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Meritocracy and market over-recognition

Jonathan Aldred

 

High rates of pay are hard to justify and harmful to economy and society in various ways. We face a problem of over-recognition of the contribution of some workers.

 

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 creditfor 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 difference may be undeserved, because some nurses may want to become doctors, but not have the opportunity to do so, for the same reasons as Paul – they cannot afford the training. Pay differences seem deserved only if we all have a fair opportunity to earn more, otherwise earning less is not truly our fault, our responsibility. Similarly, someone may fail to gain entry to medical school to train as a doctor because of a demographic quirk that year – lots of young candidates, and few older doctors at retirement age. Had they applied a year earlier, they would have been accepted. Again, the opportunities seem unfairly distributed.

 

Why market recognition does not reflect contribution

Even if we ignore these deep flaws in the first part of the contribution argument, the argument depends on its second part too: the claim that in free markets, people are paid roughly according to the contribution they make. But this is generally not true, because market pay rates are strongly influenced by supply and demand, not just the value of contributions. If doctors are scarce but there are plenty of nurses, doctors will be paid even more, for instance in comparison to another economy where doctors are less scarce, although the relative contributions of doctors and nurses are the same in both economies.

Orthodox economists have a stock reply to this objection. If doctors are scarce, then their contributions will be worth more. Therefore, when market forces reflect this scarcity by pushing up their pay, they will still be paid what they deserve. But assuming each doctor works no more hours, how can their contribution be worth more? The value of the hours worked will be greater. Doctors in short supply will prioritise the most important work and ignore the rest, so on average, the work they do will be relatively more important – relatively more valuable – than if there were enough doctors to do it all. This reply clearly rests on debatable premises, such as the assumption that the average value of nurses’ work remains the same when doctors are scarce – when we might expect them to take on some of the tasks usually performed by doctors.

But in any case, the economists’ reply cannot be generalised. In the case of medical staff, the argument implicitly appeals to an objective measure of contribution (such as patients treated or lives saved), independent of market pay rates, to justify the latter. Unfortunately, there is no objective measure in general, and orthodox economists rely instead on the market prices of goods and services to measure the contribution of the person who supplied them. The idea is simple enough: the market price reflects how much consumers are willing to pay for something, which in turn indicates how valuable it is. If market prices do measure contribution, and people are paid exactly the market price of the goods and services they produce, then it follows that pay equals contribution, and so the second part of the contribution argument holds. In reality, there are many reasons why market prices fail to measure contribution satisfactorily.

To begin with, most goods and services are jointly produced by many people. Although we may know the market price of the product, it is very hard to see how each worker’s share of that total value could be determined. The CEO of a big corporation may take the credit for a large rise in profits, but the improvement will inevitably be the result of efforts by many different people in the organisation.

Another problem is that how much your work is valued in the market depends on who is buying your output. The rich are willing to pay more for most things than the poor. An artisan maker of crocodile skin handbags may earn more than someone providing debt advice to the poor. But it would be hard to justify the pay difference on the grounds that crocodile skin handbags provide more benefit for the rich than debt advice does for the poor. It is just that the rich pay more for what they want.

This example raises a more general issue. Consumer willingness-to-pay in the market is a deeply unreliable indicator of value. Real people are not the ‘sovereign consumers’ of economic theory, and there is robust psychological evidence that they frequently make choices which do not serve their own best interests. Just because they are observed paying more for something does not imply that it makes them happier, or serves their goals better, than something less costly. As described in the surprise bestseller Nudge, humans inevitably suffer from various cognitive biases which lead them to make mistakes in decision-making (Thaler and Sunstein, 2008). Advertising, and an excessive range of alternatives to choose between, can make matters worse.

Many progressives have been wary of criticising market willingness-to-pay as a measure of value for fear of being branded elitist. But the psychological arguments here do not depend on an elitist account of value, Marxian false consciousness, or any appeal to values beyond individual preferences. Put another way, Nudge has been accepted across the political mainstream, with readers including Barack Obama and David Cameron. It takes the existence of meaningful, autonomous individual preferences for granted; the focus is on the mistakes we make in trying to satisfy them.

