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Compensating Differentials Likely Temper Any Growth in Income Inequality

As a law professor, I earn a lot less than my law school classmates who graduated with similar records, and a small fraction of the income earned by those at the very top.  But I am compensated in other ways.  In the loveliest line of the wonderful song “If I Were a Rich Man,” from Fiddler on the Roof, Tevye says that the “sweetest thing of all” from becoming wealthy would be the leisure gained to “discuss the Holy Books with the learned men seven hours a day.” The secular equivalent is what I get paid to do.

My situation illustrates what economists call compensating differentials. I get less income from my job because I get more enjoyment than I would in a job requiring similar skills and education. Thus, as Tyler Cowen and Alex Tabarrock note in a recent video,  the market would pay a sewer inspector a lot more than a lifeguard even if it had to attract equally skilled job takers. Similarly, if a job creates risks of death, injury or ill health, it will have to pay more to workers to compensate.

This simple observation suggests that focusing only on earned income from employment can provide a misleading picture of  any growth in inequality.Overall satisfaction from a job comes not only from earnings but also from the amenities it provides and the risks it presents.  If our economy is improving lower income jobs by reducing risks and providing a more enjoyable environment this trend could compensate for at least some of any growth in income inequality.

And there is reason to believe that this trend is in fact occurring.  Since 1970 workplace deaths have plunged 65 percent and workplace illnesses 67 percent.  The rise in amenities is harder to gauge, but the move from an industrial economy to a service economy has made jobs less back breaking and relentlessly repetitive. It has also permitted more personal interaction and most people like being with people more than moving inanimate objects or cutting plants.  .

These economic transformations differentially help those on the lower income part of the scale. The one percent never faced much risk from their duties and almost always worked in pleasant surroundings.   It is hard to measure how much difference this makes, although most people would pay something to avoid even a small risk of death and likely something as well to avoid the boredom of repetition.  But it does show that focusing on income measures may misguide us.  Man does not live by bread alone, and thus changes in income equality cannot completely capture changes in economic equality more broadly understood.

Reader Discussion

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on April 10, 2015 at 16:42:49 pm

This simple observation suggests that focusing only on earned income from employment can provide a misleading picture of any growth in inequality.

Absolutely: You'd want to focus on income from all sources. :-)

But otherwise, yeah, what McGinnis said. It's always been true that there's more to a compensation package than the compensation package. I hadn't really thought about how differently changing circumstances might alter this non-financial type of compensation for people at the different ends of the income ladder. Nice insight.

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nobody.really
on April 10, 2015 at 16:52:02 pm

When I started reading the post, I thought McGinnis would be remarking on another distorting effect of focusing only on income: People with the highest income tend to live in places with the highest cost of living – especially rents. That is, people who earn the high salaries reap reputational rewards – but their landlords may reap the financial gain.

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nobody.really
on April 10, 2015 at 17:09:09 pm

OK, this is true so far as it goes to demonstrate that there are other significant components to valuing a job / profession.

However, we must not lose sight of the fact that with the amelioration of less than optimal workplace conditions has come a decline in the number of positions that, while not as "stimulating, pleasant, etc" as certain professions, nevertheless paid a not insubstantial wage to the workers. I can attest to the fact that in the technology industries, i.e., the manufacturing arms of that industry, the number of these positions has dwindled DRAMATICALLY (We'll not go into reasons - they are varied). Working conditions were on a par with a typical office setting, various amenities, etc. Risk to health / safety were almost non-existent AND we employed thousands upon thousands. Sadly, this is no more. I can assure you that many of my former employees would gladly GO BACK and *suffer* through the "indignities" of factory work in order to regain a fair paycheck.
I know there is no going back, but it does sadden me to realize that this is so.
Yet what McGinnis (and nobody) says is true; I suspect that we constrict our understanding when we constrict our vision to the more *noble* professions. Again, this saddens me and indicates that we may not have a sufficiently complete grasp of the problems we do (and will) confront. I suppose that is why I am not so enthralled with Mr. Cowen.

