Wage differences and inequality

By Eric Crampton 25/07/2013 2

Late last week, Geoff Bertram, retired University of Victoria at Wellington economist, addressed a Wellington conference on inequality and there made a remarkable policy request. He asked that the government cease awarding contracts to companies where the highest-paid worker earns more than three times the lowest paid worker.

Economists vary in opinion on the amount of redistribution that should be undertaken. Those on the right, me included, tend to worry that we do great harm to longer run growth and thereby exacerbate poverty when we implement policies that exchange growth for current redistribution. Some on the left worry that not doing enough to address current poverty not only hurts poor people now but could also hurt longer run growth if we fail to help those at the bottom to achieve their potential. I’m not here going to get into the empirical literature on this question; I’m instead going to note the mechanism. Whether of the left or right, economists will most typically reckon that redistribution either to reduce inequality or to reduce poverty should be done through the tax system. Take money from the relatively rich and use it to give a bundle of money and services to the relatively poor.

Bertram’s mechanism is a bit different. He wants the burden of addressing inequality to fall within particular firms rather than to be handled through the tax system. It is …hard to sustain a case that this could be desirable.

Over at Offsetting, I pointed to some of the very very predictable consequences of this kind of a rule. For example, hospitals contracting with government now to provide services would either have to stop doing that (most likely), or increase the pay rates of the cafeteria staff so the cashier makes no less than one third what the top brain surgeon or anesthetist makes (blows out the budget), or cut the pay of the top brain surgeons and anesthetists to being no more than three times what a cashier makes (bye-bye anesthetists and brain surgeons, or at least the ones you’d trust to do that kind of work). If the rule doesn’t extend to government departments, it basically just bans government contracting – in which case, Bertram should have just said he wants to ban government contracting. If it does, then we blow out the budget or lose the brain surgeons from the hospitals.

At AntiDismal, Paul provides some empirical evidence on how rules of these kinds have played out at worker co-operatives. The most skilled don’t want to join those firms; even Mondragon had to wind up increasing the permissible pay gap.

Bill Kaye-Blake, in comments at Offsetting, noted another likely problem:

Yikes! I was Unplugged over the weekend so missed this. What Geoff doesn’t realise is that he’s calling for bad policy all ’round. The private sector will pay for better experts than the public sector and successfully rent-seek as a result.

Also, pay rates for consulting firms is a flexible concept. A shareholder employee could be paid three times someone else and also share in firm profits. How will we police that?

Matt over at TVHE called the proposal “disingenuous”; I think he was too charitable.

If you care either about reducing poverty, or about reducing inequality, the appropriate levers are the tax and redistribution system. Running this through firms, well, as far as I’m concerned this kind of advocacy is a terrible kind of posturing. The advocate of policies of this sort gets to enjoy the smugness, gets to bask in the adulation of those who do not understand economics, gets to pretend that the only thing preventing these policies from being implemented are those awful fat cats, and gets all of it at zero cost because there is no chance a government would be daft enough to implement it. But the longer term cost is that it increases public stupidity about economic policy by short-circuiting debates around inequality and poverty. Here’s a magic box that would fix things! If only they’d implement my magic box!

2 Responses to “Wage differences and inequality”

  • You say:
    “Those on the right, me included, tend to worry that we do great harm to longer run growth and thereby exacerbate poverty when we implement policies that exchange growth for current redistribution.”

    One doesn’t usually see “right wing scientists”. But there is no doubt there are scientists who are right wing. But could one suggest that a “real” a scientist HAS to be, first, neutral. To consider the facts before them, coming up with a theory that can be used to predict, eg, that the rocket will get to the moon.

    Does an economist fulfill that criterion if one first takes the step of defining their prior philosophical state?

  • I like to think that I’m a scientist first on the facts of the world. The facts of the world will establish the real-world cost of achieving various policy ends, whether or not you agree with those ends.

    Pure scientists can easily disagree about the appropriate amount of redistribution: two people can look at a good (current period poverty reduction) and decide differently on whether the policy solution (redistribution) is too high or too low at the current existing margin.

    I spend a lot of my time trying just to push us onto the science frontier, ruling out policy solutions that are simply impossible.

    One of the things I like about curating Dismal is that I’m bringing together feeds from folks that I know span the left-right space, but who put the science first when it comes to describing the actual tradeoffs faced in the world. Good economists of the right get pissed off about stupid economics on the right because while they can be used in folk econ policy pushes to get towards particular policies, they do so disingenuously and in a way that cannot then be sustained. So if you sell a tax cut on that it’ll actually increase tax revenues based on too-strong an interpretation of Laffer’s results, you’ll have damaged the case for improving longer-term growth rates via tax reform. Similarly, good economists of the left will get angry about bad arguments around income inequality because the policy solutions that flow from those bad econ arguments are often at the cost of rather more effective potential policy solutions.

    Just getting us onto the efficient frontier is a pretty big ask.