Value creation vs. value transference

There are (at least?) two ways that people can earn money:

(1) They can create value.

(2) They can transfer value created by other people to themselves.

Certain economist types, even though they acknowledge the existence of “rent seeking behavior,” seem oblivious to the fact that the majority of economic activity in the United States (if measured by dollars) is about value transference rather than value creation.

The most base type of value transferring activity is theft. For example, you reach into your wallet, and it’s not there. A pickpocket has stolen your wallet, transferring the money that was in there to himself.

The most blatant types of value transference activities are illegal. It’s considered illegal fraud when someone tries to sell you a share of the Brooklyn Bridge. But what about when Juicy Couture sells you a $5 t-shirt for $88? Surely this is an example of value transference, yet it’s perfectly legal, and not really so much different than the Brooklyn Bridge hypothetical.

The more money a person makes, the more likely it is that he’s involved in value transference and not value creation. This is because there is only so much value that a single human being is capable of creating. The salary paid to the best engineers or computer programmers, about $150,000/year, is probably close to the upper limit of how much value a person can create. It’s extremely unlikely that a person making more than $200,000/year is doing it purely through value creation.

You don’t have to be rich to earn your living through value transference. Both the welfare mother and the senior citizen living off of Social Security rely on value transference as their primary source of income. Being rich merely increases the likelihood that you’re a transferee rather than a creator.

Winner-take-all markets are an important mechanism of value transference. Take CEO pay for example. The nature of the system creates the opportunity for the person who is CEO to transfer a lot of value from the shareholders to himself. What would have happen if A, the CEO of Big Corporation who gets paid $10 million per year, died in a car accident? Well, shortly afterwards, someone else, B, would be given A’s CEO job, and B would get a huge increase in his income because of his good luck (which was A’s bad luck). Is B somehow magically able to create more value because he was promoted? No! It should be obvious that B’s ability to create value hasn’t changed, only his circumstances have changed.

Entrepreneurialism is often idolized as the ultimate in value creation, but actually it’s just another example of a winner-take-all market and value transference. If Bill Gates had died in a high school computer accident, would all his billions of dollars of wealth have never been created? This is highly unlikely. Other people would have stepped into his shoes and the same stuff would have been created. (There are many who think that better software would have been created in his absence.)

Our economy is a big pyramid in which the majority of people on the bottom create value (but take home less money than the value they created because some of it is transferred away from them), while the small number of people at the top are very rich because of the value they transferred from the people at the bottom of the pyramid to themselves.

Value transference doesn’t lead to long-term economic growth, but it can create the illusion of short-term economic growth based on the way that the economy is measured. Suppose that B transfers X value from A to himself. Then C transfers X value from B. Then D transfers X value from C. Then finally A transfers X value from D. In reality, there has been no value creation, the value has just moved around in a circle. But economists, who assume that all income is legitimate, will say that there has been 4X of income added to the economy.

Comments

[hugh go naught]

Two things come to mind when reading this:

1. Sounds a bit like Marx's labor theory of value.

2. The talk of value being transfered around giving the illusion of value added to economy mirrors the critiques of the fiat money system and government-created inflation.

[John Smith]

Well, if you think that the rich are not creating value, then how is the economy actually able to generate 13 trillion$ worth of stuff for people to consume if only a fraction of the people are actually creating?

Are you saying that the engineers are being exploited?

[Spungen]

It appears that you don't think management of people creates any value. I disagree. I think very little can be accomplished without effective management. Many otherwise capable people have difficulty managing themselves, let alone others.

[keil]

And this is why scientists need to be paid more! Firstly,out of justice, for what creates more value than scientific discoveries? But also, and more importantly, to entice some of the intelligent corporate leeches of the future to enter a productive field!

I though of Marx instantly as well when I read this. Proletariat, capital, means of production, etc. But the new twist of information age products factored in.

[Nathan]

Juicy Couture is selling an image as well. It is not just the t-shirt itself. Anyone who is wearing a Juicy Couture t-shirt is implicitly stating "I am hip."

Come on, HS. Didn't you write about the emergence of the "marketing economy." When someone sells you a name brand, they have added value to their product through advertising. Just because it is not tangible does not mean it does not exist. Ever heard of intangible assets?

[miles]

Keil wrote:

"And this is why scientists need to be paid more! Firstly,out of justice, for what creates more value than scientific discoveries? But also, and more importantly, to entice some of the intelligent corporate leeches of the future to enter a productive field!"

