17 September 2009

Salaries, Scarcity and So On

One of the defining stories of modern economics is the way it resolves the water and diamonds paradox. Water is necessary for life itself, but cheap, a few dollar per thousand gallons. Gem quality diamonds have almost no utilitarian value, but they are exceedingly expensive. Why? Because the supply of water is great relative to demand, and the supply of gem quality diamonds are not.

The same principal mostly explains salaries.

Education As A Hierarchical Economic Factor

Generally speaking, someone with both a high school diploma and a college degree can do anything that someone with a mere high school diploma can do. Likewise, someone with a graduate degree can do anything that someone with the pre-requisite college degree can do. The converse, of course, is not true. There are many things that people with college degrees are able to do that people with only high school diplomas are unable to do or are unable to do as well. There are likewise many things that people with graduate degrees are able to do that people with only the pre-requisite college degrees or unable to do are are unable to do as well.

Similarly, stereotypes notwithstanding, most people who can do college level mathematics can also engage in college level reading, writing and thinking, and but many people who can master college level reading, writing and thinking are utterly incapable of doing college level mathematics. And, successful completion of college level math (and also college level chemistry and physics, both of which have a strong mathematics component), is a real hurdle for many people. Flunk rates for freshman calculus, calculus based physics, and college chemistry all approach 50%, and that's among people who volunteered to sign up for those classes in the first place. Only those who not only pass, but excel in these high flunk rate subjects go on to take the courses for which these foundations are a pre-requisite.

Jobs the require skills with a smaller pool of eligible applicants, a smaller supply in economic jargon, are paid more than jobs that more people are capable of performing. Hence, it is hardly surprising that all fourteen undergraduate college majors that are most remunerative require college level math to complete.

Beyond Skill Scarcity

Of course, the number of people with a certain skill level isn't the only factor in compensation. For example, ultimately the economy can pay no more to people in terms of purchasing power than it can produce or borrow. Salaries in excess of a profession's ability to secure revenue are unsustainable. The engineers, physicists and mathematics majors making good salaries in our economy are mostly doing work that creates economic value; there aren't many mathematicians outside academia making a living doing number theory or trying to prove the great unsolved hypotheses of mathematics.

Tax prof and blogger James Edward Maule mused on the non-supply and demand issue this week.

On the other hand, some occupations are under more pressure to keep salaries low than are others. Do nurses earn less than they otherwise would because of financial constraints compelling health care institutions to reduce costs in reaction to reductions in payouts from health insurance companies? Do teachers earn less than they would in a marketplace that was unencumbered by taxpayer pressure on school boards to minimize teacher salaries?

All in all, though, considering the importance of school teachers to the formation of the next generation, it is disturbing that America invests more in professional sports and entertainment than in elementary education.

He's right that the structure of the economy impacts pay, although his examples are ill chosen.

Health Care Provider Pay

The United States has the best paid health care workers in the world. An experienced ear-nose-throat specialist physician at a hospital in Japan makes $100,000 a year. In major U.S. cities, someone doing the same job makes three times as much. The trend applies across the board to international comparisons of physician pay. Getting paid by the private sector, both directly and indirectly, is usually a plus for professionals with scarce skills.

Physicians have seen their incomes trend strongly upwards in after inflation terms, despite an increasing supply of physicians, in the 1980s, in the 1990s, and in the current decade, with specialist physicians whose skills are more scarce and who cannot easily be replaced by generalist physicians (although specialist physicians have a somewhat greater ability to become generalist physicians) seeing their income grow more rapidly than generalist physician incomes.

A median registered nurse (a job that requires a four year education including scientific subjects) makes $66,427 per year, and 25% of registered nurses make more than $90,157. U.S. nurses generally make about 50% more than they do in other developed nations (after taxes and adjusted for the cost of living), despite the fact that the U.S. does not have a particularly elderly population relative to other developed nations and has a relatively low health care utilization rate, both of which are important factors in the demand for nurses. From 1983 to 2006, the nurse compensation grew 27% faster than inflation, at a time period when compensation for people with high school educations was stagnant.

The unique American health care system may very well be responsible for this disparity, but the notion that stingy, profit driven health insurance companies are artificially holding down compensation for nurses and other health care professionals is a myth. The single biggest direct reason that the U.S. pays so much more than other countries for health care, as a percentage of GDP, is that the U.S. pays its health care providers so much more. The health care system impacts why this is the case, but in magnitude, higher provider costs account for more dollars than administrative and profit dollar amounts in the health insurance industry. This is what makes cost control in the health care industry so sticky. While reducing administrative jobs and profits in insurance companies isn't a very politically controversial option for cost control for the general public, paying health care providers less is a politically explosive prospect particularly given the fact that an aging U.S. population and slow growth in the number of health care professionals that we are educating is putting pressure on our society to increase health care provider pay.

