Academic Questions 5: Paying the Personnel

I keep thinking about a couple of conversations I had in the US:

Here is a furious after-dinner argument at a meeting years ago: on one side is a business-law colleague who is interested in labor regulation, and on the other side is a financial economist who opposes labor regulation (like safety and minimum-wage laws) because he believes it can’t create real welfare improvements. People get paid their marginal product, he says. What they get from the company is determined by how much money they make for it. So companies can’t pay their lower-level people more, or provide them with more safety, than they do. There isn’t any slack in the system, there isn’t anywhere the money could come from. If you take it away from people who are earning more, and contribute more, they’ll leave, and that won’t help the people who are still in the company.

Here is a quasi-monologue from a macroeconomist when we are sitting in one of the local espresso joints one morning: I hate seeing my brother-in-law at holidays, says the macroeconomist. He has his own business, and he says, You’re an economist, you should be able tell me how to make money. I don’t know how to tell him to make money. He says, Don’t you have some formula for maximizing profits? Sure, I say, the marginal costs of your inputs, like labor and materials, should equal their marginal revenues. Then he says, How do I know what the marginal revenues of my labor and materials are? Then I say, You’re the businessman, you’re supposed to know that. And the conversation just gets worse from there.

Was I paid my marginal product when I was a maid in a cheap motel?  When I had a named professorship at a respectable research university? Nah, I doubt it. And, contrary to the financial economist’s beliefs, it’s not just because regulation distorts the purity of markets.

As the macroeconomist’s brother-in-law said, it’s hard to know what marginal revenues (and sometimes marginal costs) are. Exactly how much more money does Coca-Cola, Inc. make as a result of hiring one more janitor at headquarters? Besides, how well-defined is the marginal product of one input if there are complementarities in the production function? That is, if you and I working together can produce more than the sum of what we can produce working separately, then to whom should that “more”—that synergy surplus—be attributed and paid?

The uncertainties here allow some room for fudge in determining how much people are paid. Because we don’t know marginal products, we have to guess at them, and our guesses are influenced by highly salient (not always highly informative) facts and by sociopolitical pushes and pulls. This influences the personnel costs of universities in some curious ways.

1)   Faculty salaries in professional areas like business, law, and medicine are much higher in the US than in Germany, which is one of the (many) reasons that higher education is more costly in the US. And one of the reasons faculty salaries are higher is that starting salaries for new graduates in these area are also much higher in the US than here. This drives faculty compensation up, because paying teachers much less than their students earn immediately at graduation discourages people from becoming teachers. 

The national differences in entry-level professional salaries are not just differences in the overall level of economic performance but also (and more so) differences in how income is distributed within countries. Mean per capita income is about $8,000 lower in Germany than in the US. But mean starting MBA salaries are about $28,000 lower, and starting family-physician salaries are something like $100,000 lower in Germany. (Data from www.topmba.com, www.mdsalaries.com, and www.thieme.de/viamedici/arzt-im-beruf-weiterbildungs-coach-allgemeine-infos-1570/a/was-verdienen-aerzte-18665.htm  Different sources would undoubtedly provide different numbers, but the basic picture shouldn’t change.)  

There are all sorts of reasons for these differences, and the reasons are entangled in the whole socioeconomic structure. Just a sample: In the US, it's possible to make really big money from compensation in some fields: for example, the top reaches of business, entertainment, law, and medicine. This is less true in Europe, where big money comes more from ownership of capital, not from compensation (see Paul Krugman’s piece in the May 8 New York Review for more on this). 

Second, entry-level pay can be lower relative to later-life pay here than in the US. (It isn’t always, but it can be.) Archangel was extremely startled to find, when he was hiring people in Berlin, that age—not just work experience or accumulation of credentials, but pure number of years since birthdate—was one of the elements that went into the pay formula. He simply was not allowed to pay a brilliant twenty-eight-year old very much, regardless of credentials and work experience and past performance, because the person was, well ...  twenty-eight.

This was a civil-service rule on a particular job, not a universal practice; but it exists—it’s acceptable here when I think it wouldn’t be in the US—in part because there is a greater cultural skepticism about the value of youth. American popular culture is full of the themes of children being smarter than their parents, young people’s ideas being better than older people’s ideas, and so on. If I may generalize from some limited television-watching, there’s more sense in popular culture here that the young can be volatile and thoughtless and haven’t yet learned to manage their lives; they need guidance from their more solid elders. (The sense that the old don’t “get it,” and the young do, comes in part from the strong immigrant culture in the US: in immigrant families it’s the kids who acculturate quickly and speak the language better. Their parents are lost and have to be helped to navigate the culture.)

In any case, social structures put a lid on recent graduates’ salaries here, and that reduces some of the upward pressure on professors’ salaries.

2)   The way university education is financed also makes a difference to compensation levels. Tuition is relatively trivial here: the state pays most of the cost of running the universities via tax-funded appropriations. In the US, you graduate from business school or med school or law school with a big load of debt, because of the high tuition. So you “have to” make a lot of money in your first job in order to pay off the debt. (That is, people won't go into this line of work and incur the debt for the education unless they can make high starting salaries.)  And because graduates have to make so much money in their first jobs in order to pay off their debts, their professors have to be paid highly, which makes the education more expensive to provide, which increases the debt load, which increases the need for high starting salaries for graduates, which … etc., etc.  Some part of this dynamic is absent in Germany.

3)   The terms of the tradeoff between the monetary and non-monetary rewards of work are different in different places, because what you can and cannot buy with the money (and what you can buy only with the money) differ from place to place. You can translate dollars to euros at purchasing power parity, but the "same" money in this sense does not let you buy the same things. (Nor would you even want to buy the same things, perhaps, in different cultural settings.) German colleagues complain, with reason, about the difficulty of getting capable PhD students and faculty for the salaries that are offered here. But I think that you would have even more trouble getting them for the same price in the US because of the differences in what money can and must buy. What more money (past a certain moderate level) buys you here is more toys. What it buys you in the US, especially in large urban areas is protection against more existential threats. You need it for personal safety, health care, education for your kids. (Because schools are not funded by local property taxes here--property taxes are almost nonexistent, and school funding is not local--the question of what your children will learn in school is not so intimately tied to the size of your house.) So having more money can be a more pressing matter in the US--and this must affect the way that people sort themselves into jobs and bargain over compensation.