Yup......I agree with that 1000%

Jucy Couture, Abercrombie and Fitch........all that jazz that sells Chinese made clothing that might be "fitted" just a bit better to athletic bodies at absurd markups exists because young people are dumb enough to fall for it. It just enriches the people at corporate HQ and the shareholding class. You could buy a nice fall wardrobe at K-mart for what you'd pay for 4 outfits at those stores.............and look pretty nice.

Personal note: A pretty young woman can wear cleaned pressed outfits bought at Target and look ten times better than a chick who wears hipster junk bought at an expensive mall store that was made to look old or trendy.............for about one sixth as much.

[Nathan]

Miles:

Having the Juicy Couture brand on your jeans sends a much different (i.e., hip, cool and have money)signal than does having Target/Kmart (cheap, poor and un-hip)brand on your jeans.

You are right that a pretty girl will look good in just about anything that fits right, but she will be looked down on by the hipster/trendy people.

Juicy Couture brands itself (and spends a lot of $$$ doing so) that way.

[Rain And]

But what about when Juicy Couture sells you a $5 t-shirt for $88? Surely this is an example of value transference...

Huh? What is the "real value" if it isn't what people are willing to pay. This is value creation by any meaningful definition.

[Half Sigma]

Spungen: "It appears that you don't think management of people creates any value. I disagree."

I didn't say that. Managers create order out of chaos, and that's valuable. The mid-level manager making a five figure salary probably owes most of his salary to the value he's creating (assuming he's working for a value creating organization).

[John S.]

You seem to be laboring under the misconception that price means something other than the amount of money someone is willing to pay for something. If someone pays $88 for a t-shirt, then that t-shirt is worth $88 to them, by definition. It may not be worth $88 to you, but that's a given -- you didn't buy it.

A house in Indianapolis sells for $100,000. The identical house in Seattle could sell for $400,000. Who created that extra $300k? Are the sellers in Seattle somehow cheating the buyers?

[tvoh]

"A house in Indianapolis sells for $100,000. The identical house in Seattle could sell for $400,000. Who created that extra $300k? Are the sellers in Seattle somehow cheating the buyers?"

There is no real value created, but some is being destroyed as the increase in the selling price is a function of inflation in most cases.

[bbartlog]

Sounds like you are reprising the arguments of the physiocrats, though imposing your own ideas about who is actually a member of the 'productive class' and who is a member of the 'sterile class'. But your fundamental error is still very similar.

[Steve Miller]

Rain And and John S. nailed the t-shirt example. Value is inherently subjective, and your main mistake is to assume that it is (or can be) somehow objective. It isn't. It depends entirely on time, place, and personal preference. That's basic economics since the marginal revolution.

[Spungen]

The mid-level manager making a five figure salary probably owes most of his salary to the value he's creating (assuming he's working for a value creating organization).

OK, what about the top-level manager making six or seven figures? What about the person who started and runs the company and manages the top managers?

All are necessary for the company to function. If the business grabbed market share away from another business by providing a slightly better service or product, that's value added. The person who started the business probably invested a lot of time and money and risked a lot, at least at the beginning.

Provide some examples of value-creating organizations versus non-value-creating. Is a campaign manager creating any value? How about the place that prints the campaign's brochures? How about the manufacturer that makes the printing equipment used for the brochures?

Just how does your ideal economy work, Mr. Wharton? Would we all make our livings as individual artisans grinding out swords or horseshoes?

[Half Sigma]

John S: "A house in Indianapolis sells for $100,000. The identical house in Seattle could sell for $400,000. Who created that extra $300k?"

Government regulations (zoning and the construction approval process) create a shortage of houses in Seattle, and this has the effect of transferring value to those who own homes in Seattle from those who don't.

[po]

Law firms create no value. Many are just wealth transference systems. Engineering firms create value. Advertising firms create no value. The company producing the cars that advertsisng firms "sell" create value.

Half Sigma figures out our economy! I agree with your analysis entirely. People can argue about t-shirt values all they want, but there are basically jobs where something productive is being done, and those that are just make-work jobs, or ones where you collect money from truly productive people.

The libertarian free-marketeers just don't get it. We do have a big pyramid scheme here. That's the way its always been.

[bbartlog]

We do have a big pyramid scheme here. That's the way its always been.