Already, the percentage of nurses in the United States who work part-time has fallen as increased pay driven by rising demand has lured more qualified nurses back into the full time work force.

Higher pay may, ironically, have had the opposite effect on physicians, giving them a greater ability to reach levels at wealth that they feel are sufficient to allow them to retire. The percentage of physicians who retire early increased by about two-thirds between 1983 and 1992. This trend continued in the period from 1996 to 2004.

Educators and Athletes

Well, what about the athletes and the educators? Also, mostly myth.

Do we really spend more on pro athletics than education?

The United States spent $599 billion on K-12 education (public and private combined) in 2007, about half of which goes to elementary education. It spent about $34 billion on spectator sports (including spectator sports promoters and agents, but excluding racetracks, where the real money comes from gambling and not merely watching performances). Throw in the performing arts and the total is still only about $70 billion.

These schools employed 3,637,000 teachers. There are about 47,000 people who work for professional sports teams or clubs, and the number of people who are professional athletes in major league football, baseball, basketball, soccer, or are pros in golf or tennis, where the high salaries are paid, is far smaller. There are far more people who make a living at sports in K-12 education as physical education teachers and coaches, than there are pro athletes.

The Logic of Civil Servant Compensation

"Do teachers earn less than they would in a marketplace that was unencumbered by taxpayer pressure on school boards to minimize teacher salaries?"

This is doubtful. Public school teachers are paid significantly more, on average, that private school teachers. If public school teachers were underpaid, one would expect the reverse.

The fact that many public school teachers are unionized, while few private school teachers at the K-12 level are unionized, is probably also an important factor in the distinction.

Moreover, school boards are not necessarily under all that much pressure to minimize teacher salaries. As governmental entities, they are non-profits, so the school board members have nothing to gain personally from lowering teacher salaries and like most governmental entities, those with intense interest in school board decisions, like school employees, have a much greater incentive to lobby for better pay than individual taxpayers do to lobby for lower pay.

Also, generally speaking, school boards have very little impact on how much is available to them to spend on teacher salaries. School funding is often set at the state level, and local contributions to school funding often have to be approved by local voters. Many of the expenses of running a school, like bus driver pay, food, stationary, administrative staff, and utilities are set in a much larger marketplace that they have less of an impact on, so educator salaries are residual. School boards can influence the distribution of pay among teachers quite a bit, but have very little ability to set the aggregate amount of money available to pay teachers collectively.

Public opinion may influence teacher salary, but probably not in a direct way. Generally, in government, public opinion focuses on the pay of the top executives in a governmental unit, not the rank and file employees. Voters and the media care about what presidents, governors, their cabinet members, mayors, elected officials and superintendents make, not what ordinary civil servants earn. Voters and the media are also sensitive to very poor pay for low level full time career civil servants. As a result, in general, senior government employees tend to make less than people in private sector jobs of comparable responsibility, mid-level governmental employees tend to make similar amounts to private sector employees, and low level governmental employees often receive better compensation than their private sector counterparts.

In big governmental entities like the federal government and large states, the prestige involved in public service and the powerful intuition that subordinates should be paid less well than their superiors has a very powerful impact on salaries. Senior military officers with line command authority over tens of thousands of people, for example, make far less than their private sector counterparts.

At the low end, some of the apparent exceptions prove the rule. Low pay for privates in the military is tolerated because family size driven benefits keep soldiers' families out of poverty, because they receive much of their needs in kind, and because low ranking soldiers are promoted in short order as a matter of course in a matter of months, so their career incomes are not exceptionally low. Low pay for adjunct professors and substitute teachers is tolerated because neither is seen by the public as a form of full time or career employment.

But, the public will tolerate top executive pay in a much smaller governmental entity, like a school district, that is only marginally less (or even somewhat more) than pay for a state governor or senior executive branch official in the state or federal government. Also, the far lower prestige and public image of a school superintendent than a senior state or federal government employee, means that school superintendents aren't willing to work for much less than they could command in the private sector due to their management abilities. And, there aren't that many layers in a typical school district bureaucracy between a superintendent and a senior teacher. Often the only employee between the two in a direct supervisor-subordinate chain is a principal for a particular school. As a result, public opinion about chief governmental entity executive pay doesn't have nearly as much of a cramping effect on teacher salary as it does on senior public servant salary. This is probably one of the important reasons that we have school districts at all. Divided government makes possible higher employee pay.

