Two weeks ago, John Kay was arguing in the Financial Times that the orthodoxy on wages might be deficient. Here is how he describes the status quo:
101 teaches that earnings reflect marginal productivity. The wage
equates supply and demand for each type of labour, just as the price of
other commodities equates their supply and demand...[T]o set the earnings of any group at a level above the market rate is
not only to reduce employment for that group but to undermine economic
What is the alleged flaw in this textbook approach? The world is so "complex"...:
modern production is undertaken in teams, and the make-up of an
effective team is largely fixed by the nature of the production process.
It is difficult, perhaps impossible, to attribute output meaningfully
to any particular member. Individual rewards are largely determined by
custom and hierarchy. And through a political process involving
bargaining between shareholders and employees and among different groups
This is all pretty unsurprising: workers complement one another and politics sometimes intervenes in the wage-setting process. The implication of the first fact should be that it would be hard to determine theoretically what any one worker should earn and that we should leave that determination to the willingness of employers - who get to practically test that worker's contribution in the context of their respective work teams - to bid for the worker's services. Knowledge is complex and decentralized and prices should therefore be set directly by the market. Conversely, this implies that a political wage-setting process that sets the same wage across many firms might be unable to fully account for these complexities as it excludes any practical consideration of what the worker's productivity is in the context of the specific team and workplace that he is hired into. Leaving this complex calculation of marginal productivities to the employers most immediately concerned via the market wage for individual workers should get us as close as possible to an efficient allocation of workers into the work teams that Kay mentions. Thereby we can maximise productivity and then we can use redistribution, perhaps via lump-sum transfers, to ensure that the fruits of this efficient process are given to those we deem deserving in a manner that does the least damage to the underlying productive process, right?
But John Kay, agreeing with UK Labor Party leader Ed Milliband, seems to draw the exact opposite conclusion:
Wouldn’t it be simpler if poor people in work were just paid more in the first place? That is, apparently, predistribution.
To recap: he argues that it is very complex, even for the employers of the workers in question to figure out what their marginal productivity really is and political distortions make this even harder. And the answer is to abandon market wages and rely on an even more politicized process led by people who have even less of an idea what the productivity of the workers is? Oh, and while you're at it, wages can only go up not down as a result of that process! Unless you're a chief executive that is, because although this is all really "complex", we are very certain that those guys have "excessive earnings", because...well, John Kay says so.
So we would like to make most labor more expensive while making sure that global talent is less well-paid than elsewhere. Sounds like the secret formula for a healthy labor market and strong growth, doesn't it? Just look at Germany in 2003!