Except that pyramid schemes collapse. And of course our economic arrangement does not actually look much at all like a pyramid scheme, since pyramid schemes deliver their profits to the originators and early promoters (and inevitably collapse), whereas our economy rewards some combination(s) of intelligence, hard work, gamesmanship, good looks and what have you (and does not collapse).

[Gannon]

Law firms and a judiciary may not create wealth, but they avoid great harm and damage by resolving conflicts peacefuly.

Law firms and a judiciary may not create wealth, but they avoid great harm and damage by resolving conflicts peacefuly.

You're joking, right?

[[email protected]]

You need to not take the word "pyramid scheme" so literally. The idea is that most at the top are not those that actually do anything of real value, but those who game the system to make money from everybody else.

Three words prove this point exactly:

Washington D.C.

End of argument.

[GOP Lurker]

(1) Other than criticizing gov't methods of measuring productivity, what is HS's major complaint? Surely it would not be rational for the "value transferers" to stop doing what they are doing. Indeed, HS notices that if Bill Gates had not existed there would just be another "Bill Gates".
(2) If I can sell my expensive branded t-shirts in a foreign market and bring back value to the US, have I not contributed meaningfully to GDP? Does the bank ask you were the check came from?
(3) "Value(s)" may possibly be the most slippery concept in all of philosophy, economics, and lesser social sciences.

-I thought Veblen as much as Marx...

[Half Sigma]

GOP Lurker, Thorstein Veblen was a brilliant thinker. He wrote about the fact that, throughout human history and pre-history, there existed a "leisure class" that transferred value from the workers to itself.

[bbartlog]

Three words prove this point exactly:
Washington D.C.
End of argument.

Yes, because DC is constantly spawning billionaires. Not. FWIW I don't dispute the existence of rent-seeking behavior; obviously DC is full of maggots who feast on society. But you seem to want to characterize our economy *as a whole* that way (and further claim 'that's the way it's always been'). Bringing up our fedgov as an example does nothing to further that point, since most of our wealth and activities are still not governed from DC, and in any case its growth in size is a recent phenomenon.

[Peter]

It's all a matter of proportions. Most every person and company both creates and transfers value. It's just that in some cases, there's far more creation than transferrence, while other cases are the opposite.

I'll agree that paying $88 for a t-shirt is ridiculous, but many people are ready and willing to spend that much.

[eddie3k]

"Wealth-creation" is a very fashionable "buzzword" these days...it probably appears on almost every page of The Economist, for example.

The implication is rather oddly metaphysical. As if wealth is "created" by some tiny portion of humanity while everyone else "just consumes".

It strikes me that this phrase "wealth creation" is an attempt to dignify -- or even "spiritualize" -- what used to simply be called capital investment.

If you already have more wealth than you need to meet your basic consumption needs, then you can use the excess to "create more wealth"...or at least attempt to do that.

Traditionally, this was done by financing the creation of additional means of production. That is, ways by which some additional "piece" of "raw nature" could be converted into commodities that humans could use. In the last analysis, this is done by human labor, of course -- though that labor is directed by the investor.

This now seems to be less and less the case in the "old" capitalist countries -- Europe and North America. There are still a lot of useful things being produced...so wealth is still being "created". But much of what these countries economically "do" not only does not "create wealth" but actually destroys wealth.

Consider the vast and growing financial derivatives sector, for example. This is no more "wealth creation" than a casino; there are "winners" and "losers" but nothing gets made from this furious "activity".

In fact, this applies to all of the "speculative" sectors of the economy. If you purchase real estate on the premise that its market value will increase over time, you may make a bundle or lose your shirt...but in either case, no "wealth" has been "created" by you unless you build something that's useful.

Then consider the enormous burden of security. Larger police forces, more prisons, more private security firms, and a permanent military swollen to cancerous proportions. Here and there, almost by accident, something useful emerges (like the internet)...but almost all of it is entirely wasted.

Even the "security" that is promised is rarely actually delivered.

Consider further the massive advertising industry...which consumes many billions of dollars every year.

To what useful purpose? Rarely the simple transfer of useful information about a particular product to a potential consumer.

Instead, it's almost all propaganda...in the "bad" sense of that word. It may indeed "stimulate" economic activity...but does it "create wealth"?

Not in any sense that I can see.

[Slim Dusty]

Except that pyramid schemes collapse. And of course our economic arrangement does not actually look much at all like a pyramid scheme, since pyramid schemes deliver their profits to the originators and early promoters (and inevitably collapse), whereas our economy rewards some combination(s) of intelligence, hard work, gamesmanship, good looks and what have you (and does not collapse).