Of course we can go further, and in a direction which should not offend neo-liberals, because it reflects recent attempts to re-connect orthodox economics with its utilitarian roots – ‘happiness economics’ (Frey and Stutzer, 2002; Layard, 2005). Happiness economics takes seriously the possibility that individual preferences, however autonomous, well-defined, and successfully pursued, may not improve individual happiness. It is supported by rapidly accumulating empirical evidence and provocative neuroscience (Clark et al, 2008; Camerer et al, 2005).

What are we to make of it? At the very least, because it is rapidly entering the economic and political mainstream, happiness economics makes it safe once again for progressives to question market preferences as a measure of value. But the mainstream do not seem to have noticed that once the link between preference and value is severed, the link between free market pay and contribution is also lost, and with it the principal ethical justification for significant pay inequalities.

Time for a blunt summing up. When bankers are paid much more than nurses, this pay difference cannot be justified in terms of people earning their ‘just deserts’, or as a reflection of differing contributions. Bankers earn vastly more than nurses because their work is more highly valued in a market economy. Professional footballers earn more than cleaners for the same reason. There is no reason to believe that the value of our work in the market has any connection with its true value to society, or with what we deserve.

Most of us have always known this, but we urgently need to remind each other – and especially the bankers – of this basic moral truth. Although it may be stating the obvious, it is worth stressing why all this matters. Even among progressives, it is still widely believed that there is some connection between pay and economic contribution or ‘wealth creation’. This leads to the view that high earners to some extent deserve their rewards, suggesting the conclusion that while poverty is a problem, inequality in itself is not. And the contribution argument is used to bolster the case against higher tax for the rich, hinting that there are ethical as well as economic reasons to resist more progressive taxation.

 

Respecting market rewards: the incentive argument

Mention of the economic case against strongly progressive taxation brings us to incentive arguments. In deregulating labour markets and rolling back progressive taxation, perhaps what we recognise is not that high pay is deserved, but merely that it is economically expedient. High pay encourages high performance, with economic benefits for us all.

Yet it is easy to overstate this argument. Just because some pay differences are necessary, in order to attract talented people into important jobs and incentivise good performance, it does not follow that the enormous salaries we see in the financial sector can ever be justified. We face a trade-off between efficiency and equality: some pay inequality may be justified insofar as overall economic welfare or happiness increases enough. As well as overall happiness, we may follow Rawls and be especially concerned with improving the lot of the poorest. Pay inequalities which make the rich much richer and leave the rest of us largely untouched are unlikely to be justified.

 

Defining the merit in meritocracy

There is nothing especially radical in this trade-off view and it need not challenge meritocracy. A direct concern with inequality – that is, inequality as intrinsically wrong, not just because of its derivative effects – does not require us to abandon meritocracy. Amartya Sen has emphasised that the ‘merit’ in meritocracy means success against a set of criteria which are open to us to define: ‘The art of developing an incentive system lies in delineating the content of merit in such a way that it helps to generate valued consequences’ (Sen, 1999, 9). If one of the criteria is reducing inequality, then rewarding merit can, in principle, be reconciled with a concern for inequality.

However, achieving that reconciliation in practice may prove difficult. The problems begin with ‘a tension of moral psychology within the incentive-based rationale of rewarding merits, arising from its instrumental nature. Actions are rewarded for what they help to bring about, but the rewarding is not valued in itself’ (Sen, 1999, 10). In other words, market recognition of high performance is not to be celebrated in itself, but tolerated as a means to the end of enlarging the economic cake. But because we struggle with the psychological tensions built into this subtle distinction, we tend to ignore it. The result is celebrating success for its own sake, leading to pay inequalities far greater than those which can be justified on incentive grounds.

One way this can arise is through the entrenching of particular routes to financial reward. Suppose, for example, entry to the particularly lucrative higher echelons of a specific occupation – say, becoming a partner of a City law firm – is common once certain necessary conditions have been met. In our example, these conditions might include attendance at an elite university, attaining a series of professional qualifications, followed by several years spent in gruelling junior posts working long, unsociable hours. It is easy to see how workers who have satisfied these conditions see the high pay once they become a partner as somehow ‘deserved’ or ‘owed’ to them.

