Pay is determined by your best alternative job


Economic theory tells us that we really ought to be paid our marginal productivity. And no one at all believes that that actually happens in detail. However, we can take a step back to a point which even Karl Marx got, which is that your pay will reflect the demand for labour. More specifically, the better the alternatives you have the more your pay is going to go up. And here's a nice little story from the Frozen North to illustrate that:

There’s been a lot of attention paid to how Canada’s oil boom has helped make gasoline cheaper. What many people may not realize is that the boom is also driving up the prices they pay for burgers and steaks.

Surging energy investment in Prairie Provinces, home to most of the nation’s farms and cattle ranches, has boosted domestic crude output to a record and sent pump prices to a three-year low. That’s led to jobs on drilling rigs or pipe crews paying two-thirds more than those in livestock, luring cowboys and beef-plant workers to the oil patch.

By cowboy there they really mean more what we English might call a cowman, rather than some Bill Cody type. But it's obvious what is happening. There's no more to do out on the prairie than just oversee the creation of cowpats and that's driving up the wages of those who are there. It's the very same process that leads to a hairdresser making very much more money in the UK than one in China does: the pay of hairdressers is not determined directly by the productivity with comb and scissors, rather by the pay on offer in the next alternative job.

This doesn't mean that the economic theory is wrong though: only that it operates in a rather clunky manner and so is something that gets tended towards rather than an equilibrium state at which we all always exist. As higher productivity jobs appear then they will tempt away some of the labour force. And so all wages tend towards the productivity of the work being done.

At which point we might have a little snark about the UK. There's a lot of complaining going on that the jobs being created these days aren't very well paid, something which is true. But it's also true that the highest productivity jobs in the UK have for some decades been those in wholesale finance in The City. Which is exactly the sector that those same complainants are determined should shrink.

Just like oil wells push up wages for cowboys, so does shutting down highly paid jobs in banking reduce other wages in the same economy.