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Three Ways In Which Workers Might be Underpaid

In my latest column for AIER I distinguish three ways in which workers might legitimately be said to be underpaid. Here are my opening few paragraphs:

There are three ways that a worker – call him Joe – can legitimately be said to be underpaid. One way – the way that is identified in modern economics textbooks – is for Joe’s pay (wage plus fringe benefits) to be below the value of his marginal product (“VMP”). If Joe is one of four janitors employed by Acme Inc. and is – like his co-workers – paid $70 per day, Joe is underpaid if his daily contribution to Acme Inc.’s revenues is more than $70. Call this kind of underpayment “Strict Economic Textbook” underpayment.

A second way for Joe to be underpaid is if he’s willing to work at a better job at which an employer offers to employ him, but coercion is used to stop him from taking that better job. Suppose Aunt Esmerelda’s Pizza Emporium offers to employ Joe at $75 per day and Joe accepts. But neighborhood thugs immediately threaten to cage Aunt Esmerelda if she employs Joe. She withdraws her offer of employment. Joe is stuck in his current job. He is here underpaid, even if in his current job his pay is equal to the value of his marginal product. Call this kind of underpayment “Denied the Best Option” underpayment.

A third way for a worker to be underpaid is for that worker to be forcibly or fraudulently prevented from improving his or her marketable skills. Suppose that Joe was, because of his religion or skin color, not allowed to attend college. As a consequence, Joe winds up working as a janitor. Even if Joe’s wage as a janitor equals the value of his marginal product, and even if he is today not prevented from accepting other job offers, Joe can legitimately be said to be underpaid.

In the current period Joe is not technically underpaid. That is, Joe isn’t underpaid according to the strict economic meaning of the term: his pay equals the value of his marginal product, and employers are allowed freely to compete for his services. But stepping back to examine the processes that operated over time we see that Joe, by going to college, would have increased his skills but was forcibly stopped from doing so. As a result Joe is stuck today with fewer skills and, thus, with lower-paying employment. Joe is here, in a real sense, underpaid despite the fact that today’s labor market is operating just as it should. Call this kind of underpayment “Kept Less Skilled” underpayment.