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gabe
on April 11, 2015 at 12:23:38 pm

[…] 6. John McGinnis on compensating differentials and income inequality. […]

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Saturday assorted links
on April 11, 2015 at 12:48:23 pm

[…] 6. John McGinnis on compensating differentials and income inequality. […]

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Saturday assorted links | Homines Economici
on April 11, 2015 at 21:09:09 pm

i agree with Gabe. I don't see how compensating differentials makes much of a difference at lower pay levels. Professor McGinnis decided to become a law professor instead of a highly paid lawyer as his law school friends did because of the greater joy teaching and research gives him. Good for him. More of us should probably follow his example. But the extrapolation that people in lower paying jobs willingly take less pay for less dangerous or less uncomfortable work, thus increasing the level of inequality, seems a stretch to me. Does Professor McGinnis have any data supporting this supposition?

The median salary of a law professor is $153,000 a year. ( http://swz.salary.com/salarywizard/Professor-Law-Salary-Details.aspx?hdcbxbonuse=off&isshowpiechart=true&isshowjobchart=false&isshowsalarydetailcharts=false&isshownextsteps=false&isshowcompanyfct=false&isshowaboutyou=false ) I assume Northwestern law professors earn more than this. While Professor McGinnis's former classmates may earn twice or more than he, one can hardly claim that he suffers that much of a financial disadvantage in the sense that not only does he do something he enjoys, he also, I'm sure, lives in a nice home in a nice neighborhood, drives a nice car, has nice relaxing vacations, and sends his kids, if he has any, to good schools. If he is married, odds are his wife also works at a good high paying job, somewhat cushioning any financial loss Professor McGinnis may suffer as the result of his choice of employment. The last couple of points is speculative, but not unreasonable.

In any case, the latest data on the median household income in the US is $54,000. (http://www.advisorperspectives.com/dshort/updates/Median-Household-Income-Update.php) In my experience, in my own case as well as in the cases of many people I know, those living in households receiving less than the annual median income will go to great lengths and make uncomfortable sacrifices to earn a few more bucks a month if they have the means. Certainly one will find many who will accept $10/hour if a job paying $12/hour is in some way judged to be too onerous. On the other hand, far more people are willing, for example, to endure an additional 2 hours riding a bus to work if it means increasing their income by 20%. And take it from me: the $10/hour job isn't any more enjoyable than the $12/hour job. So where is the compensating differential?

Generally speaking, people in a certain economic class have no clue how people in the lower classes make their decisions regarding jobs or just about anything else. They assume that poorer people are a lot like they are and make decisions in similar ways, and that the theory of compensation differentials is as valid for a single mom struggling with food stamps and section 8 housing as it is for a law professor. Rather than actually talking to people who earn little money, let's rely on a theory because it explains the behavior of prosperous law professors. I probably should be more polite, but that seems height of hubris.

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frank
on April 12, 2015 at 09:27:38 am

I would think that reduction in defined benefit pensions is at least a counter to the compensating differentials of a safer workplace. At least I assume that such pension accrual was never booked as income in data and was thus a compensating differential of many jobs.

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Phil
on April 12, 2015 at 11:46:33 am

Yep, true and a significant difference for ALL occupations.

Coming up next (already begun?) deterioration of health benefits.

Goodness, this is certainly a new form of compensation by compensating!!!!

In the on-deck circle: Employment for the spouses of B-1 visa holders so that current citizen employees may enjoy the compensating effects of a good long layoff!

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gabe
on April 13, 2015 at 08:02:08 am

your data/evidence please?

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Pshrnk
on April 13, 2015 at 10:39:50 am

Herman Melville: "Of all the preposterous assumptions of humanity over humanity, nothing exceeds most of the criticisms made on the habits of the poor by the well housed, well warmed, and well fed."

Ogden Nash: "People who have what they want are fond of telling people who haven't what they want that they really don't want it."

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nobody.really
on April 13, 2015 at 12:05:15 pm

If I may add to Nash: " “People who have what they want are fond of telling people who haven’t what they want that they really don’t want it." - nor SHOULD they want it! After all, they are probably not competent to handle it!

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gabe
on April 13, 2015 at 15:31:12 pm

I think the quote you are looking for is this one:

Just because every child can't get his wish doesn't mean there isn't a Santa Claus…. [D]on't you see, dear? Some children wish for things they couldn't possibly use, like real locomotives or B-29s….

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nobody.really

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