Chapter 34 Question 028

Why do the salaries of high earners rise so much faster than ordinary people? In the thirty years after World War II, the income growth rate of people in the upper and lower income brackets was almost 3% per year.Since then, however, top earners have been earning more and more.Therefore, although the actual purchasing power of middle wage earners is basically the same as it was in 1975, the income of the top 1% has tripled compared to 1975.The higher you go, the greater the income increase.For example, the salary of the CEO of a large American company is 500 times higher than that of ordinary workers today, but in the 1980s, it was only 42 times higher.Why did this change occur?

While many factors are involved, one in particular stands out as the rapid pace of technological development, which enhances the personal advantage of the most capable people.The conditions of each industry are different, we might as well take the situation of tax consulting industry to get a glimpse. In the 1970s, the industry was largely controlled entirely by local accountants.The most able accountants earn significantly more than their colleagues, but the pay gap is generally not large.Then there was a wave of national tax consulting firms, such as H&R, Block & Company, etc. The organizers of such agencies discovered that with the guidance of a relatively small group of experts, most tax return work can be done entirely by non-professionals. people to complete.Driven by effective national advertising, these firms capture the local accounting market, generating huge revenues for the organizers.

More recently, people have begun to rely on computer software to guide them through tax refunds.At first there were a plethora of such programs vying for buyers' attention, but when Intuit's Turbo Tax and several other programs with the most comprehensive features and user-friendly interfaces came out on top, the market for competing software shrank dramatically. This way, once the best tax software is coded, software companies can produce copies of the software at close to zero marginal cost, effectively crowding out software with fewer users.So, if we compare the tax consulting industry today with that of the 1970s, the losers are the local accountants, and the big winners are the organizers of the top tax preparation software companies.

The same goes for CEO salary increases.Modern information technology, along with lower transportation costs and tariff barriers, have expanded the reach of markets.A tire company that once survived simply by being the No. 1 producer in Ohio now has to be among some of the most efficient producers in the world.Markets are much wider and more competitive than in the past, and small differences in the quality of a leader's decision-making can translate into huge differences in a company's revenue. Of course, stronger advantages and more competition cannot explain all of the increase in CEO earnings.The Enron and WorldCom scandals illustrate how some CEOs cheat their books to boost their paychecks.But studies have shown that top managers' salaries have risen largely because managers' decisions have become more important to improving company performance.

In product markets, the price of a commodity depends on its characteristics.For example, high-definition televisions are more expensive than conventional televisions.In the labor market, the situation is the same, the salary of a particular job depends on its characteristics.Economists' so-called compensatory wage differential theory was originally developed by Adam.Smith stated in The Wealth of Nations: The advantages and disadvantages of the different employments of labor and capital must, on the whole, be perfectly equal, or constantly tending to be equal, within the same neighbourhood.If, in the same place, one employment is evidently more favorable or more unfavorable than another, many will leave the less unfavorable occupation and crowd into the more favorable one.The interest of this occupation, then, will soon take into account the interest of the individual as with all other occupations, and men will seek the profitable ones and leave the unfavorable ones.

Smith's theory explains why, other relevant factors being equal, wages are generally higher for jobs that are riskier, require more effort, or have dirty or smelly workplaces.The following examples illustrate other, less conceivable consequences of the compensating wage differential theory.