Productivity Inequality is the Source of Income Inequality
Inequalities in productivity are unfortunate and maybe unfair. People with job skills have opportunities to earn higher wages than those without, and people living near companies hiring skilled workers have an advantage over people in other regions and countries. Employees at well-managed companies are likely to be more productive and better compensated, earning higher wages and bonuses as company owners earn more profits (and consumers get better products).
Income inequality is a consequence of productivity inequality. And productivity is much higher in some countries and companies than in others. Anyone interested in addressing income inequality would do well to investigate the causes of variations in productivity.
Low wages are a result of low productivity, which can be caused by workers lacking skills, or not working hard. But more likely the cause is poor management and lack of sufficient labor-multiplying machinery.
Critics of market economies complain that wages can be arbitrary with owners and managers paying some less that others independent of productivity. That surely can and does happy. Managers sometimes can’t measure how productive people are, and sometimes they discriminate against, say, short people, or women, or people with strange accents (which are accents owners and managers think strange). When that happens, it is unfair and inequitable. Workers have incentives to be more productive when they have opportunities to earn more. If they dislike their managers or co-workers, they should be free to find other employment. And other employers have incentives to search out underpaid and under-appreciated employees at competing firms.
CareerBuilder’s SuperBowl ad from 2005 encouraged underappreciated employees to use their services to locate more capable employers.
Low wage rates send price signals out to entrepreneurs and investors. And separately, income inequalities attract politicians and social activists who lobby for new wage and employment regulations, higher taxes, and new redistribution programs. In relatively free economies, income and productivity are two sides of the same coin. Low pay and productivity attracts firms able to hire workers away to work at new factories and service centers where they will be more productive. New firms with the know how to train and manage new workers can pay them higher wages and still profit from their higher productivity. A mix of entrepreneurship, good management, and investment capital open the doors to higher-paying, higher-productivity jobs.
Higher productivity and wages for Southeast Asian workers
In his 2003 documentary Johan Norberg travels to Vietnam to ask local workers about new companies arriving with factories offering higher-productivity jobs with higher pay. The Vietnam segment is about 20 minutes into the documentary here. Nike paid more to attract capable workers, then struggled as other companies try to hire their best workers away at still higher pay. The whole 2003 documentary, Globalisation is good, is worth watching. And Norberg’s films page has links to his many later videos and interviews.
Employees in the United States, Western Europe, Japan, HK, Singapore, South Korea and Taiwan have, on average, productivity levels far higher than workers in less developed countries. Higher productivity is the source of higher wages. Productivity is the measure of value added by workers. Each work day bakers, factory workers, programmers, etc. add value to goods and services at the enterprise where they are employed.
What is the cause of higher productivity? Better tools, or capital, which allow people to produce higher quality more complex products faster. Better coordination matters, and turns on market prices, quality communications, and incentives. Institutions are key, including property rights and legal rules keeping contracts and exchange secure and transparent. People may or may not work “harder” or longer hours in high-productivity firms and societies. But in the time they do work, they add significant value to the goods and services they work with.
For those who wish to “do something about global inequality” and about the wide differences in living standards between countries, understanding economic principles and development economics, is essential. Life can seem deeply, deeply inequitable for those born in much of Africa, Asia, and Latin America. Why should the billions who happen to be born in some societies suffer with little access to capital and institutions essential for high-productivity jobs?
In a post titled “World Income Inequality: Is the world becoming more unequal?” by the Conference Board of Canada notes:
42 per cent of total world income goes to those who make up the richest 10 per cent of the world’s population, while just 1 per cent goes to those who make up the poorest 10 per cent. Global income distribution is therefore very highly skewed toward the 16 richest countries that make up the top decile.
At the 2011 World Economic Forum in Davos, income inequality and corruption were singled out as the two most serious challenges facing the world.1 Zhu Min, a special adviser at the International Monetary Fund, told delegates that “the increase in inequality is the most serious challenge for the world. . . . I don’t think the world is paying enough attention.”
Again, though, it is productivity that is unequal, and wage rates just reflect that. Worldwide, income inequality has generally been decreasing as average productivity and income in India and China especially have grown increased. (For more on this, see Tyler Cowen’s July 19, 2014 NYT column, “Income Inequality is Not Rising Globally. It’s Falling.)
Astonishingly, China is now classified by the World Bank among Upper-Middle-Income Countries, where income average in the range of $4,000 to $12,000 a year. India’s rapid economic growth started a decade later, after the 1991 financial crisis opened the door for deregulation.
Economic freedom is the key to reducing the inequality of opportunity for better jobs, that is, for higher-paying, high-productivity jobs. Johan Norberg addresses these issues in his recent documentary, Free or Equal, which is still streaming free online.