raise the minimum wage to about $9 an hour…

Britain introduced a minimum wage in 1999, at a level between the United States and France: in 2013 it was £6.19 (or about 8.05 euros). Germany and Sweden have chosen to do without minimum wages at the national level, leaving it to trade unions to negotiate not only minimums but also complete wage schedules with employers in each branch of industry. In practice, the minimum wage in both countries was about 10 euros an hour in 2013 in many branches (and therefore higher than in countries with a national minimum wage). But minimum pay can be markedly lower in sectors that are relatively unregulated or underunionized. In order to set a common floor, Germany is contemplating the introduction of a minimum wage in 2013

it seems likely that the increase in the minimum wage of nearly 25 percent (from $7.25 to $9 an hour) currently envisaged by the Obama administration will have little or no effect on the number of jobs. Obviously, raising the minimum wage cannot continue indefinitely: as the minimum wage increases, the negative effects on the level of employment eventually win out. If the minimum wage were doubled or tripled, it would be surprising if the negative impact were not dominant.

the best way to increase wages and reduce wage inequalities in the long run is to invest in education and skills. Over the long run, minimum wages and wage schedules cannot multiply wages by factors of five or ten: to achieve that level of progress, education and technology are the decisive forces.

In other words, Piketty has no idea at what hourly number the minimum wage should be set, or why Germany and Sweden have lower-than-American-wage-inequality without any minimum wage at all, but he assumes that if the government is setting wages then the number is going to be optimal. How well have the central planners in France managed the minimum wage?

The substantial increase in French inequality between 1945 and 1967 was the result of sharp increases in both capital’s share of national income and wage inequality in a context of rapid economic growth. The political climate undoubtedly played a role: the country was entirely focused on reconstruction, and decreasing inequality was not a priority, especially since it was common knowledge that inequality had decreased enormously during the war. In the 1950s and 1960s, managers, engineers, and other skilled personnel saw their pay increase more rapidly than the pay of workers at the bottom and middle of the wage hierarchy, and at first no one seemed to care. A national minimum wage was created in 1950 but was seldom increased thereafter and fell farther and farther behind the average wage. Things changed suddenly in 1968. The events of May 1968 had roots in student grievances and cultural and social issues that had little to do with the question of wages (although many people had tired of the inegalitarian productivist growth model of the 1950s and 1960s, and this no doubt played a role in the crisis). But the most immediate political result of the movement was its effect on wages: to end the crisis, Charles de Gaulle’s government signed the Grenelle Accords, which provided, among other things, for a 20 percent increase in the minimum wage. In 1970, the minimum wage was officially (if partially) indexed to the mean wage, and governments from 1968 to 1983 felt obliged to “boost” the minimum significantly almost every year in a seething social and political climate. The purchasing power of the minimum wage accordingly increased by more than 130 percent between 1968 and 1983, while the mean wage increased by only about 50 percent, resulting in a very significant compression of wage inequalities. The break with the previous period was sharp and substantial: the purchasing power of the minimum wage had increased barely 25 percent between 1950 and 1968, while the average wage had more than doubled.20 Driven by the sharp rise of low wages, the total wage bill rose markedly more rapidly than output between 1968 and 1983, and this explains the sharp decrease in capital’s share of national income that I pointed out in Part Two, as well as the very substantial compression of income inequality. These movements reversed in 1982–1983. The new Socialist government elected in May 1981 surely would have preferred to continue the earlier trend, but it was not a simple matter to arrange for the minimum wage to increase twice as fast as the average wage (especially when the average wage itself was increasing faster than output). In 1982–1983, therefore, the government decided to “turn toward austerity”: wages were frozen, and the policy of annual boosts to the minimum wage was definitively abandoned. The results were soon apparent: the share of profits in national income skyrocketed during the remainder of the 1980s, while wage inequalities once again increased, and income inequalities even more so (see Figures 8.1 and 8.2). The break was as sharp as that of 1968, but in the other direction.

Piketty’s perspective on the supposedly absolute power of employers to set wages reminds me of conversations that I have had with American academics. They love their jobs, which to them are like daily cocktail parties stuffed with interesting people. This leads them to disagree with anyone who suggests that higher tax rates will result in people working fewer hours (despite a huge quantity of research by fellow academics showing precisely this correlation, e.g., this NBER paper, a Forbes summary of a 2006 paper). They’d go to work for free, so even a 100% tax rate wouldn’t discourage them!

