The Theory of Wage Rates 7

Why Different Workers Are Paid Different Wages

The Theory Applied to Alternative Wage Rates

M. Northrup Buechner

[The full context for this blog is posted on my website:  objectiveeconomics.net.]

Now let us apply this theory of wage rates to some real cases, both historical and current.

An increase in demand for workers of a particular type relative to the supply represents an increase in relative scarcity. This is the typical experience of many industries coming out of a recession. When it happens, the wages of those particular workers rise.

A decrease in the supply of workers relative to the demand also represents an increase in relative scarcity. This seems to be a much less frequent occurrence. An historical example: historians estimate that the Black Plague killed between one third and two thirds of the European peasants. This created an enormous increase in the relative scarcity of labor, and wages rose. The result was one hundred years of what may be called the golden age of the European peasantry.

A decrease in demand relative to the supply represents a decrease in relative scarcity, and wages fall. This is most likely to happen at the beginning of a recession.

An increase in supply relative to demand also represents a decrease in relative scarcity. The wage increases following the Black Death increased the average life span, so more people lived to adulthood and had more children. Within a hundred years, the population increased to the point that wages fell back to the level preceding the Black Death.

Now let us consider the wages of different occupations in terms of the relative scarcity of their members. The most widely known minimum wage employees are fast-food workers. Why are they paid a minimum wage? Because, although the work is hard, almost anyone can do it. Thus, if the wage rises above the minimum level, more workers will enter the field, increasing the supply of fast-food workers, reducing their relative scarcity and therefore their wage.

A good divorce attorney in New York City may earn $400 an hour. Why does he get so much more than fast-food workers? Because the supply is much smaller. Many fewer people can do what he does than can prepare fast food. On the demand side, there are many wealthy people in New York, and when they get divorced, they need, and can afford to pay, high–quality divorce attorneys. Divorce attorneys are much more scarce than fast-food workers.

On the other hand, an attorney with political connections in Washington may get $1000 an hour, because such attorneys are much more scarce than divorce attorneys, and in greater demand.

The scarcest employees in the business world are CEOs. Out of the world’s population of approximately 7 billion, there may be, perhaps, 50,000 people who would be able to run a major corporation. By my calculation, $3000 an hour seems to be a fair estimate of the hourly wage earned by a CEO making $10 million a year.

But CEOs are not the scarcest workers in the economy. Much more scarce are quarterbacks who can play professional football. Casual observation suggests that there are probably less than ten who excel at their work. I estimate that their hourly wage comes to about $10,000 an hour.

Great opera singers are certainly as skilled and dedicated and rare as professional quarterbacks, but they make much less. Why is that? Because the number of people who are eager to pay to watch professional football is many times greater than the number of people who will pay to hear great opera. In other words, professional quarterbacks are relatively much more scarce than professional opera singers.

Finally, there are the scarcest of all the workers in the economy, the true superstars, the highest paid workers in today’s free market: movie stars. Again, casual observation suggests that they may make as much as $100,000 to $1,000,000 an hour.

Suppose the government decreed that the pay rate for NFL quarterbacks and opera stars had to be the same (because they are equally skilled and dedicated and rare). Or that CEOs could not be paid more than ten times the wage of their lowest paid employee. Or that a lawyer with connections in Washington could not be paid more than a good divorce attorney. In other words, suppose that wages were not allowed to reflect relative scarcity. What would happen? We will take up that question next.