Fair Pay Under Capitalism

Washington Post writer Steven Pearlstein recently published a thoughtful piece on the morality of capitalism that has gotten a lot of attention. I have a lot to say about it, and I want to start with one of the more intriguing questions raised by Pearlstein.

After going over what he calls “the moral case against redistribution,” he raises “one glaring problem”:

For implicit in the imperative to let the productive keep what they earn is an assumption that the markets distribute income in a way that accurately reflects everyone’s relative economic contribution — and therefore is fair. But is that true?

Pearlstein goes on to say that in a simple barter economy, the connection between what a person contributes to production and his wealth is clear. But in a complex division of labor economy? “[T]he connection between what is produced and who is responsible for producing it is not so obvious.”

Can you see where Pearlstein is going with this? If the connection between what a person gets paid on a market and what he contributes to production is fuzzy, then that person has no moral grounds for objecting when the government confiscates and doles out his income.

But Pearlstein is wrong. Dead wrong. On a free market, the connection between what a person contributes to production and his income is as clear as day: what he makes is what he produces — as judged by those who voluntarily pay him.

When Pearlstein raises the question of whether pay reflects productive contribution, he is adopting a central planner’s perspective. Implicit in his question is the idea that under capitalism, resources start out as some collective pie, markets then distribute those resources “somehow,” and now we have to stand back and look at market outcomes and divine if they “fairly” reflect each individual’s contribution.

But wealth is not a tribal product which some disembodied “market” “distributes.” What actually happens is that, under capitalism, individuals create and trade wealth. There is no “distribution” of income. Instead every dollar a person gets comes from the voluntary judgment of each individual who chooses to deal with him.

What makes your income “fair” is not that it matches some arbitrary economic benchmark (e.g., some fixed “share” of income going to capital and labor, as Pearlstein seems to endorse) — what makes it fair is that it is the product of an objective process: the free, uncoerced, voluntary judgment of market participants.

Contrast that with the approach implied by Pearlstein’s argument: a group of bureaucrats will get together, decide those voluntary decisions are “unfair,” and coercively seize and distribute people’s wealth so that it conforms to theirs, the bureaucrats’, feelings about what is “fair.”

What’s especially revealing about this argument is Pearlstein’s concession that if a person could claim to have earned his income, then it would be a moral travesty to take it and hand it over to people who didn’t earn it. And on that point he is absolutely right.

But Pearlstein aside, there is a legitimate question: how do market participants assess others’ productive contribution in a complex, division of labor economy? How does a board of directors assess the contribution of the CEO and other high level executives? How do managers assess the productive contribution of their employees?

It ain’t easy. They have to have a lot of knowledge about their company, all of the people involved, how many others in the labor market have the skills and aptitudes necessary to do the various kinds of work, to name just a scant few factors.

Do they always get it right? Of course not. But what’s unique about capitalism is that market forces reward people for good decisions and punish them for bad decisions: companies that pay people too little see good employees head for greener pastures; companies that pay people too much see their resources depleted relative to competitors. As a result, there is a tendency in a market for income to reflect productivity.

And if it is challenging for someone to assess the productive contribution of people within his own company, it is virtually impossible for a complete outsider to do so. What does Larry Ellison contribute to Oracle? How much value does he bring to the table? That’s a Herculean question for Oracle’s board of directors to answer, and it’s ludicrous to expect—as critics of market outcomes such as Pearlstein often do — that someone not deeply familiar with Oracle and its industry should be able to answer it.

The majesty of capitalism is that it doesn’t matter. Why not? Because “we” aren’t the one’s paying Ellison’s salary. Oracle’s shareholders are, and if an individual shareholder thinks Ellison is overpaid, he is free to sell his shares. The fairness of Ellison’s pay is not anyone’s to decide but his and those who voluntarily choose to pay him (or not).