If You’re So Smart Why Ain’t You Rich?

In a recent post James Joyner riffs off an article in Atlantic:

It’s possible for a function to simultaneously be essential to society and yet require relatively little skill to accomplish. That’s true of the mundane tasks we all perform to keep our households running and those required to keep our stores stocked. In any industry, there are jobs that require more skill, experience, and talent to do well than others.

I see no problem with acknowledging this reality or in seeking to ensure that people who would like to find work that’s more well-paying or meaningful are equipped with the skills necessary to do so. The problem, as Lowrie suggests, is the inference that those who lack particular skills are therefore lesser citizens, unworthy of dignity and respect.

Both pieces are such jumbles of fallacies, misunderstandings, and misconceptions, I thought I needed to try to explain why. For 48 hours I’ve been trying to organize my thoughts and I thought I’d give this approach a try. Wages are determined by a variety of factors including:

• Supply and demand
• Profitability/return on investment
• Cost of entry
• Substitutability
• Credentials/requirements
• Subsidies
• History
• Luck

Those aren’t all of the factors but they are important factors.

Supply and demand

Strong in the discussion of skills and compensation is the notion of “true worth” or “inherent worth”. Those are fantasies. What are real are supply and demand. People will pay what they can for things and beyond that, regardless of other considerations, they will not pay. Trying to compare two different goods or services and trying to determine their value relative to each other based on their costs of production or some assessment of their comparative social value is a futile pastime.

Profitability/return on investment

How profitable a sector is has implications for wages in that sector. Highly profitable sectors will always have higher compensation rates than low margin sectors like retail or hospitality.

Cost of entry

By this I mean what the ante is for a job, how much you need to spend to secure the job. Some jobs have very high costs of entry. The practice of medicine, for example, has an entry cost anywhere from a half million dollars on up but some jobs have even higher entry costs. For example, if you want to be assured of a job at Goldman Sachs, it will be very expensive and, in all likelihood, your parents will need to have made the right decisions for you since before you were born. There’s a sort of pipeline that runs through exclusive private schools, to Ivy League schools, to top business schools for your MBA, ending in jobs in the financial sector. While it’s possible to get that gold-plated job without having been in the pipeline the odds are against it.

Substitutability

Substitutability is a term of art in economics meaning the ability of goods or services to be replaced by another good or service in use or consumption. It isn’t pointed out frequently enough but in most jobs how well qualified you are for the job or how well you perform the isn’t nearly as important as how many others could perform your job. Compensation is based less on your performance than on the performance of others who may only resemble you superficially. There just isn’t that much difference in pay between the most highly credentialed, most skillful burger-flipper at McDonalds and the least credentialed or least skillful.

Credentials/requirements

While credentials, prerequisites, requirements, and licensing may ensure that people are actually capable of doing the job, they also serve to raise the cost of entry and limit the labor supply.

Subsidies

The effect of subsidies on wages is easily explained by basic supply and demand. If you constrain the supply of something and subsidize its consumption, its price will increase—the subsidy increases willingness to pay by removing some of the discipline imposed by pricing. A lot of jobs these days are subsidized, either directly through government payoffs or indirectly via regulations or both.

History

History is an important determinant of wages, too. I’ll give an example. For the first century of so of public education most public school teachers were single women. For a variety of reasons including sexism and the belief that, since single women were not expected to be able to support a family, their wages were kept low. That began to change about a half century ago and in many places, viz. Chicago, it’s no longer the case but the fact remains that teachers were starting from a very low base for historical reasons.

Luck

I returned, and saw under the sun, that the race is not to the swift, nor the battle to the strong, neither yet bread to the wise, nor yet riches to men of understanding, nor yet favour to men of skill; but time and chance happeneth to them all.

Ecclesiastes 9:11

Luck is an important factor, too. An uninformed reading of that is that it’s all luck; a more informed one is that luck plays a part.

Let’s consider some scenarios as illustrations of these factors at play. From the Atlantic piece:

At a strip-mall Korean restaurant, I caught a glimpse of the kitchen and stood dumbfounded for a few minutes, watching a guy slicing garnishes, expending half the energy I would if I were doing the same at home and at twice the speed. The economy of his cooking was magnetic. He moved so little, but did so much.

Being a prep cook is hard, low-wage, and essential work, as the past year has so horribly proved.

That’s a great illustration of a number of the factors. However necessary the hospitality sector is, it operates at notoriously low margins, the cost of entry to work in them is essentially zero, the requirements for the job are few, and you can be replaced at any time by an ever-growing number of competing job-seekers. It makes little difference if you’re the greatest prep cook or busboy in the world. You can still be replaced by someone who can do a barely adequate job and there are lots of them. There’s a handful of very highly compensated chefs but most of the cooks are poorly paid and the most skilled prep cook is unlikely to make a lot more than the least. It’s basic supply and demand.

Here’s another example, from James’s post:

LeBron James, a Black man whose formal education ended in high school, made more money, by orders of magnitude, than I, a white man with a PhD, will make in my entire lifetime, by the time he turned 19.

529 players work in the National Basketball Association, a $9 billion industry. There are a million and a half college professors in higher education nearly all of whom have doctorates which brings in about $600 billion/year. Do the math. $17 million/player in the NBA; $400,000/professor in colleges and universities. Those are the upper limits of what can be paid were the entire proceeds to be paid to the workers. To get a job playing in the NBA you need to have skills. To get a job as a college professor you need a doctorate.

Now let’s try to piece all of these things together. I think there’s dignity in all work and supporting yourself and your family. It doesn’t matter to me whether the work is digging ditches, stocking shelves, or being a neurosurgeon. They’re all respectable and deserving of respect. Unfortunately, many people in today’s United States don’t think that way. They only look to how much money you make and your conspicuous lifestyle. There’s nothing I can do about that. There are people who make scads of money but are shmucks. I don’t particularly respect them but there are lots of Americans who do. Nothing I can do about that either.

When I say someone is “unskilled” what I mean is that they do not have valuable marketable skills. See above for an explanation of what those are.