Track 2 · Human Capital · lesson 2
Creating value and being paid for it are separate events
11 min
Track 2 · Human Capital · lesson 2
11 min
Water keeps you alive. Diamonds do not. Water is nearly free and diamonds are not, and this bothered serious people for about a century before anyone explained it properly.
The resolution is that the two questions being run together are different questions. How much is water worth to humanity has one answer, which is effectively infinite. How much is the next litre of water worth to you, given that you already have as much as you need has a completely different answer, which is approximately nothing.
Price answers the second question. It was never answering the first.
Creating value and capturing value are two separate events with two separate sets of causes.
Value created is how much better off everyone is because the thing exists. Value captured is how much of that lands in the hands of whoever did it.
The gap between them is not a scandal and it is not a mistake. In a functioning market it is usually enormous, and most of it goes to the people who buy the thing. But which side of the gap you end up on is decided by scarcity and position, not by how much you contributed — and those are the two facts that have to sit together without one of them cancelling the other.
Suppose a thing costs 3 to make and you would have paid 50 for it. It sells for 9.
Value created: 47, the difference between what it cost the world in resources and what it is worth to you. Value captured by the seller: 6. Value captured by you, the buyer: 41. You got the overwhelming majority of it and you experience the transaction as having spent money.
That is the normal outcome of competition, and it is the single most important thing markets do. Over time competition pushes the price towards the cost, which means the share captured by producers falls and the share captured by everyone else rises. The rise in living standards over two centuries is largely a story about that share moving.
Predict
Nursing creates value that is difficult to overstate. Teaching creates value that compounds across decades and shows up in people who never think about where it came from. Neither is paid in proportion to that.
There is a lazy explanation and a real one, and the lazy one is corrosive.
The lazy explanation is that pay reflects worth and therefore these people are worth less. Nothing supports that, and the argument collapses the moment you notice that the same job is paid differently in different countries and different decades while the value it creates is unchanged.
The real explanation has three parts, none of which is about merit.
Capture requires scarcity of the alternative, not scarcity of value. What sets a wage is what it would take to replace that person, not what would be lost without them. Those two numbers are wildly different for almost every job worth doing, and the gap is largest exactly where the work is most valuable.
Capture requires a position from which to bargain. Value that is created jointly, by a large team, over a long period, is hard to attribute to any individual, which weakens everybody's claim to it. Value created by one person holding one bottleneck is easy to attribute, which is why bottlenecks are paid.
Capture requires the buyer to have an alternative that is worse. Where the buyer is a single large purchaser and the sellers are many and cannot easily go elsewhere, most of the surplus stays with the buyer regardless of what the work is worth.
Two readings
Over time, competition pushes what someone is paid towards the extra output their presence produces.
What someone is paid is settled inside a range by scarcity, alternatives and who can walk away.
Both sides accept
Both accept that nobody is paid more than they help produce for very long, and that among people producing similar amounts of value, pay varies enormously. Neither claims that pay measures moral desert. The disagreement is about how wide the range is in practice and how quickly competition closes it.
Which is which? Put each one on a side.
The same qualification earns substantially different amounts in two neighbouring countries
A firm that persistently underpays a scarce skill loses those people to competitors and eventually raises pay
A role's pay rises sharply the year a second large employer opens nearby
Pulling it together, the share of created value that anyone captures depends on four properties of their situation. None of them is about effort.
Attribution. Can anyone tell what you contributed? Value produced by a team over years is real and unattributable, and unattributable value is hard to bill for.
Substitutability. How long would it take, and how much would it cost, to replace you with something adequate? That number is the ceiling.
Ownership of the scarce input. Whoever owns the thing that stays scarce captures the surplus. If the scarce input is a machine, the machine's owner captures it. If it is a reputation, the holder does. If it is a legal right, the holder of the right does.
The number of buyers. One buyer and many sellers moves the surplus to the buyer. Many buyers and one seller moves it the other way. This is why the same skill is paid differently in a company town and in a city.
Check
Two conclusions people reach from this, one of which does not follow.
It does follow that pay is a poor measure of contribution and a much better measure of position, and that treating a salary as a score is a category error in both directions — upward for the people it flatters and downward for the people it does not.
It does not follow that capture is illegitimate or that markets are a con. The same mechanism that limits what a nurse captures is the mechanism that hands almost all of the value of a smartphone, a vaccine or a bag of rice to the people who buy them rather than the people who sell them. A world where producers captured most of the value they created would be a very much poorer world for everyone doing the buying, which is everyone.
Holding both of those at once is uncomfortable and correct.