Thursday, 18 August 2011

Productivity and context

Just listened to Econtalk with Bob Lucas, Nobel Laureate and professor of economics at the University of Chicago, on economic growth. Naturally they also touched on productivity. It was almost funny how they avoided one conclusion. It was on the tip of my tongue as the ending of many sentences.

They talked about a person raising chickens in Indonesia, producing about 50 eggs per chicken per year and having to pick them himself. They asked themselves the question why he did not use modern technology to produce 300 eggs a year. Lucas answer was the lower cost of labor in Indonesia and he stated that this cost is determined by people working in factories in the cities. Lucas: "Economic growth is always associated by a move out of agriculture and into the city environment."

Then the host Russ Roberts asked Bod Lucas why an unskilled immigrant makes so much more money as soon as he (illegally) crosses the US border. Or in other words why he suddenly becomes more productive, while his human capital did not change. Lucas said that it is about cooperation with other people, how productive you are, e.g. as a busboy, depends on the quality of the waiters and of the cooks. Furthermore, the richer people in America are willing to pay more for a dinner.

Roberts then notes that it is a beautiful and interesting problem, that he is probably not more intelligent than his dad, but his standard of living is much higher. Lucas avoids answering, but states: "The other thing is: How many people are competing with you at your level?" "Don't drop out of high school!"

The answers hint at the following: Context is very important in determining productivity and wages. In the two examples, the farmer and the immigrant, context determines their wage, not their skill, not their education, not their human capital. For the farmer it is important that other people get better wages in the city, for the immigrant is is important where he works.

Productivity thus cannot be determined by looking at a person, it is not defined at the level of a person. Scientifically put: it is a nonlinear computation, not a linear one. In the latter case you could isolate one element, one person. Strictly speaking productivity is only defined at the global level. It is still reasonably well defined for nations and probably for large companies. (Even the productivity of companies is determined strongly by their network of partners and institutional factors.) Thus it is also not possible to compute how much a worker should earn. It is up for negotiation. And you certainly cannot claim that someone deserves to earn a certain amount.

Of course, the employee does need to work and often needs skills. Lets not start a nature-versus-nurture-type debate. Productivity is determined (almost) 100% by context and 100% effort. Just as an organism is determined 100% by nature (genes) and 100% by nurture (environment; context) and you can only split these two factors for a given variability in the environment.

It is thus very well possible that top managers get better salaries because they have a better bargaining position, not because they are more productive as it often stated in the media. Doubling the salary of all workers would be a problem to a company. However, a company does not go bankrupt because their CEO gets a double salary; there is only one CEO and there are basically no market forces to reduce it until it becomes extremely excessive. That may be an important reason for the differences in salaries, rather than skills.

Further reading

More posts on economics.

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