Ordinarily, the contribution of sanitation workers, store-shelf stockers, bus drivers, delivery people, emergency medical technicians, childcare providers, and many others, are routine, unnoticed, and taken for granted. During the covid pandemic, however, the general public became acutely aware of their dependence on these essential workers. But if their value is so high, why is their pay so low?
The Diamond-Water Paradox
The quandary of value versus market-determined price has a long history in economics. 250 years ago Adam Smith, founder of modern economics, examined the logic of the problem when he posed the Diamond-Water Paradox: Why does water, essential for life itself, sell for a low price, while gem diamonds, mere adornments, sell for a high price? Smith never solved the riddle; it was not until 1816 that David Ricardo observed that this is not a paradox at all; price and value are very different economic concepts. He explained that the value of water in its use — especially the life-sustaining uses — is greater than its price in market exchange. In fact, the two measures can move in opposite directions: the greater the abundance of water the greater its value in use but the lower its market price.
Applying Ricardo’s logic to labor: wages paid do not measure the total value of what workers produce any more than the price of water measures the value of water in its many uses. Just as the market price of water lies far below the total value of water, the wages of essential workers under-represent the value of their work.
The Market Distributes Surplus Value Upward
When goods and services are bought and sold in the market system, those exchanges generate surpluses, defined as the excess of value over price. The surplus value resides in the work product, not the wage. Those with more disposable income can purchase more goods and services, and, in turn, acquire more of the associated surpluses; those who are paid less are constrained to buy less and so acquire less of the surplus. Therefore, because the surpluses are enjoyed by those who own the work product and are not included in the market wages paid to the workers, the market forces will redistribute the surpluses to the higher-income people who can afford to buy more of that work product.
Although market-determined wages do not measure the contribution of labor to national wealth, markets do perform a very important “allocative” function in the labor market: they equate “supply and demand.” That is, the market wages are determined at the level where the quantity of labor that employers want to employ equals the quantity of labor that workers want to offer.
Sharing the Surpluses.
A society that recognizes the mismatch between wages and value of work-product commonly wishes to supplement the low incomes of essential workers, either in kind or with money payments. One way is to use progressive income tax revenue to provide public goods of benefit to those workers, such as education, health insurance, transportation, and enabling them to vote in minutes rather than hours. Most Americans, certainly most of the essential workers, rely on these public resources for their health, safety, education of their children, and other social investments and risk-sharing insurances. Such a redistribution requires a political role in mediating market forces through a democratically-elected representative government.
A second way is to use general taxes to finance wage supplements. Such staunch adherents of market economics as Milton Friedman and Ronald Reagan advocated using the tax system to supplement low-wage work. During the Reagan administration, this redistribution was implemented through the “Earned Income Tax Credit,” which reversed the flow of taxes for low-income workers: instead of paying into the tax system, these workers would receive wage-supplement payments from the tax system. These wage supplements could take the form of bonus payments paid to emergency health workers as “hazardous duty pay,” or even universal basic income, core support for low-income citizens.
Such redistribution uses market forces to offset some of the upward distribution of surpluses inherent in labor-market transactions. Markets are great producers of wealth through the coordination of incentives, but political intervention is needed to distribute the wealth more in line with individual contributions to the total.
William L. Holahan is Emeritus Professor and former Chair of Economics at the University of Wisconsin-Milwaukee.