Can We Pay Everyone The Same Salary? (Newsletter 037)
I suspect you've already thought of several reasons why paying everyone the same salary would be suboptimal. We'll explore those reasons in a moment. Before that, let's explore a few important concepts that come up in discussions of what we pay people for working.
First is median household income. Half of households will earn less than this amount, and half more. The US Census Bureau tells us that in America in 2020, the median income was $67,521, a drop from the 2019 figure of $69,560. These figures are a snapshot across all U.S. households, so represent a mix of very different households and people in those households. Not surprisingly, nonfamily or single person households have something less than half the income of family households.
And what effect do you think the level of educational attainment has on household income? This chart from the Census Bureau illustrates well the dramatic impact of education on earnings (see Median Household Income chart for further details):
Next up is the minimum wage. In the U.S. the federally mandated minimum wage is $7.25/hour, although many States require a higher wage, up to $15/hour in California. Is working full time at the minimum wage enough to satisfy one's needs? In answering this question, we start by comparing earnings to the federal poverty threshold to determine whether people are able to afford basic needs. The 2020 poverty threshold for a four-person household is about $26,500. Two adults working full-time at the federal minimum wage would exceed the poverty threshold, but not by much.
Some people argue that the poverty threshold is too stingy, and that if we take into account costs beyond basic needs, people need to earn more than the minimum wage, or a so-called living wage. What is a living wage? It obviously varies depending on where one lives. Although there is a lot of discussion about this, MIT's Living Wage Calculator estimates that the average U.S. living wage should be $16.54/hour, which translates into an annual income of $68,808, assuming two adults working full-time.
With this background, let's turn to the discussion proper. As we do, I urge you to keep an open mind. Even when we hold strong beliefs, leaving open the possibility that we may be wrong allows us to learn new information and have better interactions with others. I discuss this in one of my ACC Docket articles this week:
Alert readers will have noticed that the recommended living wage slightly exceeds today's actual median household income. This raises some interesting questions. Is it possibly the case that fully half of U.S. households are today earning below a threshold that represents a "living wage?" That is certainly possible, although looking around the United States, one might also conclude the living wage has been set at an aspirational level.
But if you think the living wage is close the right figure, ask yourself this question: what happens when we raise the household incomes of everyone below the median up to the level of the median? The median itself rises, and significantly. This is why Compensation Committees setting executive pay see compensation rising so quickly. The peer group is raising its pay, and the median rises along with it.
And further, when the incomes of everyone below the median have risen so dramatically, will that have any impact on the incomes of those currently above the median? Recall the chart above showing the great leaps in income as one climbs the educational ladder. How will people with college degrees or some college react to people without a high school diploma earning the same as them?
I expect well-understood concepts of supply and demand, and basic human incentives, will come into play. We already see one of these concepts playing out in practice, namely qualification inflation:
- As an employer, if it costs me a similar amount for a lesser educated employee as it does for one with a college degree, I am inclined to require the college degree for new hires. I do this even though the job wouldn't technically demand it, because why not? I assume the person with the college degree has other, useful qualities demonstrated by their having obtained the degree in the first place.
- Some of you may be wondering whether a related dynamic is at work, call it degree deflation. That is, college degrees themselves have become less valuable as signifiers of a person's characteristics and ability. When universities admit students without standardized testing, and pass them along without grades, is the degree as valuable as it once was? When students graduate each year with less practical knowledge but a healthy dose of concern for social justice issues, are they as attractive to employers?
The two factors are playing against one another: it is easier for companies to inflate job requirements to require college degrees, while college graduates are becoming less attractive as prospective employees with each passing year.
Now consider how things look from the students' perspective. The cost of their education is rising faster than just about anything else and has done so consistently for decades. Many incur massive student debt and are sensibly starting to question the payback of their degrees.
I will predict as follows:
- If companies continue to require college degrees for jobs that don't otherwise demand them, expect policymakers and activists to further pressure universities to admit and graduate more students without regard to their qualifications. This will further erode the perceived value of such degrees.
- If pressure to pay a living wage results in the median income of those at the bottom of the educational distribution raising to become substantially closer to those with some college education, fewer prospective college students will see the value of attending college.
Either way, I would not want to be in the business of providing a college education today.
So far, we've been exploring what happens when we seek to artificially influence market rates (i.e. the minimum wage, a living income) for individuals doing the same types of work. A much bigger problem arises when we consider that individuals do all kinds of different work that society has traditionally valued differently.
Consider the professions at the top of the pay scale, doctors and lawyers. There are stiff barriers to entry, as reflected in persistence, intelligence, and time commitment. It takes many years of education and post-education experience to become fully qualified. Because demand for services from such professionals remains high, many earn relatively high incomes. Under what plausible scenario is it sustainable to pay someone with no high school diploma the same or even remotely similar to someone who put in ten to fifteen years of additional work to become qualified?
There are even more extreme examples, where success comes to a tiny minority who make the attempt. Consider professional athletes, or successful musicians, actors, or authors. Many of these could see themselves with incomes tens, hundreds, or thousands of times greater than the median incomes. U.S. public companies are now required to disclose the ratio of the CEO's pay to that of the median employee. These ratios are typically above 300:1 and rising.
The vilification of successful people and reflexive calls to "tax the rich" happily ignore that these people earned their money entirely legally, creating goods and providing services that society places a high value on. Yes, the persons bagging groceries and serving food are every bit as deserving of human dignity, but they are not delivering equivalent value that society is willing to pay for as, say, Beyoncé or Jamie Dimon.
The system of laws and property rights we live under, and which allow such discrepancies to arise, is profoundly important to maintaining society. In Moral Letter 073 On The Rule Of Law, we discuss why this is so, and why efforts to achieve equity may be more harmful than helpful.
This week's other letter, Moral Letter 074 On Internal Versus External Value offers a solution. Because comparing ourselves to others will inevitably lead to disappointment, a far more useful frame of reference is to compare ourselves to ourselves. When we do this, we are not bothered by what others do (or earn). We can focus on making incremental improvement in our own condition.
In sum, we may certainly conclude as a society that individuals near the bottom end of the income distribution should earn more. When proposing changes, however, we should remember that our solutions will come at a cost. Have we correctly forecast the cost, and are we willing to pay it? And because nothing comes for free, what are we willing to give up as a result of this new investment? Finally, because everyone responds to incentives, we should be alert to the risk of unintended consequences when making big changes.
And ultimately, even if we think the costs and risks of meddling with the rule of law to address income inequality are acceptable, we may suffer from a great irony. That is, that by focusing on external metrics we may usher in wide-reaching changes that do nothing to address individuals' long-term satisfaction and happiness. I'd be careful.