Fire grandad! Hire junior!

18th March, 2006

The Undercover Economist – FT Magazine, 18 March
Extended version available at Slate.

When I first came to London to seek my fortune, was taken out to lunch by a family friend with about three decades more experience than I. She cheerfully told me that I wasn’t worth the salary that my brand new job was paying me. She was right, as it happens, since I was an extraordinarily bad management consultant, but she was betting against the odds. The typical young person is worth more than he or she is paid. Young people who feel that the odds are stacked against them turn out to be right.

Older workers, on the other hand, tend to be overpaid relative to what they produce. This is not because they are less productive than the young – although many important skills do start to decline at the age of thirty, or even earlier – but because they are paid so much more. Decades of economic studies have produced the conclusion that average wages increase with age almost until retirement, yet average productivity seems to be flat or perhaps even declining after the age of fifty. (The studies are not unanimous, because productivity is very hard to measure and, of course, the averages hide huge variations from job to job and person to person). Perhaps my plain-speaking mentor was paid five times as much as I was, but if she was only three times as productive then I was the bargain basement employee.

I can look forward to a big bag of hate mail for reporting on this research, but I think that subconsciously we know it’s true, because we tend to fret about the problem of age discrimination in the workplace. Age discrimination is much more of a risk if older workers are indeed paid well relative to young ones: it means they’re the ones managers want to sack to save a bit of cash. The government is introducing new, tougher rules against age discrimination in October; if older workers tended to be worth much more than they were paid, it would scarcely be necessary.

This is a puzzle. Young workers can rightly grumble that they are paid a pittance for doing valuable work. Older workers also have good cause to worry: they are being subsidized, but subsidies are expensive and that means they have every reason to fear the sack. Wouldn’t it make more sense for young workers to be paid a bit more, old workers to be paid a bit less, nobody to feel exploited and nobody to fear premature retirement?

The income of self-employed people does tend to track their productivity more closely, which suggests that the odd relationship of underpaying and then overpaying is a corporate phenomenon. One explanation comes from the economist Edward Lazear, who suggested that young employees are often encouraged to perform by the promise of a cushy cruise toward retirement. If it’s hard to measure performance directly, but there is always the chance that shirkers will be sacked, workers will beaver away knowing that if they can hold onto their jobs it will all be worthwhile.

Lazear also suggested that the managing director’s fat-cat salary is designed to motivate the lean and hungry young trainees beneath him, and has very little connection to his own performance. (Much is explained.)

This is all fine in theory, but not so great if the firm goes bankrupt or decides under new competitive pressures that the ‘job for life’ system has to go. But seniority wages are here to stay simply because it is hard to reward good performance instantly and accurately. Meanwhile, Professor Lazear has in his late fifties been nominated to chair President Bush’s Council of Economic Advisors. It is a difficult job; we shall see whether his performance exceeds his pay.

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