It is not clear that the US economy will not collapse ... nor that a 1930's style recession is not in our futures.

I've been everywhere man!

[po]

Washington DC is spawning LOTS of billionaires--they just work for the companies lobbying the government for contracts involving tax money.

You really need to figure out how it all works, guy.

[tommy]

Well, if you think that the rich are not creating value, then how is the economy actually able to generate 13 trillion$ worth of stuff for people to consume if only a fraction of the people are actually creating?

I read Half Sigma's post as indicating that the majority of the working population is creating value, but the majority of very wealthy people are mostly transferring value.

I've thought about this exact same thing before and my only problem is that it is sometimes difficult to distinguish between value creation and value transference. That difficulty becomes more evident as you move up the pyramid. Management can play a big role in whether or not products and services are delivered efficiently and cheaply, for example.

There is a hole in our thinking about these matters that has been filled rather badly by Marxist theory over the past several decades. With Marxism on the decline, it is time for capitalist thinkers to give these matters of political economy more attention.

[Rothbard]

"Just how does your ideal economy work, Mr. Wharton?"

Half Sigma believes that value is objective and measurable by an IQ test, rather than subjective and determined by consumer preference -- which explains the huge chip on his shoulder and the undaunted self-pitty. It's a weird form of Marxism for nerds.

[michael vassar]

And then there are the CEOs who can create billions of dollars of value each year
http://www.wired.com/techbiz/it/magazine/16-04/bz_apple

[tommy]

Half Sigma believes that value is objective and measurable by an IQ test, rather than subjective and determined by consumer preference -- which explains the huge chip on his shoulder and the undaunted self-pitty. It's a weird form of Marxism for nerds.

At the end of the day, I suspect mean national IQ measures a country's GDP at least as well as consumer preference. That is probably, in large part, because IQ strongly determines consumer preference. It is libertarians anxious to ignore IQ and promote Third World immigration that can't seem to grasp that.

[Spungen]

Half Sigma believes that value is objective and measurable by an IQ test, rather than subjective and determined by consumer preference -- which explains the huge chip on his shoulder and the undaunted self-pitty. It's a weird form of Marxism for nerds.

Unless the subject of valuation is a woman with a high IQ, I'll bet. ;) Then she's just a whore, especially if she's married to a man who earns more than Half Sigma.

Oh, and HS, I'll take your lack of response to my email as a yes.

[Bruno]

where does the value come from indendently of it being created or transfered ? For example, in France, we say that we'll need more workers to pay future retired pensions. But let's imagine we'd accept 30 millions african or south-american or whoever be interested in coming into France. Would those people be able to create the equivalent value (created or transfered) of existing workers ? it seems unprobable to me. I'm wondering if the value is related to historical links among people and reflects people, cities, regions, countries valorisation. But even this is not completely convincing : if only the 10% where obliged to do 40% of the children and the poorest half were forbiden to reproduced themselves, would the value created converge to the top 10% level at leat 4 times quicker ?

[Spungen]

It's still not clear what this theory's supporters think should happen. Would we be better off if all jobs not involving the production of goods disappeared? Should all lawyers, lobbyists and advertisers retrain as tailors, milliners and apothecaries? Apparently some people assign no value to negotiation or to providing information.

but the majority of very wealthy people are mostly transferring value.

Actually, a lot of very wealthy people inherited most or all of their money. In spending that money, they're transferring value outward.

[SFG]

Mike: did Jobs create that value, or did his engineers (and marketers)? It's pretty clear CEOs add some value, probably just not as much as they're getting. How about in Europe where CEO salaries are much lower?

I don't think all management jobs are valueless; still, clearly these guys are skimming off much more than their actual value. Also, it's not clear that people wouldn't still want to be CEOs if they made only a few hundred thousand; after all, the President makes half a million or so, and they never seem to lose aspirants for that job.

[tommy]

CEOs who run companies into the ground while garnering enormous pay increases would seem to be a good example of value transference. Not that such pay hikes aren't well deserved: it takes a lot of talent to lose that kind of money. ;-)

[Gannon]

It always surprises me when people compare Southamerican to Africans. Southamerican countries have GDp's around 7000 US, whereas Africamn countries have GDP's of around 1500 US. These realities can't be compared.

