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Wages and the Lottery

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Sunday, 26 February 2012 10:21

Adam Davidson has an interesting piece about how many low-paying jobs have a sort of lottery component where people are willing to accept low wages for a period of time in the hope that they will end up having a very high-paying job in the future. The best example of this sort of lottery system is probably the motion picture industry in Hollywood, where many people will spend years working in low-paying jobs in the hope that at some point they will make it big as an actor or director.

The piece then points out that many other occupations have a similar, if less extreme, lottery component. For example, lawyers are expected to work very hard as associates, but then can expect much higher pay if they get promoted to partner. Similarly, non-tenured faculty can face serious pressures to produce large amounts of research, before getting to enjoy the good life as a tenured faculty member.

Taking this view more broadly, most jobs have some sort of lottery component in the sense that there is a benefit to staying with a firm for a long period of time that workers lose if they leave, either by their choice or their employers. In more mundane jobs, the benefit might just be a pension, job security, and perhaps above-market pay for workers as they near retirement. The logic is that workers might get below-market pay when they are young and energetic, but if they stay with a firm long enough the situation is reversed as they slow down and their wage rises with seniority.

This point is interesting because it implies an obvious way that firms can increase their profit, at least in the short-term: take away the lottery prize. The savings on the prize is a pure short-term gain. In the case where a firm is keeping older, less productive, workers on the payroll and paying them a premium for seniority, ending the lottery prize (i.e. firing the workers) is a pure short-term gain. (This is of course a caricature -- older workers are not necessarily less productive.) In the longer term it may not be a profit maximizing strategy, since younger workers will not make a commitment to mastering firm specific skills if they do not expect to be able to stay at the firm.

An article by Larry Summers and Andre Shliefer argued that breaking commitments of this sort was at the heart of the better-than-normal profits that private equity companies were able to earn. They argued that by breaking implicit contracts with workers and other stakeholders, private equity companies could increase profit at least in the short-run. If their intention is to sell out their stake at a profit, then a short-run gain would suit their purposes, even if the strategy might be harmful to the company and the economy in the long-run.

Comments (9)Add Comment
Dumping the older workers saves Us a big bundle
written by jumpinjezebel, February 26, 2012 12:23
This is precisely the practice of the Big Companies such as Boeing who does everything they can to ensure the early exit of long term highly compensated workers who have worked their butts off for 30 years. Too bad - if your new snot nosed Director makes less than you - your out.
...
written by rmt, February 26, 2012 1:17
Unfortunately, I don't see this being a bad long-term strategy, because at least in fields like tech, younger workers are extremely naive about this kind of thing. They believe that job security is only for dead weight, and that they are so exceptional that they will always have a job no matter what's happening to other workers in their industry.
reverse in higher education...
written by pete, February 26, 2012 2:09
In a university setting, as rookie salaries rise, senior faculty can be found making substantially less, unless they keep their research productivity close to rookie level. Many departments, not necessarily at the top schools, can have significant salary inversion. It is then extremely costly to have these low paid senior folks retire to be replaced with higher paid rookies who also might have 1/3 the teaching load of the retirees. Seniority does not mean cost, only with k-12 teacher unions (and some other states higher ed systems) does merely staying alive grant increased wages.
Private Equity Motivation
written by DanC, February 26, 2012 4:41
The goal of Private Equity is to maximize their profits. This is generally accomplished by taking underperforming companies and gussing them up (e.g. the lipstick on a pig approach) before dumping them on other longer-term investors/suckers. The lipstick can take various forms (firing workers, selling off assets, etc.)

Occasionally, they wind up putting lipstick on a supermodel, but I attribute that to the law of large numbers, rather than "Alpha" on the PE firm's part.
Except that in a legal lottery. . .
written by Hugh Sansom, February 26, 2012 9:58
Buy a lottery ticket, and you really are in the running, with your one in 100 million chance of winning. Many of the workers entering the various jobs in the hope of striking it big are really never in the running at all. Increasingly, firms are figuring ways to lure workers and then dump them. And as long as the economy stays weak or worse, firms don't even have to do that.

What kind of lottery is it when, if you win, you get to subsist?
No Dearth of Short-sightedness in Corp Hyena Models
written by Betth in OR, February 27, 2012 3:13
We've seen this variant at work as public school systems contracted out Public Employee classified workers for "savings" using private contractors. Districts have shed these support workers and positions since 2005 even as the sales pitch for charter schools has ramped up.

The employees (many long time) were "let go" with the understanding they could apply for their old job with the private contractor. The lower wages, loss of benefits, and loss of work if one was not hired by the contractor (along with loss of union representation) were staggering to families dependent on those jobs. For the districts, it was the icing on the cake. The Public and the workers lose when committed public employees are displaced by the private sector.
The parenthetical is the rub.
written by LSTB, February 27, 2012 7:11
In the case where a firm is keeping older, less productive, workers on the payroll and paying them a premium for seniority, ending the lottery prize (i.e. firing the workers) is a pure short-term gain. (This is of course a caricature -- older workers are not necessarily less productive.)


The older workers in many of these contexts, e.g. law firms, accounting firms, and other professional service firms, are also the firms' owners, so firing them isn't always easy. That is, unless the other partners oust them, which is what happens in law over the last few years.

The other issue is that age is sometimes more beneficial than youth due to the experience, name recognition, and rain-making abilities elder workers provide firms. Part of it is the old, rich, white men network, which is an economic problem in itself.
Not just school board cashing in ...
written by deanx, February 28, 2012 4:38
Ever since Bain & Company visited Cornell in 2009 we have seen a similar thing at Cornell. There have been rounds of early retirements, re-organizations, budget cuts and layoffs for the last 3 years.

http://www.paintedbarstables.c...-2011.gif


The net effect is a dramatic drop in staff and faculty (39% overall). While the $60M+ savings is no doubt important for Cornell's new NYC campus, it does seem a crippling blow to the Ithaca campus, especially to future research.
...
written by comma, February 28, 2012 6:48
Of course, the long term problem with that approach is that at some point information will reach the younger generation. When that happens you will find young people aren't willing to work 80 hours a week, doing morally questionable activities if there is no payoff at the end of the rainbow. (Rumors in law are already circulating that there is really no pay day in the profession, the possibility of making partner being miniscule regardless of ability and willingness to self-flagellate).

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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