The Theory of Wage Rates 6

Why Different Workers Are Paid Different Wages

Summing up to this point: If we list the annual wages of all the workers in the economy, from lowest to highest, the resulting hierarchy simultaneously ranks every kind of employee on two different scales: (1) their relative scarcity and (2) their value to their employers. Workers with higher salaries are relatively more scarce than workers with lower salaries. Workers with higher salaries are valued higher by their employers than workers with lower salaries.

Consider, for example, a scientist working in the research and development department of a large corporation. The scientist contributes nothing to current output; he has no role in reducing current costs; he does not help market the corporation’s product, or improve corporate communications, or facilitate management control. His contribution is entirely prospective and uncertain. Yet management chooses to pay him a very high salary, perhaps on the level of a vice president. Why?

The fundamental cause is his scarcity value in the worker market for scientists of this kind. The corporation must pay him the money equivalent of his scarcity value in order to retain his services. Second, and equally important, management evaluates his work as essential to the survival of the company—because, while his contribution is prospective and uncertain, it is a certainty that the corporation will fail without him. Over the long run, without research and development, the quality of the corporation’s products will decline relative to its competitors and it will not survive.

The fundamental principle governing the creation of wages and salaries is that businessmen pay their employees what they must pay them in order to employ them. What they must pay them reflects the ongoing conditions of demand and supply in each worker’s particular worker pool—that is, the worker’s relative scarcity.

Then, given what he must pay the worker in order to hire him, the employer decides whether his long-run profits will be served by paying that price. If he thinks they will be served, he pays it; if not, not. There is not a whisper of any motive here other than rational self-interest.

Next time I will apply this theory to the explanation of some of the actual wages in the economy and answer these questions: Why are fast-food workers paid mostly minimum wages? Why is the income of divorce attorneys in New York City much less than that of attorneys with connections in Washington? Why is an NFL quarterback much better paid than an opera star? Who are the highest paid workers in the economy?