[Steve Johnson]

Some posts on this blog remind me of a history of economic thought class I once took.

There are two factors in how someone is paid:

1) How easily can you replace them?
2) The value of their output.

Engineers or programmers only make 150k at the top end because that's the cost to replace them even though their output can be higher. Other professions like i-banking, acting and biglaw have much higher rates of pay because there are barriers to entry.

But there's a reason the limit on programmers / engineers is where it is.

Take a counter-factual. A programmer feels underpaid so starts his own software company. What does he create? If he doesn't know what to build using his skills, then someone made that decision for him as an employee and that decision is valuable. Logically, someone in the organization that he used to work for provided these ideas and was worth that value. Let's say his idea is for a piece of software that is too large for one person to write. Now the programmer has to have the skills needed to manage a team of programmers or at least the skills needed to identify people who are capable of managing programmers. This skill existed in the organization that paid him 150k per year and was worth something.

When you take into account all the barriers that stand between a good programmer or engineer starting a company to sell programming or engineering services (directly or indirectly in the form of products), you'll see that the typical programmer / engineer is paid right at the intersection of how much he would cost to replace and what the expected payout of entrepreneurship would be.

Are there other factors that classical economics wouldn't consider? Yes. For example, the best programmers aren't just like the best i-bankers in personality. They're more likely to be introverted, just as likely to be male but less likely to be athletic, etc. All of these have influence on the options that great programmers have. If the overall bunch of skills and traits that a group has make it less likely that members of that group will be successful entrepreneurs that group will be paid less as a consequence.

Usually when half sigma talks about modern economics, he's pretty well onto something but this is a really old problem that the genuinely best minds that classical economics had to offer worked on. In this case, the orthodox economic answer is pretty good.

[Steve Johnson]

The main factor in CEO pay isn't cost of replacement and the CEO's best alternative but is the principal / agent problem.

CEO pay is set by the board of directors. The members of the board of directors are often friends and social acquaintances of the CEO. Sometimes the board members are officers at other corporations and the CEO serves on the board at those corporations.

Basically they all conspire to rip off the shareholders.

The solution to this is actually pretty simple as far as economic problems go. (1) Make takeovers really really easy to accomplish and (2) put in a rule that says that any pay packages put in by a given board are void if that board is voted out by the shareholders.

Both of those would serve as strong checks against outrageous CEO pay.

Personally the part of CEO pay that makes me most angry is when they fuck up and get paid a quarter billion dollar severance package to stop fucking the company. That would dry up with my rules. Nice to dream.

[SFG]

Steve: yeah, but the shareholders are usually too busy to care. I mean, do you notice CEO pay for every company in your mutual fund?

[Steve Johnson]

SFG

If takeovers were legally easy, there would be (more (because there are some now)) people who watch things like that for a living. Individual investors are never going to be effective watchdogs because they can't raise enough capital to buy up large chunks of shares.

That would be a much better use of the high IQ talent that now goes into hedge fund management.

Unfortunately, corporate CEOs are buddies with politicians and corporate raiders are demonized. That dynamic makes anti-takeover legislation easy to pass, even though the outcome is CEOs who rip off shareholders. People aren't savvy enough to put two and two together.

[Cameron]

CEOs who run companies into the ground while garnering enormous pay increases would seem to be a good example of value transference. Not that such pay hikes aren't well deserved: it takes a lot of talent to lose that kind of money. ;-)

Tommy, though I agree that some individuals receive payment through transfers, it is worth pointing out that a CEO is often paid by how much value board members think he will create. If the board members overestimate the amount of value added in a future period by a CEO, the CEO will make more than he created. Resulting in an unintentional transfer of payment.

[Steve Johnson]

Cameron:

a CEO is often paid by how much value board members think he will create. If the board members overestimate the amount of value added in a future period by a CEO, the CEO will make more than he created. Resulting in an unintentional transfer of payment.

I don't think anyone involved thinks it's an unintentional transfer; I think it's just that there's almost nothing the shareholders can do about it.

If it were unintentional, then packages for CEOs wouldn't include extremely lavish payouts when the CEO is fired. If you reach the point where the board is removing a CEO, obviously he wasn't good at the job. If you pre-arrange to pay him in that situation you don't care about performance.

[Pico]

CEOs who run companies into the ground while garnering enormous pay increases would seem to be a good example of value transference.

