Doubtless, anyone reading this blog has heard, at one time or another, someone ask why baseball or football players earn so much. Almost inevitably the question is framed along these lines: "Firemen and policemen take huge risks and perform essential services, and yet they earn only a fraction of what a major league baseball player does." Or perhaps: "Teachers are so essential to our society and yet they earn only a tiny percentage of what an actor does."¹ It is one of those questions which seems to cut across party lines, being asked as often by conservatives as liberals. Though conservatives seem to favor the "actor" version, while liberals tend to be more critical of athletes, make of that what you will. And, sadly, it is a question that it seems no one can adequately answer. Which is rather depressing, as our inability to answer such a question shows not only the shallow understanding most of us have of economics, but how poorly we grasp the free market, and, in the long run, how weak is our support for individual economic liberty.

The first explanation should always be the most simple, and, thankfully, that answer is the one I have heard, admittedly far too infrequently, offered in response to this question. And that response is: "No one is forcing anyone to pay them. If people want to pay a pitcher or an actor, that is their choice." And that is, in a nutshell, all the explanation we really need to give. Baseball players make so much because people are willing to pay them that much. No other explanation should be needed. But, as our grasp of economics has grown so tenuous, and we seem to have developed the peculiar belief that economic outcomes must be "just" or "fair"², it is an unfortunate necessity that we must offer our contemporaries a more elaborate explanation, demonstrating  that such salaries "make sense".

Not that such an explanation is difficult to make. I may think it is unnecessary, but it is not terribly difficult.

Let us suppose a teacher can provide a student with services worth $2000. Or a police man prevents crime that would have cost a given neighborhood an average of $100 per resident. Clearly, people using these services would be happy to pay any amount up to those amounts. Now, let us suppose after a full season of football you estimate a given player provided you with enjoyment worth $5. Or, based on a given movie, an actor provided you with a service for which you would pay $0.50. As you can see, in your subjective opinion, the athlete and the actor are worth far less than the teacher or police officer. And the amount you pay to each will certainly reflect this fact³.

But that is one person. What happens when we look at the whole economy? That one teacher, how many people can she serve? Twenty? Thirty? Multiply that by the worth you assigned, and the teacher earns $60,000. The police officer may serve more, maybe 50 or 60⁴. And that puts him at a similar wage. However, the athlete can bring his $5 of enjoyment to millions. If we figure he brings enjoyment equal to yours to even 1 million people, that gives us a salary for the season of $5 million. And the same is true of the actor. He may have brought only $0.50 of enjoyment to you in a given picture, but if 10 million saw the picture, he will earn the same amount as the athlete.

And that is the simple mechanism that explains these tremendous salaries. The same mechanism also answers another question we hear far too often, and, sadly, many times from supposed conservatives. And that is why a CEO earns a salary so many hundreds or even thousands of times that of a single worker.

As the solution is slightly different, though not much, allow me to explain. A given worker, not matter how productive, is limited in his productivity by the value he can impart to a finished product. This is partly the outcome of the capital invested in the worker, in terms of training, and also in terms of equipment provided (and also general infrastructure - see "Capital Investment"), but those only determine his potential output, the final amount is dependent entirely on the amount consumers are willing to pay, and the value they place upon his contribution⁵. And so, in the end, if a worker, mounts doors on a minivan, and consumers value his contribution at, $10 per van, his income will be something approaching that amount times the number of vans he can assemble⁶.

I mention this because the CEO is paid on a similar basis. The difference is just that he can touch so much more of a massive organization, the same way the athlete or actor can reach more consumers. For example, if he saves $1 per user on health care premiums, and the corporation has 100,000 employees, he saves $100,00 through that act alone, and thus is worth at least a salary of $100,000, even if he does nothing else⁷.  Or, let us look at it this way, if a worker on the line improves his productivity 1%, he earns an extra dime per door. If a CEO improves overall productivity 1%, that could amount to tens of millions of dollars or more. Again, as with the athlete or actor, it is simply a question of scope.

There is one final factor, which is sometimes offered wrongly as an explanation on its own, and that is scarcity. If you think about it, it should be obvious that scarcity, while necessary for high wages, is hardly sufficient. For example, those capable of acting as effective CEOs of global corporations are certainly not numerous,  but neither are the best sort of teachers or police officers, and yet even the best teachers and police officers will never earn as much as a CEO. And, to offer an even more absurd example, those who can sing opera translated into Navajo or juggle hedgehogs are also probably quite rare, and yet neither of those skills will earn one even as much as a teacher or police officer.

The reason behind this should be obvious, as it is the same explanation I have been giving all along. The teacher and the police officer, not matter how rare, no matter how good, can reach only a few, and so can earn only that multiple of their worth. And in the case of the hedgehog juggler, the numbers are even worse, as not only can he only reach a few, but even those few don't put much value on his skill, making his salary doubly reduced. And this, no matter how rare, these individuals will not see the tremendous salaries of those who can reach the masses.

So, if that is the case, why is scarcity a necessary condition? The answer there is equally simple, competition. If there are only a handful who can play professional baseball, each will need to serve millions of fans, and thus earn a fortune. But if thousands are capable of such feats, those millions are now divided among many more players, and salaries are proportionately reduced. Not only that, but with many more offering the same service, it is likely the fees charged will be bid down in an effort to attract a greater percentage of the market, resulting, over time, in a much lower salary than would exist with the smaller number of players. And the greater the number of players, the greater this tendency, which is why scarcity is necessary for the tremendous salaries we see in professional sports or among Hollywood stars.

