Thursday, January 13, 2011

Prices are set by scarcity, not fairness

It is a ubiquitous fact about the world that wages and prices differ sharply from what people consider fair. Witness the perpetual outrage about how much CEOs are paid. Most of it, of course, derives from people who aren't shareholders of the companies in question, and whose stake in the matter is merely that of envy. The sophisticated frame the matter as one of corporate governance - wages are so high that it must be because the CEOs have undermined the proper function of the company board, and set their own outrageous wages. I enjoy pointing out to them that CEO wages of companies that are taken private (e.g. bought out by private equity, or by management) tend to be as high or even higher, despite these agency problems not being present. Typically they agree that this is a puzzle, but not enough to reverse their conviction about CEOs being paid "too much", however measured.

I was talking to EFS about the relative wages of the movers he recently hired when moving house. EFS is a professor at a prestigious school and he said that if he had to do the same job as the movers, even for his current pay, he wouldn't be able to do it. It seemed surprising that they do such a hard job, yet are paid relatively little.

As I pointed out, if you want to make a first-order guess at relative prices, figure out what is the scarce resource. Moving lots of boxes is tough work, but there's lots of people willing and able to do it. Ergo, wages are low. Being a university professor is cushy work, however most people are unable to come up with enough compelling ideas to publish successfully. Ergo, wages are high.

The real question is why people would think that fairness should have anything to do with prices. What, exactly, about the universe gives you the impression that it cares much about the human perception of fairness? This is doubly so if explicit efforts haven't been made to make the world fair - prices are set by the spontaneous order that emerges from billions of related transactions, and as Hayek pointed out, this system is far too complex for people to understand all the drivers of a particular price. Certainly it is possible to shape at least some economic events to human perceptions of fairness - just pass a law capping CEO pay. Markets won't clear properly, of course, but that's never stopped politicians before.

But if this hasn't been done, why would wages be expected to reflect fairness, other than through the conceit that the world should spontaneously operate exactly as we wish?

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