Published on 10/28/2013.
All of us have heard of Cristiano Ronaldo, the start winger of Real Madrid. He’s famous among football fans (even among the people who call it soccer) for having the highest transfer fee in history in his name among one of the most paying salaries, an estimated 21 million Euro in 2013. This is equal to about 40 Euros a minute, meaning if he sleeps 8 hours in a day, he can save for a 20,000 Euro car! That’s a lot of money!
All of us have had one teacher that we’ll remember forever. Think back to your school or university days. You must have attended a classroom in the presence of a teacher/professor that “rocked” your world, a teacher/professor that changed the way you think about the world and genuinely made you smarter. Think about how much that professor or teacher gets paid? According to national U.S. data, the median salary for a university professor amounts to 203,000 dollars or 147,000 Euros annually, which translates to about 0.38 dollars or 0.28 Euros a minute.
The discrepancy between those two figures is shockingly appalling. I mean, think about all the positive impact a great teacher has. Teachers are trusted with the educational component of a person’s upbringing and character. Arguably, a great teacher has an impact on many of his/her students and thus assists them in achieving their life goals! That has to be more valuable than some guy scoring a crazy amount of goals! Yet one gets paid millions of Euros every year, while the other (if lucky) gets paid a few ten-thousands.
However, as it is always the case, there is an economic explanation for this phenomenon. But before we go into the reasoning behind a teacher’s and Ronaldo's salary, let’s take a step back and explain how wages (salaries) are determined (economically speaking of course!). It’s best to explain this by the use of an example.
Assume that you are an owner of a factory that produces 100 pens every day. Those 100 pens generate $500 in profit for you per day (sales less cost) after deducting all costs that you can think of. You want to expand your production of pens so you hire an additional worker, call him Joe (this is a recurring character that I’ll use in my examples; you might have last seen him as a sexist cab driver). You observe that after you hired Joe, you started producing 110 pens. Let’s say that those extra 10 pens produced $50 in sales (note that I’m not talking about profit).Assume that all other non-labor costs remain the same and the extra 10 pens are attributed only to Joe’s hiring (improved efficiency in the factory using the same materials is one explanation). The question is how much should you (the factory owner) pay Joe?
The answer is $50 or less. If you pay Joe $30 a day, then your net profit will be $520, still better off than the original $500 before you hired Joe. If you pay Joe $50, then you are in the same situation as before, earning $500 in profit. Note that this makes you indifferent, whether you hire Joe or not, you don’t care because it’ll be the same to you. If you pay Joe $60, then your net profit will be $490, which is less than the original $500 before you hired Joe. So paying a salary of $60 for Joe is not optimal since you’re making less profit than before.
The underlying argument is that a worker should get paid an equal amount to the value of their marginal product. I know this is technical but it is very simple. To determine a worker’s wages, you need to determine what extra value that is attributed to the worker. If you bring Joe in, and your revenue increased by $100 only because of Joe's effort, then you can pay him up to a $100 (economists will identify this as the holy grail of economics: marginal cost equals marginal revenue). This logic makes the hiring decision economically optimal (and rational for that matter).
Now that we have covered the basic determination of wages in economic theory, let’s go back to our original story between Cristiano Ronaldo and Miss Thomson (your most influential teacher). Each of them should be paid equally to the additional revenue that they bring to their respective organizations. Let’s start with Ronaldo. Ronaldo is a player with an exceptional ability and a unique skill set that distinguishes him from anybody in the entire world. When people say he’s “one of a kind”, this indicates that his skills are rare, and that alone should warrant a higher pay (this is the famous diamond-water paradox in economics, see the Wikipedia article for a great explanation). However, the more goals Ronaldo scores the more wins the team will achieve. More wins mean more trophies and a larger fan base and thus higher revenue in terms of ticket and merchandise sales. All of those reasons together justify his higher pay. It ultimately boils down to the “view-ability” argument. People want to see Ronaldo play, and they’re willing to pay for it.
What about Miss Thomson, the greatest and most influential teacher or professor that you've ever had? She indeed might be a unique and one-of-a-kind teacher, but honestly, are you willing to watch her do her work in every class? You probably would rather just hear about her work, and not pay. Also, economists agree that higher quality teachers do improve academic performance and future success for students, but it’s often hard to quantify the specific effect of one teacher (compared to football games where you can easily track merchandise sales for a specific player).
Great professors do have a great impact on life; however sadly, most of them are extremely underpaid. Great teachers and professors must be compensated sufficiently for the effect that they have. However, in turn, quantifiable performance indicators must be set in order to track performance and correlate pay with it. Strict entry requirements must be set to ensure that teachers are of high caliber (see the entry requirements for Singapore’s Ministry of Education for a good example). I will return to the topic of Education in a later post.