This example raises a more general issue. Rather than rewarding good performance, high pay can become attached to the possession of ‘talent’ or other personal characteristics. Merit, and with it some form of recognition, becomes attributed to particular people. But rewarding people for their characteristics has no link whatsoever with the reward of desirable actions or good performance which is at the heart of the incentive argument.

 

Incentives in practice: performance-related-pay and intrinsic motivation

We turn now to the practical problems with the use of financial incentives to encourage good performance, exemplified by performance-related pay (PRP) schemes (Dixit, 2002). Most workers ‘multi-task’, and if performance pay is attached only to some aspects of their job, it will lead to the relative neglect of the rest. Performance-related pay can also have perverse effects if employees work together in teams. It is then difficult or impossible to measure individual performance, but if the performance of the team as a whole is rewarded, this creates an incentive for team members to rely on the effort of their colleagues. Another difficulty is that a worker may serve many masters, each of whom has different views about which aspects of the job matter most.

There are less familiar difficulties with performance-related pay schemes too, which have largely been overlooked by orthodox economics. Performance-related pay has most motivational power if it rewards against performance criteria which can be objectively measured, the criteria and the measurement scheme being known to the worker in advance. But the effect is to prioritise the measurable. Performance criteria for which objective data is lacking, or which are inherently non-quantitative, will be ignored in favour of those which can be measured (Aldred, 2009).

A more fundamental challenge to performance-related pay, and incentive arguments for market rewards in general, is that explicit financial incentives can be self-defeating. They can erode or ‘crowd out’ workers’ intrinsic motivation to do the job well (Frey and Jegen, 2001). There are two dangers. First, if performance-related pay or similar incentive schemes suggest that workers’ intrinsic motivation is inadequate on its own, this implicit criticism serves to undermine workers’ self-esteem, which in turn leads to a doubting and devaluing of intrinsic motivation. The criticism is to some extent self-fulfilling. Second, if the goal of managers or politicians is perceived to be control, manipulating behaviour through the use of incentives, then intrinsic motivation will again be undermined: it is futile and unnecessary to have intrinsic motivation if you feel forced to do something regardless. Intrinsic motivation withers along with perceived autonomy.

In recent years there has been some acknowledgement of these problems in the debate over public service reform, not least because intrinsic motivation is regarded as especially significant among public service workers. Julian Le Grand has developed an elaborate analysis of the interaction between extrinsic financial motivations and intrinsic ones (Le Grand, 2003; Le Grand, 2007) – besides having been a key Blair adviser on public service reform. The central claim of his theory is that small financial incentives have a positive effect on motivation ‘since they signify social approval of the sacrifice … [the public service worker] is making’ (Le Grand, 2003, 67), while sufficiently large financial incentives also encourage performance, for obvious self-interested reasons. But there is an intermediate range of incentive payments which can be counter-productive.

Although Le Grand’s theory displays impressive quantitative sophistication, it lacks the qualitative sophistication of context. The response of a doctor or teacher to the introduction of monetary incentives will be shaped by many contextual factors; the amount of money in itself may often be less important. Recognition is of course a key contextual factor itself. A classic example is care work for the elderly or for those with mental health problems, which tends to be undervalued, or even unnoticed, compared to other forms of health care. Increased financial rewards may have a beneficial effect on motivation, by raising recognition and respect for these activities.

A higher wage may also lead to an increase in an activity because the worker feels they can now ‘afford’ to do it. Carers may undertake more care work instead of other paid employment; hospital consultants may do more NHS work and less private practice. Note that motives here are not simplistically self-interested, because in both cases the workers may suffer an overall pay cut.