Hopefully that explanation was sufficiently brief to appeal to those who find ti difficult to explain why salaries so often seem to deviate from the "true worth" of a profession. It is one of those questions which, if we are going to stand up up for conservative principles, deserves a good answer, and yet  rarely receives one. Maybe, if we keep reminding ourselves of these economic principles, that will change in the future.

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1. There is another variation, about CEOs, with which we will deal later.

2. There are two problem with the terms "fair" and "just". First, the words lack anything approaching an objective meaning outside of a few very specific contexts, and so signify nothing but the preconceptions of the speakers. ("The Most Misleading Word", "Luxury and Necessity", "A Question of Fairness", "Protean Terminology",  "Bad Arguments") Second, even if we agree to use them in a more general sense, the terms are meaningless when discussing mutual, voluntary transactions."Fair" and "just" can apply only to potentially arbitrary decisions made unilaterally. (Such as the rulings of a judge or the call of a referee.) When agreements are made by mutual consent, there is no sense at all in using these terms. ("In Praise of Contracts", "Life Is Not Fair - And Trying To Make It So Makes Things Worse")

3. The issue is a bit confused by the fact that policemen are paid through involuntary taxes, and so you do not explicitly agree to pay a set fee. However, your taxes are effectively a set of fees you agree to pay for a number of services, and politicians win or lose office, in part, by properly estimating the amount of taxes you are willing to pay. So, to a degree, you do set the pay of police officers by voting based on a combination of the amount of tax you will willingly pay, and what portion of that amount a given politician will set aside for police salaries. (Of course, in a two party system, even if we include primaries, you are forced to choose between maybe 8 to 10 combinations at most, so your personal input may be somewhat distorted, but over time the aggregate decisions on such matters are expressed. See "Misunderstanding Democracy", "Symmetry and Asymmetry in Government", "Negative and Positive Rights" and "Power and Disorder".)

4. This number is hard to determine, as a given community may be served by more than one police officer. As a result, the value of a police officer is something of an estimate. Then again, this is not that unusual. Our auto worker is not really adding $10 of value, we are dividing the aggregate value of the whole vehicle across the workforce, adjusted for the differing tasks. So we can apply a sort of cost accounting to figure the value of a given police officer's work as well.

5. This is an important part, as a person producing a good no one wants may be very productive, but he will still earn little. Likewise, many may believe a product to be "objectively" worthless, like the pet rock or other fads and novelties, but if consumers value it more highly, the wage for producing or selling it will match the consumers' valuation. ("The Right Way", "The Inherent Disappointment of Authoritarianism", "Absolute Values", ""True" Prices", "Misunderstanding the Market".)

6. As I explain in "Exploited Labor", "Capital Investment",  "Fairness and the Free Market","The Harm of Closed Shops and Collective Bargaining" and "Pro-Labor Cannibalism, A Look At The Union Food Chain", competition ensures wages will be very close to total value produced. In a competitive market it is almost impossible to maintain artificially low wages for any length of time.

7. I discussed this before ("A Little More On CEO Salaries"), but this also explains why a company can lose money and yet still pay massive CEO salaries. Suppose a company would lose $100 million, but a good CEO cuts that loss in half. If he demands $20 million as a salary, the company is still $30 to the good for hiring him. This easily explains a situation so many find puzzling.

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POSTSCRIPT

This is a topic I have addressed several times, but always as part of another essay. And so, when I wrote a comment on a web site giving a brief explanation of this point, it struck me that there was now a better explanation on another web site than there was on this one. That being a rather embarrassing situation, I decided it was time to address this topic explicitly, and thus this post was born.

For those interested, my comment is on the site Jabootu's Bad Movie Dimension, specifically here. It reads as follows:

There is an even more important reason actors and sports stars get such money. Let us say, in your opinion, your teacher in high school gave you $2000 worth of value, while Brad Pitt gave you maybe $1 of enjoyment. So you pay each that amount. However, [a] teacher can, at best, teach 30 students, and so earns about $60K, while Brad Pitt can give $1 of enjoyment to 30 million people, and so gets $30M dollars. Same with sports stars. They may objectively give much less benefit to each individual than a cop or firefighter, but a cop or firefighter will benefit a lot fewer people.

It is the same reason Sam Walton earned a lot more than your neighborhood hardware store owner. (He may have personally made less per unit, but he sold a lot more units.) Or look at McDonald's versus a much better local restaurant. The same applies here. Famous individuals may bring less benefit than a lot of unsung heroes, but they reach so many more.

I am a bit concerned about reproducing it here, as I worry readers may find it a better version than the one in the post above. I know it is much pithier, but I hope the longer essay I have just completed fleshes it out well enough to justify the longer version.

POSTSCRIPT II

I wrote extensively about CEO salaries in the pat, especially when this was a "hot topic" on political sites. Here is a list of all the articles I wrote on the topic:

A Really Foolish Idea
Greed
Greed Part 2
A Little More On CEO Salaries
Another Bad Idea
What Is Fair? or, How Game Theory Leads Us Astray
Envy Kills
Envy And Analogy
Pointless or Destructive
Crippling Business
AIG Absurdities
AIG Nonsense
Living Large During the Good Times
He's Bad So He Must Be Wrong
A New Look At Intervention

Fortunately, it seems conservatives have forgotten about this topic and thus sound slightly less like liberals. But we should remember how quickly supposed conservative can jump onto foolish populist bandwagons, and do our best to discourage others from following them. ("Beware Populist Deception", "How Conservatives Defeat Themselves", "The Single Greatest Weakness",  "What We Deserve", "Who Is To Blame?", "Don't Blame the Politicians", "You Lose When You Think You Win", "Tyranny Without Tyrants", "Envy And Analogy", "Good News and Bad News")