“We’ve had it wrong for a long time,” my friend Francis Franks told me at lunch in his school’s cafeteria.
“For generations,” he continued, “economists tried to explain how the pie is sliced … how much goes to labor and how much to capital, the resources used to produce the goods and services exchanged in the marketplace.”
“Good tuna salad,” I managed to say.
“They do a decent job here,” he acknowledged. “But how much will workers get of the price you paid for that sandwich? How much will go to the school that built this building, put in the kitchen equipment and bought the bread and tuna?”
“Good questions,” I muttered.
“Good?” he exclaimed. “Those are essential questions economists must answer. Particularly now, with debates about income distribution in our society, as top executives get bigger pay checks, bigger slices of a slowly expanding pie.”
“I thought we settled that over a century ago,” I said.
“So did I,” he responded. “Yet the debate is intensifying. We were taught a simplified model of the economy where all labor was the same. Then, the pay for each worker was determined by the value of the product the last worker added to the total revenue of the firm.”
“Yes,” I agreed, “undifferentiated labor and the value of the marginal product. I remember it well.”
“Too well,” Francis sneered. “We all know workers have different skills, different work habits and different experiences. Therefore, they differ in their contributions to the company. That’s why there are differences in paychecks.
“It was easy to teach about a simplified world. However, our students are out there now, using our oversimplified representation of the world as a model for how the world should be. And the government produces statistics that are based on our elegant but misleading ideas.”
“What are you saying?” I said.
“This won’t be popular,” he said, “but could the wide difference in pay between the top and the bottom actually be based on differences in skills, experience, knowledge, work habits and so forth?
“Maybe top managers get paid for their knowledge, connections and skill in surviving under highly competitive conditions.
“They earn their rewards by knowing when it is best for the company to purchase new equipment, when to hire or lay off workers.
“They understand the best timing of a bankruptcy that saves some jobs, sacrifices others and wipes out the investments made by shareholders and lenders. The game is survival, not responsibility for the interests of others.
“We talk about the knowledge economy, the need for workers to have skills, the value of experience and good work habits, but we don’t have the means of evaluating these characteristics.
“What we do have is a very poor tool called ‘labor productivity,’ a catch-all concept that has little meaning in our highly differentiated world.”
He paused. I told him, “Better eat up before the thought police catch you.”
Morton Marcus is an economist, formerly with the Indiana University Kelley School of Business. Send comments to firstname.lastname@example.org.