Read an Excerpt
Chapter One
The Big Lie
You Are Paid What You Deserve
In 2011, the journalist Ron Suskind quoted Larry Summers, one of the leading neoliberal economists and policy makers of the last generation, as saying, "One of the reasons that inequality has probably gone up in our society is that people are being treated closer to the way that they're supposed to be treated."
Outrageous as this remark seems, Summers was merely stating the conventional wisdom of academic economics, which is endlessly repeated by policy makers, pundits, journalists, business executives, and career counselors. This is the theory that wages directly reflect the actual contribution of each worker to the enterprise, from the janitor to the CEO. And this is the theory that underlies claims that government can and should do nothing to boost wages for workers, other than helping them acquire skills that the perfectly competitive labor market automatically will reward. If it is true, then rapid increases in the skills of the economic elite must explain why, in the last forty years, the earnings from labor income of those of the 95th percentile of American workers increased by 63.2 percent, while the hourly wages of the 50th percentile went up only 15.1 percent and wages of the 10th percentile only 3.3 percent.
This theory is false, even if the bipartisan establishment believes it. Obviously there is some relationship between skills and pay. But in most companies, government agencies, and nonprofit organizations, there is considerable flexibility when it comes to compensation. What workers are paid, along with their working conditions and benefits, depends on the relative bargaining power of workers and employers. Naturally workers want to increase their bargaining power, while self-interested employers want to diminish the bargaining power of their employees. The greatest hoax of our time is the success of employers in persuading the American public-and many American workers themselves-that bargaining power has nothing to do with pay.
There are two ways of explaining the increasing dispersion of wages in the U.S. job market: the worker power story and the human capital story. The human capital story is the one you probably heard from your economics professor and from mainstream economists, pundits, and politicians.
The human capital story says that every individual worker's wages are determined automatically and without human interference by the worker's contribution to the output of the firm or agency. The worker's economic contribution to the firm in turn more or less directly reflects the worker's personal skills or "human capital." The lowest-paying jobs? They pay poorly because they are not providing what is most valuable as a result of advanced information technology, or global markets, or some other impersonal, irresistible force.
According to the human capital story, the polarization of wages in the twenty-first-century United States accurately reflects the skills demanded by the new, globalized, high-tech economy. Automation and other kinds of technological progress have eliminated many "middle-skilled" jobs in manufacturing. What remain are high-skilled jobs in the high-tech "knowledge economy" and low-skilled jobs in "high-touch" sectors such as low-end nursing, leisure and hospitality, and retail.The human capital story is based on an academic economic theory. The marginal revenue product (MRP) theory holds that what each individual worker at a firm earns exactly reflects that individual worker's contribution to the firm's profits-not a penny more, not a penny less.
The MRP theory of wages continues to be taught by academic economists and treated as orthodoxy by most libertarian ideologues and free-market conservatives, as well as many center-left neoliberals in the United States. In a defense of welfare payments that compensate for low wages for workers, James Pethokoukis of the American Enterprise Institute invokes the theory: "Economics won't be ignored. If workers at a big profitable company only generate $10 an hour of revenue, then the company won't pay them $15 an hour."
The MRP theory of wage determination may approximate reality in a few cases. In a fast-food restaurant, it might be possible to correlate sales with how many hamburgers particular workers make per hour. But how is it possible to specify the individual contributions to the annual global sales of a multinational corporation like Boeing of an executive secretary, a vice president for marketing, and a production engineer? It can't be done.
Nevertheless, the bipartisan American economic elite has taken the human capital theory to heart. And with good reason, from its perspective. The human capital story shifts any responsibility for low wages from employers or government policies. The theory can be invoked as proof that all wages are accurate and objective reflections of worker contribution to profits, based on worker skills. It is inevitable that some nursing aides and janitors will be paid poverty wages-so the story goes. To interfere with the automatic operations of the allegedly free labor market-for example, by unionizing nursing aides and janitors or raising the federal, state, or local minimum wages-would only backfire. Therefore, if nursing aides or janitors want to improve their wages, they should not even think about collective labor action or political campaigns. Instead, they should focus on upgrading their own personal skills, by gaining more vocational or college education, and switching to a better-paid profession. In particular, they should obtain skills in STEM (science, technology, engineering, and math) vocations.
