Social Econ Blog

A few weeks ago, I posted about the long upper tail of the income distribution (or superstars). Yesterday's newspapers contained two stories which I think are relevant to our continued discussion of this topic that I want to point out.

First, Paul Krugman looks at the results I described and is worried that our society is tending toward a corrupt oligarchy. (The first link is to the TimesSelect page for subscribers; the second is to the Lexis-Nexis version for Harvard students (although I am not sure if this approach will work); if neither of the above work, Brad DeLong posts an excerpt and his thoughts here.) Krugman presents one alarming, though not totally crazy, view of the potential downside of growing upper-tail inequality. As I return to the series on inequality, I will try to illuminate the full set of issues related to this topic. That way, you can decide on your own whether or not you think Krugman is correct. For now, read it and ponder.

Second, "Da Vinci Code" author Dan Brown got sued for copyright infringement by two guys who wrote a book that made arguments similar to those which form the basis for Brown's book. I would expect higher income inequality to lead to more of these types of law suits. An economy that produces noticeably large returns to (somewhat randomly determined) superstars is ripe for such complaints.

First, in the presence of higher paid superstars, the expected benefits of filing such suits grows. A larger pot of money (and thus a higher potential reward) increases the expected return to filing a law suit for constant (or even slightly declining) probabilities of success.

Second, perceived "injustice" lowers the cost of litigation. We will discuss later humans' willingness to impose costs on themselves in order to punish those who have behaved "unfairly" or to right perceived wrongs. For now, it will suffice to point out that I am not surprised that some people feel slighted by someone else achieving great fame and fortune using a slightly modified version of their ideas.

Why?

People are always perplexed by the superstar economy. Why do athletes, movie stars, authors, etc. make such enormous returns for doing what appears to be so little? Sherwin Rosen's classic paper on Superstars argued that small, but perceptible differences in talent create very skewed compensation schemes in some fields. This occurs because everyone prefers to see the one extremely talented performer (instead of 10 mediocre ones). As such, most of the revenue in the market accrues to the top talents. (Check out the paper for a real description of his argument.)

His ideas seem correct and make it hard to argue that the existence of very highly paid superstars is unfair. If some people really are more talented then others (and thus provide a higher quality product then potential competitors), they deserve compensation for their ability to supply what people demand.

But what if differences in popularity (or superstarness) are not the result of pure, god-given talent? What if a large part of becoming a superstar is dumb luck? Or what if a large part of "talent" is produced? These, I think, raise more troubling questions for society to grapple with.

The case against Dan Brown essentially takes the view that talent is produced (I will ignore the dumb luck view for the time being). As such, those that contributed to his ability to perform should be compensated. The problem in this (and many other) cases revolves around ownership and fair compensation for use of ideas. Dan Brown got rich, perhaps in part, due to the fact that these guys provided ideas which he was able to turn into a best seller.

Patents and copyrights are supposed to make sure that those who generate useful ideas are compensated for them, but I am not sure how well this whole system works. We'll see how the case plays out. I need to think about this more, but I expect that the market for ideas is ripe with potential market failures.

Aha! Insight, here's what I think a substantial part of the problem is, although I am just now putting this all together so I may be off. Highly skewed distributions may tend to trigger thoughts about relative status. If someone in my reference group gets to the top of the distribution, I might become more aware of (and dissatisfied with) my own place. I may be particularly upset if I feel that I contributed in some meaningful way to that person's success, yet I do not rise up the fame, income, status distributions in proportion to my contribution. As such, people who contribute to star's success do not just want to be paid some absolute fee for their work done at the time. They want some of the backend. They want their income, etc. to rise (but probably not fall) with the star in order to reduce the gap in relative income.

Let's just use class as an example. On this blog and in class, I share my ideas with you, and I am training you to be more productive. I am paid a fixed fee for providing this service. This fee is the same for all tutorial leaders. Assume (and this not very realistic) that the compensation is proportional to the expected effect that tutorial leaders have on their students. That is, I get some function of the average effect of all tutorial leaders on their students. What I am arguing here is that, instead of being compensated in proportion to the expected effect of all tutors, I want to be compensated in proportion to the actual outcomes of my own students.

Many would argue that I should be compensated based upon my effect on my own students. If I am a more productive teacher, then I should get paid more. By tying my compensation to my effect on my own students, I have the proper incentives to do a good job. While that may be true (assuming that it is possible to measure my effect on my students -- which is probably not that easy to do), this scheme could be implemented by figuring out my expected effect on my students. I am arguing for something different.

I am arguing that a distribution which is highly skewed upward makes me prefer compensation based on the actual, not the expected, effect I have on students. Given that there is some chance that one of you will go on to fame and fortune, I don't want to be left behind. Even though my expected compensation does not depend on whether or not actual or expected outcomes are used, my concerns about my status relative to you (my former students) might lead me to prefer actual outcome based compensation. If you shoot up in the distribution, I want to shoot up some too. Otherwise, I will feel really bad about myself and you.

As such, in order to reduce the likelihood that I will feel ill will toward you should you go on to fame and fortune writing relationship advice columns, I will be refunding a small amount of my compensation to you in return for a percentage of your future earnings.

Ok, probably not, but would such a system work in equilibrium? Would it produce better outcomes?