Ever try running a business that is failing? It ain't easy. And it is a lot harder than trying to run a business that is doing well in a strong economy. Share holders would do well to hire a CEO that will loose a company only $100 million rather than $200 million in a given year. They could pay him $50 million and still come out ahead.

[InterestedParty]

Must...not...ad hominem. I'll just put it this way - people who believe what you believe will never be wealthy.

[theoretic]

So do actors create value, or are they transferring value to film?

[Poor Postdoc]

Well, I think HS has addressed this issue previously and better than here. We are kind of done with Marxism. Some careers have normal and others log-normal salary distributions. People drawn to normally distributed fields such as engineering and science have their eyes as much on the left tail as the right tail of the distribution. They have reasonable expectations and are fine with $100k. This kind of personality is not good for higher-risk fields where people with bigger egos and a solid focus on the right tail of the income distribution end up. Having good IQ goes a long way for an engineer, but for an artist, CEO etc, it is more important to hook up with the right network. Family connections then also become more important. It is a lot easier to answer the question "What does a reasonably clever kid need to do to become an engineer?" than the same exercise for CEO or a successful artist - the guarantees are just not there unless you have a wealthy, well-connected family.

[Cameron]

If it were unintentional, then packages for CEOs wouldn't include extremely lavish payouts when the CEO is fired.

If I'm not mistaken, payouts are usually in the CEO's employment contract, signed on the hiring date.

i.e.
Accentia Biopharmaceuticals, CEO, Section 4.4

[Cameron]

If you pre-arrange to pay him in that situation you don't care about performance.

So your saying the board members don't care about the CEO's performance if they put a severance package in the contract??

I think the whole point of hiring a CEO is to get good, or possibly better performance from your company.

[Steve Johnson]

Cameron:

So your saying the board members don't care about the CEO's performance if they put a severance package in the contract??

Yes, I'm saying that if the board puts in a huge severance package as part of the hiring, that shows that they do not care about about CEO performance.

This is made quite clear by the existence of "golden parachutes" where the CEO gets a huge payout if the corporation is taken over. Typically if a CEO is booted after a takeover it's because the business has a large underlying value that bad management is suppressing. The board sets up a situation where management gets to be bad, but not bad enough that it's worth it to take over the company. For example, some company is being mis-managed to the tune of $10 million / year but the CEO has a $200 million dollar severance package arranged. Basically, the board has cheated the shareholders out of $10 million dollars / year (because the company isn't better managed) plus whatever the CEO is paid (because he's not creating value, he's destroying it).

That contract Cameron linked to specifically mentions a change in control triggering the payout. For a normal employee, severance is fair because there is a high chance that if he gets laid off it's due to events out of his control. If a company gets taken over, the main factor is that the current CEO is doing a bad job. Paying the CEO under those circumstances is just sticking it to the shareholders for the benefit of a buddy of the board. Classic principal / agent problem.

In contrast, when Warren Buffet takes over a corporation he always leaves the CEO in place. This is because when he buys an existing business he does it because it's well run, not badly run.

Well, what about risky businesses where the CEO needs to make bold changes that may fail just to keep the business going? I'll grant that in that situation you need to get creative with how to pay a CEO. However, from the shareholder perspective, severance pay for CEOs still has to be one of the worst ideas ever.

[anon]

A lot of people seem to think that CEO salaries aren't tied to the market, but in reality this idea is silly. Want to hire a CEO that has a history of turning million dollar losses into billion dollar profits? Sorry but 100k won’t cut it. The idea that CEOs are like everyone else but have better connections is a media myth. Most of the inflated salaries you read about are actually tied to stock options that have grown over time, and thus their salary is in fact tied to the increased value of the company.
What also seems to have been left out of this conversation is that fact something of value can have that value increased by others. A marketer for example can make an engineer's idea more valuable to him by advertising it in a way that the engineer is either incapable of or does not have the time or resources to do. A lawyer can increase the value of the idea by filing for a patent which keeps other from producing it without compensating the engineer. This is especially forgotten today when people bemoan record companies as greedy or undeserving of the artist's compensation. In reality the artist wants to sell his work to a record company to receive a better return on what that artist has already produced. The artist wants the record company to increase the value of the work through marketing/mass production so in the end the artist profits more than if he tried to sell his work alone.

[Nathan]

Anon is spot on. All this talk about "what is fair pay" is stupid. I can't believe that HS spouted the BS in the post about value creation vs. value transference.

If you want to talk about "transference," talk about the welfare mammy who gets money from the government. That is a transference.

