When I worked for a software company, a fellow computer programmer once lamented that the salespeople earned so much more than the coders, despite the fact that the coders were generally better educated, more intelligent, and more essential to the company's core value: its products. The reason for the disparity is straightforward. Salespeople are closer to the money. It is very difficult for executives to perceive the value good programmers, who represent cogs somewhere deep in the machine, but the value of good salespeople is obvious from their sales numbers. For instance, it is easy to justify paying $200,000 in salary and bonus to a salesperson who makes sales worth $500,000 in annual profits.

My colleague's dismay exhibited the wide gap between "merit value" and "market value." Merit value is an amorphous sense of the worth of an employee based on capability, education, seniority, and hard work. Market value is the perceived monetary worth of an employee. Our economy is primarily based on market value. Insofar, as we reward merit value, it is because of cultural reasons and a loose, indirect relationship between merit value and market value: people generally perceive monetary value in the meritorious qualities of capability, education, seniority, and hard work. Yet while this indirect relationship may hold true within a particular field, it varies widely between fields. Thus, the most capable coders are likely be the top paid programmers, but they are unlikely to be paid as well as the most capable salespeople.

The principle of market value infuses even those industries that we might like to think of as merit-based. Book publishers, for instance, pay the highest advances to the authors they believe will most likely generate the highest sales, which is why prominent writers of trashy romances and conservative screeds can get high advances, while brilliant academic historians rarely receive any. Even within the academy, tenure for the sciences is primarily awarded to the professors who can capture the most grant money.

Which brings us to bankers. Many investment bankers are intelligent, hard-working, and capable, but like any other employee, those qualities are only indirectly tied to their compensation packages. Bankers make the big bucks because they are extremely close to a lot of money. When an employee conducts transactions worth tens or even hundreds of millions of dollars, then small differences in ability can make a difference of millions of dollars for the employer in a very obvious way. For that reason, it is an easy decision for banking executives to pay massive salaries and bonuses for the top talent. Such monetary considerations travel all the way up to the CEOs, who are perceived to make the largest difference to a bank's profitability.

Of course, the cronyism and short-term thinking prevalent in banking is certainly a related problem, but it is a market value problem of mistaken perception, not a merit value problem. Yet what seems to drive the rage of the anti-Wall Street crowd is not market inefficiency but the myth of merit value: bankers getting compensated far more than they deserve for their work. But our system is based on market value, and while this system is not ideal, we have not been able to invent a better one. The only known alternative to market value is some kind of human judgment of merit. Such judgment inevitably devolves into political bias, which is even less related to merit than market value. From nation-sized communist systems to department-sized bureaucracies, human judgments too often result in higher pay for the most loyal and sycophantic employees, not the most capable.

Because our system relies on market value, the government's current plan to cap executive salaries at companies that received bailouts will do nothing to address income disparities between the rich and poor. It will not affect banks that did not receive bailouts or all the other industries, from law to medicine to Hollywood to all manner of business, where compensation of certain employees towers above that of everyone else in the country. And within a year or two, the government's bailout leverage will dwindle, and it will be back to business as usual among the bankers as well.

Though it may seem like a paradox, if we really want to address income disparity, we need to be honest with ourselves and firmly reject the myth of merit value. That is because as much as merit value appeals to capitalism's critics, the myth of merit value is even more prevalent among the pro-market anti-tax crowd. Conservatives tend to fiercely oppose taxes on the grounds that rich moneymakers deserve their wealth due to their capabilities and work ethics. If we abandon the notion that people deserve all the money that they earn and are instead simply beneficiaries of somewhat arbitrary market forces, then implementing higher taxes on top income brackets will be less controversial. The rich people who are most open to high taxes tend to treat their wealth as a kind of lucky windfall rather than a well-deserved fortune. We need to encourage this attitude towards wealth and stop pretending that financial compensation must be something that it cannot be.

Or for a more cynical take, see Willam K. Wolfrum's How to be a "Swashbuckling Captain of Capitalism" by Patrick Byrne.

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Cross posted at dagblog.com. You can subscribe to all my posts via RSS feed or email.