What determines wages

by Russ Roberts on May 25, 2006

in Standard of Living, Wal-Mart, Work

What determines wages? Some say that a nation should strive to acquire high-paying jobs if it wants a high standard of living. In this view of the world, jobs are boxes that workers jump in and out of. Each box has a bar code that determines how much the job pays. The goal is to get a good box with a high wage attached to it.

An alternative view of the world is that the bar code is on the worker’s forehead.  The worker gets scanned not the job.The wage depends not on the job title but on the skills of the worker.

This sounds like an irrelevant semantic distinction—after all, workers with lots of skills are in high-paying jobs. But I think the distinction keeps you from making errors of reasoning about the source of prosperity.

For example, the bar code-on-the-box view of wages worries about outsourcing and technological change because these often destroy high-paying jobs. The bar code-on-the-forehead view of wages (the one I think is correct) embraces outsourcing and technological change because they create wealth. The workers that are displaced will use their skills somewhere else.

In the box view of the world, Haiti can get rich by creating its own pharmaceutical industry because chemists are well-paid. In the forehead of the world, Haiti gets rich when its people acquire knowledge.

I was thinking about this listening to a podcast by Douglas Baird on Coase‘s theory of the firm. (I’m halfway through it and really enjoying it other than Baird’s aside  describing the Coase Theorem.)

Baird points out that one of the obsessions of Henry Ford was to improve the precision of the parts of a car sufficiently so that unskilled people could assemble a car. When the parts were not machined precisely, there was a highly skilled highly paid worker called a fitter who was able to get the imperfect pieces to mesh. 

So was better precision a good thing or a bad thing? In the box view of the world, it was bad. America lost the high-paying jobs, the jobs for fitters. But in the forehead view of the world, the world where wages depend on human capital (skill, knowledge and knowhow), Ford’s improvement was good for the world. By finding a more efficient way to make cars, wealth was created. The people who were once fitters went on to do new things, new things that were possible partly because people now had more resources available that were once spent on assembling cars.

In the box view of the world, another reason that Ford’s innovation was bad was that it created a lot of unskilled jobs, the jobs on the assembly line that paid less than the fitter jobs. But in fact, Ford increased the demand for low-skilled workers, so if anything, those workers also benefited.

The box view of the world thinks the existence of Wal-Mart impoverishes America because it causes the creation of low-paying jobs. In fact, Wal-Mart is good for low-skilled workers because Wal-Mart, just like Ford, has found a way for low-skilled workers to be productive in a profit-making enterprise. That increases the demand for low-skilled workers and makes them better off.


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