[Cameron]

A lawyer can increase the value of the idea by filing for a patent which keeps other from producing it without compensating the engineer.

I don't think it's the lawyer that increases the value in this case, but more-or-less the patent laws. Of course, if the lawyer does a good job in writing the patent (so that the idea is better protected, etc...) that may be considered a value-added activity.

[Pico]

From Thomas Sowell's latest book, "Economic Facts and Fallacies" (p.145):

When Sewell Avery was head of U.S. Gypsum from 1905 to 1931 and then head of Montgomery Ward retail store chain after 1931, he was regarded as on of the premier business leaders in the country. However, during his later years, when conditions in retailing became quite different, there were complaints about his leadership of Montgomery Ward, and bitter internal struggles to try to get rid of him. When he finally left, the value of Montgomery Ward strock shot up immediately. It might well have been a bargin for stockholders, the customers, and the employees to have paid Avery enough to get him to leave earlier, since a badly run company hurts all of these people.

A CEO severance package is like a prenup, it is designed to reduce some of the cost of an ugly divorce. But Steve makes a great point about the threat of a takeover as a politically incorrect means of keeping CEO compensation committees honest.

[anon]

A lawyer can increase the value of the idea by filing for a patent which keeps other from producing it without compensating the engineer.
--
I don't think it's the lawyer that increases the value in this case, but more-or-less the patent laws. Of course, if the lawyer does a good job in writing the patent (so that the idea is better protected, etc...) that may be considered a value-added activity.

Both the lawyer and the patent system add value to the product. The lawyer is providing a service to the engineer that he could otherwise not perform or at least not at the same cost efficacy.

Let's say it takes the engineer 24 hours to write the patent but it takes the lawyer 4.
Both actions add value to the product but the lawyer can often do it at a lower fraction of the product's total value. Remember that although the lawyer needs to be paid, the engineer's time is also worth money. While the lawyer is writing the patent the engineer could be adding value to the product in a more cost-effective manner, or perhaps working on an entirely new product to increase his overall wealth.

Note that this is all theoretical; meaning that in some cases it is probably not worth it to the engineer to hire the lawyer to file the patent, especially if the engineer has experience in this area. The point here is that a specialized professional can add value to a product that someone else has created. In fact entire companies can add value to the product, meaning that every person from the janitor to the manager are working in unison to extend the value of a product.

[SFG]

You know, it's not impossible for CEOs to (a) create great value for companies and (b) still be vastly overpaid. European companies don't throw such huge sums at their executives and still run pretty well.

From the utilitarian point of view there's no point throwing all that money at these guys since almost anyone else would get more joy from it. If they only made a million bucks each people would still step on each other's throats for the job--power and all that.
The only reason you have to pay these guys millions is because they've managed to drive each others' salaries up. But drive them down somehow (I would imagine government regulation, but I'm sure one of you guys can come up with a free-market solution) and you'll still get good management at a fraction of the cost. See, people go for relative status. 500K is a good salary if everyone else makes 200K and a lousy salary if everyone else makes a million.

Never gonna happen, I know.

But overall I think Sigma's insight is described as 'rent-seeking', no? Most rich people get that way via collecting rents, not creating value, is what I think he is trying to say. Of course I am not an economist.

[anon]

Where would the salary cap stop? Where you *feel* it should? So if I want to hire a ceo away from a competing company, you're going to use the government to stop a voluntarily exchange so it makes you feel better? I feel that Hollywood celebrities are overpaid, can we cap their salaries too?

[Spungen]

Half Sigma is being coy. He hints that he thinks our economy is unjust, but he won't actually come out and say it. This is probably because he fears revealing his liberal stripes.

I want to hear what Half Sigma thinks should change, and why. Is the average receptionist, bookkeeper or quality assurance specialist making too little? Or is this really just about CEOs being overpaid? I can't imagine even grossly overpaid CEOs have much effect on the overall economy. There are too few of them.

[Turambar]

This post need to go back to the shop for a rethink; the argument is just very scatter shot. The real motivating concept seems to be "people making more than I do arent doing 'real work'".

Is B somehow magically able to create more value because he was promoted? No! It should be obvious that B’s ability to create value hasn’t changed, only his circumstances have changed.

If you accept the idea that organizing peoples work effort by low level managers is creating value, then organizing them at a high level as a C level exec must do so too. How much is it worth to a company to make the decision to kill the Folio or to prioritize development on the iPhone over other projects.