An academic was fuming about income inequality on Facebook, passionately supporting Barack Obama’s proposals for new laws, taxes, and regulations. After reflecting on his wife’s millions of dollars of earnings from writing fiction, I emailed him privately:

This seems like a tricky idea when you look at people in different fields, e.g., what kind of income disparity should exist between myself (computer programmer/helicopter instructor) and Justin Bieber (singer?)? But it should be easier when comparing people who do the same thing, e.g., all programmers.

But then I thought about your peculiar situation. You are married and therefore your household income includes that of your wife (cc’d). Your wife is a fiction writer. The median income of a fiction writer is $0 (since more than half can’t get anything). It is hard to think of an occupation where there is a greater and crueler disparity of income as well as non-economic benefits (fame, readership, satisfaction). How far does your advocacy of greater equality go? Would you support a higher tax on Judy’s [name changed] income so that fiction authors currently earning $0 per year were able to receive something for their work? Will you say that Obama needs to take action to stop Judy from receiving a $1 million advance for a book when there are novelists who’ve been working full-time for 30 years who cannot get published at all? Or who receive only $5,000 as an advance?

So how does an advocate for income equality go home to a woman who works in a field that has more income inequality than almost any other?

The wife (also a PhD) wrote back

Your example about my income is pretty specious. For one thing, I take issue with your cited median income of a fiction writer. I could just as easily say that the median income of a computer programmer is $0, since we have to account for all those people who take computer programming classes but who can’t go on to get jobs as computer programmers. The market rewards writing as it rewards computer programming, I would think. Skill plays a part, but so does timing, connections, and sometimes luck. In actuality, the median advance for a work of fiction from a Big Six publisher is about $50,000. Do people write fiction who can’t get published (or paid)? Sure. But if they’re not paid, then they’re not professional fiction writers. They are avocational fiction writers. There are avocational singers and computer programmers too. Is it unfair that most fiction writers get advances of 50K when a select few command six or even seven figures? Yes, it is. But the entertainment industry is increasingly structured on a blockbuster system that shrinks from risk.  …

Solving income equality isn’t about figuring out what the average wage should be for a given field. It’s about raising median wages on the whole so that anyone who has a job is able to support him or herself by doing that job. It’s about creating incentives to support industries that will generate well-paying jobs for more people, rather than incentives for financialization and consolidation in industries (like tech) that employ fewer people than manufacturing once did. And it’s about people giving from each according to his ability, to each according to his need, which a graduated income tax ensures.

[emphasis added]

To me the bold-faced sentence above is the most revealing. Academics love their jobs and might well pay the university to keep them. It doesn’t bother them that someone would enjoy a comfortable Welfare-funded home-based lifestyle for decades. What does bother them, however, is if a person goes to a job that they don’t love and yet still does not earn enough to enjoy a comfortable lifestyle.

Authors tend to write what they know. Even when an author has a PhD in Economics, what he or she knows about employer-employee relations is mostly in fact about employer-employee relations at top universities. But Harvard, Yale, MIT, and Princeton are in a much stronger position relative to workers than is Walmart and the employee experience of a teacher/researcher at a university is different than the employee experience of a worker at a Walmart store.

 

 

10 Comments

  1. henry

    May 22, 2014 @ 11:10 pm

    1

    Obama’s latest tax increase on “the wealthy” cost me over $100,000 this year. I worked for several decades at roughly six different startups, and when one of them finally succeeded with a ‘liquidity event’, my options converted to cash involuntarily and were taxed as ordinary income (as an ordinary engineer, I did not have the pull to structure a complex tax deal at the start of employment for this eventuality).

    So the payoff for me came in the form of a giant salary for one year, which is now taxed at close to 50%. So there goes a large chunk that could have been used for retirement, paying the mortgage off, paying the kids college. That seems like a really efficient way to discourage people from working for risk-taking new enterprises. Unintended consequence of Obama trying to stick it to the rich people, in order to make political advantage for the Democratic party? You decide…

  2. Matt Henderson

    May 23, 2014 @ 6:19 am

    2

    So much of this — from both your citations from Piketty’s book and your email discussion with your friend — reminds me of the episode from Milton Friedman’s “Free to Choose” series where he warns against setting equality of outcome as the objective, rather than equality of opportunity.

