Jared Bernstein — Inequality and Pay: “Rents” vs. Merit

In the age of Piketty, it is increasingly recognized that historically high levels of economic inequality are a serious and growing problem in many economies across the globe. The problems caused by this phenomenon range from stagnant incomes and sticky poverty rates for the majority on the “have-not” side of the divide, to skewed political power (especially, given all the money in politics, here in the US), to possibly slower macroeconomic growth, self-reinforcing wealth accumulation, and a tendency toward terribly damaging bubbles.

The causes of increased inequality are generally viewed to be increased competition through globalization, technological change, diminished union power, lower minimum wages, and persistent slack in the job market, which has the effect of significantly lowering the bargaining power of most workers.

But there’s another alleged cause: there’s a lot more inequality, especially in earnings, because in this day and age, really talented people are finally able to get paid what they’re actually worth (and note that it is rising high-end earnings that explain most of the growth in inequality in recent decades). Some of the factors listed above play a role here, as technology and trade have created access to broad new markets where millions more consumers can interact with producers of entertainment, apps, and clever financial instruments. These forces have helped to unleash the earning power of a small number of individuals who are simply and legitimately earning their “marginal product,” i.e., the true value of their contribution to the world (hereafter MP).

Now, I happen to think that’s wrong, but contrary to popular opinion, it’s actually the first assumption made by economics in evaluating pay. The average person looks at figures showing more wealth or income inequality than ever and sees something out of whack. In economic terms, they see evidence of “rents:” people who are, by dint of some economic inefficiency, being paid well beyond their MP. But the economics textbook sees, by assumption, fair remuneration....

It’s both interesting and important to think about why that’s wrong.

This is the nub of it. Neoclassical economics is marginalist economics, and it eliminates consideration of institutions, power, and rents. As a consequence, it is an oversimplification that doesn't not accord with the real world situation. It can be argued that neoclassical economics and marginalism are economic liberalism's "answer" to Marx by ruling out factors that show how economic liberalism tilts the playing field. As such it is chiefly performative rather than descriptive.

"The rent is too damn high."

On the Economy
Inequality and Pay: “Rents” vs. Merit
Jared Bernstein