There is an inverse relationship between utility and reward. The most lucrative, prestigious jobs tend to cause the greatest harm. The most useful workers tend to be paid least and treated worst.
This, however, obscures a vital question: what exactly is the source of the high marginal utility of people on mega-salaries to their employers? Is it because such people are genuinely useful, or is it because they are lucky but useless? Hence my question: are they diamonds or fool's gold?
First, we should distinguish between social and private utility. A CEO, for example, might be tremendously useful to his shareholders but not to society if he increases profits by creating externalities - if, for example, a mining company destroys the local environment.
An important set of cases here is risk pollution. Banks, for example, make money for their senior staff (if only rarely shareholders) by taking on extra risk in the knowledge that, if things turn bad, taxpayers will partly bear these risks. Banks, in effect, get a massive subsidy from the taxpayer.
Secondly, perceived marginal utility, and hence demand, is in part an ideological construct. Imagine a society in which remuneration committees thought: "Corporate growth is largely random and bosses have very little foresight into how their strategies will work. There's no point therefore paying CEOs millions. All we need is a competent administrator paid a respectable professional salary." And imagine this belief coexisted with the idea that people must have dignity in old age and that only a few care workers (to take George's example) have the personal skills to enhance that dignity. In such a world, care workers would be more highly prized. Wage differentials between the CEO and care worker would thus be modest.
What's more, there can be lower-level market failures which create big demand and hence high salaries even for failures:
- Werner Troesken has shown that demand for quack (pdf) remedies in the 19th and early 20th centuries was strong. He says: "Patent medicines proliferated and flourished not despite their dubious medicinal qualities, but because of them”. One reason for this was that quacks invested massively in product differentiation. The failure of one remedy did not therefore discredit the industry but merely shifted demand towards others. I suspect the same thing is true for CEOs and for fund managers: under-performance by one (or many) merely leads to a search for the superstar who can succeed.
- Marko Tervio has shown that what employers want is not talent but proven talent. This, he says, serves to greatly limit the supply of suitable workers, with the result that mediocrities with some kind of track reord get big money: film stars or CEOs fit this model.
- Bjorn-Christopher Witte shows how competition between fund managers can sometimes encourage reckless risk-taking with the result that lucky chancers will thrive. For example, in the early 00s bankers who danced to the music and took risks got big bonuses whilst those who sat it out got sacked. And during the tech bubble money flowed to those managers who thought boo.com and Baltimore Technologies were good stocks, whilst sceptical fund managers such as Tony Dye were fired.
- Hedge fund managers can, in normal times, generate good returns and fees merely by artlessly taking on tail risk - as in Andrew Lo's example (pdf) of Capital Decimation Partners. In fact, non-financial bosses can also "succeed" by taking tail risk - for example by under-investing in R&D, IT or maintenance.
My point here is a simple one. Appealing to demand or marginal utility does not suffice to explain or justify high salaries. Instead, we must ask: what is the source of that marginal utility? Once we ask this, we can see that George's claim that many of them are in fact parasitic kleptocrats might be more consistent with orthodox economics than Tim (or indeed George) appreciates.