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Unions, Value, and Your Paycheck 2

Where does wealth come from?

By Petrarch  |  March 3, 2011

In the first article in this series, we explored how the protesting unions in Wisconsin and elsewhere are yelling about a totally faulty premise: that there is some level of wealth that they "deserve."  Nobody deserves any wealth at all; in a capitalist system, you are worth only what you can convince somebody else to pay you willingly.

This creates obvious injustices such as the fact that Snooki makes vastly more than the Teacher of the Year.  The only alternative to paying people what they can persuade others to pay them is a Communist command economy where you are paid whatever your betters think you should get and there's not much you can do about it.

Nothing free about that, and as the Soviet Union demonstrated, it's economically disastrous.  As Russian workers said, "We pretend to work and they pretend to pay us."  Snooki's freedom to charge whatever the market will bear is a small price we pay for liberty and national wealth.

The major reason to work is that there's some chance that a worker can become wealthy.  The difficulty is that in order for anyone to get wealthy, or even to receive anything at all, the wealth has to come from somewhere - and that's what we'll explore in this article.

The Roots of Wealth

Why is it that Americans earn so much more than Chinese?  Because each American worker produces vastly more than each Chinese worker, as the following graph illustrates:

This graph shows the amount of national productivity, in dollars, per person in each country. Note that that is not the salary of each person or of each worker; it's simply the total national output, the Gross Domestic Product (GDP), divided by the population.

On average, each American generates ten times as much wealth as each Chinese.  If you look closely at the graph, you'll see that Chinese wealth has been growing enormously; it's at least tripled in the last ten years, but it started from a base pretty close to zero due to Mao's mismanagement of the Chinese economy.

Average American production has increased too.  In fact, in actual dollars it has increased by more than the Chinese, by about $12,000 as compared to maybe $3,000.  We were vastly richer than they in the first place, however, so on a percentage basis, they've increased more.

There are many reasons for this difference.  As with the backhoe-driver who can dig in an hour what would take ten men a week with shovels, America simply has enormously more capital equipment than the Chinese.  We have railroads, highways, factories full of equipment, airports, bridges, schools and universities of every description; until recently the Chinese pretty much had none of this.  They're catching up astonishingly quickly, but they have an incredibly long way to go before the average Chinese person lives anything like as well as the average American.

What has this to do with the wages workers earn?  Here we encounter a fundamental law of economics that cannot be altered or revoked, no matter how desperately the Wisconsin union protesters wish they could:

Long-term, on average, people cannot be paid more than the value they produce.

Worth More Than Your Salary

Of course, every country contains people that don't work (economically) at all: housewives, schoolchildren, the retired, the disabled, the unemployed, welfare recipients, people in jail, and so on.  We also all know people who have conned their bosses into a good paycheck despite being lazy shirkers.

On average, however, no organization - no family, no company, no country - can receive or spend more than the wealth they produce.

For many years, General Motors earned a great deal of money selling cars that people were willing to buy.  Much of this money was spent on materials or in wages for the factory workers; more was invested in capital equipment like new factories.  Even so, GM generated mammoth profits for shareholders for decades on end.

One day it reported losses instead: new competitors offered better cars for less money, whereas GM's unions demanded ever more lavish compensation.  Instead of profits, GM generated losses.

Because of the great wealth earned by previous generations, GM didn't die immediately; it sold off assets and took loans from friendly banks.  Eventually and inevitably, GM reached the end of the line; it would have gone bankrupt and closed in 2009 had it not been bailed out by your tax dollars for political reasons.

If GM is ever to recover, every employee from the CEO down to the lowliest janitor must produce more value for the company than they receive in pay; that hasn't been the case for 20 years and it will be difficult for them to change such a longstanding mindset.  GM ended 2010 in profit; they spent a portion of that profit, but not all of it, on employee bonuses.

It's easy to know whether GM as a whole earned more money than it paid out: did it make a profit or not?  It's harder to know whether each individual employee was worth their salary; how do you judge the individual contribution of one lineworker or janitor?

There are actually a handful of jobs where it's simple to know exactly how much money one person made for the company; it's no coincidence that those jobs, like salesman or investment banker, tend to be very highly paid for the successful.  Goldman Sachs knows to the penny exactly how much money they made on each deal put together by each banker that works there; so do the bankers, and they don't fail to point it out at their annual reviews.

If you, personally, earned $100 million for your employer by sagacious stock trading, they'll pay you $10 million of it, after all waitresses get 15% and you're only asking for 10%.  If your employer isn't willing to be that generous, you'll find a new one who is.  Nobody will pay you the full $100 million, of course, so no matter how massive your paycheck, you will still be earning your employer an even more massive amount.

Unfortunately, public-sector unions have a sordid history of demanding far more than they've ever produced, for years on end.  How is this possible?  That's the subject for the next article in this series.