Tale of Two Clones

Tim Taylor reports on the latest take on U.S. income inequality by the labor economist Richard Freeman. Freeman notes that rising wage inequality coincides with rising inequality of wages across firms, which in turn coincides with growing inequality in productivity across firms. Thus two equally skilled workers might be paid vastly different wages depending on whether they happened to land a job at a high-paying or low-paying company.

This is an interesting and important recent finding about inequality. What is unclear to me is the extent to which the inter-firm wage differentials reflect differences in firm-specific productivity versus firm-specific rents. A firm can afford to pay a worker more to the extent that the worker adds more to output, but also to the extent that the revenue earned from each unit of product is greater. Differences in both productivity and market power in the product market could contribute to divergent wages across firms.

Here's the illustrative example Freeman provides, quoted by Taylor:

[C]onsider two indistinguishable workers, you and your clone. By definition, you/clone have the same gender, ethnicity, years of schooling, family background, skills, etc. In 2006 you/clone graduated with identical academic records from the same university and obtained identical job offers from Facebook and MySpace. Not knowing any more about the future than the analysts who valued Facebook and MySpace roughly equally in the mid-2000s, you/clone flipped coins to decide which offer to accept: heads – Facebook; tails – MySpace. Clone’s coin came up heads. Yours came up tails. Ten years later, Clone is in the catbird’s seat in the job market — high pay, stock options, a secure future. You struggle.

Fair enough. But is the difference between Facebook and MySpace a consequence of Facebook's much superior technology and organization– i.e., its productivity? Or were the initial differences in productivity somewhat marginal, and then the dynamic of network externalities led to a divergent, winner-take-all outcome? In the latter story, the lucky workers at Facebook are earning higher wages in large part because the winner, Facebook, is earning monopoly rents and sharing them with the workers. Why firms might share rents with workers is an interesting question, but there are certainly plausible reasons they might.

Whether it is productivity or rents driving interfirm variation in wages does not much matter for the argument that it is "luck" that accounts for the difference in fortunes of the clones. Whether, how, and how much society should reduce inequality arising from pure luck remain essential questions.