In essence, the problem with the economic analysis of financial carrots versus intrinsic motivation – and it is this analysis which has dominated debate over public service reform – is that it assumes a cost-benefit view of the emotions (Aldred, 2009). In this reductionist model, emotions are just psychic costs and benefits, weighed up on the same scale as financial ones, so more of one should substitute for less of another. The model does not bear scrutiny: for instance, it does not explain the damage caused by some financial incentives lingering long after they have been removed. The behaviour and morale of workers is not immediately restored. Once trust is lost, it cannot quickly be rebuilt. New theories of recognition are needed to help develop a more nuanced and realistic economic analysis.

 

The case against market recognition

We have seen that the contribution argument is flawed. Market recognition – that is, market pay differentials – cannot be justified in terms of differing worker contributions. The economic incentive argument for market recognition has a kernel of truth, but it supports only limited pay inequalities. It has been stretched far beyond that in the name of meritocracy. There are practical problems with financial incentives too, especially when they erode intrinsic motivation.

Nevertheless, our case against market recognition remains incomplete: even if the standard arguments for market recognition fail, there has been little direct mention of the damage that it does. Although most of the damage caused by excessive pay inequality is all too obvious, it is worth spelling out the less obvious effects.

First, poverty and inequality don’t just hurt the poor. The middle classes suffer too. As now demonstrated beyond doubt by epidemiological research, inequality breeds stress, anxiety and depression across the full spectrum of society, not just among the poor and deprived (Wilkinson and Pickett, 2009). And we have known at least since pioneering work on positional goods (Hirsch, 1995) that a strong concern with relative income is not mere envy or status anxiety, but a rational response to economic inequality in a world of important absolute scarcities (Aldred, 2009).

Second, as just discussed, in some circumstances additional financial reward can undermine intrinsic motivation to such an extent that the incentive for good performance is reduced overall. So in these cases, market rewards may tend to shrink the economic cake rather than enlarge it.

Third, inequality is bad enough, but giving market-generated inequalities recognition is worse. That is why the ethical arguments about deserved pay inequalities are ultimately more dangerous than the economic incentive arguments. They are used to resist attempts to reduce inequality, whether through taxation of income, wealth or inheritance, or direct intervention in the labour market.

Once we accept that market over-recognition is at best about economic expediency, rather than morality, our perspective alters. An open-minded debate about taxation may finally be possible, one not tainted with the view that taxes on income and wealth are in some sense immoral. This article has aimed to encourage that debate to begin.

 

References

Aldred, J. (2009) The Skeptical Economist: revealing the ethics inside economics, London, Earthscan.

Camerer, C, Loewenstein, G. and Prelec, D. (2005) ‘Neuroeconomics: how neuroscience can inform economics’, Journal of Economic Literature 43 (1): 9-64.

Clark, A, Frijters, P. and Shields, M. (2008) ‘Relative income, happiness and utility’, Journal of Economic Literature 46 (1): 95-144.

Dixit, A. (2002) ‘Incentives and Organisations in the Public Sector’, Journal of Human Resources 37: 696-727.

Frey, B. and Jegen, R. (2001) ‘Motivation Crowding Theory’, Journal of Economic Surveys 15 (5): 589-611.

Frey, B. and Stutzer, A. (2002) Happiness and Economics, Princeton, Princeton University Press.

Hirsch, F. (1995) Social Limits to Growth, revised edition, London, Routledge.

Layard, R. (2005) Happiness: Lessons from a new science, London, Penguin.

Le Grand, J. (2003) Motivation, Agency, and Public Policy, Oxford, Oxford University Press.

Le Grand, J. (2007) The Other Invisible Hand, Princeton, Princeton University Press.

Olsaretti, S. (2004) Liberty, Desert and the Market, Cambridge, Cambridge University Press.

Rawls, J. (1999) A Theory of Justice, Oxford, Oxford University Press.

Sen, A. (1999) ‘Merit and Justice’, in Arrow, K, Bowles, S. and Durlauf, S. (eds) Meritocracy and Economic Inequality, Princeton, Princeton University Press.

Thaler, R. and Sunstein, C. (2008) Nudge, New Haven, Yale University Press.

Wilkinson, R. and Pickett, K. (2009) The Spirit Level, London, Allen Lane.

Young, M. (1961) The Rise of the Meritocracy, London, Penguin.

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