When B got promoted from say COO to CEO the scope of his job greatly increased as well as his ability to make value creating decisions. Hence his potential value increases. The wealth creating effect of a jeweler isn't the same when he is work on topaz as when he is working on diamonds.

You also assume that B inherited the compensation package of A. This isnt so. When Palmisano took over for Gerstener he had a much smaller package. Same with Imhelt and Welch.

[SFG]

Half Sigma is being coy. He hints that he thinks our economy is unjust, but he won't actually come out and say it. This is probably because he fears revealing his liberal stripes.
No, it's more complicated than that. His (relative) lack of economic success has moved him left, but he won't admit it to himself. I never saw what was wrong with modifying your political beliefs based on events in your life--you're entitled to vote in your own self-interest, IMHO--but he probably has a conservative temperament too.

Where would the salary cap stop? Where you *feel* it should? So if I want to hire a ceo away from a competing company, you're going to use the government to stop a voluntarily exchange so it makes you feel better?
Not just me, more money for everyone else.

I feel that Hollywood celebrities are overpaid, can we cap their salaries too?
Sure, why not? Athletes too. Just 'cause I'm a liberal doesn't mean I have to agree with other liberals on everything, or never support making another liberal's life harder. Don't confuse me with your strawman, I'm a lot heavier. ;)

[Kirk]

This is a pretty interesting article on our FIRE (Finance, Insurance, Real Estate) economy, and its propensity to survive bubble-to-bubble. It's a little long, but a good read nontheless.

Harper's Article

[Al Fin]

Not one of HS' better thought out posts, but he does have enabler po to cheer him on, so all is not lost! Not a criticism, HS. Blogging should be about experimenting with ideas. Just admit it when they don't work out.

For all those who think socialist theory of wealth is more rational than the market theory, I suggest that you move to the USSR or East Germany and enjoy all that rationality. Ooops! They're gone, aren't they?

[Half Sigma]

Al Fin: "For all those who think socialist theory of wealth is more rational than the market theory, I suggest that you move to the USSR or East Germany and enjoy all that rationality. Ooops! They're gone, aren't they?"

You're missing the point of the post if you think it's an endorsement of communism.

[SFG]

What is it an endorsement of, then? You're right that CEOs are overpaid and hedge fund managers contribute nothing to society, but these are legal transactions between consulting adults. Do you support government regulation here (which isn't the same as full-fledged communism), or not?

[Spungen]

You're missing the point of the post if you think it's an endorsement of communism.

Tease, tease. I want a good, solid example of a job where wealth is transferred to an undeserving other. Something from this decade -- no hypothetical widget-makers with robber baron bosses.

Tease, tease. I want a good, solid example of a job where wealth is transferred to an undeserving other. Something from this decade -- no hypothetical widget-makers with robber baron bosses.

John Edwards

[Anon]

Not just me, more money for everyone else.

Do you realize that most of those obscene salaries only go to the top 10 or 15 Fortune 500 CEOS? How much do you think you would really save with a salary cap? A couple billion at the most? There are 300 million people in the U.S. So you would burden our top companies with a price fix so you could what, buy everyone lunch once a year?

[John Wesley]

I like your stuff. It gets me thinking. But this whole concept of transfer of value v. value creation is lame. Seems like you are rationalizing your own lack of wealth and trying to cut down the super rich. The world is what it is, and people deserve what they get. You create something great, you get rich. There is no stealing there. Just capitalism.

[James]

Everything is worth what its purchaser will pay for it. Theft is therefore completely different from any kind of voluntary transfer.

[Stephen]

Your assumption that Bill Gates's earned his fortune through wealth transfer is flawed. To transfer wealth means that the wealth need already exist, and therefore able to be exchanged. In Bill Gates's case, who was holding on to the billions of dollars of added productivity created by better, more user friendly computers? Nobody, that's who. Strictly because somebody else probably would have invented a very similar product is not the same as the invention itself having no value.

In terms of CEOs not adding productivity, strictly speaking that may be true, but consider the negative productivity that occurs of having no CEO, or a bad CEO? Market prices pay CEOs what they get paid because of the cost of NOT paying them. I realize that this is an idealized assumption, as surely the top CEOs get paid too much relative to an average CEO.

I guess the point is that someone who has an idea and hires people to bring it to profitable fruition, can still be considered as adding value to the economy.