  3. philg

    May 23, 2014 @ 8:38 am

    3

    Henry: A friend of ours from MIT is on a presidential panel for encouraging entrepreneurship and posts pictures on Facebook of herself with Obama. I asked her if she didn’t think it was ironic that a president who presided over an increase in federal capital gains tax rates from about 15 percent to 24 percent (20.25 to 29.25 here in Massachusetts) was struggling to think of ways to encourage startups. Her reply was simply to deny that tax rates had any effect. Entrepreneurs were born to start companies so they would do it regardless of the after-tax reward. I said “Well, what about investors? Wouldn’t an increase in the capital gains rate make them more likely to prefer alternative investments to venture funding, e.g., the S&P 500?” Again, she simply denied that this was a conceivable factor.

    Reasoning in the abstract, I think that she is wrong and I am right. Given the tenuous business plans that are getting funded right now for stratospheric valuations, despite the higher tax environment, I think the empirical evidence suggest that she is right and I am wrong.

  4. Anthony

    May 23, 2014 @ 10:12 am

    4

    Phil, I just wanted to point out that when PIketty says its obvious that the value of public sector employees cannot be measured, he’s making an Austrian argument: that without prices and sales figures it’s impossible to know what the government’s services are worth, and if you don’t know what the total pie is how can you divide that value among the workers?

  5. Dick Kusleika

    May 23, 2014 @ 10:16 am

    5

    Raising capital gains tax isn’t going to reduce the number of startups to zero. It’s not binary. But what if the number of startups fell by 10%. Or what if the growth rate of new startups went from 20% to 10%. These are real losses.

    It’s irresponsible to say that entrepreneurs were born to found startups. Yes, some will do it regardless of the tax. But if you dissuade just enough of them, the economy and the country is worse off.

  6. Vince

    May 23, 2014 @ 1:35 pm

    6

    In other words, Piketty has no idea at what hourly number the minimum wage should be set, or why Germany and Sweden have lower-than-American-wage-inequality without any minimum wage at all…

    I don’t think that’s fair. Unions, which he mentions in your excerpt, are stronger in Germany. The strong unions are probably part of the explanation for the lower inequality. From what I’ve read, German CEOs are not paid anywhere nearly as well as American CEOs. The financial sector is probably also smaller in Germany than in the US and the UK. If you were able to ask Piketty, he might mention those facts are causes for the lower German inequality. In fact, if he discusses Germany much in the book, those issues may be covered.

  7. Vince

    May 23, 2014 @ 2:12 pm

    7

    Henry: I think that the lapsing of the Bush tax cuts caused tax rates to go up 5%, maybe a bit less, on salary income over $400,000. So you must have made, what, around 2½ million last year? Good for you.

    As Phil writes, there do seem to be a vast number of people willing to work for or invest in new, risk-taking companies in the hope that they’ll have at least one year when make a million bucks.

    I saw an article in the National Review claiming that Obama’s taxes and regulation will kill risk-taking deter people like Bill Gates and Steve Jobs from starting companies. The writer didn’t realize that those two guys started their companies in the dreaded 1970s, when marginal tax rates on high incomes were much greater and a number of industries, such as the airlines, were more highly regulated.

  8. Anonymous

    May 23, 2014 @ 3:11 pm

    8

    philg: Tenuous business plans getting funded for stratospheric valuations could be one symptom of increasing inequality (too much money at the top chasing too few investment opportunities).

  9. George

    May 23, 2014 @ 3:33 pm

    9

    Vince: taxes have gone up in ways other than the increase in marginal income tax rates. Medicare tax rates have increased from 2.9% to 3.8% on income over $200k. And personal exemptions and itemized deductions have been limited once you cross the $250k income threshold. So the total impact is more than the 4.6% increase in the top marginal tax rate, and the impact is felt well before you get to the $400k income level.

  10. Tom

    May 23, 2014 @ 3:40 pm

    10

    “… Prof Piketty, 43, provides detailed sourcing for his estimates of wealth inequality in Europe and the US over the past 200 years. In his spreadsheets, however, there are transcription errors from the original sources and incorrect formulas. It also appears that some of the data are cherry-picked or constructed without an original source.” (and more)

    http://www.ft.com/cms/s/2/e1f343ca-e281-11e3-89fd-00144feabdc0.html#axzz32Z08Ouqt

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