In other words, they should learn to code.
The other story-the correct one-is the worker power theory of wage determination. If wages, along with other elements of jobs such as hours and benefits, do not correspond directly to an individual worker’s measurable productivity, then how are wages set? They are set by bargaining.
We often assume that prices are set only by markets or, for some goods, by government regulation, but that is wrong. In the real world, prices can be, and often are, set by a third method: negotiation among two or more parties.
A bazaar provides an illustration. What is the price of a rug in a vendor's booth? The price of the rug is whatever the vendor and the buyer can agree on. Vendor and buyer may reach agreement only after a prolonged process of bargaining, during which the would-be buyer may threaten to walk away. The vendor may insist several times that this is a final offer before capitulating and offering a lower price to lure the departing buyer back. The point is that there is no objective price of that particular rug.
The role of bargaining in setting prices is familiar in many areas. Often a large group, negotiating as a unit, can get better prices than isolated individuals. A trade association planning a convention can get discounts for its members from a hotel. A large corporation can get discounts for health insurance for its employees that are not offered to small businesses or self-employed individuals. Labor unions seek to use collective bargaining to get higher wages for their members than any isolated individual worker could obtain.
Academic economists, along with the policy makers and pundits whom they teach, frequently claim that collective bargaining among organized labor and single or allied employers threatens economic efficiency, by raising the price of labor above its single, true market price. But in most markets of all kinds, there is no single, true market price.
Neoclassical economics is based on the idea of "general equilibrium": prices are magically and automatically set by simultaneous auctions among countless buyers and sellers throughout an entire economy. Among other things, equilibrium theory assumes zero or near-zero profits, with perfect competition driving down profits to match costs. In almost all markets for all goods and services in the real world, profits exceed costs considerably. If they did not, nobody would want to go into that line of business.
The most famous classical liberal economist, Adam Smith, recognized that prices, including wages, may be indeterminate within a broad range and must be "fixed by the higgling of the market." Smith observed that in negotiations over wages employers usually have much greater bargaining power than individual workers: "In the long-run, the workman may be as necessary to his master as his master is to him; but the necessity is not so immediate."
A later classical liberal, J. S. Mill, agreed that wages are set by "what Adam Smith calls the 'higgling of the market.'" This being the case, Mill asked, "What chance would any labourer have who struck singly for an advance of wages?" Mill concluded: "I do not hesitate to say that associations of labourers, of a nature similar to trade unions, far from being a hindrance to a free market for labour, are the necessary instrumentality of that free market; the indispensable means of enabling the sellers of labour to take due care of their own interest under a system of competition." A few generations later, Alfred Marshall, a transitional figure between classical and neoclassical economics, agreed: "It is this unfairness of bad masters which makes unions necessary and gives them their chief force."
The human capital theory of American wage polarization is not supported by international comparative studies. The human capital theory holds that the polarization of wages and jobs in the United States is the inevitable result of technological and economic forces. If this were true, the same worldwide forces should produce similar results in all advanced industrial economies. In reality, however, the growth of inequality in wages as well as wealth has been far more extreme in the United States than in western Europe or East Asia, suggesting that purely domestic American institutional factors must be important.
While it has occurred to some degree in all Western countries in the neoliberal era, the assault on worker bargaining power in the private sector has been taken to an extreme in the United States. Union membership remains higher in most European democracies.
Other English-speaking countries tend to share America's pro-market and antigovernment traditions. Among Western democracies, anti-union neoliberalism in economic policy was strongest under Thatcher and Reagan and similar politicians in Anglophone nations. Even so, private sector union membership in 2021 was 13.8 percent in Canada and 12.8 percent in the UK, about twice as high as the roughly 6 percent private sector unionization rate in the United States. In the nineteenth century the United States was unique among Western countries for the bloody violence of its labor conflicts. Today the United States is unique among developed nations when it comes to the thoroughness with which the economic overclass has decimated the bargaining power of the multiracial working-class majority.