Base Pay v. Total Compensation

Base salary doesn't tell the whole story with teachers. The complete package of economic compensation and leisure for a teacher isn't directly comparable to the typical compensation package of a college educated employee outside the education field in the private sector. Career government employees, like teachers, typically have much better pensions and job security than private sector employees with comparable educations, and teachers, even considering their need to secure continuing education and prepare for teaching, have far more vacation time than almost any full time private sector employee outside of education, in the United States (the distinction is far less stark in Europe, where private sector employees have more job security, better pensions through the welfare state, and more paid vacation). Some U.S. teachers work summers teaching summer school, run camps or tutor, but they typically receive additional pay for this work. Few jobs provide a more convenient schedule for parents who want to be available when their children are not in school.

Professors in the higher education system receive similar perks, have smaller teaching loads (although greater research expectations), have more "vacation" and are paid considerably more than K-12 educators, mostly because their PhDs make their skills much more rare particularly in light of the fact that professors of one type are not easily substitutable for professors of another type.

International Comparisons Of Educator Pay

Unlike U.S. health care providers, by international, developed world, standards U.S. high school teachers (I don't have any comparative statistics for elementary school teachers or professors) are paid in the mid-range of the pay of their peers abroad (adjusted for purchasing power according to OECD statistics cited by the World Almanac 2009).

High school teachers in French speaking Belgium, Finland, the Netherlands, Norway, Denmark, Australia, England, Scotland, and South Korea have starting salaries within 10% of the average American high school teacher. High school teachers are much better paid in Luxembourg, Switzerland and Germany (double the amount of U.S. high school teachers in Luxembourg). Sweden, Austria, Italy, France, Greece, Portugal and New Zealand all pay their high school teachers less than the United States. Japan and Ireland both have significantly lower starting salaries for high school teachers, but pay experienced teachers more than the United States does. Most countries set teacher pay at the national level and have a "top of the scale" salary which is the most that a public school teacher can earn. The only countries where the top of the pay sale exceeds $68,000 in U.S. purchasing power equivalent are Luxembourg ($123,187), Switzerland ($83,900), and South Korea ($82,790). (Perhaps not surprisingly, the children of North Korea's supreme leader received their high school educations in Switzerland). Both South Korea and Japan also have considerably higher student to teacher ratios than the United States, in addition to having more pay variation with seniority, allowing education dollars per student to translate into higher salaries for experienced teachers.

Still, teachers aren't exceedingly well paid anywhere. And, who knew that the secret to having really well paid teachers was an economy based upon international tax evasion?

Gender Influences On Income

Incomes of teachers and nurses historically were suppressed by artificially large supplies of qualified people due to the fact that those were two of the only professions in which educated women were permitted by prevailing custom to be employed. The rise in salaries for nurses closely coincides with the end of de facto bars to entry based on gender in other professions like law.

Disproportionate numbers of women in both teaching, particularly at the elementary school level, and in nursing, also influences pay in those professions. Married women have lower labor force participation than men, and frequently have interrupted their careers to spend time as stay at home moms when they have young children. This time off suppresses the income potential of women, on average, so there is less pressure for college educated women who are certified teachers to join the private sector in other jobs where a liberal arts college education is an asset.

The lower income potential of women who have left the workforce also causes many women to view their incomes as secondary within a family, so their subjective sense of the income tax rates on their are higher on average than men because they view their income as being taxed at higher marginal rates. This also causes many households to see child care as an expense charged against the wife's income, putting pressure on these women to conform their own employment to the school calendar and thus, reducing their labor market options. And, the view of many married women of their incomes as secondary also reduces the extent to which these women are able credibly threaten to do other, less desirable work than men who subjectively feel more pressure to subjugate their own preferences to household economic necessity, particularly in an era when assortive marriage trends mean that married college educated women usually have college educated husbands.

Skill Scarcity Revisited

Historically, teachers were educations in normal schools (aka teacher's colleges) which were not considered on a par with a bachelor's degree. Higher education was required for elementary school teachers even later, and to a less extent, than it was for high school teachers, on the theory that high school graduates had the subject matter knowledge that they needed to teach elementary school children. College education did not become the norm for K-12 teachers until the 1920s. Professors in higher education routinely lacked PhDs and not uncommonly lacked any graduate degree, into the 1950s. One can become a licensed practical nurse with a two year community college degree which is less scientifically demanding that the course of study required to become a registered nurse.

Certainly, there are highly paid professional athletes. But, this is a product of a mix of productivity and scarcity too. In the American model of K-12 education, student to teacher ratios rarely exceed 30. In public schools, as of 2006, the average teacher to student ratio was 15.5, in private schools it was 13.4. In contrast, there are tens of thousands of fans present in person, and hundreds of thousands (if not millions) of fans watching on television at every major league sports game, each of which involves two teams that combined have only dozens of players. Each major league pro sports player is serving far more people and generating far more revenue per person than any given K-12 educator (and even the true stars in higher education teach no more than a couple of thousand people in any given class, assisted by numerous graduate assistants). But, why don't the team owners get that revenue instead of the players?

