Do the Wealthy Really Earn What They Produce?

by Fred Siegmund

In a comment from my post on How to Cut the Federal Deficit, there was objection to taxing the wealthy at higher rates.

The comment said: “Remember ? they [the wealthy] worked hard for that money, and free markets determined what they do is of such high value.”

I did not suggest it was fair or unfair, nor question whether the wealthy are more productive than the rest of us. I made the statement because the country needs to close its budget deficit and so it has to tax where there is income to tax.

However, the comment does raise an important question: can value be measured to show that wages reflect individual productive value?

It is an old question that goes back into the 19th century when British and European philosophers and economists applied science reasoning to the craft industries of the day: wheelwrights, blacksmiths, shoemakers and so on.

How Much Value Are You Producing?

These economic philosophers suggested that if a shoemaker works 8 hours a day producing 5 pairs of shoes and then sells them at $10.00 each, he produces $50 worth of value.

Then, they had the shoemaker hire a helper to specialize in cutting leather while the shoemaker sews and assembles the final product. Together they make 9 pairs of shoes a day.

We can see right away the shoemaker’s shop went from 5 pairs a day to 9 pairs a day, so the helper added 4 more pairs to the total produced in a day. His production can be measured in money terms when the product is sold.

Craft industries would be expected to have small local markets, so it might be necessary to lower the price to sell 4 more pairs of shoes a day. If the price is lowered to $8 a pair to sell 9 pairs per day instead of 5, then the revenue jumps to $72.

With that knowledge, we can see the new hire’s work added $22 = $72-$50 of value a day to the firm.

If the hired helper is paid what he is worth to the firm, he will receive $22. It is a maximum because if pay exceeds $22, the firm’s net revenue will drop below $50 and the shoemaker would do better without the helper.

The wage could be less than $22 depending on how many other people apply for the job and how many other shoemakers compete for hired help.

The Scientific Method for Economics

It might be a surprise to learn I have condensed and summarized what continues to be part of current study in economics courses throughout U.S. colleges. It uses the scientific method because only one thing changes — labor time — while everything else remains constant.

The additional product of labor can be precisely determined as part of the experiment. Economists continue to use examples like the shoemaker because it applies science to wages and they want people to believe that today’s wages reflect individual productive value as part of science, and not politics or favoritism.

For those who are comfortable transferring the fable of the shoemaker to the wages and incomes in today’s economy, including the wealthy, they will feel comfortable that the wealthy earn what they produce.

For some of us though, it is all bluff.

About the author: Fred Siegmund covers America's jobs as part of work doing labor market analysis and projections for a client base of recruiters, trainers and counselors. Visit him at www.americanjobmarket.blogspot.com

{ 1 comment… read it below or add one }

Jason Schoenbrun March 7, 2010 at 1:21 am

(I must be missing something, because I’m not sure how the shoemaker example demonstrates value cannot be measured to show that wages reflect individual productive value, as you seem to set out to do.)

You may have set out disclaiming fairness from your perspective (which I wholeheartedly disagree with, but that’s in my comments in your other article) , but your ill feelings for market-determined value is all too evident and represents another serious issue.

At the end of the day, we live in a capitalistic free market. Value is determined by the market. The fair value of a person like your example may fluctuate, and is just like the market capitalization of Apple. As the market determines their price to be valued at $X or $Y per share, so does their actual worth. There is no purer way for worth to be fair. For contrast, the opposite would be true if the government or some other entity steeped in and declared: “The value of Apple shall be $Z.”

To apply this principle to both of your columns, it seems to me that you do not respect free markets. You are offended that the market dictates Conan O’Brien to be worth so much money, so much so that you intimate how wonderful it would be if he bought you a cell phone instead of being such a greedy jerk.

If you don’t want an iPhone, don’t buy one. If you like a competitor’s product more, buy it. By doing so, you are validating that the rich (companies or people, whichever) are earning with they produce because as the consumer, you are saying so by putting your money in the product you believe will be a maximum cost-benefit gain for you. At the end of your purchase, you have in a small but real way affected Apple’s market capitalization, or in terms we’re discussing here, determined that Steve Jobs has earned what he produced (or perhaps that the competitor has).

The shoemaker will command what the market determines he commands. What is the market? A murky but inherently true conglomeration of such factors as shoe demand, demand for his skill in a shoe, number of people with his skill and what each of them command, and actual value added to a particular company for hiring the guy, as in your example. Why you think this example demonstrates that the wealthy don’t earn what they produce is not clear to me.

I also just don’t get how you seem to think taxing the rich a higher proportion/percentage simply because they’re rich is not an encumbrance on the free market capitalism that has surged innovation and technological advancement in this great country more than any other throughout history. When you encumber such an incredibly, incredible powerful force, you may be nobly using the rich’s money to bring up the middle class from the lower decks of the ship, but you end up bringing down the entire ship even more. Meritocracy and the you-earn-it-you-keep-it mentality is the single most powerful way to bring up the entire ship.

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