A study of eighteen advanced economies, including that of the United States, by the International Monetary Fund between 1981 and 2010 concluded that 40 percent of the rise in the income share of the top 10 percent could be attributed to union decline. In the United States, the decline of unions might have been responsible for 20 percent of the rise in earnings inequality among male workers in the 1980s. One study estimated that one-fifth to one-third of the growth in wage inequality in the United States between 1973 and 2007 was the result of de-unionization.
In 2008 and 2011, reports by the Organization for Economic Cooperation and Development (OECD) claimed that pretax incomes in the United States and the European Union are similar; Europe is more equal only because of greater after-tax transfers through the welfare state. This argument reinforced the tendency of American neoliberal Democrats to ignore issues of worker power and focus their energy on increasing redistributive after-tax social spending to supplement low wages. It also strengthened the neoliberal consensus, by appearing to support the view that lower wages were caused everywhere by impersonal global economic or technological forces and that nothing could be done except to provide more government welfare for the poorly paid.
In 2020, however, three scholars-Thomas Blanchet, Lucas Chancel, and Amory Gethin-took another look at the data and declared that the OECD had been wrong. In fact, both pretax and post-tax inequality rose much more in the United States than in Europe between 1980 and 2017. Between two-thirds and 90 percent of the difference is caused by more equal European wages, according to the study.
Contrary to a widespread view, we demonstrate that Europe's lower inequality levels cannot be explained by more equalizing tax-and-transfer systems. After accounting for indirect taxes and in-kind transfers, the US redistributes a greater share of national income to low-income groups than any European country. "Predistribution," not "redistribution," explains why Europe is less unequal than the United States.
"If anything, taxes and transfers reduce inequality more in the US than in Europe," the authors conclude.
The main reason for the uniquely bad record of the United States in creating large numbers of low-wage jobs must be sought in institutional factors unique to the United States. And the most significant factors are those that shape the relative bargaining power of employers and workers, with the degree of unionization being the most important.
Nine years after claiming that wage inequality was due to "people . . . being treated closer to the way that they're supposed to be treated," Larry Summers abandoned the human capital theory in a 2020 study published with the Harvard economist Anna Stansbury. In "The Declining Worker Power Hypothesis: An Explanation for the Recent Evolution of the American Economy," they write, "By worker power, we mean workers' ability to increase their pay above the level that would prevail in the absence of such bargaining power. In this framework, worker power not only acts as countervailing power to firm monopsony power but also gives workers an ability to receive a share of the rents generated by companies operating in imperfectly competitive product markets." In other words, workers in some fortunate sectors can share the market power of the firms that employ them, as we have seen already.
Summers and Stansbury rejected the theory that sectoral changes-from manufacturing to services, for example-could explain the decline in labor rents. They also dismissed globalization and the increasing concentration of business as the main cause, as opposed to contributing factors. They concluded: "The evidence in this paper suggests that the American economy has become more ruthless, as declining unionization, increasingly demanding and empowered shareholders, decreasing real minimum wages, reduced worker protections, and the increases in outsourcing domestically and abroad have disempowered workers-with profound consequences for the labor market and the broader economy." The fact that even a neoliberal economist as influential as Larry Summers now endorses the worker bargaining power theory of wage inequality is an encouraging sign that the human capital theory can now be criticized even within the American establishment.
Notwithstanding the attempts of the economic elite to distract us with misleading explanations for low wages in the United States, worker bargaining power remains the central issue. Certain institutions and policies increase worker power and diminish the bargaining power of employers-among them, a high degree of labor union membership, or at least coverage, by collective bargaining agreements; limits on the ability of firms to avoid paying high wages by moving jobs out of the country or importing immigrants willing to work for lower pay in worse conditions than native and naturalized workers; high federal and state minimum wages; and a system of unemployment insurance and other social insurance that allows individual workers to “hold out” longer while waiting for employers to give in and raise wages.