First, because major league pro sports is unionized. Second, because, performance in major league sports is decidedly not random. Third, because winning is more profitable for a pro sports franchise owner than losing. Even if a particular player has good and bad days, there are very few players outside their respective unions who consistently perform better than the people in the union. In contrast, other than pro soccer, in which the entire sports league is constituted as a single entity for player employment purposes, pro sports teams compete with each other to employ players. It doesn't take much advanced economics to realize the employees do better when they have a monopoly on the services they are offering and employers are not in a monopoly bidding situation. So, players get a large share of the available pie that their performance create, despite the fact that pro sports is a for profit enterprise. High productivity, scarcity, and bargaining power combined translate into exceptionally high salaries.

Incidentally, there is little indication that education provides much of a benefit to pro sports athletes that make it, although it probably does provide considerable benefit to those who seek to go pro and fail. Both baseball players, who often go straight from high school to professional sports, often in the minor leagues, without proving themselves on college teams, and basketball and football players, who overwhelmingly spend time on college sports teams before going pro, receive extremely high salaries. The differences that do exist are probably best explained without resort to academic education as an important factor.

Creative People

The economics of the performing artist compensation is quite similar to that of athletes. Authors don't have the unions that the other two groups do, but the other considerations apply and intellectual property rights afford them bargaining power somewhat similar to the bargaining power that unions afford to performing artists and athletes.

Academic education also doesn't appear to have a great direct effect on the compensation of performing artists and authors. Hollywood and Nashville are not dominated by graduates from Julliard, and even status conscious classical orchestras often make it their practice to do literally blind auditions in which performers play music separated by a visual screen from the people making the hiring decision. Many young performing artists manage to command high salaries despite having limited formal educations, although the vast majority of successful performing artists have long hours of practice in their art before they make it big. Authors not infrequently pitch their works through agents using pseudonymns, a practice that was probably employed by the true author of Shakespeare's plays and sonnets, many hundreds of years ago.

Well Paid People In Business

Professor Maule didn't discuss the pay of senior executives in big business and their senior professional outsourced service providers (like lawyers, accountants and inventment bankers), or in small business. The omission is notable, in part, because compensation in private businesses is to some extent the social norm for compensation.

Given the length of this post already I won't say much about them either, despite the fact that CEO pay in big business is often the companion of discussions about excessive pay for top performing artists, authors and athletes, I'll say something. The gist of the reasoning is that even immense pay is modest compared to very large enterprises and transactions, that those at the very top effectively are self-dealing so they aren't constrained by the marketplace in the same way as other labor market participants, and that those who are key allies of CEOs at the very top are compensated in part for their loyalty to the CEO who depends upon them for support in regard to critical compensation and management issues. Below the senior management level, big business compensation has a much larger labor market driver and is also impacted by a greater opportunity to be productive in senior positions in a big business, because one's decisions have more impact, and by the internal sociological culture of the particular entities and large business organizations generally, like the widely honored principle that a superior's pay should be higher than a subordinate's pay.

Put another way, those at the top of the big business world get paid a lot because there are, by definition, not many positions at the top of the big business world, but our economic system naturally concentrates wealth there. These businesses are so big that productivity is rarely a strong constraint. Other people's contributions have already made the pot very large. Someone has to be at the top, however, and the people who manage to make it to the top reap those rewards in the absence of effective regulatory or organization constraints.

In small businesses (or businesses that start small), productivity provides a very palpable limitation on income, but it is also possible for people who make the right business choices to earn income far out of proportion to what the labor market would be willing to pay someone with comparable skills and education. Neither skills nor education are necessary to make good business decisions and some people simply get lucky and achieve business success mostly through good luck. But, wealth, skills and education combined all do provide individuals who have them with a great edge in the business world over those who do not.

This edge is simply not quite so absolute as it is in big business and the professions where the hiring process and professional licensing laws often categorically exclude people who don't have the right credentials on paper from consideration for many desirable jobs. College dropouts don't get hired as professors. Jail house lawyers don't get jobs as corporate counsel. Enrolled agents (i.e. non-lawyer, non-accountant tax professionals) don't get hired to be comptrollers.

At a macro level, this is why small business founders, whose compensation is intentionally unrestrained beyond the limits of productivity in our economic system, are disproportionately represented among the wealthy, and why they are particularly disproportionately represented among the nouveau rich.

No comments: