Are Exceptionally High Wages Really Rent?

Dan Sullivan and H. William Batt

[Reprinted from a Land-Theory online discussion, 1 August 2002]

There is a real division of opinion about whether the income of prominent sports stars, film and music stars, and other such celebrities' income is rent or wages. Most neoclassical economists regard it as rent, regarding it as a natural endowment rather than due to any skills that they may have honed. (Ironically, the neoclassicists regard rent as a trivial aspect of the total economy, typically listing it as about 1 percent. At the same time they don't see the significance of rent in other natural resources like the land area itself, the spectrum, and other elements of nature.)

The conventional view of rent, agreed upon by both classical and neoclassical economists, is that it is that part of a payment that is above that necessary to keep any resource -- land, labor, or capital -- in economic production. Hence, if Babe Ruth would have been willing to play for free, any income that he got, or the owner of the Yankees got, would be economic rent. So also with certain starlets that do nothing except appear in public to be pretty: all their compensation is in economic rent. Dan Sullivan, taking issue with the Baumol and Blinder taxt, clearly disagrees.

Dan Sullivan:
The return to Jordan and Spears is not rent, nor are they capital. They are people, and the return is wages. Exceptionally high wages go to those with exceptionally applications of high talents. They do not enjoy a monopoly, as anyone is allowed to endeavor to do what they are doing.

Bill Batt:
Dan, I don't think this is the way that the neoclassical economists use the term rent. They see any "natural endowment," even in persons, as rent.

Dan Sullivan:
Then they have fallen into absurdity, as all persons are differently endowed, so that everyone who is employable at all has an endowment over and above someone else.

Bill Batt:
I have just checked some of the conventional textbooks I have on the shelf, and I'll choose the passages from Baumol and Blinder, fifth edition, pp 752-754. They're about as authoritatively reflective of the mainstream economics as one can get.

Dan Sullivan:
Note that the following is not Batt's own nonsense. It is just more evidence of the depths of absurdity to which neoclassical economics has sunk.

Generalization: What Determines John Elway's Salary?

Baumol and Blinder: "Land is not the only scarce input whose supply is fixed, at least in the short run. Toward the beginning of this century some economists realized that the economic analysis of rent can be applied to inputs other than land (see box on page 756 for some current research uses of the concept. The boxed reference on page 756 talks about TV and radio station licenses.). As we will see, this extension yield some noteworthy insights."

Dan Sullivan:
Radio and TV licenses are land titles of another sort, as the magnetic spectrum is a natural resource. Thus there is no "extension" at that point.

Baumol and Blinder: "Consider as an example the earnings of John Elway, star quarterback of the Denver Broncos. Football Players seem to have little in common with plots of land in downtown Chicago. Yet, to an economist, the same analysis -- the theory of rent -- explains the incomes of those two factors of production. To understand why, we first note that there is only one John Elway (or so he would like management to believe). That is, he is a scarce input whose supply is fixed just like the supply of land. Because he is in fixed supply, the price of his services must be determined in a way that is similar to the determination of land rents. Hence, economists have arrived at a more general definition of economic rent as any payment made to a factor above the amount necessary to keep that factor in its present employment."

Dan Sullivan:
Yes, supply and demand apply to all three factors of production. Thus, when the typewriter was new, the ability to type commanded a very high salary. When it became commonplace, the question, "Can you type?" became viewed as an insult to women. Yet it is absurdity to call the pay once afforded a typist "rent."

Baumol and Blinder: "To understand the concept of economic rent, it is useful to divide the payment for any input into two parts. The first part is simply the minimum payment needed to acquire the input: the cost of producing a ball bearing or the compensation for the unpleasantness, hard work, and loss of leisure involved in performing labor. The second part of the payment is a bonus that does not go to every input, but only to those that re of particularly high quality. Payments to workers with exceptional natural skills are a good example. These bonuses are like the extra payment for a better piece of land, and so are called economic rents."

Dan Sullivan:
This is sheer nonsense. The premium paid to a better worker is still a wage, and the premium paid for a better piece of equipment is still interest. Only payment for privileges is rent. Perhaps, if the labor force were artificially restricted by laws protecting unions, or by the threat of union violence, that premium could be called rent, but the mere payment of a higher wage to get the benefit of a higher performance is just that -- a higher wage.

Baumol and Blinder: "Notice that only the first part of the factor payment is essential to induce the owner to supply the input. IF a worker is not paid at least this first part, he will not supply his labor. But the additional payment -- the economic rent -- is pure gravy. The skillful worker is happy to have it as an extra. But it is not a deciding consideration in the choice of whether or not to work."

Dan Sullivan:
Again, that is absurd. If the worker will do the same quality of work for that employer for less money, the employer will offer less money. The fact is that paying less money incurs the risk that the worker will *not* perform at the same level for that employer. He might not work as hard, he might take his services elsewhere, or he might retire. There is not mechanism whereby John Elway or any other athlete commands a premium other than his ability to turn down the offer.

Baumol and Blinder: "A moment's thought shows how this general notion of rent applies both to land and to John Elway. The total quantity of land available for use is the same whether rent is high, low, or zero; no payments to landlords are necessary to induce land to be supplied to the market. So., by definition, the payments to landholders for their land are entirely economic rent -- payments that are not necessary to induce the provision of the land to the economy. John Elway is (almost) similar to land in this respect. His athletic talents are somewhat unique and cannot be reproduced."

Dan Sullivan:
That is flat out nonsense. There is a continuing supply of future quarterbacks arising from the efforts of thousands of high-school athletes and hundreds of college athletes, all striving to be the best. The author acts like someone pulled Elway fully formed out of a turnip patch, when in fact Elway and many like him applied their talents with passion and dedication in hopes of becoming great quarterbacks. They all gambled on this, and Elway was one of the few big winners. This does not make his payment rent by any stretch of the imagination.

Baumol and Blinder: "What determines the income of such a factor? Since the quantity supplied of such a unique, nonreproducible factor is absolutely fixed."

Dan Sullivan:
There are many great quarterbacks, some of whom might have been better than Elway. This same nonsense was stated about Joe Montana until he retired and the back- up quarterbacks stepped in and continued the same game plan without a hitch.

Baumol and Blinder: "...and therefore unresponsive to price, the analysis of rent determination summarized in Figure 35-6 applies. The position of the demand curve determines the price."

Dan Sullivan:
The highest quality commands the highest price whether we are speaking of land, labor or capital. When the task at hand is winner-take-all competition, the value of top quality is particularly high. None of that has bearing on what the factor of production is or on what the return to that factor is properly called.

Baumol and Blinder: "Figure 35-8 summarizes the "John Elway market." Vertical supply curve SS=92 represents the fact that no matter what wage he is paid there is only one John Elway."

Dan Sullivan:
However, there was, during Elway's career, also one Jim Kelly, one Joe Montana, one Troy Aitman, one Dan Marino, etc. Only Denver fans and this author believe that nobody compared to Elway. And if Elway was better than some other quarterback, how much of the difference stems from Elway working harder, having better coaches instruct him along the way, etc.?

Baumol and Blinder: "Demand curve DD is a marginal productivity curve of sorts, but not quite the kind we encountered earlier in the chapter. Since the question, "What would be the value of a second unit of John Elway?" is nonsensical."

Dan Sullivan:
Again, an absurd statement. It is no more nonsensical than saying a second Dan Sullivan working in the steel mill. There was, in fact, no second Dan Sullivan, either, but there were other people who could do the job. So are there other people who can quarterback winning football teams. Denver might not have one of them at the moment, but that is beside the point.

Of course, Elway was the "winningest quarterback," but this is more due to Denver's high altitude, to which opposing teams were unaccustomed, than to one particular player. The overwhelming majority of his wins and of his famous comebacks were at home, and during his tenure as a starting quarterback, the Dallas Cowboys won more Superbowls than his team did.

This is not to negate his greatness, but only to negate the presumption that he is some freak of nature, so superior to mere mortals that the laws of economics do not apply to him.

Baumol and Blinder: "The demand curve is constructed by considering only the portion of his time demanded at various wage levels. The curve indicates that at an annual salary of $6 million, no employer can afford even a little bit of Elway. At a lower salary of, say, $3 million per year, however, there re enough profitable uses to absorb two-thirds of his time. At $2 million per year, Elway's full time is demanded; and at lower wage rates, the demand for his time exceeds the amount of it that is for sale."

Dan Sullivan:
Where does he get this garbage? "A little bit of Elway" has no value whatsoever. Nobody is interested in less than 100% dedicated performance and the passion to do whatever it takes to win. There are very few people who have that dedication and passion, which is why their wages are so high. It is no different than in a competitive fast-food joint, where energetic workers keep their jobs and get raises, while slow, lazy workers stay at minimum wage or get fired. Are the energetic workers collecting "rent"?

Baumol and Blinder: "Equilibrium is at point E in the diagram, where the supply of and demand for his time are equal. His annual salary here is $2 million. Now we can ask: How much of John Elway's salary is economic rent? According to the economic definition of rent, his entire $2 million salary is rent. Since, according to the vertical supply schedule, Elway's financial reward is unnecessary to get him to supply his services, every penny he earns is rent."

Dan Sullivan:
Here again is an absurdity. It is not like he grew up in Denver and wanted to play for the Broncos regardless, for he was raised in California and went to college in California. It is not even a foregone conclusion that he would play football, as the Yankees had drafted him in the first round to play baseball. And, certainly it is absurd to assume that he would play continuously for sixteen years without any pay at all.

Baumol and Blinder: "This is why we said that top athletes like John Elway are almost good examples of pure rent. For, in fact, if his salary were low enough, Elway might well prefer to stay home rather than work. Suppose, for example, that $50,000 per year is the lowest salary at which Elway will offer even one minute of his services, and that his labor supply then increases with his wage up to an annual salary of $300,000, at which point he is willing to work full time. Then, while his equilibrium salary will still be $2 million per year, not all of it will be rent, because some of it, at least $50,000, is required to get him to supply any services at all."

Dan Sullivan:
Spoken like a true neoclassical, as if human beings, like land and capital, were mere objects to be manipulated, not free agents who choose not only where to work, but what kind of work to do and how much of themselves to put into their work.

I wonder how much of this economist's salary is rent? After all, here I am, writing what is far more coherent, for no money at all. Why doesn't his employer just put him behind a typewriter with an infinite number of other monkeys and give him an occasional banana for pounding the keys?