Meritocracy and market over-recognition.

Author:Aldred, Jonathan

Bankers don't deserve their bonuses. If we ever doubted this, we don't any longer. 'There can be no reward for failure', as Brown has repeatedly said. Suppose we indulge in a fantasy. The Brown government has just announced a comprehensive package of measures designed to curb City bonuses. In future they can only be awarded in rare cases of demonstrable out-performance. Problem solved? Not at all.

The current debate about high pay and bonuses is about whether it's fair to pay them when company performance is poor, shareholders are nursing losses and the taxpayer has funded big bail-outs. There's also some mention of contractual obligations to pay bonuses, but that's it. The debate is a very narrow one, resting on the unstated assumption that high pay and bonuses will be deserved once the good times return. It's part of a larger vision of meritocracy, which has been adopted across the political mainstream as a model of fairness. But we have forgotten that Michael Young invented the idea of meritocracy as a dystopian vision, and a warning (Young, 1961). In other words, the fundamental problem with big City salaries is not one of rewarding failure, but rewarding success.

While many readers of Renewal will be sympathetic to the argument that big City salaries are undeserved, it is worth developing this argument in more detail, because spurious ideas about paying people their 'just deserts' remain extraordinarily deep-rooted, even on the left. In what follows, I show how hard it is to justify the pay differences we observe in contemporary labour markets as 'deserved'. I go on to argue that the orthodox economic arguments for big pay differences based on 'incentives' are also overdone. Given that high rates of pay are harmful to economy and society in various ways, I conclude that we face a problem of over-recognition of the contribution of some workers.

Respecting market rewards: the contribution argument

Within orthodox market economics, what does it mean to demand that we give someone 'due recognition' for their work? Insofar as market economics and market theorising offers a normative basis for market rewards, it is this: a person's pay should equal the value of their contribution, defined as the increase in the value of goods and services resulting from their work, measured in terms of the price of these goods and services in the market.

Orthodox economics holds that in a free market this goal will in fact be met: every person's wage will in fact equal their 'marginal revenue product'. Of course, these perfectly free markets do not exist outside textbooks--but that is not our subject here. Rather, the question is whether idealised free labour markets give people due recognition for their work, even in principle.

A positive answer to this question within the framework of orthodox economics is provided by the 'contribution argument' for market rewards, which makes two claims (Olsaretti, 2004):

  1. People deserve to be paid roughly according to the value of the contribution they make through their job.

  2. In free markets, people are paid roughly according to the contribution they make.

Why contribution is not a good guide to how much we deserve

The crucial problem with the first claim is that the value of someone's contribution will typically depend on various factors outside their control, for which they not responsible. And most of us believe that people can only deserve credit for things they are responsible for. As well as pure luck, other factors which affect the value of someone's contribution include their training, natural talents and market conditions (supply and demand).

Clearly we are not responsible for pure luck or market conditions, so we do not deserve changes in our pay due to these factors. But it might appear that we deserve credit for our training and talents. Appearances are deceptive though. John Rawls elegantly captured one of the intractable problems: 'We do not deserve our place in the distribution of natural talents, any more than we deserve our initial starting place in society' (Rawls, 1999, 89). In other words, those born with inherited talent deserve it no more than those born with inherited wealth. In both cases, we are not responsible for our inheritance, so we do not deserve it.

The extra pay we earn as a result of getting better education and training is no easier to justify on the basis of what we deserve. Imagine Rich, an investment banker, got his job because he went to the elite university from which the bank takes half of its recruits. But he only went to that university because his pushy parents pressured him into applying. Rob went to a less famous university, and purposely chose a safe but less well-paid career as an accountant. But lucky for him, he specialised in insolvency, and has just received a big bonus because insolvency work is so profitable these days. Rob will earn as much as Rich this year--which of them is more deserving? And pity poor Paul, who wanted to be an investment banker like Rich--without being pushed by his parents--but could not afford the fees and attended his local university instead. It has a weak reputation, and Paul is still unemployed. The line between luck and responsibility is painfully difficult to draw.

The contribution argument fares no better in the seemingly more structured, less arbitrary world of the public sector. Compare doctors and nurses in the NHS. Doctors earn more than nurses; suppose for the sake of argument that their contribution is greater. Nevertheless, the pay...

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